When Mike Wells takes the hot seat at Prudential on Monday, he will in effect take charge of four FTSE 100 companies.
Under his predecessor Tidjane Thiam, the group’s market value ballooned by about £28bn. Each of its four divisions — insurance arms in Asia, the US and UK, and the asset manager M&G — could be members of the blue-chip index in their own right.
Given its recent successes, investors are hoping Prudential will continue under the American in much the same way as it did before: capitalising on the rise of the middle classes in Asia as well as focusing on US and UK baby boomers hitting retirement.
The incoming chief executive, who has worked for Jackson, the Pru’s US business, for 19 years, has already told shareholders to expect him to refrain from making any radical changes — which he calls “our current strategy-plus”.
Yet his ability to do so will depend in part on whether he can successfully navigate choppy regulatory waters in the coming months.
The industry is bracing itself for the new EU-wide Solvency II capital requirements, which finally take effect at the start of next year after a gestation that has lasted more than a decade.
A fund manager at one of Prudential’s largest 20 institutional shareholders said dealing with Solvency II was the “biggest single short-term challenge” for Mr Wells. “It’s got the potential to really screw things up.”
Although policy makers in Brussels have already laid down the regulations, national regulators have yet to fine tune the requirements for each large insurance company. The details will be crucial.
Most big UK insurers face uncertainty while the regulator scrutinises their applications before the rules take effect at the start of next year.
Yet consultants said the stakes were particularly high for Prudential — partly because doubts remain over how its chunky operations in the US and Asia will be treated.
Moreover, Prudential’s share price could be especially sensitive to a disappointing outcome, given that they trade at a multiple of 3.5 times the company’s book value — a significant premium to UK peers.
Prudential gave an indication of the scale of the uncertainty over Solvency II in the small print of its annual report.
As of the end of December, Prudential held surplus capital of £9.7bn. It had an “economic capital ratio” of 218 per cent — meaning it had more than twice the minimum funds required to back the policies it had written.
But in the annual report, the group said an unfavourable treatment of its Asia growth engine under Solvency II had the potential to reduce this surplus by £1.9bn, or 23 percentage points.
It is not just Prudential’s overseas divisions that could be punished under the new regime. Like other UK insurers that write annuities, how its domestic business will be treated also remains uncertain — even though the industry secured a series of concessions from Brussels to make Solvency II less burdensome.
An increase in capital requirements at its UK annuity business could reduce the group’s buffer by £600m. At the same time, the group said that if was granted “transitional relief” — the ability to phase in the new requirements — for its UK annuity operation, it would boost its capital surplus by £1.3bn.
Prudential said these were “intended to provide examples and should not be considered indicative of the adjustments that the PRA may ultimately require.” Overall, though, the insurer cautioned that Solvency II “will result in a lower [capital] ratio”.
Investors regard Prudential as among the best capitalised companies in the sector. Before he left, Mr Thiam said Prudential’s “strong capital position means that Solvency II will be manageable for this group.”
That said, the imposition of more onerous capital requirements could have tangible consequences for Prudential — such as reducing Mr Wells’ leeway to increase dividend payouts.
Edward Houghton, analyst at Bernstein, said: “In a worst-case scenario . . . then Prudential’s economic capital ratio could suffer materially.
“That wouldn’t represent a threat to the current dividend, but it could potentially impact on the group’s ability to progress the dividend as fast as it might otherwise have liked.”
Under Mr Thiam the group had increased its dividend substantially: in four years, according to Eamonn Flanagan at Shore Capital, Prudential lifted its total annual payout from £510m to £900m.
Nevertheless, the shares yield a relatively low 2.5 per cent. Although this is partly a function of a relatively high valuation, some analysts believe the group should consider paying out a higher proportion of its earnings.
A top 20 shareholder said: “There’s scope to significantly increase the dividend.”
Despite the regulatory challenges, Mr Wells — who could collect an annual pay and bonus package of as much as £7.5m if all goes well — is unlikely to allow the new rules to interfere substantially with the company’s plans.
In its annual report Prudential repeated its threat to uproot its headquarters from the UK as a last resort, although people familiar with the matter said the company was not actively preparing to do so.
“We regularly review our range of options to maximise the strategic flexibility,” the report said. “This includes consideration of optimising our domicile as a possible response to an adverse outcome on Solvency II.”