G: Financial assets
and liabilities

The Group designates all financial assets as either fair value through profit and loss, available-for-sale, or as loans and receivables. Financial liabilities are designated as either fair value through profit and loss, amortised cost, or as investment contracts with discretionary participation features accounted for under IFRS 4 as described in note A4.

 

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  2010 £m
  Fair value through profit and loss Available- for-sale Loans and Receivables Total carrying value Fair value
Financial assets          
Cash and cash equivalents 6,631 6,631 6,631
Deposits 9,952 9,952 9,952
Equity securities and portfolio holdings in unit trusts 86,635 86,635 86,635
Debt securitiesnote i 90,027 26,325 116,352 116,352
Loansnote ii 227 9,034 9,261 9,083
Other investmentsnote iii 5,779 5,779 5,779
Accrued investment income 2,668 2,668 2,668
Other debtors 903 903 903
  182,668 26,325 29,188 238,181  
 

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  2010 £m
  Fair value through profit and lossv Amortised cost IFRS 4 basic value Total carrying value Fair value
Financial liabilities          
Core structural borrowings of shareholder-financed operationsnotes i,H13 3,676 3,676 3,866
Operational borrowings attributable to shareholder-financed operationsH13 3,004 3,004 2,991
Borrowings attributable to with-profits fundsH13 82 1,440 1,522 1,524
Obligations under funding, securities lending and sale and repurchase agreements 4,199 4,199 4,236
Net asset value attributable to unit holders of consolidated unit trust and similar funds 3,372 3,372 3,372
Investment contracts with discretionary participation featuresnote iv 25,732 25,732
Investment contracts without discretionary participation features 15,822 1,882 17,704 17,652
Other creditors 2,321 2,321 2,321
Derivative liabilities 2,037 2,037 2,037
Other liabilities 1,129 1,129 1,129
  21,313 17,651 25,732 64,696  
 

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  2009 £m
  Fair value through profit and loss Available- for-sale Loans and Receivables Total carrying value Fair value
Financial assets          
Cash and cash equivalents 5,307 5,307 5,307
Deposits 12,820 12,820 12,820
Equity securities and portfolio holdings in unit trusts 69,354 69,354 69,354
Debt securitiesnote i 79,083 22,668 101,751 101,751
Loansnote ii 8,754 8,754 8,686
Other investmentsnote iii 5,132 5,132 5,132
Accrued investment income 2,473 2,473 2,473
Other debtors 762 762 762
  153,569 22,668 30,116 206,353  
 

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  2009 £m
  Fair value through profit and lossv Amortised cost IFRS 4 basic value Total carrying value Fair value
Financial liabilities          
Core structural borrowings of shareholder-financed operationsnotes i,H13 3,394 3,394 3,424
Operational borrowings attributable to shareholder-financed operationsH13 2,751 2,751 2,751
Borrowings attributable to with-profits fundsH13 105 1,179 1,284 1,281
Obligations under funding, securities lending and sale and repurchase agreements 3,482 3,482 3,540
Net asset value attributable to unit holders of consolidated unit trust and similar funds 3,809 3,809 3,809
Investment contracts with discretionary participation featuresnote iv 24,880 24,880
Investment contracts without discretionary participation features 13,840 1,965 15,805 15,866
Other creditors 1,612 1,612 1,612
Derivative liabilities 1,501 1,501 1,501
Other liabilities 877 877 877
  19,255 15,260 24,880 59,395  

Notes

  1. As at 31 December 2010, £685 million (2009: £659 million) of convertible bonds were included in debt securities and £352 million (2009: £347 million) were included in borrowings.
  2. Loans and receivables are reported net of allowance for loan losses of £52 million (2009: £44 million).
  3. See note G3 for details of the derivative assets included. The balance also contains the PAC with-profits fund's participation in various investment funds and limited liability property partnerships.
  4. It is impractical to determine the fair value of investment contracts with discretionary participation features due to the lack of a reliable basis to measure such features.
  5. For financial liabilities designated as fair value through profit and loss there was no impact on profit from movements in credit risk during 2010 and 2009.

Determination of fair value

The fair values of the financial assets and liabilities as shown in the table above have been determined on the following bases.

The fair values of the financial instruments for which fair valuation is required under IFRS are determined by the use of current market bid prices for exchange-quoted investments, or by using quotations from independent third-parties, such as brokers and pricing services or by using appropriate valuation techniques. Investments valued using valuation techniques include financial investments which by their nature do not have an externally quoted price based on regular trades and financial investments for which markets are no longer active as a result of market conditions, e.g. market illiquidity. The valuation techniques used include comparison to recent arm's length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option adjusted spread models and, if applicable, enterprise valuation. These techniques may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these instruments. When determining the inputs into the valuation techniques used priority is given to publicly available prices from independent sources, when available, but overall the source of pricing is chosen with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date.

The fair value estimates are made at a specific point in time, based upon available market information and judgements about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Group's entire holdings of a particular financial instrument, nor do they consider the tax impact of the realisation of unrealised gains or losses from selling the financial instrument being fair valued. In some cases the disclosed value cannot be realised in immediate settlement of the financial instrument.

The loans and receivables have been shown net of provisions for impairment. The fair value of loans has been estimated from discounted cash flows expected to be received. The rate of discount used was the market rate of interest.

The estimated fair value of derivative financial instruments reflects the estimated amount the Group would receive or pay in an arm's length transaction. This amount is determined using quoted prices if exchange listed, quotations from independent third-parties or valued internally using standard market practices. In accordance with the Group's risk management framework, all internally generated valuations are subject to assessment against external counterparties' valuations.

For investment contracts in the US with fixed and guaranteed terms the fair value is determined based on the present value of future cash flows discounted at current interest rates.

The fair value of other financial liabilities is determined using discounted cash flows of the amounts expected to be paid.

Level 1, 2 and 3 fair value measurement hierarchy of Group financial instruments

In March 2009, IFRS 7 'Financial Instruments: Disclosures' was amended by the IASB to require certain additional disclosures to be included in IFRS financial statements. This includes, as is presented below, a table of financial instruments carried at fair value analysed by level of the IFRS 7 defined fair value hierarchy. This hierarchy is based on the inputs of the fair value measurement and reflects the lowest level input that is significant to that measurement.

The classification criteria and its application to Prudential can be summarised as follows:

Level 1: Quoted prices (unadjusted) in active markets for identical assets and liabilities

Level 1 principally includes exchange listed equities, mutual funds with quoted prices, exchange traded derivatives such as futures and options, and national government bonds unless there is evidence that trading in a given instrument is so infrequent that the market could not possibly be considered active. It also includes other financial instruments (including net assets attributable to unit-holders of consolidated unit trusts and similar funds) where there is clear evidence that the year end valuation is based on a traded price in an active market.

Level 2: Inputs other than quoted prices included within level 1 that are observable either directly (i.e. as prices) or indirectly (i.e. derived from prices)

Level 2 principally includes corporate bonds and other non-national government debt securities which are valued using observable inputs, together with over-the-counter derivatives such as forward exchange contracts and non-quoted investment funds valued with observable inputs. It also includes net assets attributable to unit-holders of consolidated unit trusts and similar funds and investment contract liabilities that are valued using observable inputs.

The nature of Prudential's operations in the US and the UK mean that a significant proportion of the assets backing non-linked shareholder-backed business are held in corporate bonds, structured securities and other non-national government debt securities. These assets, in line with market practice, are generally valued using independent pricing providers in the US and third-party broker quotes in the UK and Asia either directly or via third-parties, such as IDC or Bloomberg. Such assets are generally classified as level 2 as the nature of these quotations means that they do not strictly meet the definition of level 1 assets. These valuations are determined using independent external quotations from multiple sources and are subject to a number of monitoring controls, such as monthly price variances, stale price reviews and variance analysis on prices achieved on subsequent trades.

Pricing services, where available, are used to obtain the third-party broker quotes. Where pricing services providers are used, a single valuation is obtained and applied.

When prices are not available from pricing services, quotes are sourced directly from brokers. Prudential seeks to obtain a number of quotes from different brokers so as to obtain the most comprehensive information available on their executability. Where quotes are sourced directly from brokers, the price used in the valuation is normally selected from one of the quotes based on a number of factors, including the timeliness and regularity of the quotes and the accuracy of the quotes considering the spreads provided. The selected quote is the one which best represents an executable quote for the security at the measurement date.

Generally, no adjustment is made to the prices obtained from independent third-parties. Adjustment is made in only limited circumstances, where it is determined that the third-party valuations obtained do not reflect fair value (e.g. either because the value is stale and/or the values are extremely diverse in range). These are usually securities which are distressed or that could be subject to a debt restructure or where reliable market prices are no longer available due to an inactive market or market dislocation. In these instances, prices are derived using internal valuation techniques including those as described above in this note with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date. The techniques used require a number of assumptions relating to variables such as credit risk and interest rates. Examples of such variables include an average credit spread based on the corporate bond universe and the relevant duration of the asset being valued. Prudential measures the input assumptions based on the best available information at the measurement dates. Securities valued in such manner are classified as level 3 where these significant inputs are not based on observable market data.

In addition level 2 includes debt securities that are valued internally using standard market practices. Of the total level 2 debt securities of £89,948 million at 31 December 2010 (2009: £83,301 million), £6,638 million are valued internally (2009: £6,426 million). The majority of such securities are valued using matrix pricing, which is based on assessing the credit quality of the underlying borrower to derive a suitable discount rate relative to government securities of a comparable duration. Under matrix pricing, the debt securities are priced taking the credit spreads on comparable quoted public debt securities and applying these to the equivalent debt instruments factoring a specified liquidity premium. The majority of the parameters used in this valuation technique are readily observable in the market and, therefore, are not subject to interpretation.

Level 3: Significant inputs for the asset or liability that are not based on observable market data (unobservable inputs)

Level 3 principally includes investments in private equity funds, investments in property funds which are exposed to bespoke properties or risks, investments which are internally valued or subject to a significant number of unobservable assumptions and certain derivatives which are bespoke or long dated. It also includes debt securities which are rarely traded or traded only in privately negotiated transactions and hence where it is difficult to assert that these have been based on observable market data. The inherent nature of the vast majority of these assets means that, in normal market conditions, there is unlikely to be significant change in the specific underlying assets classified as level 3.

At 31 December 2010 the Group held £4,194 million (2009: £5,190 million), two per cent of the fair valued financial instruments (2009: three per cent), within level 3. Of these amounts £3,359 million (2009: £3,510 million) was held by the Group's participating funds and therefore shareholders' profit and equity are not impacted by movements in the valuation of these financial instruments. Total level 3 assets represented 3.3 per cent of the total assets of the participating funds at 31 December 2010 (2009: 3.7 per cent). Total level 3 liabilities at 31 December 2010 were £371 million out of total participating fund liabilities of £112,196 million (2009: £348 million out of £104,817 million).

Of the £866 million level 3 fair valued financial investments at 31 December 2010 (2009: £1,684 million), net of derivative liabilities which support non-linked shareholder-backed business (1.6 per cent of the total financial investments net of derivative liabilities backing this business) (2009: 3.6 per cent), £728 million are externally valued and £138 million are internally valued (2009: £1,653 million and £31 million respectively). Internal valuations, which represent 0.2 per cent of the total financial investments net of derivative liabilities supporting non-linked shareholder-backed business at 31 December 2010 (2009: 0.06 per cent), are inherently more subjective than external valuations.

If the value of all level 3 investments backing non-linked shareholder-backed business was varied downwards by 10 per cent, the change in valuation would be £14 million (2009: £3 million), which would reduce shareholders' equity by this amount before tax. Of this amount a £7 million decrease (2009: £5 million increase) would pass through the income statement substantially as part of short-term fluctuations in investment returns outside of operating profit and a £7 million decrease (2009: offset by an £8 million decrease) would be included as part of other comprehensive income, being unrealised movements on assets classified as available-for-sale.

 

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  31 December 2010 £m
  Level 1 Level 2 Level 3 Total
With-profits        
Equity securities and portfolio holdings in unit trusts 29,675 1,281 415 31,371
Debt securities 11,114 41,375 772 53,261
Other investments (including derivative assets) 137 1,207 2,543 3,887
Derivative liabilities (56) (626) (25) (707)
Total financial investments, net of derivative liabilities 40,870 43,237 3,705 87,812
Borrowings attributable to the with-profits fund held at fair value (82) (82)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (519) (511) (346) (1,376)
Total 40,351 42,644 3,359 86,354
Percentage of total 47% 49% 4% 100%
Unit-linked and variable annuity separate account        
Equity securities and portfolio holdings in unit trusts 54,272 2 54,274
Debt securities 3,784 5,268 2 9,054
Other investments (including derivative assets) 43 88 131
Derivative liabilities
Total financial investments, net of derivative liabilities 58,099 5,358 2 63,459
Investment contracts without discretionary participation features held at fair value (13,841) (13,841)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,360) (1,360)
Total 56,739 (8,483) 2 48,258
Percentage of total 118% (18)% 100%
Non-linked shareholder-backed        
Loans 227 227
Equity securities and portfolio holdings in unit trusts 808 21 161 990
Debt securities 10,389 43,305 343 54,037
Other investments (including derivative assets) 52 1,146 563 1,761
Derivative liabilities (80) (1,049) (201) (1,330)
Total financial investments, net of derivative liabilities 11,169 43,650 866 55,685
Investment contracts without discretionary participation features held at fair value (1,981) (1,981)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (220) (383) (33) (636)
Total 10,949 41,286 833 53,068
Percentage of total 20% 78% 2% 100%
Group total        
Loans 227 227
Equity securities and portfolio holdings in unit trusts 84,755 1,304 576 86,635
Debt securities 25,287 89,948 1,117 116,352
Other investments (including derivative assets) 232 2,441 3,106 5,779
Derivative liabilities (136) (1,675) (226) (2,037)
Total financial investments, net of derivative liabilities 110,138 92,245 4,573 206,956
Borrowings attributable to the with-profits fund held at fair value (82) (82)
Investment contracts without discretionary participation features held at fair value (15,822) (15,822)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (2,099) (894) (379) (3,372)
Total 108,039 75,447 4,194 187,680
Percentage of total 58% 40% 2% 100%
 

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  31 December 2009 £m
  Level 1 Level 2 Level 3 Total
With-profits        
Equity securities and portfolio holdings in unit trusts 28,688 799 475 29,962
Debt securities 7,063 39,051 1,213 47,327
Other investments (including derivative assets) 79 1,199 2,170 3,448
Derivative liabilities (54) (504) (25) (583)
Total financial investments, net of derivative liabilities 35,776 40,545 3,833 80,154
Borrowings attributable to the with-profits fund held at fair value (105) (105)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,354) (305) (323) (1,982)
Total 34,422 40,135 3,510 78,067
Percentage of total 44% 51% 5% 100%
Unit-linked and variable annuity separate account        
Equity securities and portfolio holdings in unit trusts 38,616 4 38,620
Debt securities 3,283 5,525 40 8,848
Other investments (including derivative assets) 30 80 110
Derivative liabilities
Total financial investments, net of derivative liabilities 41,929 5,609 40 47,578
Investment contracts without discretionary participation features held at fair value (12,242) (12,242)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1,324) (7) (2) (1,333)
Total 40,605 (6,640) 38 34,003
Percentage of total 119% (19)% 0% 100%
Non-linked shareholder-backed        
Equity securities and portfolio holdings in unit trusts 557 36 179 772
Debt securities 5,783 38,725 1,068 45,576
Other investments (including derivative assets) 155 787 632 1,574
Derivative liabilities (20) (703) (195) (918)
Total financial investments, net of derivative liabilities 6,475 38,845 1,684 47,004
Investment contracts without discretionary participation features held at fair value (1,598) (1,598)
Net asset value attributable to unit holders of consolidated unit trusts and
similar funds
(110) (342) (42) (494)
Total 6,365 36,905 1,642 44,912
Percentage of total 14% 82% 4% 100%
Group total        
Equity securities and portfolio holdings in unit trusts 67,861 839 654 69,354
Debt securities 16,129 83,301 2,321 101,751
Other investments (including derivative assets) 264 2,066 2,802 5,132
Derivative liabilities (74) (1,207) (220) (1,501)
Total financial investments, net of derivative liabilities 84,180 84,999 5,557 174,736
Borrowings attributable to the with-profits fund held at fair value (105) (105)
Investment contracts without discretionary participation features held at fair value (13,840) (13,840)
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (2,788) (654) (367) (3,809)
Total 81,392 70,400 5,190 156,982
Percentage of total 52% 45% 3% 100%

Reconciliation of movements in level 3 financial instruments measured at fair value

The following tables reconcile the value of level 3 financial instruments at 1 January 2010 to that presented at 31 December 2010 and at 1 January 2009 to that presented at 31 December 2009.

Total gains and losses recorded in the income statement in the year represents realised gains and losses, including interest and dividend income unrealised gains and losses on financial instruments classified at fair value through profit and loss and foreign exchange movements on an individual entity's overseas investments. All these amounts are included within 'investment return' within the income statement.

Total gains and losses recorded in other comprehensive income includes unrealised gains and losses on debt securities held as available-for-sale within Jackson and foreign exchange movements arising from the retranslation of the Group's overseas subsidiaries and branches.

The transfers out from level 3 during 2010 comprise mainly transfers within the Jackson's portfolio. Certain broker-priced assets of Jackson were previously classified as level 3 holdings as a result of illiquidity in the market and the resultant lack of observability into the assumptions used to produce those fair values. During 2010, as a result of ongoing consideration regarding the use of assumptions by pricing sources and the changes in the level of observability of these inputs over recent periods, Jackson determined that these assets would be more appropriately categorised as level 2. As a result, Jackson transferred debt securities of £606 million and derivative assets of £101 million from level 3 to level 2. The remaining transfers out of level 3 of the Group are primarily debt securities reclassifications from level 3 to level 2 which reflect improving liquidity during the period.

The transfers out from level 3 during 2009 included a transfer of £2,072 million from level 3 to level 2 in respect of structured securities of Jackson. At 31 December 2008, Jackson had utilised internal valuations for certain structured securities given the illiquidity of the market at that time. These assets had therefore been classified as level 3 given the unobservable nature of assumptions within the internal valuation models used. During the first half of 2009, improvements were observed in the level of liquidity for these structured securities such that external prices based on observable inputs from pricing services or brokers were used to value nearly all of the structured securities at 31 December 2009. The remaining transfers in and out of level 3 in 2009 represented sundry individual asset reclassifications, none of which are materially significant as highlighted in the table below.

 

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  At 1 Jan 2010
£m
Total gains/ losses in income statement
£m
Total gains/ losses recorded in other compre- hensive income
£m
Purchases
£m
Sales
£m
Settled
£m
Transfers into
level 3
£m
Transfers out of level 3
£m
At 31 Dec 2010
£m
With-profits                  
Equity securities and portfolio holdings in unit trusts 475 (6) 48 (59) (43) 415
Debt securities 1,213 (113) 18 15 (158) (34) 11 (180) 772
Other investments (including derivative assets) 2,170 309 5 372 (312) (1) 2,543
Derivative liabilities (25) (25)
Total financial investments, net of derivative liabilities 3,833 190 23 435 (529) (34) 11 (224) 3,705
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (323) (32) 9 (346)
Total 3,510 158 23 444 (529) (34) 11 (224) 3,359
Unit-linked and variable annuity separate accounts                  
Debt securities 40 3 2 (4) (18) (21) 2
Total financial investments, net of derivative liabilities 40 3 2 (4) (18) (21) 2
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (2) 2
Total 38 3 2 (4) (18) (19) 2
Non-linked shareholder-backed                  
Equity securities and portfolio holdings in unit trusts 179 43 5 30 (95) 2 (3) 161
Debt securities 1,068 49 72 46 (213) (27) 61 (713) 343
Other investments (including derivative assets) 632 15 32 129 (144) (101) 563
Derivative liabilities (195) (5) (1) (201)
Total financial investments, net of derivative liabilities 1,684 102 108 205 (452) (27) 63 (817) 866
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (42) (17) (1) (16) 43 (33)
Total 1,642 85 107 189 (409) (27) 63 (817) 833
Group total                  
Equity securities and portfolio holdings in unit trusts 654 37 5 78 (154) 2 (46) 576
Debt securities 2,321 (64) 93 63 (375) (79) 72 (914) 1,117
Other investments (including derivative assets) 2,802 324 37 501 (456) (102) 3,106
Derivative liabilities (220) (5) (1) (226)
Total financial investments, net of derivative liabilities 5,557 292 134 642 (985) (79) 74 (1,062) 4,573
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (367) (49) (1) (7) 43 2 (379)
Total 5,190 243 133 635 (942) (79) 74 (1,060) 4,194
 

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  At 1 Jan 2009
£m
Total gains/ losses in income statement
£m
Total gains/ losses recorded in other compre- hensive income
£m
Purchases
£m
Sales
£m
Settled
£m
Transfers into
level 3
£m
Transfers out of level 3
£m
At 31 Dec 2009
£m
With-profits                  
Equity securities and portfolio holdings in unit trusts 509 (3) (1) 26 (56) 475
Debt securities 1,342 (14) (11) 50 (225) (17) 142 (54) 1,213
Other investments (including derivative assets) 2,122 (211) (89) 403 (55) 2,170
Derivative liabilities (2) (23) (25)
Total financial investments, net of derivative liabilities 3,973 (230) (101) 479 (359) (17) 142 (54) 3,833
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (381) 9 49 (323)
Total 3,592 (221) (101) 528 (359) (17) 142 (54) 3,510
Unit-linked and variable annuity separate account                  
Debt securities 33 2 1 16 (8) (4) 40
Total financial investments, net of derivative liabilities 33 2 1 16 (8) (4) 40
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (1) (1) (2)
Total 33 2 1 15 (8) (1) (4) 38
Non-linked shareholder-backed                  
Equity securities and portfolio holdings in unit trusts 318 (47) (34) 21 (55) (24) 179
Debt securities 3,996 (15) (565) 104 (473) (2) 200 (2,177) 1,068
Other investments (including derivative assets) 692 130 (76) 153 (308) 43 (2) 632
Derivative liabilities (246) 93 (64) 23 (1) (195)
Total financial investments, net of derivative liabilities 4,760 161 (675) 214 (813) (2) 242 (2,203) 1,684
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (65) 17 6 (42)
Total 4,695 178 (669) 214 (813) (2) 242 (2,203) 1,642
Group total                  
Equity securities and portfolio holdings in unit trusts 827 (50) (35) 47 (111) (24) 654
Debt securities 5,371 (27) (575) 170 (698) (27) 342 (2,235) 2,321
Other investments (including derivative assets) 2,814 (81) (165) 556 (363) 43 (2) 2,802
Derivative liabilities (246) 91 (64) (1) (220)
Total financial investments, net of derivative liabilities 8,766 (67) (775) 709 (1,172) (27) 384 (2,261) 5,557
Net asset value attributable to unit holders of consolidated unit trusts and similar funds (446) 26 6 48 (1) (367)
Total 8,320 (41) (769) 757 (1,172) (27) 383 (2,261) 5,190

Of the total gains and losses in the income statement in 2010 of £243 million gains, £315 million relates to financial instruments still held at the end of the year, which can be analysed as £18 million for equity securities, £110 million for debt securities, £243 million for other investments, £(6) million for derivative liabilities and £(50) million for net asset value attributable to unit holders of consolidated unit trusts and similar funds.

Of the total gains and losses in the income statement in 2009 of £41 million losses, £(205) million relates to financial instruments still held at the end of the year, which can be analysed as £41 million losses for equity securities, £44 million losses for debt securities, £221 million losses for other investments, £76 million gains for derivative liabilities and £25 million gains for net asset value attributable to unit holders of consolidated unit trusts and similar funds.

Transfers between level 1 and level 2

During 2010, transfers from level 1 to level 2 amounted to £354 million in respect of certain investment funds held by the Group's participating funds which arose to reflect the change in the observability of the inputs used in valuing these funds.

There were no significant transfers between level 1 and level 2 during 2009.

Interest income and expense

The interest income on financial assets not at fair value through profit and loss for the year ended 31 December 2010 from continuing operations was £1,994 million (2009: £1,998 million).

The interest expense on financial liabilities not at fair value through profit and loss for the year ended 31 December 2010 from continuing operations was £427 million (2009: £366 million).

 

Interest rate risk

The following table shows an analysis of the classes of financial assets and liabilities and their direct exposure to interest rate risk. Each applicable class of the Group's financial assets or liabilities is analysed between those exposed to fair value interest rate risk, cash flow interest rate risk and those with no direct interest rate risk exposure:

 

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  2010 £m
  Fair value interest rate risk Cash flow interest rate risk Not directly exposed to interest rate risk Total
Financial assets        
Cash and cash equivalents 6,631 6,631
Deposits 887 8,941 124 9,952
Debt securities 110,168 5,824 360 116,352
Loans 6,238 3,001 22 9,261
Other investments (including derivatives) 1,616 448 3,715 5,779
  118,909 18,214 10,852 147,975
Financial liabilities        
Core structural borrowings of shareholder-financed operations 3,676 3,676
Operational borrowings attributable to shareholder-financed operations 2,624 377 3 3,004
Borrowings attributable to with-profits funds 679 710 133 1,522
Obligations under funding, securities lending and sale and repurchase agreements 631 3,568 4,199
Investment contracts without discretionary participation features 988 894 15,822 17,704
Derivative liabilities 705 431 901 2,037
Other liabilities 121 129 879 1,129
  9,424 6,109 17,738 33,271
 

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  2009 £m
  Fair value interest rate risk Cash flow interest rate risk Not directly exposed to interest rate risk Total
Financial assets        
Cash and cash equivalents 5,307 5,307
Deposits 896 11,884 40 12,820
Debt securities 95,817 5,550 384 101,751
Loans 5,923 2,816 15 8,754
Other investments (including derivatives) 1,381 368 3,383 5,132
  104,017 20,618 9,129 133,764
Financial liabilities        
Core structural borrowings of shareholder-financed operations 3,394 3,394
Operational borrowings attributable to shareholder-financed operations 2,128 620 3 2,751
Borrowings attributable to with-profits funds 804 312 168 1,284
Obligations under funding, securities lending and sale and repurchase agreements 611 2,871 3,482
Investment contracts without discretionary participation features 1,098 867 13,840 15,805
Derivative liabilities 647 286 568 1,501
Other liabilities 79 92 706 877
  8,761 5,048 15,285 29,094

Liquidity analysis

i) Contractual maturities of financial liabilities

The following table sets out the contractual maturities for applicable classes of financial liabilities, excluding derivative liabilities and investment contracts that are separately presented. The financial liabilities are included in the column relating to the contractual maturities at the undiscounted cash flows (including contractual interest payments) due to be paid assuming conditions are consistent with those of year end.

 

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  2010 £m
  Total carrying value 1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over 20 years No stated maturity Total
Financial liabilities                  
Core structural borrowings of shareholder-financed operationsH13 3,676 164 861 731 1,314 835 1,244 1,469 6,618
Operational borrowings attributable to shareholder-financed operationsH13 3,004 2,510 561 3 3 3 10 3,090
Borrowings attributable to with-profits fundsH13 1,522 155 1,051 161 2 2 121 182 1,674
Obligations under funding, securities lending and sale and repurchase agreements 4,199 4,199 4,199
Other liabilities 1,129 867 16 50 196 1,129
Net asset value attributable to unit holders of consolidated unit-trusts and similar funds 3,372 3,372 3,372
Other creditors 2,321 2,321 2,321
  19,223 13,588 2,489 945 1,319 840 1,375 1,847 22,403
 

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  2009 £m
  Total carrying value 1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over 20 years No stated maturity Total
Financial liabilities                  
Core structural borrowings of shareholder-financed operationsH13 3,394 148 588 733 1,394 877 1,343 1,422 6,505
Operational borrowings attributable to shareholder-financed operationsH13 2,751 2,351 435 9 9 9 31 2,844
Borrowings attributable to with-profits fundsH13 1,284 228 882 102 205 1,417
Obligations under funding, securities lending and sale and repurchase agreements 3,482 3,482 3,482
Other liabilities 877 643 11 14 211 879
Net asset value attributable to unit holders of consolidated unit-trusts and similar funds 3,809 3,809 3,809
Other creditors 1,612 1,612 1,612
  17,209 12,273 1,916 858 1,403 886 1,374 1,838 20,548

ii) Maturity analysis of derivatives

The following table provides a maturity analysis of derivative assets and liabilities:

 

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  2010 £m
  Total carrying value 1 year or less After 1 year to 3 years After 3 years to 5 years After 5 years Total
Net derivative position 2 1 1 2
 

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  2009 £m
  Total carrying value 1 year or less After 1 year to 3 years After 3 years to 5 years After 5 years Total
Net derivative position 279 340 10 (1) 349

The net derivative positions as shown in the table above comprise the following derivative assets and liabilities:

 

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  2010 £m 2009 £m
Derivative assets 2,039 1,780
Derivative liabilities (2,037) (1,501)
Net derivative position 2 279

The majority of derivative assets and liabilities have been included at fair value within the one year or less column representing the basis on which they are managed (i.e. to manage principally asset or liability value exposures). Contractual maturities are not considered essential for an understanding of the timing of the cash flows for these instruments and in particular the Group has no cash flow hedges. The only exception is certain identified interest rate swaps which are fully expected to be held until maturity solely for the purposes of matching cash flows on separately held assets and liabilities. For these instruments the undiscounted cash flows (including contractual interest amounts) due to be paid under the swap contract assuming conditions are consistent with those at year end are included in the column relating to the contractual maturity of the derivative.

The table below shows the maturity profile for investment contracts on an undiscounted basis to the nearest billion. This maturity profile has been based on the cash flow projections of expected benefit payments as part of the determination of the value of in-force business when preparing EEV basis results.

 

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  2010 £bn
  1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over 20 years Total undis- counted value Carrying value
Life assurance investment contracts 3 12 15 14 12 15 71 43
 

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  2009 £bn
  1 year or less After 1 year to 5 years After 5 years to 10 years After 10 years to 15 years After 15 years to 20 years Over 20 years Total undis- counted value Carrying value
Life assurance investment contracts 3 11 13 13 11 17 68 41

Most investment contracts have options to surrender early, albeit these are often subject to surrender or other penalties. It is therefore the case that most contracts could be said to have a contractual maturity of less than one year, but in reality the additional charges and term of the contracts means these are unlikely to be exercised in practice and the more useful information is to present information on expected payment.

The maturity profile above excludes certain corporate unit-linked business with gross policyholder liabilities of £11 billion (2009: £9 billion) which has no stated maturity but which is repayable on demand.

This table has been prepared on an undiscounted basis and accordingly the amounts shown for life assurance investment contracts differ from those disclosed on the statement of financial position. Durations of long-term business contracts, covering insurance and investment contracts, on a discounted basis are included in section D.

The vast majority of the Group's financial assets are held to back the Group's policyholder liabilities. Although asset/liability matching is an important component of managing policyholder liabilities (both those classified as insurance and those classified as investments), this profile is mainly relevant for managing market risk rather than liquidity risk. Within each business unit this asset/liability matching is performed on a portfolio by portfolio basis.

In terms of liquidity risk a large proportion of the policyholder liabilities contain discretionary surrender values or surrender charges, meaning that many of the Group's liabilities are expected to be held for the long term. Much of the Group's investment portfolios is in marketable securities, which can therefore be converted quickly to liquid assets.

For the reasons above an analysis of the Group's assets by contractual maturity is not considered necessary to evaluate the nature and extent of the Group's liquidity risk.

Credit risk

The Group's maximum exposure to credit risk of financial instruments before any allowance for collateral or allocation of losses to policyholders is represented by the carrying value of financial instruments on the balance sheet that have exposures to credit risk. These assets comprise cash and cash equivalents, deposits, debt securities, loans and derivative assets, and other debtors, the carrying value of which are disclosed at the start of this note and note G3 for derivative assets. The collateral in place in relation to derivatives is described in G4. Notes D2, D3 and D4, describe the security for these loans held by the Group, as disclosed at the start of this note.

Of the total loans and receivables held £74 million (2009: £64 million) are past their due date but have not been impaired. Of the total past due but not impaired, £26 million is less than one year past their due date and £9 million is more than six months but less than one year past their due date (2009: £64 million and £11 million respectively). The Group expects full recovery of these loans and receivables.

No further analysis has been provided of the age of financial assets that are past due at the end of the reporting period but not impaired as the amounts are immaterial. No further analysis has been provided of the element of loans and receivables that was neither past due nor impaired for the total portfolio. This is on the grounds of immateriality of the difference between the neither past due nor impaired elements and the total portfolio.

Financial assets that would have been past due or impaired had the terms not been renegotiated amounted to £97 million (2009: £55 million).

There was no collateral held against loans that are past due and impaired or that are past due but not impaired at 31 December 2010 (2009: £nil).

In addition, during the year the Group took possession of £22 million (2009: £15 million) of other collateral held as security, which mainly consists of assets that could be readily convertible into cash.

Currency risk

As at 31 December 2010, the Group held 18 per cent (2009: 19 per cent) and 14 per cent (2009: 13 per cent) of its financial assets and financial liabilities respectively, in currencies, mainly US dollar and Euro, other than the functional currency of the relevant business unit.

The financial assets, of which 70 per cent (2009: 74 per cent) are held by the PAC with-profits fund, allow the PAC with-profits fund to obtain exposure to foreign equity markets.

The financial liabilities, of which 28 per cent (2009: 34 per cent) are held by the PAC with-profits fund, mainly relate to foreign currency borrowings.

The exchange risks inherent in these exposures are mitigated through the use of derivatives, mainly forward currency contracts (note G3 below).

The amount of exchange gains recognised in the income statement in 2010, except for those arising on financial instruments measured at fair value through profit and loss, is £82 million (2009: £201 million losses). This constitutes £16 million losses (2009: £41 million losses) on Medium Term Notes (MTN) liabilities and £98 million of net gains (2009: £160 million net losses), mainly arising on investments of the PAC with-profits fund. The gains/losses on MTN liabilities are fully offset by value movements on cross-currency swaps, which are measured at fair value through profit and loss.

Derivatives

The Group enters into a variety of exchange traded and over-the-counter derivative financial instruments, including futures, options, forward currency contracts and swaps such as interest rate swaps, cross-currency swaps, swaptions and credit default swaps.

All over-the-counter derivative transactions are conducted under standardised ISDA (International Swaps and Derivatives Association Inc) master agreements and the Group has collateral agreements between the individual Group entities and relevant counterparties in place under each of these market master agreements.

The total fair value balances of derivative assets and liabilities as at 31 December 2010 were as follows:

 

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  2010 £m
  UK insurance operations US insurance operations Asian insurance operations Asset management Unallocated to a segment Group total
Derivative assets 926 645 310 44 114 2,039
Derivative liabilities (792) (799) (222) (78) (146) (2,037)
  134 (154) 88 (34) (32) 2
 

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  2009 £m
  UK insurance operations US insurance operations Asian insurance operations Asset management Unallocated to a segment Group total
Derivative assets 910 519 150 48 153 1,780
Derivative liabilities (709) (461) (146) (49) (136) (1,501)
  201 58 4 (1) 17 279

The above derivative assets are included in 'other investments' in the primary statements.

The notional amount of the derivatives, distinguishing between UK insurance and US operations, was as follows:

 

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  2010 £m
  UK insurance operations
Notional amount on which future payments are based
US insurance operations
Notional amount on which future payments are based
As at 31 December 2010 Asset Liability Asset Liability
Cross-currency swaps* 808 921 379 173
Equity index put options 1,458
Swaptions 18 13,093 3,832
Futures 3,068 7,150 2,701
Forwards* 19,668 19,793
Inflation swaps 3,032 2,945
Credit default swaps 1,148 20 26
Credit derivatives 134
Put options 8,048
Equity options 34 3,514 867
Total return swaps 215 215 192
Interest rate swaps* 4,035 4,403 7,185 8,495
 

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  2009 £m
  UK insurance operations
Notional amount on which future payments are based
US insurance operations
Notional amount on which future payments are based
As at 31 December 2009 Asset Liability Asset Liability
Cross-currency swaps* 808 881 376 168
Swaptions 900 900 12,694 5,263
Futures 2,267 2,987 1,534
Forwards* 20,235 20,184
Inflation swaps 2,337 2,205
Credit default swaps 90 12
Credit derivatives 189
Put options 9,072
Equity options 30 552 3,246 562
Total return swaps 420 421
Interest rate swaps* 5,529 5,710 1,579 3,957

* In addition, the other operations, including the Group Treasury function and the Asian operations, have cross-currency swap assets and liabilities with notional amounts of £492 million (2009: £819 million) and £209 million (2009: £122 million) respectively, forward currency contracts assets and liabilities with notional amounts of £2,619 million (2009: £570 million) and £440 million (2009: £958 million) respectively, interest rate swaps assets and liabilities of £832 million (2009: £793 million) and of £195 million (2009: £522 million), respectively, and cliquet options assets of £nil (2009: £7 million).

These derivatives are used for efficient portfolio management to obtain cost effective and efficient exposure to various markets in accordance with the Group's investment strategies and to manage exposure to interest rate, currency, credit and other business risks. See also note D3 for use of derivatives by the Group's US operations.

The Group uses various interest rate derivative instruments such as interest rate swaps to reduce exposure to interest rate volatility.

The UK insurance operations use various currency derivatives in order to limit volatility due to foreign currency exchange rate fluctuations arising on securities denominated in currencies other than sterling. See also note G2 above. In addition, total return swaps and interest rate swaps are held for efficient portfolio management.

As part of the efficient portfolio management of the PAC with-profits fund, the fund may, from time to time, invest in cash-settled forward contracts over Prudential plc shares, which are accounted for consistently with other derivatives. This is in order to avoid a mismatch of the with-profits investment portfolio with the investment benchmarks set for its equity-based investment funds. The contracts will form part of the long-term investments of the with-profits fund. These contracts are subject to a number of limitations for legal and regulatory reasons.

Some of the Group's products, especially those sold in the US, have certain guarantee features linked to equity indexes. A mismatch between product liabilities and the performance of the underlying assets backing them, exposes the Group to equity index risk. In order to mitigate this risk, the relevant business units purchase swaptions, equity options and futures to match asset performance with liabilities under equity-indexed products.

The US operations and some of the UK operations hold large amounts of interest-rate sensitive investments that contain credit risks on which a certain level of defaults is expected. These entities have purchased some swaptions in order to manage the default risk on certain underlying assets and hence reduce the amount of regulatory capital held to support the assets.

Hedging

The Group has formally assessed and documented the effectiveness of the following hedges under IAS 39.

Fair value hedges

The Group used interest rate derivatives to hedge the interest rate exposures on its US$300 million, 6.5 per cent perpetual subordinated capital securities until September 2010. The hedge terminated at this point. The impact on the Group's income statement was immaterial. Where the hedge relationship has been de-designated and re-designated, the fair value adjustment to the hedged item up to the point of de-designation continues to be reported as part of the basis of the hedged item and is amortised to the income statement based on a recalculated effective interest rate over the residual period to the first break clause date of the perpetual subordinated capital securities.

The Group has chosen to designate as a fair value hedge certain fixed to floating rate swaps which hedge the fair value exposure to interest rate movements of certain of the Group's operational borrowings.

The fair value of the derivatives designated as fair value hedges above at 31 December 2010, was an asset of £5 million (2009: asset of £7 million and liability of £1 million). Movements in the fair value of the hedging instruments of a net loss of £1 million (2009: net loss of £11 million) and the hedged items of a net gain of £1 million (2009: net gain of £11 million) are recorded in the income statement in respect of the fair value hedges above.

Cash flow hedges

The Group has no cash flow hedges in place.

Net investment hedges

The Group has designated perpetual subordinated capital securities totalling US$2.3 billion (2009: US$1.55 billion) as a net investment hedge to hedge the currency risks related to the net investment in Jackson. The carrying value of the subordinated capital securities was £1,462 million as at 31 December 2010 (2009: £966 million). The foreign exchange loss of £45 million (2009: gain of £118 million) on translation of the borrowings to pounds sterling at the statement of financial position date is recognised in the translation reserve in shareholders' equity.

This net investment hedge was 100 per cent effective.

 

Securities lending and reverse repurchase agreements

The Group has entered into securities lending (including repurchase agreements) whereby blocks of securities are loaned to third-parties, primarily major brokerage firms. The amounts above the fair value of the loaned securities required to be held as collateral by the agreements depend on the quality of the collateral, calculated on a daily basis. The loaned securities are not removed from the Group's consolidated statement of financial position, rather they are retained within the appropriate investment classification. Collateral typically consists of cash, debt securities, equity securities and letters of credit. At 31 December 2010, the Group had lent £8,708 million (2009: £10,501 million) of which £6,488 million (2009: £7,910 million) was lent by the PAC with-profits fund of securities and held collateral under such agreements of £9,334 million (2009: £10,669 million) of which £6,910 million (2009: £8,086 million) was held by the PAC with-profits fund.

At 31 December 2010, the Group had entered into reverse repurchase transactions under which it purchased securities and had taken on the obligation to resell the securities for the purchase price of £1,208 million (2009: £1,587 million), together with accrued interest.

Collateral and pledges under derivative transactions

At 31 December 2010, the Group had pledged £800 million (2009: £644 million) for liabilities and held collateral of £804 million (2009: £586 million) in respect of over-the-counter derivative transactions.

In accordance with the Group's accounting policy set out in note A4, impairment reviews were performed for available-for-sale securities and loans and receivables. In addition, impairment reviews were undertaken for the reinsurers' share of insurance contract liabilities.

During the year ended 31 December 2010, impairment losses of £145 million (2009: £647 million) were recognised for available-for-sale securities and loans and receivables. These were £124 million (2009: £630 million) in respect of available-for-sale securities held by Jackson and £21 million (2009: £17 million) in respect of loans and receivables. The 2010 impairment charge for loans and receivables of £21 million (2009: £17 million) relates to loans held by the UK with-profits fund and mortgage loans held by Jackson.

Impairment losses recognised on available-for-sale securities amounted to £124 million (2009: £630 million). Of this amount, 90 per cent (2009: 86 per cent) has been recorded on structured asset-backed securities, primarily due to reduced cash flow expectations on such securities that are collateralised by diversified pools of primarily below investment grade securities. Of the losses related to the impairment of fixed maturity securities, the top five individual corporate issuers made up 32 per cent (2009: 11 per cent), reflecting a deteriorating business outlook of the companies concerned.

The impairment losses have been recorded in 'investment return' in the income statement.

In 2010, the Group realised gross losses on sales of available-for-sale securities of £160 million (2009: £134 million) with 45 per cent (2009: 60 per cent) of these losses related to the disposal of fixed maturity securities of 15 (2009: five) individual issuers, which were disposed of as part of risk reduction programmes intended to limit future credit loss exposure. Of the £160 million (2009: £134 million), £99 million (2009: £6 million) relates to losses on sales of impaired and deteriorating securities.

The effect of those reasonably likely changes in the key assumptions underlying the estimates that underpin the assessment of whether impairment has taken place depends on the factors described in note A3. A key indicator of whether such impairment may arise in future, and the potential amounts at risk, is the profile of gross unrealised losses for fixed maturity securities accounted for on an available-for-sale basis by reference to the time periods by which the securities have been held continuously in an unrealised loss position and by reference to the maturity date of the securities concerned.

For 2010 the amounts of gross unrealised losses for fixed maturity securities classified as available-for-sale under IFRS in an unrealised loss position was £370 million (2009: £966 million). Notes B1 and D3 provide further details on the impairment charges and unrealised losses of Jackson's available-for-sale securities.

 

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