Our commitment to the shareholders who own Prudential is to maximise the value over time of their investment. We do this by investing for the long term to develop and bring out the best in our people and our businesses to produce superior products and services, and hence superior financial returns. Our aim is to deliver top quartile performance among our international peer group in terms of total shareholder returns.
UK Products • Annuities • Corporate and Individual Pensions • With-profits Bonds • Savings and Investment Products • Prudential International – life assurance, savings and investment products
Institutional Business • Segregated fixed interest, pooled pension funds, structured and private finance
Coming into the industry, one of the things on which I have spent time is the way life insurers in the United Kingdom report their financial results. In particular, people often ask why we present these in two different ways: modified statutory basis and achieved profits basis. Philip Broadley, Group Finance Director, talks about this in detail in his Financial Review later in this Report but I wanted to touch briefly on the issue here as it has a direct relationship with our focus on delivering value over the long term.
We are confident that we are managing the business prudently in the current market environment and that we will preserve the Group’s strong competitive position and growth prospects for the benefit of all our shareholders.
Prudential broadened its distribution during the year through a distribution agreement with Abbey National for an initial four-year period. This arrangement anticipates proposed changes to polarisation rules that will liberalise sales channels and allow banks to offer advice on other companies’ regulated 6 Prudential plc Annual Report 2002
JNL has strong product manufacturing and administrative capabilities, a low-cost and flexible infrastructure supported by proprietary technology, a relationship-driven distribution model and effective risk management and financial discipline.
In Force Achieved Profit The UK in force profit (excluding re-engineering costs) of £304 million was down 19 per cent on 2001, principally reflecting lower than expected returns from business in force after applying a lower discount rate, a strengthening of persistency assumptions and negative experience variances.
The overall impact on the Group achieved profit result for 2002 from the use of the revised economic assumptions compared to those used in the prior year has been to increase new business achieved profit (NBAP) by around £20 million and to reduce the in force operating result by around £110 million. Achieved profits basis shareholders’ funds are around £290 million lower than they would have been under the 2001 assumptions.
The US component primarily includes £156 million reflecting the full charge for bond write-downs and impairments incurred in 2002 to the extent that it is not included in operating profit, a £128 million negative variance against long-term investment returns for equity investments, including private equity holdings, and £145 million primarily in relation to changed expectations of future profitability on variable annuity business in force arising from adverse current year equity returns. This arises due to equity market returns in the year being lower than the assumed long-term rate. This gives rise to lower than expected year-end values of variable annuity assets under management with a resulting effect on the level of future account values and hence future profitability.
Egg’s UK banking operations, having become profitable during the fourth quarter of 2001, generated a profit of £35 million before losses on joint ventures of £5 million, excluding the exceptional profit arising from the sale of 15 per cent of Funds 16 Prudential plc Annual Report 2002
Within the improvement in the negative adjustment for shortterm fluctuations the US result has improved from a loss of £368 million in 2001 to a loss of £258 million. The short-term fluctuations in Asia principally reflect the five-year averaging impact of an appreciation in bond values. In addition, the 2001 Group result included a £95 million loss, primarily in respect of the General Insurance operations.
The long-term funds remain well capitalised and the PAC long-term fund is rated AA+ by Standard & Poor’s and Aa1 by Moody’s.
The table below shows the change in the investment mix of Prudential’s main with-profits fund: 31 Dec
Based on achieved operating profits from continuing operations and interest payable on core structural borrowings, interest cover is 9.7 times in 2002 compared to 10.4 times in 2001.
The aim of Prudential’s capital funding programme, which includes the European Medium Term Note programme together with an unlimited commercial paper programme, is to maintain a strong and flexible funding capacity.
Procurement During the year, procurement activity focused on securing significant cost reductions, and ensuring appropriate contractual cover for third party expenditure. A number of initiatives were undertaken to capture the synergies, on common spend areas, across the Group. Prudential has also worked closely with 48 suppliers, as part of its Environmental Supply programme, to improve their environmental impacts.
Shareholders’ funds on an achieved profits basis at a given point in time represent, in present value terms, the value of future cash flows expected to arise from the current book of long-term insurance business plus the net worth of the company. The results can be presented in a way that provides details to management and shareholders of the change in value during the reporting period.
The different timing of profit recognition under the two bases is also shown (bottom right), which demonstrates the cumulative level of profit recognition for the yearly profits shown in the previous chart. It shows that under the achieved profits basis profits emerge earlier, but over time, the total profit is the same under both bases. These charts are purely illustrative of the general features of the different reporting bases.
Communities In partnership with charities and educational bodies, we are actively promoting lifelong financial learning. In 2002, we joined forces with the Organisation for Economic Co-operation and Development (OECD) to fund a major three-year research programme. This will inform dialogue with opinion formers across markets about how financial education might play a part in helping consumers plan effectively for the long term and cater for increasingly complex needs. In the UK, our financial literacy work continues with organisations such as Citizens’ Advice, through the funding of a grant scheme to enable local advice bureaux to deliver community-based projects, supported by a dedicated programme manager.
Dialogue and Communication In setting CR strategy, we benchmark our social and environmental performance against that of our peers in the financial services sector and wider best practice. We also maintain dialogue with business and non-business interest groups in order that our approach to CR remains meaningful and relevant. We are committed to reporting our CR progress publicly on an annual basis, using quantifiable, measurable data where possible.
1. David Clementi Chairman (Age 54) Chairman since 1 December 2002. He is also a non-executive director of Rio Tinto plc with effect from 28 January 2003. From September 1997 to August 2002 he was Deputy Governor of the Bank of England. During this time he served as a member of the Monetary Policy Committee and as a non-executive director of the Financial Services Authority. From 1975 to August 1997 he worked for Kleinwort Benson, latterly as Chief Executive.
Non-executive directors do not have service contracts but are appointed pursuant to letters of appointment which are terminable by the Company at any time without liability for compensation.
Mark Wood (appointed 21 June 2001, note 9) 450 162 42 654 459 275 734
Face value of conditional Conditional awards Conditionally Payments awards Date of outstanding awarded made outstanding end of at 1 Jan 2002 in 2002 in 2002 at 31 Dec 2002 performance
In addition, these directors are eligible for death benefits broadly equivalent to the PSPS death benefits (both the lump sum and the capitalised value of spouse’s and children’s pensions) on that part of their basic salary not covered by the Inland Revenue approved scheme under the Prudential Supplementary Life Assurance Scheme (PSLAS). The premiums paid by the Company to this scheme are a taxable benefit.
It is Group policy to give full and fair consideration and encouragement to the employment of applicants with suitable aptitudes and abilities, and to continuing the employment of staff who become disabled, and to provide training and career development opportunities to disabled employees.
Debtors Debtors arising out of direct insurance operations: Debtors arising out of reinsurance operations 23 21 Other debtors: Tax recoverable 212 174
The net cash (outflow) inflow was invested as follows: Portfolio investments Purchases: Ordinary shares 39 20 Fixed income securities 3,209 2,416
Total banking business liabilities 9,882 7,465 Intragroup liabilities 0 3 Tax balances 20 16 Debenture loans (note 31) 202 124
**Annuity business written by Prudential Annuities Limited, a subsidiary of the with-profits fund of the Prudential Assurance Company Limited (PAC), and by a separate fund of the PAC with-profits fund, which comprises non-participating and linked business purchased from the Scottish Amicable Life Assurance Society.
Tax on profit on ordinary activities (including tax on actual investment returns)* 44 21 *The effective tax rate on total profit was 9% in 2002 and 5% in 2001 due to tax payable on the profit on sale of UK general business operations and on the merger break fee being relieved against capital losses available to the Group.
Deferred tax liability at end of year 696 2,005 72 Prudential plc Annual Report 2002
The balance at beginning of 2002 comprises cost of £258m less accumulated amortisation of £61m and tax of £59m.
The assets in the schemes and the expected rates of return were: Long-term Long-term expected expected
(b) Actuarial losses attributable to shareholders This comprises the losses charged to the statement of total recognised gains and losses, after adjustment for amounts attributable to the PAC with-profit fund, as follows: £m
Consultancy services: Regulatory reviews 1.3 10.7 Tax and accounting advice 0.2 0.3
Other borrowings of general insurance and shareholders’ funds: Bank loans and overdrafts 1 21 1 21 Obligations under finance leases 3 5 3 5
Provisions in respect of the costs associated with the review have been included in the change in the long-term technical provision in Prudential’s profit and loss account. Within the long-term technical provisions, the transfer from the FFA has been determined accordingly. The following is a summary of the changes in the pension mis-selling liability, including internal and external legal and administrative costs, for the years ended 31 December 2002 and 31 December 2001: Year ended Year ended 31 December 31 December £m £m
Guarantees and Commitments Guarantee funds in both the UK and US provide for payments to be made to policyholders on behalf of insolvent life insurance companies. These guarantee funds are financed by payments assessed on solvent insurance companies based on location, volume, and types of business. Prudential estimated its reserve for future guarantee fund assessments for Jackson National Life to be £25m at 31 December 2002. Similar assessments for the UK businesses were not significant. Management believes the reserves are adequate for all anticipated payments for known insolvencies.
The effect of these transactions, which have been accounted for as acquisitions, was: Zebank and
Book and fair value of assets at acquisition 8 21 29
Results for the year Long-term business: New business of continuing operations: Gross premiums written and investment product contributions 31,487 25,263 17,760 16,133 11,009 Operating profit before amortisation of goodwill: US broker dealer and fund management 14 16 7 (6) –
Actual investment return on investments less longer-term returns included within operating profit(iii) (295) (413) Investment return related loss due primarily to changed expectation of profitability on variable annuity business arising from adverse current year equity returns* (145) (85) Transition writedown on implementation of EITF 99-20 for interests in securitised financial assets – (23)
(Loss) profit on ordinary activities before tax (including actual investment gains and losses) (743) (269) 398 5 (609) 126 (483)
Achieved profits basis shareholders’ funds 2,918 2,657 1,407 108 7,090 106 7,196
Under the terms of engagement we are required to report to the Company our opinion as to whether the supplementary information has been properly prepared in accordance with the guidance using the methodology and assumptions set out on page 92. We also report if we have not received all the information and explanations we require for our audit.
Basis of Audit Opinion We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the supplementary information. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the supplementary information, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.