TIDMPRU
RNS Number : 9411Q
Prudential PLC
03 March 2021
Risk Factors
A number of risk factors may affect Prudential's business,
financial condition, results of operations and/or prospects and,
accordingly, the trading price of its shares. The risk factors
mentioned below should not be regarded as a complete and
comprehensive statement of all potential risks and uncertainties.
The information given is as of the date of this document, and any
forward-looking statements are made subject to the reservations
specified under 'Forward-looking statements'.
Prudential's approaches to managing risks are explained in the
section of this document headed 'Group Chief Risk and Compliance
Officer's report on the risks facing our business and how these are
managed'.
1. RISKS RELATING TO PRUDENTIAL'S FINANCIAL SITUATION
1.1 The Covid-19 pandemic has had a significant impact on
financial market volatility and global economic activity, increased
operational disruption risks to the Group and has adversely
impacted Prudential's sales in affected markets and its financial
condition, results of operations and prospects. The full extent of
the longer-term impacts from the pandemic remains uncertain
The Covid-19 pandemic has significantly increased the volatility
of equity markets, interest rates and credit spreads, reduced
market liquidity and reduced global economic activity. The
potential adverse impacts to the Group of these effects are
detailed in the Financial Market and Economic Conditions risk
factor detailed below. However, the full extent of the impact of
the pandemic on financial markets and economic growth remains
highly uncertain and unpredictable and will be influenced by the
actions of governments, policymakers and the public. This includes
the duration and effectiveness of mitigating measures against the
current and future strains of the coronavirus, including a
continued reliance on restrictions of movement and the deployment
of vaccination programmes (which may occur over a prolonged period
of time), the effectiveness and timing of which remains uncertain
across markets. Where these impacts are prolonged, this may affect
the solvency position of Prudential's subsidiaries and prevent or
limit their ability to make remittances, adversely impacting the
financial condition and prospects of the Group.
The immediate regulatory and supervisory responses to the
Covid-19 pandemic have been broad and have included increased
scrutiny of the operational resilience, liquidity and capital
strength (including the impact of making dividend payments) of
financial services companies. Various governments have effected, or
may effect, the postponement of elections and other constitutional
or legislative processes in response to the pandemic, and this may
result in an increase in constitutional and political uncertainty
in the markets in which the Group operates. Governments are either
starting or planning the roll-out of Covid-19 vaccination
programmes, and accessibility to vaccine supplies has the potential
to contribute to an increase in geopolitical tensions. The longer
term political, regulatory and supervisory developments resulting
from the Covid-19 pandemic remain highly uncertain. These may
include changes to government fiscal policies, laws or regulations
aimed at increasing financial stability and/or measures on
businesses or specific industries to contribute to, lessen or
otherwise support, the financial cost to governments in addressing
the pandemic. This may include requirements on private insurance
companies and healthcare providers to cover the costs associated
with the treatment of Covid-19 beyond contractual or policy
terms.
The Covid-19 pandemic, and measures to contain it, have slowed
economic and social activity in the Group's geographical markets.
While these conditions persist, the level of sales activity in
affected markets has been, and will continue to be, adversely
impacted through a reduction in travel and agency and bancassurance
activity, which may be prolonged in markets which continue to rely
on containment measures based on restrictions of movement rather
than vaccine deployment. The impact to economic activity and
employment levels may result in an elevated incidence of claims,
lapses, or surrenders of policies, and some policyholders may
choose to defer or stop paying insurance premiums or reduce
deposits into retirement plans. The pandemic may also indirectly
result in elevated claims and policy lapses or surrenders, and with
some delay in time before being felt by the Group, due to factors
such as policyholders deferring medical treatment during the
pandemic, or policyholders lapsing or surrendering their policies
on the expiry of grace periods for premium payments provided by the
Group's businesses. Extended restrictions on movement in particular
may adversely impact product persistency in the Group's Asia
business. While these impacts to the Group have not been material
to date, the full extent of the impact of the Covid-19 pandemic is
currently highly uncertain and the Group's claims experience to
date and its current insurance assumptions cannot be taken as an
indicator of future potential experience from the Covid-19 pandemic
which may deteriorate significantly and have a material adverse
effect on Prudential's business, financial condition, results of
operations and prospects.
Disruption to Prudential's operations may result where its
employees, or those of its service partners and counterparties,
contract the coronavirus or are affected by restrictions on
movement; where office closures and other measures impacting
working practices are effected, such as the imposition of remote
working arrangements; and where quarantine requirements and
isolation measures under local laws apply, and as a result of
social distancing and/or other psychosocial impacts. While such
measures are in place, there may be an increase in attempts to
compromise IT systems through phishing and social engineering
tactics.
In some markets Prudential has implemented changes to its sales
and distribution processes. These include virtual face-to-face
sales of its products and the online recruitment, training and,
where possible, licensing of agents. Such changes may increase or
introduce new operational and regulatory risks, in particular those
focused on customer outcomes and conduct. A failure to implement
appropriate governance and management of these new or incremental
risks may adversely impact Prudential's reputation and brand and
the results of its operations. In markets where the level of sales
under these new processes is material or where such processes
become permanent distribution channels, the commercial value of the
Group's existing sale and distribution arrangements, such as
bancassurance arrangements, may be adversely impacted.
1.2 Prudential's businesses are inherently subject to market
fluctuations and general economic conditions, each of which may
adversely affect the Group's business, financial condition, results
of operations and prospects
Uncertainty, fluctuations or negative trends in international
economic and investment climates could have a material adverse
effect on Prudential's business and profitability. Prudential
operates in a macroeconomic and global financial market environment
that presents significant uncertainties and potential challenges.
For example, during 2020 interest rates in the United States ('US')
and some Asian countries in which Prudential operates have
decreased to historic lows driven by the responses of central banks
to mitigate the impact of the Covid-19 pandemic. The transition to
a lower carbon economy may also impact long-term asset
valuations.
Global financial markets are subject to uncertainty and
volatility created by a variety of factors. These factors include
slowdowns or reversals in world economic growth (particularly where
this is abrupt, as has been the case with the impact of the
Covid-19 pandemic), fluctuations in global energy prices, changes
in monetary policy in China, the US and other jurisdictions
together with their impact on the valuation of all asset classes
and effect on interest rates and inflation expectations, and
concerns over sovereign debt. Other factors include the increased
level of (geo)political risk and policy-related uncertainty
(including the broader market impacts resulting from the trade
negotiations between the US and China) and socio-political,
climate-driven and pandemic events. The extent of financial market
and economic impact of these factors may be highly uncertain and
unpredictable and influenced by the actions, including the duration
and effectiveness of mitigating measures of governments,
policymakers and the public.
The adverse effects of such factors could be felt principally
through the following items:
- Lower interest rates and reduced investment returns arising on
the Group's portfolios including impairment of debt securities and
loans, which could reduce Prudential's capital and impair its
ability to write significant volumes of new business, increase the
potential adverse impact of product guarantees included in
Jackson's variable annuities and non-unit-linked products with a
savings component in Asia, increase reinvestment risk for some of
the Group's investments from accelerated prepayments and increased
redemptions and/or have a negative impact on its assets under
management and profit.
- A reduction in the financial strength and flexibility of
corporate entities which may result in a deterioration of the
credit rating profile and valuation of the Group's invested credit
portfolio (which may result in an increase in regulatory capital
requirements for the Group or its businesses), as well as higher
credit defaults and wider credit and liquidity spreads resulting in
realised and unrealised credit losses. Similarly, mortgages and
mortgage-backed securities in the Group's investment portfolio are
subject to default risk and may be adversely impacted by delays or
failures of borrowers to make payments of principal and interest
when due.
- Failure of counterparties who have transactions with Prudential (such as banks, reinsurers and counterparties to derivative transactions) to meet commitments that could give rise to a negative impact on Prudential's financial position and on the accessibility or recoverability of amounts due or, for derivative transactions, adequate collateral not being in place. Concentrations of counterparty credit risk could exacerbate the impact of these events where they materialise.
- Estimates of the value of financial instruments becoming more
difficult because in certain illiquid or closed markets,
determining the value at which financial instruments can be
realised is highly subjective. Processes to ascertain such values
require substantial elements of judgement, assumptions and
estimates (which may change over time). Where the Group is required
to sell its investments within a defined timeframe, such market
conditions may result in the sale of these investments at below
expected or recorded prices.
- The Group holds certain investments that may lack liquidity,
such as privately placed fixed maturity securities, mortgage loans,
complex structured securities and alternative investments. If these
investments were required to be liquidated on short notice, the
Group may experience difficulty in doing so and may be forced to
sell them at a lower price than it otherwise would have been able
to realise.
- A reduction in revenue from the Group's products where fee
income is linked to account values or the market value of the funds
under management. In particular, equity price falls impact the
amount of revenue derived from fees from the unit-linked products
in the Group's Asia business and from annuity contracts at Jackson,
where fees are charged on account and asset values.
- Increased illiquidity, which includes the risk that expected
cash inflows from investments and operations will not be adequate
to meet the Group's anticipated short-term and long-term
policyholder benefits and expense payment obligations. Increased
illiquidity also adds to uncertainty over the accessibility of
financial resources which in extreme conditions can impact the
functioning of markets and may reduce capital resources as
valuations decline. This could occur where external capital is
unavailable at sustainable cost, increased liquid assets are
required to be held as collateral under derivative transactions or
redemption restrictions are placed on Prudential's investments in
illiquid funds. In addition, significant redemption requests could
also be made on Prudential's issued funds and while this may not
have a direct impact on the Group's liquidity, it could result in
reputational damage to Prudential. The potential impact of
increased illiquidity is more uncertain than for other risks such
as interest rate or credit risk.
In general, upheavals in the financial markets may affect
general levels of economic activity, employment and customer
behaviour. As a result, insurers may experience an elevated
incidence of claims, lapses, or surrenders of policies, and some
policyholders may choose to defer or stop paying insurance premiums
or reduce deposits into retirement plans. The demand for insurance
products may also be adversely affected. In addition, there may be
a higher incidence of counterparty failures. If sustained, this
environment is likely to have a negative impact on the insurance
sector over time and may consequently have a negative impact on
Prudential's business and its balance sheet and profitability. For
example, this could occur if the recoverable value of intangible
assets for bancassurance agreements and deferred acquisition costs
are reduced. New challenges related to market fluctuations and
general economic conditions may continue to emerge.
For some non-unit-linked products with a savings component, in
particular those written in some of the Group's Asia operations, it
may not be possible to hold assets which will provide cash flows to
match those relating to policyholder liabilities. This is
particularly true in those countries where bond markets are less
developed and in certain markets where regulated premium and claim
values are set with reference to the interest rate environment
prevailing at the time of policy issue. This results in a mismatch
due to the duration and uncertainty of the liability cash flows and
the lack of sufficient assets of a suitable duration. While this
residual asset/liability mismatch risk can be managed, it cannot be
eliminated. Where interest rates in these markets remain lower than
those used to calculate premium and claim values over a sustained
period, this could have a material adverse effect on Prudential's
reported profit and the solvency of its business units. In
addition, part of the profit from the Group's Asia operations is
related to bonuses for policyholders declared on with-profits
products, which are impacted by the difference between actual
investment returns of the with-profits fund (which are broadly
based on historical and current rates of return on equity, real
estate and fixed income securities) and minimum guarantee rates
offered to policyholders. This profit could be lower in particular
in a sustained low interest rate environment.
Jackson writes a significant amount of variable annuities that
offer capital or income protection guarantees. The value of these
guarantees is affected by market factors (such as interest rates,
equity values, bond spreads and realised volatility) and
policyholder behaviour. Changes in markets, or deviations in
policyholder behaviour experience from assumptions, may result in
the need to hold additional reserves for these products, which may
impact Jackson's liquidity, require it to raise additional capital
and/or adversely impact its net income. Jackson uses a derivative
hedging programme to reduce its exposure to market risks arising on
these guarantees. There may be circumstances where the derivatives
that Jackson enters into to hedge its market risks may not
sufficiently or effectively offset its exposures under the
guarantees, or where its exposures may be over-hedged. This
includes circumstances where:
- The derivative markets for the instruments which most
appropriately reflect the equity funds in which policyholders have
invested may not be of sufficient size or liquidity to effectively
hedge these risks;
- Operational errors occur in the execution of Jackson's hedging strategy; or
- Actual experience materially deviates from the assumptions
used in the models which inform Jackson's hedging strategy. These
assumptions include, amongst others, mortality, lapse, surrender
and withdrawal rates and amounts of withdrawals, election rates,
fund performance, equity market returns and volatility, interest
rate levels and correlation among various market movements.
If the results from Jackson's hedging programs do not correlate
with the economic effect of changes in benefit exposures to
customers, it could experience economic losses and increased
volatility in its earnings which could adversely impact the Group's
business, financial condition and results of operations. The cost
of any guarantees that remain unhedged will also affect Jackson's
results.
Periods of significant and sustained downturns in securities
markets, increased equity volatility, reduced interest rates, or
deviations in expected policyholder behaviour could also increase
the cost of hedging beyond that anticipated in the pricing of the
products being hedged and could produce losses not addressed by the
risk management techniques employed.
In addition, Jackson hedges the guarantees on its variable
annuity book on an economic basis (with consideration of the local
regulatory position) and, thus, accepts variability in its
accounting results in the short term in order to achieve the
appropriate result on these bases. In particular, for Prudential's
Group International Financial Reporting Standards ('IFRS')
reporting, the measurement of the Jackson variable annuity
guarantees is typically less sensitive to market movements than for
the corresponding hedging derivatives, which are held at market
value. However, depending on the level of hedging conducted
regarding a particular risk type, certain market movements can
drive volatility in the economic or local regulatory results that
may be less significant under IFRS reporting.
Also, Jackson has a mix of spread-based and mortality business
with assets invested in fixed-income securities and its results are
therefore affected by fluctuations in prevailing interest rates. In
particular, stable value products written by Jackson expose
Prudential to the risk that changes in interest rates, which are
not fully reflected in the interest rates credited to customers,
will reduce spread. The spread is the difference between the rate
of return Jackson is able to earn on the assets backing the
policyholders' liabilities and the amounts that are credited to
policyholders in the form of benefit increases, subject to minimum
crediting rates. Declines in spread from these products or other
spread businesses that Jackson conducts, and increases in surrender
levels arising from interest rate rises, could have a material
impact on its businesses or results of operations.
Any of the foregoing factors and events, individually or
together, could have a material adverse effect on Prudential's
business, financial condition, results of operations and
prospects.
1.3 As a holding company, Prudential is dependent upon its
subsidiaries to cover operating expenses and dividend payments
The Group's insurance and investment management operations are
generally conducted through direct and indirect subsidiaries, which
are subject to the risks discussed elsewhere in this 'Risk Factors'
section.
As a holding company, Prudential's principal sources of funds
are remittances from subsidiaries, shareholder-backed funds, the
shareholder transfer from long-term funds and any amounts that may
be raised through the issuance of equity, debt and commercial
paper.
Certain of Prudential's subsidiaries are subject to applicable
insurance, foreign exchange and tax laws, rules and regulations
(including in relation to distributable profits) that can limit
their ability to make remittances. In some circumstances, including
where there are changes to general market conditions, this could
limit Prudential's ability to pay dividends to shareholders or to
make available funds held in certain subsidiaries to cover
operating expenses of other members of the Group.
A material change in the financial condition of any of
Prudential's subsidiaries may have a material effect on its
business, financial condition, results of operations and
prospects.
1.4 (Geo)political risks and uncertainty may adversely impact
economic conditions, increase market volatility, cause operational
disruption to the Group and impact its strategic plans, which could
have adverse effects on Prudential's business, financial condition,
results of operations and prospects
The Group is exposed to (geo)political risks and uncertainty in
the markets in which it operates. Recent shifts in the focus of
some national governments toward more protectionist or restrictive
economic and trade policies with specific markets, and
international trade disputes, could impact on the macroeconomic
outlook and the environment for global financial markets. This
could take effect, for example, through increased friction in
cross-border trade, such as implementation of trade tariffs or the
withdrawal from existing trading blocs or agreements and the
exercise of executive powers to restrict overseas trade, financial
transactions, capital movements and/or investment. The degree and
nature of regulatory changes and Prudential's competitive position
in some geographic markets may also be impacted, for example,
through measures favouring local enterprises, such as changes to
the maximum level of non-domestic ownership by foreign companies or
differing treatment under regulations and tax rules.
(Geo)political risks and political uncertainty may also
adversely impact the Group's operations and its operational
resilience. Increased (geo)political tensions may increase
cross-border cyber activity and therefore increase cyber security
risks. (Geo)political tensions may also lead to civil unrest and/or
acts of civil disobedience. This includes the unrest in Hong Kong,
where mass anti-government demonstrations have given rise to
increased disruption throughout the region. Such events could
impact operational resilience by disrupting Prudential's systems,
operations, new business sales and renewals, distribution channels
and services to customers, which may result in a reduction in
contributions from business units to the central cash balances and
profit of the Group, decreased profitability, financial loss,
adverse customer impacts and reputational damage and may impact
Prudential's business, financial condition, results of operations
and prospects.
Responses by the US, UK and other governments to the enactment
and application of the national security law in Hong Kong and other
constitutional or legislative changes in the territory, which
continue to develop, may adversely impact Hong Kong's economy with
potential adverse sales, operational and product distribution
impacts to the Group due to the territory being a key market which
also hosts regional and head office functions. For internationally
active groups such as Prudential, operating across multiple
jurisdictions, government measures and responses may also add to
the complexity of legal and regulatory compliance and increase the
risk of conflicts between the requirements of one jurisdiction and
another. See risk factor 3.1 below.
1.5 Prudential is subject to the risk of potential sovereign
debt credit deterioration owing to the amounts of sovereign debt
obligations held in its investment portfolio
Investing in sovereign debt creates exposure to the direct or
indirect consequences of political, social or economic changes
(including changes in governments, heads of state or monarchs) in
the countries in which the issuers of such debt are located and to
the creditworthiness of the sovereign. Investment in sovereign debt
obligations involves risks not present in debt obligations of
corporate issuers. In addition, the issuer of the debt or the
governmental authorities that control the repayment of the debt may
be unable or unwilling to repay principal or pay interest when due
in accordance with the terms of such debt, and Prudential may have
limited recourse to compel payment in the event of a default. A
sovereign debtor's willingness or ability to repay principal and to
pay interest in a timely manner may be affected by, among other
factors, its cash flow situation, its relations with its central
bank, the extent of its foreign currency reserves, the availability
of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole,
the sovereign debtor's policy toward local and international
lenders, and the political constraints to which the sovereign
debtor may be subject.
Moreover, governments may use a variety of techniques, such as
intervention by their central banks or imposition of regulatory
controls or taxes, to devalue their currencies' exchange rates, or
may adopt monetary and other policies (including to manage their
debt burdens) that have a similar effect, all of which could
adversely impact the value of an investment in sovereign debt even
in the absence of a technical default. Periods of economic
uncertainty may affect the volatility of market prices of sovereign
debt to a greater extent than the volatility inherent in debt
obligations of other types of issuers.
In addition, if a sovereign default or other such events
described above were to occur as has happened on occasion in the
past, other financial institutions may also suffer losses or
experience solvency or other concerns, which may result in
Prudential facing additional risks relating to investments in such
financial institutions that are held in the Group's investment
portfolio. There is also risk that public perceptions about the
stability and creditworthiness of financial institutions and the
financial sector generally might be adversely affected, as might
counterparty relationships between financial institutions.
If a sovereign were to default on its obligations, or adopt
policies that devalued or otherwise altered the currencies in which
its obligations were denominated, this could have a material
adverse effect on Prudential's business, financial condition,
results of operations and prospects.
1.6 Downgrades in Prudential's financial strength and credit
ratings could significantly impact its competitive position and
damage its relationships with creditors or trading
counterparties
Prudential's financial strength and credit ratings, which are
used by the market to measure its ability to meet policyholder
obligations, are an important factor affecting public confidence in
Prudential's products, and as a result its competitiveness.
Downgrades in Prudential's ratings as a result of, for example,
decreased profitability, increased costs, increased indebtedness or
other concerns could have an adverse effect on its ability to
market products, retain current policyholders, and the Group's
ability to compete for acquisition and strategic opportunities.
Downgrades may also impact the Group's financial flexibility,
including its ability to issue commercial paper at current levels
and pricing. The interest rates at which Prudential is able to
borrow funds are affected by its credit ratings, which are in place
to measure the Group's ability to meet its contractual
obligations.
In addition, changes in methodologies and criteria used by
rating agencies could result in downgrades that do not reflect
changes in the general economic conditions or Prudential's
financial condition.
Any such downgrades could have a material adverse effect on
Prudential's business, financial condition, results of operations
and prospects. Prudential cannot predict what actions rating
agencies may take, or what actions Prudential may therefore take in
response to the actions of rating agencies, which could adversely
affect its business.
1.7 Prudential is subject to the risk of exchange rate
fluctuations owing to the geographical diversity of its
businesses
Due to the geographical diversity of Prudential's businesses,
Prudential is subject to the risk of exchange rate fluctuations.
Prudential's operations generally write policies and invest in
assets denominated in local currencies. Although this practice
limits the effect of exchange rate fluctuations on local operating
results, it can lead to fluctuations in Prudential's consolidated
financial statements upon the translation of results into the
Group's presentation currency. This exposure is not currently
separately managed. The Group presents its consolidated financial
statements in US dollars, which is the currency in which a large
proportion of the Group's earnings and assets and liabilities are
denominated or to which they are linked (such as the Hong Kong
dollar). There remain some entities within the Group the results of
which are not denominated in or linked to the US dollar and
transactions which are conducted in non-US dollar currencies.
Prudential is subject to the risk of exchange rate fluctuations
from the translation of the results of these entities and
transactions and the risks from the maintenance of the Hong Kong
dollar peg to the US dollar.
2. RISKS RELATING TO PRUDENTIAL'S BUSINESS ACTIVITIES AND INDUSTRY
2.1 The proposed demerger of Jackson carries with it execution
risk and will require significant management attention
The proposed demerger of Jackson is subject to a number of
factors and dependencies, such as prevailing market and political
conditions and external approvals (including those from regulators
and shareholders). In addition, preparing for and implementing the
proposed demerger of Jackson is expected to require significant
time from management, and management time will continue to be
required in respect of any future sale of Prudential's remaining
stake in Jackson. Management's attention may be diverted from other
aspects of Prudential's business as a result.
Therefore, there can be no certainty that the demerger of
Jackson will be implemented on the anticipated timetable, or that
it will be completed as proposed (or at all). Further, if the
proposed demerger of Jackson is completed, there can be no
assurance that either Prudential or Jackson will realise the
anticipated benefits of the transaction, or that the proposed
demerger of Jackson and/or the future sale of Prudential's
remaining stake in Jackson will not adversely affect the trading
value or liquidity of the shares of either or both of the two
businesses.
If the demerger of Jackson does complete, Prudential will
continue to hold shares in Jackson. The market price of Jackson
shares may be volatile and can go down as well as up. It is
therefore possible that the value of Prudential's shareholding may
be lower than anticipated, and the gross proceeds due to Prudential
from any future sale may be lower than Prudential might otherwise
achieve.
Failure to complete the demerger of Jackson would result in the
potential benefits of the separation not being realised and may
have an adverse effect on the reputation of Prudential and on the
external perception of its ability to implement large-scale
projects successfully. This may be the case even where the failure
to implement the demerger of Jackson is due to factors outside the
control of Prudential. A failure to complete the demerger of
Jackson may also result in increased regulatory scrutiny on
Prudential, in particular where the reasons for the demerger of
Jackson not proceeding are internal to Prudential.
2.2 The implementation of large-scale transformation, including
complex strategic initiatives, gives rise to significant design and
execution risks, may affect Prudential's operational capability and
capacity, and may adversely impact the Group and the delivery of
its strategy if these initiatives fail to meet their objectives
In order to implement its business strategies for growth,
improve customer experiences, strengthen operational resilience,
meet regulatory and industry requirements and maintain market
competitiveness, Prudential undertakes Group restructuring,
large-scale transformation and acquisitions and disposals across
its business. Many of these change initiatives are complex,
interconnected and/or of large scale, including a current focus on
preparations for the proposed demerger of Jackson, advancing the
Group's digital capability, expanding strategic partnerships and
industry and regulatory-driven change. There may be a material
adverse effect to Prudential's business, customers, financial
condition, results of operations and prospects if these initiatives
incur unplanned costs, are subject to implementation delays, or
fail to fully meet their objectives. Additionally, there may be
adverse non-financial (including operational, regulatory, conduct
and reputational) implications for the Group. These initiatives
inherently give rise to design and execution risks, and may
increase existing business risks, such as placing additional strain
on the operational capacity, or weakening the control environment,
of the Group.
Implementing further initiatives related to significant
regulatory changes, such as IFRS 17 and the transition to a
legislative framework in Hong Kong for the group-wide supervision
of insurance groups, may amplify these risks. Risks relating to
these regulatory changes are explained in the 'Legal and Regulatory
Risk' risk factor below.
The speed of technological change in the business could outpace
the Group's ability to anticipate all the unintended consequences
that may arise from such change. Innovative technologies, such as
artificial intelligence, expose Prudential to potential information
security, operational, ethical and conduct risks which, if
improperly managed, could result in customer detriment and
reputational damage.
2.3 Prudential's businesses are conducted in highly competitive
environments with developing demographic trends and continued
profitability depends upon management's ability to respond to these
pressures and trends
The markets for financial services in the US and Asia are highly
competitive, with several factors affecting Prudential's ability to
sell its products and continued profitability, including price and
yields offered, financial strength and ratings, range of product
lines and product quality, brand strength and name recognition,
investment management performance and fund management trends,
historical bonus levels, the ability to respond to developing
demographic trends, customer appetite for certain savings products
and technological advances. In some of its markets, Prudential
faces competitors that are larger, have greater financial resources
or a greater market share, offer a broader range of products or
have higher bonus rates. Further, heightened competition for
talented and skilled employees, agents and independent financial
advisers may limit Prudential's potential to grow its business as
quickly as planned. Technological advances, including the increased
capability for gathering large volumes of customer health data and
developments in capabilities and tools in analysing and
interpreting such data (such as artificial intelligence and machine
learning), may result in increased competition to the Group, both
from within and outside the insurance industry, and may increase
the competition risks resulting from a failure to be able to
attract sufficient numbers of skilled staff.
In Asia, the Group's principal competitors include global life
insurers together with regional insurers and multinational asset
managers. In most Asia markets, there are also local companies that
have a material market presence.
Jackson's competitors in the US include major stock and mutual
insurance companies, mutual fund organisations, banks and other
financial services companies.
Prudential believes that competition will intensify across all
regions in response to consumer demand, digital and other
technological advances (including the emergence of new distribution
channels), the need for economies of scale and the consequential
impact of consolidation, regulatory actions and other factors.
Prudential's ability to generate an appropriate return depends
significantly upon its capacity to anticipate and respond
appropriately to these competitive pressures. This includes
managing the potential adverse impacts to the commercial value of
the Group's existing sale and distribution arrangements, such as
bancassurance arrangements, in markets where new distribution
channels develop.
Failure to do so may negatively impact Prudential's ability to
attract and retain customers and, importantly, may limit
Prudential's ability to take advantage of new business arising in
the markets in which it operates, which may have an adverse
interest on the Group's business, financial condition, results of
operations and prospects.
2.4 Adverse experience in the operational risks inherent in
Prudential's business, and those of its material outsourcing
partners, could disrupt its business functions and have a negative
impact on its business, financial condition, results of operations
and prospects
Operational risks are present in all of Prudential's businesses,
including the risk of direct or indirect loss resulting from
inadequate or failed internal and external processes, systems or
human error, fraud, the effects of natural or man-made catastrophic
events (such as natural disasters, pandemics, cyber-attacks, acts
of terrorism, civil unrest and other catastrophes) or from other
external events. These risks may also adversely impact Prudential
through its partners which provide bancassurance and product
distribution, outsourcing, external technology, data hosting and
other services.
Exposure to such events could impact Prudential's operational
resilience and ability to perform necessary business functions by
disrupting its systems, operations, new business sales and
renewals, distribution channels and services to customers, or
result in the loss of confidential or proprietary data. Such
events, as well as any weaknesses in administration systems (such
as those relating to policyholder records) or actuarial reserving
processes, may also result in increased expenses, as well as legal
and regulatory sanctions, decreased profitability, financial loss,
customer conduct risk impacts and may damage Prudential's
reputation and relationship with its customers and business
partners.
Prudential's business is dependent on processing a large number
of transactions for numerous and diverse products. It also employs
a large number of complex and interconnected IT and finance systems
and models, and user developed applications in its processes to
perform a range of operational functions including the calculation
of regulatory or internal capital requirements, the valuation of
assets and liabilities, determining hedging requirements, and in
acquiring new business using artificial intelligence and digital
applications. Some of these tools form an integral part of the
information and decision-making framework of Prudential and the
risk of adverse consequences arising from erroneous or
misinterpreted tools used in core business activities, decision
making and reporting exists. Errors or limitations in these tools,
or inappropriate usage, may lead to regulatory breaches,
inappropriate decision-making, financial loss, or reputational
damage. The long-term nature of much of the Group's business also
means that accurate records have to be maintained securely for
significant time periods. Further, Prudential operates in an
extensive and evolving legal and regulatory environment (including
in relation to tax) which adds to the complexity of the governance
and operation of its business processes and controls.
The performance of the Group's core business activities and the
uninterrupted availability of services to customers rely
significantly on, and require significant investment in, IT
infrastructure and security, system development, data governance
and management, compliance and other operational systems,
personnel, controls and processes. During times of significant
change, the resilience and operational effectiveness of these
systems and processes at Prudential and/or its third party
providers may be adversely impacted. In particular, Prudential and
its business partners are making increasing use of emerging
technological tools and digital services, or forming strategic
partnerships with third parties to provide these capabilities.
Automated distribution channels to customers increase the
criticality of providing uninterrupted services. A failure to
implement appropriate governance and management of the incremental
operational risks from emerging technologies may adversely impact
Prudential's reputation and brand, the results of its operations,
its ability to attract and retain customers and its ability to
deliver on its long-term strategy and therefore its competitiveness
and long-term financial success.
Although Prudential's IT, compliance and other operational
systems, models and processes incorporate governance and controls
designed to manage and mitigate the operational and model risks
associated with its activities, there can be no assurance as to the
resilience of these systems and processes to disruption or that
governance and controls will always be effective. Due to human
error, among other reasons, operational and model risk incidents do
occur from time to time and no system or process can entirely
prevent them, although Prudential has not, to date, identified any
such incidents that have had a material impact. Prudential's legacy
and other IT systems, data and processes, as with operational
systems and processes generally, may also be susceptible to failure
or security/data breaches.
In addition, Prudential relies on the performance and operations
of a number of bancassurance, outsourcing (including external
technology and data hosting) and service partners. These include
back office support functions, such as those relating to IT
infrastructure, development and support and customer facing
operations and services, such as product distribution and services
(including through digital channels) and investment operations.
This creates reliance upon the resilient operational performance of
these partners, and failure to adequately oversee the partner, or
the failure of a partner (or of its IT and operational systems and
processes) could result in significant disruption to business
operations and customers, may have reputational or conduct risk
implications and which could have a material adverse effect on its
business, financial condition, results of operations and
prospects.
2.5 Attempts to access or disrupt Prudential's IT systems, and
loss or misuse of personal data, could result in loss of trust from
Prudential's customers and employees, reputational damage and have
material adverse effects on the Group's business, financial
condition, results of operations and prospects
Prudential and its business partners are increasingly exposed to
the risk that individuals (which includes connected persons such as
employees, contractors or representatives of Prudential or its
third-party service providers, and unconnected persons) or groups
may intentionally or unintentionally disrupt the availability,
confidentiality and integrity of its IT systems or compromise the
integrity and security of data (both corporate and customer), which
could result in disruption to key operations, make it difficult to
recover critical services or damage assets, any of which could
result in loss of trust from Prudential's customers and employees,
reputational damage and direct or indirect financial loss. The
cyber-security threat continues to evolve globally in
sophistication and potential significance. Prudential's increasing
profile in its current markets and those in which it is entering,
growing customer interest in interacting with their insurance
providers and asset managers through the internet and social media,
improved brand awareness and the 2016 designation of Prudential as
a G-SII could also increase the likelihood of Prudential being
considered a target by cyber criminals. Further, there have been
changes to the threat landscape in recent years and the risk from
untargeted but sophisticated and automated attacks has
increased.
There is an increasing requirement and expectation on Prudential
and its business partners to not only hold customer, shareholder
and employee data securely, but also to ensure its ongoing accuracy
and that it is being used in a transparent, appropriate and ethical
way, including in decision-making where automated processes are
employed. A failure to do so may result in regulatory scrutiny and
sanctions and may adversely impact the reputation and brand of the
Group, its ability to attract and retain customers, its ability to
deliver on its long-term strategy and therefore the results of its
operations. New and currently unforeseeable regulatory issues may
also arise from the increased use of emerging technology.
The risk to the Group of not meeting these requirements and
expectations may be increased by the development and usage of
digital distribution and service channels, which can collect a
broader range of personal and health-related data from individuals
at increased scale, and the use of complex tools, machine learning
and artificial intelligence technologies to process, analyse and
interpret this data. Regulatory developments in data protection
worldwide (such as the implementation of EU General Data Protection
Regulation that came into force in 2018 and the California Consumer
Protection Act that came into force on 1 January 2020) may also
increase the financial and reputational implications for Prudential
following a significant breach of its (or its third-party
suppliers') IT systems or data. The international transfer of data
may, as a global organisation, increase regulatory risks for the
Group. Although Prudential has experienced or has been affected by
cyber and data breaches, to date, it has not identified a failure
or breach, or an incident of data misuse in relation to its legacy
and other IT systems and processes which has had a material impact.
However, Prudential has been, and likely will continue to be,
subject to potential damage from computer viruses, unauthorised
access and cyber-security attacks such as 'denial of service'
attacks (which, for example, can cause temporary disruption to
websites and IT networks), phishing and disruptive software
campaigns.
Prudential is continually enhancing its IT environment to remain
secure against emerging threats, together with increasing its
ability to detect system compromise and recover should such an
incident occur. However, there can be no assurance that such events
will not take place which may have material adverse consequential
effects on Prudential's business, financial condition, results of
operations and prospects.
2.6 Prudential's digital health application, Pulse, has seen
increasing adoption in Asia and as the markets in which it
operates, its user base, features, partnerships and product
offerings develop, existing business risks to the Group may be
increased and new risks may be introduced
Prudential's digital health application, Pulse, is subject to
the risks discussed within this 'Risk Factors' section. In
particular, these include risks related to legal and regulatory
compliance and the conduct of business; the execution of complex
change initiatives; information security, cyber and data privacy;
the use of models (including those using artificial intelligence)
and personal data; the resilience and integrity of IT
infrastructure and operations; and those related to the management
of third parties. These existing risks for the Group may be
increased due to a number of factors:
- The number of current and planned markets in which the
application operates, each with their own laws and regulations,
regulatory and supervisory authorities, may increase regulatory
compliance risks.
- The implementation of planned application features and
offerings may require the delivery of complex, inter-connected
change initiatives across current and planned markets. This may
give rise to design and execution risks, which could be amplified
where these change initiatives are delivered concurrently.
- The increased volume, breadth and sensitivity of data on which
the business model of the application is dependent and to which the
Group has access, holds, analyses and processes through its models,
which increases data security, privacy and usage risks. The use of
complex models, including where they use artificial intelligence
for critical decision-making, in the application's features and
offerings may give rise to operational, conduct, litigation and
reputational risks where they do not function as intended.
- The application and its services relies on a number of third
party partners and providers, which may vary according to market.
This may increase operational disruption risks to the uninterrupted
provision of services to customers, regulatory compliance and
conduct risks, and the potential for reputational risks.
New product offerings may be developed and provided through the
application, some of which Prudential may have limited or no
experience in providing, which may introduce new regulatory,
operational, conduct and strategic risks for Group.
A failure to implement appropriate governance and management of
the incremental and new risks detailed above may adversely impact
Prudential's reputation and brand, its ability to attract and
retain customers, its competitiveness and its ability to deliver on
its long-term strategy.
2.7 Prudential operates in certain markets with joint venture
partners, minority shareholders and other third parties, resulting
in certain risks that Prudential does not face with respect to its
wholly-owned subsidiaries
Prudential operates, and in certain markets is required by local
regulation to operate, through joint ventures and other joint
ownership or third-party arrangements. For such Group operations
the level of control exercisable by the Group depends on the terms
of the contractual agreements, in particular, those terms providing
for the allocation of control among, and continued cooperation
between, the participants. In addition, the level of control
exercisable by the Group could be subject to changes in the maximum
level of non-domestic ownership imposed on foreign companies in
certain jurisdictions.
Prudential may face financial, reputational and other exposure
(including regulatory censure) in the event that any of its
partners fails or is unable to meet its obligations under the
arrangements, encounters financial difficulty, or fails to comply
with local or international regulation and standards such as those
pertaining to the prevention of financial crime. In addition, a
significant proportion of the Group's product distribution is
carried out through arrangements with third parties not controlled
by Prudential such as bancassurance and agency arrangements in Asia
and broker-dealer networks in the US and is therefore dependent
upon continuation of these relationships. A temporary or permanent
disruption to these distribution arrangements, such as through
significant deterioration in the reputation, financial position or
other circumstances of the third party, material failure in
controls (such as those pertaining to the third-party system
failure or the prevention of financial crime) or failure to meet
any regulatory requirements could adversely affect Prudential's
reputation and its business, financial condition, results of
operations and prospects.
2.8 Adverse experience relative to the assumptions used in
pricing products and reporting business results could significantly
affect Prudential's business, financial condition, results of
operations and prospects
In common with other life insurers, the profitability of the
Group's businesses depends on a mix of factors including mortality
and morbidity levels and trends, policy surrenders and take-up
rates on guarantee features of products, investment performance and
impairments, unit cost of administration and new business
acquisition expenses. The Group's businesses are subject to
inflation risk. In particular, the Group's medical insurance
businesses in Asia are also exposed to medical inflation risk.
Prudential needs to make assumptions about a number of factors
in determining the pricing of its products, for setting reserves,
and for reporting its capital levels and the results of its
long-term business operations.
Assumptions about future expected levels of mortality are of
relevance to the Guaranteed Minimum Withdrawal Benefit ('GMWB') of
Jackson's variable annuity business.
A further factor is the assumption that Prudential makes about
future expected levels of the rates of early termination of
products by its customers (known as persistency). This is relevant
to a number of lines of business in the Group, especially for
Jackson's portfolio of variable annuities and across product lines
in Asian markets. Prudential's persistency assumptions reflect a
combination of recent past experience for each relevant line of
business and expert judgement, especially where a lack of relevant
and credible experience data exists. Any expected change in future
persistency is also reflected in the assumption. If actual levels
of future persistency are significantly different than assumed, the
Group's results of operations could be adversely affected.
Furthermore, Jackson's variable annuity products are sensitive to
other types of policyholder behaviour, such as the take-up of its
GMWB product features.
In addition, Prudential's business may be adversely affected by
epidemics, pandemics and other effects that give rise to a large
number of deaths or additional sickness claims, as well as
increases to the cost of medical claims. Pandemics, significant
influenza and other epidemics have occurred a number of times
historically but the likelihood, timing, or the severity of future
events cannot be predicted. The effectiveness of external parties,
including governmental and non-governmental organisations, in
combating the spread and severity of any epidemics could have a
material impact on the Group's claims experience. The risks to the
Group resulting from the Covid-19 pandemic are included in the
'Covid-19' risk factor detailed in above.
Prudential uses reinsurance to selectively transfer mortality,
morbidity and other risks. This exposes the Group to the
counterparty risk of a reinsurer being unable to pay reinsurance
claims or otherwise meet their commitments; the risk that a
reinsurer changes reinsurance terms and conditions of coverage, or
increases the price of reinsurance which Prudential is unable to
pass on to its customers; and the risk of ambiguity in the
reinsurance terms and conditions leading to uncertainty whether an
event is covered under a reinsurance contract.
Any of the foregoing, individually or together, could have a
material adverse effect on Prudential's business, financial
condition, results of operations and prospects.
2.9 Prudential is exposed to ongoing risks as a result of the
demerger of M&G plc (the 'M&G Demerger')
On 21 October 2019, Prudential completed the M&G Demerger
and, in connection with this, Prudential entered into a demerger
agreement with M&G plc. Among other provisions, the demerger
agreement contains a customary indemnity under which Prudential has
agreed to indemnify M&G plc against liabilities incurred by the
M&G plc group that relate to the business of the Group.
Although it is not anticipated that Prudential will be required to
pay any substantial amount pursuant to such indemnity obligations,
if any amount payable thereunder is substantial this could have a
material adverse effect on Prudential's business, financial
condition, results of operations and prospects.
3. LEGAL AND REGULATORY RISK
3.1 Prudential conducts its businesses subject to regulation and
associated regulatory risks, including a change to the basis in the
regulatory supervision of the Group, the effects of changes in the
laws, regulations, policies and interpretations and any accounting
standards in the markets in which it operates
Changes in government policy and legislation (including in
relation to tax), capital control measures on companies and
individuals, regulation or regulatory interpretation applying to
companies in the financial services and insurance industries in any
of the markets in which Prudential operates (including those
related to the conduct of business by Prudential or its third party
distributors), or decisions taken by regulators in connection with
their supervision of members of the Group, which in some
circumstances may be applied retrospectively, may adversely affect
Prudential. The impact from any regulatory changes may be material
to Prudential, for example changes may be required to its product
range, distribution channels, handling and usage of data,
competitiveness, profitability, capital requirements, risk
management approaches, corporate or governance structure and,
consequently, reported results and financing requirements. Also,
regulators in jurisdictions in which Prudential operates may impose
requirements affecting the allocation of capital and liquidity
between different business units in the Group, whether on a
geographic, legal entity, product line or other basis. Regulators
may also change solvency requirements, methodologies for
determining components of the regulatory or statutory balance sheet
including the reserves and the level of capital required to be held
by individual businesses (with implications to the Group capital
position), the regulation of selling practices, and could introduce
changes that impact products sold or that may be sold. Furthermore,
as a result of interventions by governments in light of financial
and global economic conditions, there may continue to be changes in
government regulation and supervision of the financial services
industry, including the possibility of higher capital requirements,
restrictions on certain types of transactions and enhancement of
supervisory powers.
In the markets in which it operates, Prudential is subject to
regulatory requirements and obligations with respect to financial
crime including anti-money laundering and sanctions compliance,
which may either impose obligations on the Group to act in a
certain manner or restrict the way that it can act in respect of
specified individuals, organisations, businesses and/or
governments. A failure to do so may adversely impact the reputation
of Prudential and/or result in the imposition of legal or
regulatory sanctions for the Group. For internationally active
groups such as Prudential, operating across multiple jurisdictions
increases the complexity of legal and regulatory compliance.
Compliance with Prudential's legal or regulatory obligations in one
jurisdiction may conflict with the law or policy objectives of
another jurisdiction, or may be seen as supporting the law or
policy objectives of that jurisdiction over another, creating
additional legal, regulatory compliance and reputational risks for
the Group. These risks may be increased where uncertainty exists on
the scope of regulatory requirements and obligations, and where the
complexity of specific cases applicable to the Group is high.
Following the demerger of Jackson, these risks may become more
pronounced for the Group as markets with higher geopolitical risk
exposure will form a larger proportion of Prudential's
operations.
Further information on specific areas of regulatory and
supervisory requirements and changes are included in the
sub-sections below.
(a) Group-wide Supervision
With effect from 21 October 2019, the group-wide supervisor of
Prudential plc changed to the Hong Kong Insurance Authority ('IA').
To align Hong Kong's regulatory regime with international standards
and practices, the Hong Kong IA has developed a new Group-wide
Supervision ('GWS') Framework for multinational insurance groups
under its supervision. The GWS Framework is based on a
principle-based and outcome-focused approach, and allows the Hong
Kong IA to exercise direct regulatory powers over the designated
holding companies of multinational insurance groups. On 24 July
2020 the Insurance (Amendment) (No. 2) Ordinance, being the
enabling primary legislation providing for the GWS Framework, was
enacted. This primary legislation is supported by subsidiary
legislation and guidance material from the Hong Kong IA. The
relevant subsidiary legislation, including the Insurance (Group
Capital) Rules, was tabled before the Legislative Council on 6
January 2021 and will come into operation on 29 March 2021. The GWS
Framework is expected to be effective for Prudential upon
designation by the Hong Kong IA in the second quarter of 2021,
subject to transitional arrangements. Prior to the GWS Framework
becoming effective for the Group, Prudential remains subject to the
Regulatory Letter signed with the Hong Kong IA. This letter
outlines the interim supervision arrangements from 21 October 2019
when the Hong Kong IA became the group-wide supervisor of the
Group.
Although the GWS Framework is broadly consistent with the
interim supervision arrangements that currently apply to the Group
under the Regulatory Letter, until all elements of the GWS
Framework are finalised the Group cannot be certain of the nature
and extent of differences between the interim principles agreed
with the Hong Kong IA and the specific regulatory requirements of
the GWS Framework. The Group's existing processes and resources may
also need to change to comply with the final GWS Framework or any
other requirements of the Hong Kong IA. The need to adapt to any
such changes or to respond to any such requirements may lead to
increased costs or otherwise impact the business, financial
condition, results, profitability and/or prospects of the
Group.
With the agreement of the Hong Kong IA, Prudential currently
applies the Local Capital Summation Method (the 'LCSM') to
determine Group regulatory capital requirements under the
Regulatory Letter. Prudential currently expects the GWS methodology
to be largely consistent with these interim supervisory
requirements, with the exception of the treatment of debt
instruments outlined below which will be subject to transitional
arrangements under the GWS Framework, however any differences in
the final requirements adopted under the GWS Framework may lead to
changes to the way in which capital requirements are calculated and
to the eligibility of the capital instruments issued by Prudential
to satisfy such capital requirements.
The Hong Kong IA has agreed that the subordinated debt
instruments issued by Prudential at the date of the demerger of
M&G plc can be included as part of the Group's capital
resources for the purposes of satisfying the capital requirements
imposed under the interim LCSM principles agreed with the Hong Kong
IA. Senior debt instruments issued by Prudential are not included
as part of the Group capital resources under the LCSM. Under the
GWS Framework, Prudential's initial analysis indicates that all
debt instruments (senior and subordinated) issued by Prudential
will meet the transitional conditions set by the Hong Kong IA and
will be included as eligible Group capital resources, although this
will be subject to approval by the Hong Kong IA. If the Hong Kong
IA does not approve the subordinated debt instruments Prudential
has in issue as part of the Group's eligible capital resources for
the purposes of satisfying the capital requirements imposed under
the GWS Framework, Prudential may have less eligible capital
resources compared to under the LCSM and may need to raise
additional debt instruments, which may in turn lead to increased
costs for the Group.
(b) Global regulatory requirements and systematic risk regulation
Currently there are also a number of other global regulatory
developments which could impact Prudential's businesses in the many
jurisdictions in which they operate. These include the Dodd-Frank
Wall Street Reform and Consumer Protection Act ('Dodd-Frank Act')
and its subsequent amendments in the US which provided for a
comprehensive overhaul of the financial services industry within
the US including reforms to financial services entities, products
and markets, the work of the Financial Stability Board (the 'FSB')
in the area of systemic risk including the reassessment of the
designation of Global Systemically Important Insurers ('G-SIIs'),
and the Insurance Capital Standard (the 'ICS') being developed by
the International Association of Insurance Supervisors (the
'IAIS'). In addition, regulators in a number of jurisdictions in
which the Group operates are further developing their local capital
regimes. Across Asia this includes China, Hong Kong, Singapore,
Thailand and India. There remains a high degree of uncertainty over
the potential impact of such changes on the Group.
In November 2019 the IAIS adopted the Common Framework
('ComFrame') which establishes supervisory standards and guidance
focusing on the effective group-wide supervision of Internationally
Active Insurance Groups ('IAIGs'). The ComFrame proposals, which
include the ICS, could result in enhanced capital and regulatory
measures for IAIGs. Prudential was included in the first register
of IAIGs released by the IAIS on 1 July 2020 and was designated an
IAIG by the Hong Kong IA following an assessment against the
established criteria in ComFrame.
In November 2019 the FSB endorsed a new Holistic Framework
('HF'), intended for the assessment and mitigation of systemic risk
in the insurance sector, for implementation by the IAIS in 2020 and
has suspended G-SII designations until completion of a review to be
undertaken in 2022. Many of the previous G-SII measures have
already been adopted into the Insurance Core Principles ('ICPs')
and ComFrame. As an IAIG, Prudential is expected to be subject to
these measures. The HF also includes a monitoring element for the
identification of a build-up of systemic risk and to enable
supervisors to take action where appropriate. As a result of the
Covid-19 pandemic, this monitoring requirement has been replaced
with a Covid-19-focused exercise for 2020, with annual monitoring
expected to recommence in 2021. In November 2020 the IAIS launched
a public consultation on phase 1 of a proposed liquidity metric to
be used as an ancillary indicator in the monitoring of the build-up
of systemic risk. This followed a more general consultation on
liquidity metrics earlier in 2020. Consultations on a phase 2
liquidity metric, as well as on macroeconomic elements of the HF,
are expected to follow. The FSB published its 2020 Resolution
Report in November 2020, highlighting intra-group connectedness and
funding in resolution as key areas of attention for its work on
resolution planning. Resolution will continue to be a near term
focus in the FSB's financial stability work and may inform
decisions around the reformed G-SII designation in 2022.
The IAIS continues to develop the ICS as part of ComFrame. The
implementation of ICS will be conducted in two phases - a five-year
monitoring phase followed by an implementation phase.
(c ) IFRS 17
The Group's accounts are prepared in accordance with current
IFRS applicable to the insurance industry. The International
Accounting Standards Board (the 'IASB') introduced a framework that
it described as Phase I which, under its standard IFRS 4, permitted
insurers to continue to use the statutory basis of accounting for
insurance assets and liabilities that existed in their
jurisdictions prior to January 2005. In May 2017, the IASB
published its replacement standard on insurance accounting (IFRS
17, 'Insurance Contracts'). Some targeted amendments to this
standard, including to the effective date, were issued in June
2020. IFRS 17, 'Insurance Contracts', as amended, will have the
effect of introducing fundamental changes to the statutory
reporting of insurance entities that prepare accounts according to
IFRS from 2023. The standard is subject to endorsement in the UK
via the UK Endorsement Board which is currently being established.
Prudential has a group-wide implementation programme underway to
implement this new standard. The effect of changes required to the
Group's accounting policies as a result of implementing the new
standard is currently uncertain particularly as amendments were
issued by the IASB in June 2020, but these changes can be expected
to, amongst other things, alter the timing of IFRS profit
recognition. The implementation of this standard will involve
significant enhancements to IT, actuarial and finance systems of
the Group.
Any changes or modification of IFRS accounting policies may
require a change in the way in which future results will be
determined and/or a retrospective adjustment of reported results to
ensure consistency.
(d) Inter-bank offered rate ('IBOR') reforms
In July 2014, the FSB announced widespread reforms to address
the integrity and reliability of IBORs. The discontinuation of
IBORs in their current form and their replacement with alternative
risk-free reference rates such as the Sterling Overnight Index
Average benchmark ('SONIA') in the UK and the Secured Overnight
Financing Rate ('SOFR') in the US could, among other things, impact
the Group through an adverse effect on the value of Prudential's
assets and liabilities which are linked to or which reference
IBORs, a reduction in market liquidity during any period of
transition and increased legal and conduct risks to the Group
arising from changes required to documentation and its related
obligations to its stakeholders.
(e) Investor contribution schemes
Various jurisdictions in which Prudential operates have created
investor compensation schemes that require mandatory contributions
from market participants in some instances in the event of a
failure of a market participant. As a major participant in the
majority of its chosen markets, circumstances could arise in which
Prudential, along with other companies, may be required to make
such contributions.
3.2 The resolution of several issues affecting the financial
services industry could have a negative impact on Prudential's
business, financial condition, results of operations and prospects
or on its relations with current and potential customers
Prudential is, and in the future may continue to be, subject to
legal and regulatory actions in the ordinary course of its business
on matters relevant to the delivery of customer outcomes. Such
actions relate, and could in the future relate, to the application
of current regulations or the failure to implement new regulations
(including those relating to the conduct of business), regulatory
reviews of broader industry practices and products sold (including
in relation to lines of business already closed) in the past under
acceptable industry or market practices at the time and changes to
the tax regime affecting products. Regulators may also focus on the
approach that product providers use to select third-party
distributors and to monitor the appropriateness of sales made by
them. In some cases, product providers can be held responsible for
the deficiencies of third-party distributors.
In the US, there has been significant attention on the different
regulatory standards applied to investment advice delivered to
retail customers by different sectors of the industry. As a result
of reports relating to perceptions of industry abuses, there have
been numerous regulatory inquiries and proposals for legislative
and regulatory reforms. This includes focus on the suitability of
sales of certain products, alternative investments and the widening
of the circumstances under which a person or entity providing
investment advice with respect to certain employee benefit and
pension plans would be considered a fiduciary subjecting the person
or entity to certain regulatory requirements. There is a risk that
new regulations introduced may have a material adverse effect on
the sales of the products by Prudential and increase Prudential's
exposure to legal risks.
Any regulatory action arising out of the Group's position as a
product provider could have an adverse impact on the Group's
business, financial condition, results of operations and prospects,
or otherwise harm its reputation.
3.3 Litigation, disputes and regulatory investigations may
adversely affect Prudential's business, financial condition, cash
flows, results of operations and prospects
Prudential is, and may in the future be, subject to legal
actions, disputes and regulatory investigations in various
contexts, including in the ordinary course of its insurance,
investment management and other business operations. These legal
actions, disputes and investigations may relate to aspects of
Prudential's businesses and operations that are specific to
Prudential, or that are common to companies that operate in
Prudential's markets. Legal actions and disputes may arise under
contracts, regulations (including tax) or from a course of conduct
taken by Prudential, and may be class actions. Although Prudential
believes that it has adequately provided in all material respects
for the costs of litigation and regulatory matters, no assurance
can be provided that such provisions are sufficient. Given the
large or indeterminate amounts of damages sometimes sought, other
sanctions that might be imposed and the inherent unpredictability
of litigation and disputes, it is possible that an adverse outcome
could have an adverse effect on Prudential's business, financial
condition, cash flows, results of operations and prospects.
3.4 Changes in tax legislation may result in adverse tax
consequences for the Group's business, financial condition, results
of operations and prospects
Tax rules, including those relating to the insurance industry,
and their interpretation may change, possibly with retrospective
effect, in any of the jurisdictions in which Prudential operates.
Significant tax disputes with tax authorities, and any change in
the tax status of any member of the Group or in taxation
legislation or its scope or interpretation could affect
Prudential's business, financial condition, results of operations
and prospects.
4. ENVIRONMENTAL, SOCIAL AND GOVERNANCE RISKS
4.1 The failure to understand and respond effectively to the
risks associated with environmental, social or governance ('ESG')
factors could adversely affect Prudential's achievement of its
long-term strategy
The purpose of a business and the way in which it operates in
achieving its objectives, including in relation to ESG-related
matters, are an increasingly material consideration for key
stakeholders in achieving their own objectives and aims.
ESG-related risks may directly or indirectly impact Prudential's
business and the achievement of its strategy and consequently those
of its key stakeholders, which range from customers, institutional
investors, employees and suppliers, to policymakers, regulators,
industry organisations and local communities. A failure to
transparently and consistently implement the Group's ESG strategy,
in its key markets and across operational, underwriting and
investment activities, may adversely impact the financial condition
and reputation of the Group and may negatively impact the Group's
stakeholders, who all have expectations, concerns and aims related
to ESG matters, which may differ. In its investment activities,
Prudential's stakeholders increasingly place reliance on an
approach to responsible investment that
demonstrates how ESG considerations are effectively integrated
into investment decisions and the performance of fiduciary and
stewardship duties, including voting and active engagement
decisions with respect to investee companies, as both an asset
owner and an asset manager.
A failure to manage the material risks associated with key ESG
themes detailed below may adversely impact the reputation and brand
of the Group, its ability to attract and retain customers and
staff, its ability to deliver on its long-term strategy and
therefore the results of its operations and long-term financial
success.
(a) Environmental risks
Environmental concerns, notably those associated with climate
change, pose significant risks to Prudential and its customers.
Prudential's investment horizons are long term and it is therefore
exposed to the potential long-term impact of climate change risks,
which include the financial and non-financial impact of transition,
physical and litigation risks. A failure to understand, manage and
provide greater transparency of its exposure to these
climate-related risks may have increasing adverse implications for
Prudential and its stakeholders.
The global transition to a lower carbon economy may have an
adverse impact on investment valuations as the financial assets of
carbon-intensive companies re-price, and this could result in some
asset sectors facing significantly higher costs and a reduction in
demand for their products and services. The speed of this
transition, and the extent to which it is orderly and managed, will
be influenced by factors such as public policy, technology and
changes in market or investor sentiment. This climate-related
transition risk may adversely impact the valuation of investments
held by the Group, and the potential broader economic impact may
adversely affect customer demand for the Group's products.
Prudential's stakeholders increasingly expect and/or rely on the
Group to support an orderly transition based on an understanding of
relevant country and company-level transition plans and which takes
into consideration the impact on the economies, businesses and
customers in the markets in which it operates and invests. The
Group's ability to sufficiently understand and appropriately react
to transition risk may be limited by insufficient or unreliable
data on carbon exposure and transition plans for the assets in
which it invests. The direct physical impacts of climate change,
driven by both specific short-term climate-related events such as
natural disasters and longer-term changes to climate and the
natural environment, will increasingly influence the longevity,
mortality and morbidity risk assessments for the Group's life
insurance product underwriting and offerings and their associated
claims profiles. Climate-driven events in countries in which
Prudential or its key third parties operate could impact the
Group's operational resilience and its customers.
(b ) Social risks
Social risks that could impact Prudential may arise from a
failure to consider the rights, diversity, well-being, and
interests of people and communities in which the Group or its third
parties operate. These risks are increased as Prudential operates
in multiple jurisdictions with distinct local cultures and
considerations. As an employer, the Group is also exposed to the
risk of being unable to attract, retain and develop highly-skilled
staff, which may increase if Prudential does not have in place
responsible working practices or fails to recognise the benefits of
diversity or promote a culture of inclusion. The potential for
reputational risk extends to the Group's supply chains, which may
be exposed to factors such as poor labour standards and abuses of
human rights by third parties. Emerging population risks associated
with public health trends (such as an increase in obesity) and
demographic changes (such as population urbanisation and ageing)
may affect customer lifestyles and therefore may impact claims
against the Group's insurance product offerings. As a provider of
insurance and investment services, the Group is increasingly
focused on digital innovation, technologies and distribution
methods for a broadening range of products and services. As a
result, Prudential has access to extensive amounts of customer
personal data, including data related to personal health, and an
increasing ability to analyse and interpret this data through the
use of complex tools, machine learning and artificial intelligence
technologies. The Group is therefore exposed to the regulatory,
ethical and reputational risks associated with customer data misuse
or security breaches. These risks are explained above. The
increasing digitalisation of products, services and processes may
also result in new and unforeseen regulatory requirements and
stakeholder expectations, including those related to how the Group
supports its customers through this transformation.
(c) Governance risks
A failure to maintain high standards of corporate governance may
adversely impact the Group and its customers, staff and employees,
through poor decision-making and a lack of oversight of its key
risks. Poor governance may arise where key governance committees
have insufficient independence, a lack of diversity, skills or
experience in their members, or unclear (or insufficient) oversight
responsibilities and mandates. Inadequate oversight over
remuneration increases the risk of poor senior management
behaviours. Prudential operates across multiple jurisdictions and
has a group and subsidiary governance structure which may add
further complexity to these considerations. Participation in joint
ventures or partnerships where Prudential does not have direct
overall control and the use of third party suppliers increase the
potential for reputational risks arising from poor governance.
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