Prudential plc (PRU) Earnings Call Transcript & Summary

Hello, and welcome to today's IFRS 17 Briefing Live Q&A event. My name is Bailey, and I'll be your moderator for today's call. [Operator Instructions]. I would now like to pass the conference over to my host, Patrick Bowes, Chief of Investor Relations. Patrick, please go ahead.

Thank you, Bailey, and thank you all for joining us today to discuss IFRS 17 and Prudential as well as the formal announcement, we have today published a short video presentation. The associated slides, transcript as well as a companion guide. We'll also be publishing a transcript of this call. Just to remind you, the half year 2023 IFRS 17 results are due to be published on the 30th of August. And as ever, the IR team are available to help follow up with you. We are in a formal close period given the proximity of our half year results. This call and the matters discussed today are all covered by the disclaimers in the presentation and the other materials that we published today on the website. I'm delighted to introduce you to Ben Bulmer, our CFO, who will lead the session. Over to you, Ben.

Thank you, Patrick, and welcome, everyone. I'm looking forward to seeing you all at our interim results and subsequent roadshows. Just to let you know, I'm also joined today in Hong Kong by Rebecca Wyatt, who leads our financial reporting; and Matt Donnery from our performance management team. As you're aware, IFRS 17 is a new accounting framework, impacting the timing of profit emergence rather than total profit. It does not change the attractive fundamentals of our business nor the exciting growth opportunities ahead. We've continued our approach to investment valuation and accounting that we've used historically, which means that the adoption of IFRS 9 have no material impact on us. Both the IFRS 17 2022 opening equity and operating profit are in line with the guidance we provided earlier this year. As we indicated in March, our balance sheet, capital position and associated financial flexibility remain in very good shape. IFRS 17 does not change any of this. In respect of the mechanics of IFRS 17, profit growth is driven by growth in the Contractual Service Margin or CSM, which in turn is dependent on having more from new business than is released to profit in the period. We expect the compounding effects of growth from new business CSM to support growth in adjusted operating profit over time. Consequently, adjusted operating profit remains one of our key IFRS performance metrics. Our earnings remain very high quality, stemming predominantly from insurance services, representing 2/3 of our 2022 adjusted insurance operating profit. And finally, we continue to view our long-established embedded value reporting framework as more representative of shareholder value. That concludes my prepared remarks. Over to you, Bailey now, so we can take your questions.

[Operator Instructions] Our first question today comes from the line of Michael Chang from CGS CIMB.

My name is Michael Chang, CGS CIB. I got a question on operating profit. So if I'm taking a look at the slide of the operating profit and how that -- how that's a forecast, a large portion of that relates to the release of the CSM, could you perhaps elaborate a bit more on the release of the CSM amortization rate, whether that's stable across time. And then related to that, on the CSM, forecasting the CSM going forward, should we assume that the new business -- sorry, the new business profit CSM ratio to the EEV new business profit, should we assume that, that ratio is stable across time as well?

Okay. Thank you, Michael, for your two questions. Let me start briefly with the amortization rate. As you would have seen, we have a rate of 10% at a group-wide level. That varies slightly depending upon product mix across the group, but broadly looking across countries, we're in a range of between high single digit to low teens and of course, Whole of Life savings products will tend to have a slower rate, whereas protection products tend to have a faster rate. But given the size of our stock of future unearned profits on our balance sheet in the form of CSM, I'd expect that 10% to be relatively stable going forwards. On your second question, which was around NB CSM to EEV NBP ratio, as we set out, and there's a slide, Michael, which sort of walks through the key differences. And just briefly, they are [ tanks ], treatment of economics, of course, being the difference between the real-world returns. And we earn on an EEV basis and the market consistent risk neutral applied under 17 and then, of course, additions in the form of riders -- the geography is different as to where that value add comes in between the two frameworks. Those reasons are going to remain, the ratio you're referring to will, of course, differ from period to period. And I think you need to think through the mechanics, who are used to thinking through when thinking about projecting new business profits on an EEV basis. So the usual things of product mix, channel, geography. Of course, the other factor there, Michael, is economics and where current period economics are compared with sort of longer-term expectations.

Our next question today comes from the line of Edwin Liu from CLSA.

Thank you very much, Ben and Patrick. So I have one question, which is how should we think about the volatility to your operating profit and shareholder equity under IFRS 17 going forward compared to with that in the past, in particular, for example, the sensitivity to equity raise or spreads, those market factors compared to before? That would be very appreciated.

Okay. Thank you for your questions, Edwin. And let me deal with perhaps earnings first or adjusted operating profit, as we've labeled it in our results. I think, Edwin, the key thing stepping back from this to bear in mind, yes, there's the new standard but ultimately is the same product mix that you're familiar with. Now clearly, 2022 was an exceptional year for us in terms of market volatility but when it comes to earnings, you need to bear in mind that a high proportion of our business is classified as VFA, and that's some 70% of CSM. So the impact on earnings from market volatility through that model is always going to be a much smaller second order effect. For our GMM business, as we've said, the adjusted operating profit is actually based on longer-term returns. So the market-related volatility there is in nonoperating profit. And I think we hope the new disclosures we've given help with the predictability of the expected CSM release. We may moving from sort of operating results to and more of an equity or IFRS 17 adjusted equity, which I think is a useful measure. Clearly, in adjusted equity, we're going to have more volatility because we've brought the value of in-force into the account, which is a clear benefit of IFRS 17 over IFRS 4. Where that volatility -- market volatility comes through depends upon the accounting model, and there's a slide in the deck that directs you to the geography of this, but in short, for our VFA business, the CSM will be unlocked. For our GMM business, that volatility will come through in short-term fluctuations. And it's important to note, Edwin, when comparing us to peers, that we made very limited use of OCI. Consistency was important to us. when it came to our accounting policy decisions and transition policy decisions. So we very much remained fair value through P&L as we were before, hence, limited impact of adopting IFRS 9. I hope that answers your question, Edwin.

The next question today comes from the line of Thomas Wang from Goldman Sachs.

Just a quick question. You talked about 72% VFA in this GMM is about 28%. Is there any by market, is there anything we should be kind of aware because obviously, the VFA will -- the GMM will probably be creating more, as you say, more volatility on the profit side. So just interesting, is there any market we should be particularly aware of?

I wouldn't have said there's markets you should be particularly aware of and actually stepping back, Thomas, again, the sort of advent of a new accounting framework won't change that long-held focus that we have on writing health and protection products and savings business. And while we write the savings business, we continue to favor with profit and unit link structures. And it is this -- the Frank said in many of these contracts that we write, bundled savings and protection riders together and the fact that IFRS 17 gives us overall combined product view really gives the reason as to why about 70% of our business is measured under the VFA model. There is a slide in the pack that directs you to the style of products that tend to fit between the VFA and GMM model. So apart from the sort of geography of things, I think we're relatively ambivalent as to which model product sits under Candidly, obviously, the CSM inception is the same under each model, it's as you subsequently go forward and how market volatility is treated.

The next question today comes from the line of Andrew Crean from Autonomous.

Two questions. Firstly, on Slide 8, the economic and other variances of minus $4.4 billion has three components in them. There's obviously operating experience variance and assumption changes. Does the investment return to move from the risk neutral to the long-term real return. And then there's the genuine economic variances. And I wonder whether you could split those three and provide that split into the future because I think it's a very important element as to what bits are sustainable and what bits are nearly market. And then the second question on Slide 14, coming back to the new business issue. I suppose, two things here. Firstly, you're going to write a lot of Hong Kong MCV business. And does that broadly in IFRS terms add to the margin or detract from the margin. And more broadly, it's tough for us to understand why your IFRS new business contribution is about 20% below the embedded value basis. Whereas your peer AIA is 61% above. And I just wonder whether you might be able to give some broad commentary as to why those are so different.

Okay. Thank you. Thank you for your questions, Andrew. I'll start with the third one, if I may. Clearly, it's not appropriate for me to comment on others, but I think we have to be very, very cautious when it comes to comparability. As you're aware, there's many different approaches to transition and from a Prudential perspective, for us, consistency was important. And to that end, we have one set of best estimate operating assumptions we've applied across EEV and IFRS 17. We made widespread use of the retrospective method of application. So some 80% of our CSM is done under a retrospective method and that gives a consistent view for us in terms of profitability, particularly across in-force and new business. As you would have seen in the slides, the key difference for us really then between our EEV and our IFRS 17 adjusted equity is the removal of real-world risk-adjusted returns. And candidly, from my perspective, from a valuation lens, I think it's right to include an allowance for those returns as the very nature of the products we write with profits or unit-linked propositions, the shareholder is sharing in a share of those returns with policyholders through either fee income or cost of bonus. Your -- on your question on Hong Kong margins and MCV, if I can use -- if I may, in an EEV lens for a second, historically, the MCV margins have been very well aligned with domestic margins. I think as we flagged earlier this year, what we've seen is more savings in the mix, certainly in Q1. We've said that we expect to be on a glide path, perhaps to more of a normalized mix, but the key point to remember really with regards to kind of Q1 results is that heavy savings orientation we're seeing in MCV business, candidly, across the market. It's not just us. And that will have a lower amortization rate than the rate of 10%. You'll be in a single-digit number. Then in terms of the $4.4 billion impact on CSM, you're right. There are several different component parts. I think the key bit for us and the vast majority of the balance was essentially the impact from economic changes in the period and that's essentially the difference between the actual returns earned and of course, the risk-free that's assumed. Again, if we want to navigate back to longer-term assumed returns. Now I'd guide everybody to the $7.9 billion difference between our embedded value on an EEV basis. and that IFRS 17 adjusted NAV. Maybe just pause there Andrew.

Could I just follow up on that. Is it possible to give us the IFRS new business profit using real-world assumptions and then give the in-force unwind using real-world assumptions. That's the piece that I think people would be interested in because this neutral is a very depressed level.

Understood, Andrew, but I don't have those numbers to hand today. So perhaps that's something we can follow up on.

The next question today comes from the line of Kailesh Mistry from HSBC.

Just a follow-up question on the CFM on one rate to 10%. Are there any particular markets where that 10% is materially higher than the -- sorry, the amortization rate is materially higher than the group average. And I guess related to that, on one of the slides, you've got the breakdown in the change in OPAT between IFRS 4 and 17. Obviously, Hong Kong goes up, and I think this is due to the with-profits business. For the other markets, they're all down. What is driving this? Is it the same thing? Or are there specific differences by market? Any color on that would be helpful. And secondly, I guess this is more of a request. I know you've highlighted in your presentation that you'll provide detailed sensitivities for year '23 results, but just a request to maybe think about providing this not only for the earnings and the OCI, but also for the CSM. And I think that might help answer some of the previous questions as well.

Okay. Super. Thanks, Kailesh. In terms of sort of markets with amortization rates significantly greater than 10%. And the key one that springs to mind is we have a slightly faster rate in Indonesia really relating to the protection richness of the book. Most markets are pretty well weighted, and this is for the segments that we disclosed, close to that 10% rate. On your point on IFRS 4 to 17 differences, and I think this is your -- this is about net income, right? If I heard you correctly, Kailesh is that correct?

No, it's related to OPAT. So it's on Slide 6. So where you showed the differences on transfer from IFRS 4 to 17.

Okay. So right, you're absolutely right. So Yes. Look, in terms of a bit of color on how OPAT changed by segment, Hong Kong went up, and that was primarily driven by more smooth profit recognition from our products and higher surplus assets. And you will recall and you can see on the left-hand side of Slide 6, a bump from the shareholders' share in the profit state. The -- As I go through the other segments, by and large, I guess, there's a few effects. One is the removal of day 1 profits, so that has impacted Singapore growth markets, in particular. In Singapore on the old IFRS 4 basis, protection profits used to come through more quickly. I think they are more aligned with cash earnings candidly. Well, Malaysia [indiscernible] is a bit of a rounding on the page, actually, it's more or less in line and then, of course, we have the impact of the shift to risk neutral that washes across and the strength of that impact is ultimately dependent obviously on the mix of savings business.

The next question today comes from the line of Andrew Baker from Citi.

Just one on really the -- are you able to say anything on the medium-term growth expectations for the CSM. Obviously, 2022. I think you sort of ignore the economic moves, it looks like it grew about 1% to 2%, but that was on a lower new business contribution. If I just for that just back of the envelope, it looks like it's more like 6% growth, if I, layer in MCV business. Does this seem like a reasonable number going forward? Or are you able to say anything about what you're expecting organically from the CSM growth going forward?

Thanks, Andrew. Look, you're absolutely right with mechanics. Obviously, it's all about adding quality new business to our CSM, which in turn will drive earnings growth. I'm not going to be able to provide you with an earnings forecast today. But what we did try to do is set out the drivers for adjusted operating profit on Slides 9 and 10. And obviously, you've got the expected release of the CSM in there for 2023, which is on a discounted basis and clearly, we need to allow for new business. I do remember that net investment income, whilst on a smooth basis is based on assets at the start of the year. As you said, 2022 was an unusual year for us, not just in terms of macroeconomics but also the impacts of COVID, particularly on large markets. Looking forward, I'm highly optimistic we're going to drive significant growth in new business value. We've got a great platform here at Prudential. We're in high-growth markets and very exciting opportunities ahead. And to that end, as you saw from our Q1 trading update and comments related to that, we made a very strong start to the year.

The next question today comes from the line of Charles Zhou (sic) Cheng Zhou from Credit Suisse.

I have a question. So when we talk to other insurers, we know that they have selected the OCI option, for example, recognizing certain market fluctuation through the other comprehensive income just to reduce or to remove the earning volatility from the P&L. So do you or will you follow the suit in using the same way? Just would like to hear your comments.

Yes. Thanks for the question, Charles (sic) Cheng. As far as I mentioned earlier, we've maintained our asset valuation approach as per the IFRS 4 accounts, so largely at fair value with all investment returns passing through the income statement. And we've made very, very limited use of a comprehensive income, and that was important to us from a consistency approach and notwithstanding the operational complexity, cost of OCI treatment. So I guess if you're trying to make peer comparisons, what I'd urge you to do is to remember that the geography of some of the market volatility is going to be different. It's going to be important to look at total comprehensive income, not just PBT. For us also to deal with that volatility, we use this concept of adjusted operating profit, and observe that a lot of our peers continue to use an adjusting operating profit metric as well. And the idea of that is, of course, excluding the short-term market fluctuations from the adjusted profit in the income statement.

And I've got a question that's come in online, which I'll just read out. It's from Henry [indiscernible] the Hong Kong mortgage company. Are there any key assumptions, methodologies and so forth, which have not yet concluded and subject to change? Any points that are still under discussion with your external auditors. Thank you.

So no, there's no outstanding discussions, if you like, the companion guide. I don't know if you've managed to have a look, Henry, contains extracts from our 2022 audited accounts. We thought it would be useful to bake on the extracts of those accounts that we felt were the most relevant to guiding today's conversation and backing up the slides. So that's why we don't sort of released full accounts.

Henry, we will be publishing interim accounts, as I said, on the 30th of August and the full year accounts at the year-end, obviously, which will have quarter 4 detailed accounting notes. Obviously, today, we just extracted some information from the audited 2022 accounts. Okay. Bailey, back to you for the telephone calls.

The next question today comes from the line of Leon Qi from Daiwa.

Leon Qi from Daiwa. In fact, my question was raised by Thomas earlier, but I do have a follow-up on that. Regarding the VFA across different markets, correct me if I'm wrong, because my understanding is that across all the different markets we have, Hong Kong has relatively higher portion of par business and VFA is on par because we use GMM for non-par. If that is the case, does that mean Hong Kong, we have a relatively higher -- basically higher than 72% of VFA that you are using at the group for Hong Kong because the reason why I'm asking is because for the first half of this year, the capital market movements across different regions are a little bit different and Hong Kong is underperforming the rest of the market. So theoretically, if you have higher portion of VFA for Hong Kong business, then that would kind of negatively affect the $4.4 billion equivalent in the first half of this year. So just wondering if my understanding is correct that Hong Kong has relatively higher portion of VFA.

So thanks for the question, Leon. And the short answer is, yes, you're absolutely right. Hong Kong does have a higher proportion of VFA business in its mix. Candidly, where I'm sat today, I'm not going to make predictions about economics. I think what I'd rather do is [indiscernible] in a few weeks' time and when we can stand up and talk to the actual results. That's okay.

The next question today comes from the line of Andrew Sinclair from Bank of America.

Congratulations on the new role. Three questions for me. First is just on leverage. Just how you're thinking about leverage capacity today under IFRS 17? Do you have a target range that you'd be thinking about and I see in the appendix, you've given leverage figures, both with no CSM and 50% CSM credit. So just how you're thinking about that? That's my first question on leverage. Second was just on the CSM. Just wondered for both new business contribution and the CSM as a whole, how does that break down country by country for new business profit, should we just think about that in line with embedded value in your business profit and can give anything kind of overall in the CSM split? And then finally, just on the risk adjustments. I know it's small, but just how should we expect that to evolve going forward?