With a proven strategy, and the financial strength, international spread and technical expertise to underpin our growth platform, we are well placed to deliver more.
M&G is Prudential’s UK and European fund management business and has £167 billion of assets under management (as at 31 December 2007) of which £116 billion relates to Prudential’s long-term business funds. M&G aims to maximise profitable growth by operating in markets where it has a leading position and competitive advantage, including retail fund management, institutional fixed income, pooled life and pension funds, property and private finance.
2007 was a highly successful year for Prudential, building on our strong performances in both 2005 and 2006. Over the last three years we have doubled EEV operating profits and almost doubled statutory profits by pursuing our international growth ambitions in a targeted and disciplined way.
In 2007 more than three quarters of the Group’s new business profits came from Asia and the US, which truly differentiates us from other UK and EU life insurers. At the same time, our UK insurance operation is achieving some of the highest returns in its market, and continues to be a significant contributor to IFRS profits through its strong with-profits fund and shareholder-backed annuity business.
Our growing asset management businesses also provided almost a quarter of statutory profits in 2007.
Over the last three years the Group’s senior management, led by Mark Tucker, has developed a robust and sustainable operating model, designed to capitalise on these strengths and capture a significant share of the retirement opportunity in our chosen markets.
The Board will focus on delivering a growing dividend, which will continue to be determined after taking into account the Group’s financial flexibility and opportunities to invest in areas of the business offering attractive returns. The Board believes that in the medium term a dividend cover of around two-times is appropriate.
— By the end of 2007, £115 million of the cost saving target of £195 million had been delivered and plans are in place to deliver the additional £80 million.
— New funds were launched in five Asian markets, the US and the UK.
The variable annuity product in the US is increasingly being used by the consumer to provide an income in retirement. In 2007, almost two-thirds of Jackson’s customers were over 55 and two-thirds of all variable annuity sales included a guaranteed minimum withdrawal benefit. Jackson continues to innovate and develop its market-leading Perspective II product, which has been the top-selling variable annuity contract in the fast-growing Independent Broker channel for each of the last five years.
In 2007 we set out our strategy in the UK to focus primarily on the retirement income market based in particular on our strengths in the annuity market but also the developing lifetime mortgage and income drawdown markets. In the retirement savings market we have exited those product areas that are structurally unprofitable and launched a new range of factory gate priced savings products.
By the end of 2007, £115 million of the cost saving target of £195 million had been delivered and plans are in place to deliver the additional £80 million. A key milestone this year in the UK was the signing of a major contract to outsource a large proportion of its back book and new business policy administration. The outsource agreement will allow us to remove fixed costs from our operations and to achieve significant operating efficiencies, with an expected positive effect on embedded value estimated at £60 million by 2011.
Trusted brands We believe that our brands are a significant advantage in capturing an increasing share of the global retirement market.
Powerful distribution networks Our broad and diverse distribution network is tailored to local market and customer needs, enabling us to deliver our products and services in the most efficient and effective way in each of our chosen markets.
In the US, we have built a highly successful distribution model focused on independent financial advisers, and our Perspective II variable annuity was the top selling variable annuity contract in the US independent broker-dealer channel in 2007. The success of our model lies in the support we give to advisers through our network of wholesalers. This support includes a range of marketing, sales and educational tools to help advisers build their own businesses, combined with award-winning customer service.
Prudential plc is the Group holding company and the principal activity of its subsidiary undertakings is the provision of financial services in Asia, the US and the UK. Its principal subsidiary undertakings are listed in note I6 on page 281.
The comparatives are shown on a constant exchange rate (CER) basis.
Effect of change in time value of cost of options and guarantees: 0 60
included within operating profit in respect of equity-based investments and other items.
The actuarial gain of £116 million (2006: £207 million) included in total profit reflects the shareholders’ share of actuarial gains and losses on the Group’s defined benefit pension schemes. On the EEV basis, this gain includes a 10 per cent share of the actuarial gains and losses on the share attributable to the PAC with-profits sub-fund for the Prudential Staff and Scottish Amicable Pension Schemes. The full year 2007 gains mainly reflect changes in economic assumptions, partly offset by the effect of strengthened mortality assumptions. The very high level of gains in 2006 reflected the excess market returns over the long-term assumption and the increase in discount rate applied in determining the present value of projected pension payments from 4.8 per cent at 31 December 2005 to 5.2 per cent at December 2006.
In Asia positive economic assumption changes were £201 million, of which £110 million is due to Taiwan and £80 million is due to Hong Kong. The Taiwan credit primarily reflects a change of projected fund earned rate, offset by an increase in risk discount rate, whereas Hong Kong primarily reflects a decrease in the risk discount rate. Taiwan interest rates performed in line with the assumed EEV trended basis.
The £137 million charge for short-term fluctuations in investment returns comprises £71 million, £18 million, £47 million and £1m in respect of Asian operations, US operations, UK operations and other respectively.
£30 million reduction in the value of an investment in a CDO fund, partially offset by strong equity movements in Vietnam.
Jackson National Life Insurance Company’s (Jackson) primary focus is manufacturing profitable, capital-efficient products, such as variable annuities, and marketing these products to advice-based channels through its relationshipbased distribution model. In developing new product offerings, Jackson leverages a low-cost, flexible technology platform to manufacture innovative, customisable products that can be brought to the market quickly.
The fixed index annuity new business margin decreased from 31 per cent in 2006 to 26 per cent in 2007, primarily as a result of a change in expected future surrender charges.
During 2007, M&G has exercised continued cost discipline to ensure that top-line growth feeds through to profitability and cash generation. M&G’s cost/income ratio for 2007 was 66 per cent (2006: 71 per cent), having fallen from 83 per cent in 2003.
Explanation of balance sheet structure The Group’s capital on an IFRS basis comprises of shareholders’ funds of £6,201 million, subordinated long-term and perpetual debt of £1,570 million, other core structural borrowings of £922 million and the unallocated surplus of with-profits funds of £14.4 billion.
Jackson’s invested asset mix on a US regulatory basis (excludes policy loans and reverse repo leverage) is as follows: Bonds: Investment Grade Public 59 60 58 Investment Grade Private 18 18 19 Non-Investment Grade Public 3 4 5 Non-Investment Grade Private 2 1 2
In addition to the life products described above, Prudential offers mutual fund investment products in India, Taiwan, Japan, Singapore, Malaysia, Hong Kong, Korea, Vietnam and China, allowing customers to participate in debt, equity and money market investments. It is also licensed in United Arab Emirates. Prudential Corporation Asia earns a fee based on assets under management.
Institutional products Jackson’s institutional products division markets institutional products such as traditional Guaranteed Investment Contracts (GICs), Funding Agreements and Medium Term Note (MTN) funding agreements. The institutional product offerings also include Jackson’s funding agreements issued to the Federal Home Loan Bank. Jackson distributes its institutional products directly to investors, through investment banks or through funding agreement brokers.
The EEV Principles were a significant step towards the harmonisation of embedded value reporting in Europe. However, even with these principles and the accompanying guidance, a divergence of approaches between companies has emerged in practice. In order to further improve consistency and transparency of embedded value reporting, the CFO Forum is currently developing revised principles based on a market-consistent approach to embedded value reporting. These are expected to be published during 2008.
Derivative hedging strategies are also used on a controlled basis across the Group to manage exposure to market risks. Surplus assets held centrally are predominantly invested in short-term fixed income securities. The Group’s central treasury function actively manages the surplus assets to maximise returns, subject to maintaining an acceptable degree of liquidity.
The Group Executive Committee and Board are provided with regular updates on the Group’s economic capital position, overall position against risk limits and RAP. They also receive the annual financial condition reports prepared by the Group’s insurance operations.
For the purposes of calculating Group economic capital, Group ‘economic solvency’ is defined as the position where both: (a) the capital balance of the parent company is positive, and (b) all business units are solvent on the applicable local regulatory basis. This definition of solvency allows the Group’s capital position to be assessed on an economic basis while taking into account the actual regulatory constraints at the business unit level.
Credit risk Credit risk is the risk of loss if another party fails to meet its obligations, or fails to perform them in a timely manner. Credit risk is Prudential’s most significant financial risk, and it is actively monitored by business units via business unit investment committees and ALCos.
Business units are responsible for the management of the non-financial risks associated with their business. They conduct a formal self-assessment of material operational risks and assess their impact and likelihood. Business units also identify controls available to mitigate the impact and/or likelihood of the identified risk. The quality of the control’s design is also assessed.
In the UK, via partnerships with such diverse organisations as Citizens Advice; the Personal Finance Education Group (pfeg); Specialist Schools and Academies Trust and National Institute of Adult Continuing Education, thousands of adults and children are now benefiting from learning how to make decisions that will have a profound effect on their financial well-being.
Responsible Investment (RI) M&G‘s approach to responsible investment (RI) is set out in the booklet ‘Issues Arising from Share Ownership’, available at (www.mandg.co.uk). RI has focused principally on equity markets. However, with around £19.3 billion (as at 31 December 2007) of funds under management, PRUPIM, is one of the UK’s largest commercial property investment managers and accounts for over 75 per cent of Prudential’s direct environmental impact in the UK. Through participation in the Institutional Investors Group on climate change and its participation on the property working group of the United Nations Environment Programme Finance Initiative (UNEPFI), PRUPIM is creating awareness of the implications of climate change for property investment and how Prudential can constructively address this important issue.
As part of our reward practices we believe it is important to enable employees to share in the success of the Group through share ownership. In the UK we operate two all employee share plans: a share investment plan and a save as you earn scheme. Fifty three per cent of eligible employees in the UK participate in the save as you earn scheme and nine per cent in the share investment plan. In Asia we operate two save as you earn schemes similar to the UK scheme: one for employees and one for agents. Twenty-one per cent of eligible employees and 15 per cent of eligible agents participate in these schemes.
Customers Prudential has approximately 10 million customers in Asia, over three million policies and contracts in force across the US through Jackson, and over seven million customers in the UK through Prudential UK. 160 years after its foundation, Prudential remains committed to providing a high level of customer service, communicating openly with customers, providing clear information and to monitoring levels of satisfaction.
It is therefore Prudential’s policy to work in partnership with its suppliers who operate with policies and procedures consistent with the standards set out in its Group Code of Business Conduct and to help them reduce their impact on the environment. Procurement practices in Prudential UK have been successfully accredited with the Chartered Institute of Purchasing and Supply certification, which is an industry benchmark of recognised good practice.
C orporate governance 86 Board of directors 89 Corporate governance report
6 Unable to attend one scheduled Board meeting due to a long-standing prior commitment.
He was the acting Chief Executive Officer of Citigroup Inc. from 5 November 2007 to 11 December 2007 when he was appointed Chairman of Citigroup Inc. Prudential has a number of business relationships with Citi. The Board believes that, in respect of the Combined Code, these business relationships are not sufficiently material to compromise his independence in matters relating to Prudential.
In performing its duties, the Committee has access to employees and their financial or other relevant expertise across the Group and to the services of the Group-wide Internal Audit Director and the Company Secretary. The Committee may also seek external professional advice at the Group’s expense.
All services provided by the auditor in accordance with this policy are pre-approved by the Committee. The Committee reviewed and updated the policy in 2007 to ensure alignment with the latest standards and best practice in establishing, maintaining and monitoring auditor independence and objectivity.
Following its review of the external auditor’s effectiveness and independence, the Committee has recommended to the Board that KPMG Audit Plc be re-appointed as auditor of the
The provisions of Section 404 of the Act require the Company’s management to report on the effectiveness of internal controls over financial reporting in its annual report on Form 20-F, which is filed with the US Securities and Exchange Commission. To comply with this requirement to report on the effectiveness of internal control, the Group has undertaken a significant project to document and test its internal controls over financial reporting in the format required by the Act. The annual assessment and related report from the external auditor will be included in the Group’s annual report on Form 20-F that will be published in the coming months.
The Committee sought the views and assistance of Priscilla Vaccasin, Group Human Resources Director, Hilary Oliver, Director of Group Reward and Employee Relations and Philip Broadley, Group Finance Director. In making its decisions, the Committee also requested consultancy assistance from Deloitte and Touche LLP and PricewaterhouseCoopers LLP, market data from Deloitte and Touche LLP, Towers Perrin and McLagan and legal advice, including employment law and advice on the operation of the Company’s share plans from Freshfields Bruckhaus Deringer, Slaughter and May, and Linklaters. Some of these companies also provided other services to the Company: Deloitte and Touche LLP and PricewaterhouseCoopers LLP in relation to advice on taxation and finance matters, Towers Perrin in relation to advisory work on finance matters, Freshfields Bruckhaus Deringer and Slaughter and May in relation to advice on commercial and corporate law.
All executive directors are provided with awards under the Group Performance Share Plan and those heading businesses have additional long-term incentive plans relating to their businesses (the Business Unit Performance Plans or in the case of the Chief Executive of M&G the proposed M&G Executive LTIP described on page 108). For full details of the plans for the other executive directors see the section on ‘Executive directors’ long-term incentive plans’ on page 105.
Determined by market comparison/ practice. No new executive directors appointed since June 2003 participate in defined benefit pension plans.
To ensure close alignment with our shareholders’ longterm interests, participants receive the value of reinvested dividends over the performance period for those shares that vest.
The value of the vested shares will be paid in cash after the end of the three-year performance period.
In order to compensate him for the loss of his 2007 bonus, it was necessary to provide Tidjane Thiam with a cash payment of £325,000 on joining and an award of shares to be deferred for three years with a value of £325,000.
(until 14 December 2006)note 4 – – – – – 1,345 – Nick Prettejohn
5 It is anticipated that for Nick Prettejohn a deferred share award from the 2007 annual bonus valued at £307,625 will be made. This is included in the 2007 bonus figure.
Clark Manning Restricted Share Plan 2004 196,174 –1 31 Dec 06
(options) Conditional Market granted Conditional share awards Conditional price at upon share awards outstanding at awards date of vesting in outstanding at
Business Unit Performance Plan (Cash element) 2007 400 400 31 Dec 09
Group Performance Share Plan Awards under the Group Performance Share Plan are described on page 105.
Conditional Conditional share share awards Con- Scrip awards Market Market Year of outstanding ditionally dividends Shares outstanding Shares price at price at initial at 1 Jan awarded accumu- released at 31 Dec Date of released original date of grant 2007 in 2007 lated in 2007 2007 end of in 2007 date of vesting or
Equity securities and portfolio holdings in unit trusts 86,157 78,892 Debt securities 83,984 81,719 Other investments 4,396 3,220
In 2005 the Group chose to improve its IFRS accounting for UK regulated with-profits funds by the voluntary application of the UK accounting standard FRS 27, ‘Life Assurance’. Under this standard, the main accounting changes that were required for UK with-profits funds were: — Derecognition of deferred acquisition costs and related deferred tax; and — replacement of MSB liabilities with adjusted realistic basis liabilities.
Jackson Jackson offers individual fixed annuities, fixed index annuities, immediate annuities, variable annuities, individual and variable life insurance and institutional products. With the exception of institutional products and an incidental amount of business for annuity certain contracts, which are accounted for as investment contracts under IAS 39, all of Jackson life assurance contracts are accounted for under IFRS 4 as insurance contracts by applying US GAAP, the previous GAAP used before IFRS adoption. Under US GAAP the requirements of SFAS 60 ‘Accounting and Reporting for Insurance Enterprises’ and SFAS 97 ‘Accounting and Reporting by Insurance Enterprises for certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments’ apply to these contracts. The accounting requirements under these standards and the effect of changes in valuation assumptions are considered below for fixed annuity, variable annuity and traditional life insurance contracts.
Claims paid include maturities, annuities, surrenders and deaths. Maturity claims are recorded on the policy maturity date. Annuity claims are recorded when the annuity becomes due for payment. Surrenders are recorded when paid and death claims are recorded when notified.
The tax charge for long-term business includes tax expense on with-profits funds attributable to both the policyholders and the shareholders. Different tax rules apply under UK law depending upon whether the business is life insurance or pension business. Tax on the life insurance business is based on investment returns less expenses attributable to that business. Tax on the pension business is based on the shareholders’ profits or losses attributable to that business. The shareholders’ portion of the long-term business is taxed at the shareholders’ rate with the remaining portion taxed at rates applicable to the policyholders.
For such business the policyholder liabilities are directly reflective of the asset value movements. Accordingly all asset value movements are recorded in the operating results based on longer-term investment returns.
Profit from continuing operations before tax attributable to shareholders 1,166 1,372
Actual credit related losses in the year Bond writedowns (35) (32) Losses on sales of impaired and deteriorating bonds (51) (3) Recoveries/reversals 8 10
Based on profit for the year 1,388 (363) (3) 1,022 41.8p 41.7p 154 Prudential plc Annual Report 2007
Asian operations 16 (97) US operations (43) (384) Unallocated to a segment (Central funds) 38 257
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Investment contract liabilities with
Business units must establish suitable market, credit, underwriting and liquidity limits that maintain financial risk exposures within the defined Group risk appetite.
Internal compliance managers who report to the local management boards monitor adherence to local regulatory requirements. The head of Prudential’s Group Compliance function reports directly to the Group Chief Executive who submits regular reports to the Board of Directors.
In addition to obligations under subsidiary and Group regulatory requirements, Prudential applies an economic framework to its management of capital.
Product specific discount rates are used in order to reflect the risk profile of each major territory and product group. No allowance is required for non-market risks where these are assumed to be fully diversifiable. The majority of non-market risks are considered to be diversifiable. Finance theory cannot be used to determine the appropriate component of beta for nondiversifiable non-market risks since there is no observable risk premium associated with it that is akin to the equity risk premium.
— The Group’s shareholder results are most sensitive to market risks for assets of shareholder-backed business. — The main exposures of the Group’s IFRS basis results to market risk for life assurance operations on investments of shareholder-backed business are for debt securities.
— Other shareholder backed unit-linked business Due to the matching of policyholder liabilities to attaching asset value movements the UK unit-linked business is not directly affected by market or credit risk. The principal factor affecting the IFRS results is investment performance through asset management fees.
In the years 2003 to 2007, claims paid on the Group’s life assurance contracts including those classified as investment contracts under IFRS 4 ranged from £11.8 billion to £17.1 billion. Indicatively it is to be expected that of the Group’s policyholder liabilities (excluding unallocated surplus) at 31 December 2007 of £176 billion, the amounts likely to be paid in 2008 will be of a similar magnitude.
D2: UK insurance operations continued c Products and guarantees Prudential’s long-term products in the UK consist of life insurance, pension products and pension annuities.
There was no change in mortality assumptions for PAL in 2006 which had a material effect on the measurement of the insurance liabilities. Liabilities for PAL were increased by £47 million for the effect of change of assumptions for renewal expenses. As PAL is owned by the WPSF, this change had no effect on shareholder profit.
Equity/property yields – 1% rise 405 382 Equity/property market values – 10% fall (519) (502)
The market risk sensitivities shown above reflect the impact of temporary market movements and, therefore, the primary effect of such movements would, in the Company’s supplementary analysis of profits be included within the short-term fluctuations in investment returns.
Operating profit based on longer-term investment returns 444 398 Short-term fluctuations in investment returns (18) 53
iv Summary policyholder liabilities (net of reinsurance) and reserves at 31 December 2007 The policyholder liabilities, net of reinsurers’ share of £436 million (2006: £427 million), reflect balances in respect of the following: £m £m
Note D3(i) parts (iii) and (iv) show the sensitivities of Jackson’s results through its exposure to equity risk and interest rate risk.
Non-participating long-term products are the only ones where the insurer is contractually obliged to provide guarantees on all benefits. Investment-linked products have the lowest level of guarantee if indeed they have any.
A 10 per cent increase or decrease in these rates and those of other Asian operations would have reduced or increased profit before tax attributable to shareholders, profit for the year and shareholders’ equity, excluding goodwill, attributable to Asian operations respectively as follows: A 10% increase in A 10% decrease in exchange rates exchange rates
WPSF profits funds assurance assurance subsidiaries Group 31 December 2007 SAIF note i fund note ii Jackson subsidiaries operations M&G and funds total
Group shareholders’ equity Held outside long-term funds: Held in long-term fundsnote iii – – – 814 – – 814 – – 814
iv For regulatory purposes the Jackson surplus notes are accounted for as capital. v Other adjustments to shareholders’ equity and unallocated surplus include amounts for the value of non-participating business for UK regulated with-profits funds, deferred tax, admissibility and other items measured differently on the regulatory basis. For 2006 the other adjustments for UK regulated with-profits funds included inadmissible assets of the WPSF of £ (256) million. For Jackson the principal reconciling item is deferred tax related to deferred acquisition costs of £675 million (2006: £599 million).
ii Debt securities Of the debt securities of £857 million for M&G at 31 December 2007, £278 million were rated AAA by Standard and Poor’s, £6 million AA+, £42 million AA, £271 million AA-, £162 million A+, £7 million A and £ 29 million A-. Of the £62 million which was not rated by Standard and Poor’s £46 million was rated Aaa by Moody’s.
Long-term business, including post-tax transfers to unallocated surplus of with-profits funds (30,533) (32,162)
Within segment results above, the share of post-tax profit of associates that are equity accounted for of £nil (2006: £1 million) is allocated to the discontinued banking segment.
The shareholder elements are the components of the profit and tax charge that are of most direct relevance to investors, and it is this aspect that the IAS 12 requirement is seeking to explain for companies that do not need to account for both with-profits and unit-linked funds, where tax is borne by the Company on the policyholders’ behalf and which is not contemplated by IFRS requirement iii Basis of taxation for UK life and pension business Different rules apply under UK tax law for taxing pension business and life insurance business and there are detailed rules for apportioning the investment return and profits of the fund between the types of business.
F5: Tax continued The accounting anomaly that arises under IFRS is that due to the fact that the net of tax profit attributable to with-profits policyholders is zero, the Company’s presentation of pre-tax profit attributable to policyholders reflects an amount that is the mirror image of the tax charge attributable to policyholders.
Expected tax charge based on expected tax rates: Operating profit based on longer-term investment
Other investmentsnote iii 3,220 – – 3,220 3,220 Accrued investment income – – 1,900 1,900 1,900
The fair values of the financial instruments for which fair valuation is required under IFRS and which are in an active market are determined by the use of current market bid prices for quoted investments, or by using quotations from independent third parties, such as brokers and pricing services. If the market for a financial investment of the Group is not active, the Group establishes fair value by using valuation techniques. The valuation techniques include the use of 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 and 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.
The total fair value balances of derivative assets and liabilities as at 31 December 2007 were as follows: 2007 £m
G3: Derivatives and hedging continued The notional amount of the derivatives, distinguishing between UK insurance, US, discontinued banking and other operations was as follows: 2007 £m
During the period of ownership in 2007 and in 2006, Egg used derivative instruments for the purpose of supporting the strategic and operational business activities and reducing and eliminating the risk of loss arising from changes in interest rates and foreign exchange rates. Derivatives were used solely to hedge risk exposures and Egg did not take any trading position in derivatives.
Impairment losses recognised on available-for-sale securities amounted to £30 million (2006: £24 million). Of this amount, 14 per cent (2006: 76 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. 57 per cent (2006: 24 per cent) of the losses related to the impairment of fixed maturity securities of the top five individual corporate issuers, reflecting a deteriorating business outlook of the companies concerned.
b Deferred acquisition costs and acquired in-force value of long-term business contracts attributable to shareholders Other intangible assets in the Group consolidated balance sheet attributable to shareholders consist of: Deferred acquisition costs (DAC) related to insurance contracts as classified under IFRS 4 2,644 2,315 Deferred acquisition costs related to investment management contracts, including life assurance contracts classified as financial instruments and investment management contracts under IFRS 4 113 110
The movement on reinsurers’ share of insurance contract liabilities is as follows: Movement in the year (147) (265) Foreign exchange translation differences (7) (60)
Of the above net book amounts, £nil (2006: £102 million) of Group occupied property and £nil (2006: £261 million) of tangible assets are attributable to consolidated venture investment subsidiaries of the PAC with-profits fund at 31 December 2007. All additions arising on acquisition of subsidiaries relate to acquisitions of venture investment subsidiaries of the PAC with-profits fund.
Future minimum lease payments are due as follows: Less than 1 year 5 4
A summary of the movements in investments in associates accounted for using the equity method in 2007 and 2006 is set out below: Share of Share of Share of Total carrying capital reserves net assets Goodwill value £m £m £m £m £m
In addition, in the year ended 31 December 2007 Prudential Assurance’s main with-profits fund paid compensation of £5 million (2006: £11 million) in respect of mortgage endowment products mis-selling claims and at 31 December 2007 held a provision of £55 million (2006: £60 million) in respect of further compensation. The movement in this provision has no impact on the Group’s profit before tax.
Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the Prudential Assurance long-term fund would be liable to cover any such deficiency. Due to the quality and diversity of the assets in SAIF and the ability of SAIF to revise guaranteed benefits in the event of an asset shortfall, the directors believe that the probability of either the Prudential Assurance long-term fund or the Group’s shareholders’ funds having to contribute to SAIF is remote.
At 31 December 2007, Jackson has unfunded commitments of £181 million (2006: £174 million) related to its investments in limited partnerships and of £104 million (2006: £38 million) related to commercial mortgage loans. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
I1: Staff and pension plans a Staff and employment costs The average number of staff employed by the Group during the year were: Business operations: UK operations 7,732 8,259 US operations 3,123 2,863 Asian operations 16,807 12,114
Under IAS 19 the basis of valuation differs markedly from the full triennial valuation basis. In particular, IAS 19 requires assets of the scheme to be valued at their market value at the year end, while pension liabilities are required to be discounted at a rate consistent with the current rate of return on a high quality corporate bond. As a result, the difference between IAS 19 basis assets and liabilities can be volatile. For those schemes such as PSPS, which hold a significant proportion of their assets in equity investments, the volatility can be particularly significant. On the economic basis (including investments of PSPS and the M&G scheme in Prudential policies as assets) for 2007, a £23 million (2006: £28 million) pre-tax shareholder charge to operating results based on longer-term returns arises. In addition, outside the operating result but included in total profits is a pre-tax shareholder credit of £90 million (2006: £167 million) for net actuarial gains.
iii In addition to PSPS, there are two smaller schemes in the UK, the Scottish Amicable Pension Scheme, and the M&G Pension Scheme, with a combined deficit at 31 December 2007 of £71 million (2006: £67 million), gross of tax. There is also a small scheme in Taiwan, which at 31 December 2007 had a deficit of £10 million (2006: £9 million), gross of tax.
b Relating to Egg plc shares In April 2006, Prudential became bound or entitled to acquire shares in Egg following the announcement of its intention in December 2005 to acquire the minority interests in Egg representing approximately 21.7 per cent of the existing issued share capital of Egg. As a consequence of this acquisition, employees of Egg that were participants of its SAYE schemes were requested to either rollover all or part of their options for equivalent options in Prudential shares or to take no action. Employees could adopt different courses of actions for options granted on different dates but may only adopt one course of action in respect of each grant of options. The rollover was based on employees receiving 0.2237 Prudential shares for each Egg share that was under option with total amount payable for the new Prudential shares being exactly the same as the total amount payable for the Egg shares. As a result, all outstanding executive share options became exercisable and awards under the RSP were assessed against the performance conditions. None of the awards met the performance conditions and they have therefore lapsed in February 2006 following consideration of the performance measurement results by the Remuneration Committee.
Minimum lease rental payments for the year ended 31 December 2007 of £50 million (2006: £50 million) are included in the consolidated income statement.
The interest expense on financial liabilities not at fair value through profit and loss for the period of ownership in 2007 was £148 million (2006: £428 million).
J4: Maturities of assets and liabilities and liquidity risk continued The following table analyses the assets and liabilities of Egg into relevant maturity groupings based on the remaining period at 31 December 2006 to the contractual maturity date.
Liabilities Banking customer accounts 5,554 4.9 Core structural borrowings of shareholder-financed operations 451 6.2 Operational borrowings attributable to shareholder-financed operations 2,819 5.4 *Egg also classified £41 million of debt securities as fair value through profit and loss.
Fixed assets Investments: Shares in subsidiary undertakings 4 7,151 6,085 Loans to subsidiary undertakings 4 2,809 2,841
Borrowings Borrowings are initially recognised at fair value, net of transaction costs, and subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds, net of transaction costs, is amortised through the profit and loss account to the date of maturity.
Other assets and liabilities denominated in foreign currencies are also converted at year end exchange rates with the related foreign currency exchange gains or losses reflected in the profit and loss account for the year.
For the purpose of preparing consolidated financial statements, the Group applies IFRS basis accounting including IAS 19, ‘Employee Benefits’. However, the individual accounts of the Company continue to follow UK GAAP. In 2006, the Company early adopted the amendment to FRS 17 issued in December 2006 which aligned the FRS 17 disclosures with IAS 19.
Fair value of scheme assets, beginning of year 4,748 4,397 Expected return on scheme assets 276 266 Employee contributions 2 1 Employer contributions* 82 137 Actuarial (losses) gains (12) 141 Benefit payments (207) (194)
Less: additional losses on change of estimate of allocation of opening
‘Key management remuneration’ of the notes on the financial statements of the Group. b Information on transactions of the directors with the Group is given in note I5 ‘Related party transactions’ of the notes on the financial statements of the Group. c The Company employs no staff. d Fees payable to the Company’s auditor for the audit of the Company’s annual accounts were £0.1 million (2006: £0.1 million).
Respective responsibilities of directors and auditor The directors’ responsibilities for preparing the Annual Report and the Group financial statements in accordance with applicable law and International Financial Reporting Standards (IFRS) as adopted by the European Union (EU), and for preparing the parent company financial statements and the directors’ remuneration report in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice) are set out in the statement of directors’ responsibilities on page 300. Our responsibility is to audit the financial statements and the part of the directors’ remuneration report to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland).
Earnings per share – EEV basis Year ended 31 December 2007
Jackson issues VA contracts where it contractually guarantees to the contract holder either a) return of no less than total deposits made to the contract adjusted for any partial withdrawals, b) total deposits made to the contract adjusted for any partial withdrawals plus a minimum return, or c) the highest contract value on a specified anniversary date adjusted for any withdrawals following the contract anniversary. These guarantees include benefits that are payable in the event of death (guaranteed minimum death benefit (GMDB)), annuitisation (guaranteed minimum income benefit (GMIB)), or at specified dates during the accumulation period (guaranteed minimum withdrawal benefit (GMWB) and guaranteed minimum accumulation benefit (GMAB)). Jackson hedges these risks using equity options and futures contracts.
2 Methodology continued Time value The value of financial options and guarantees comprises two parts. One is given by a deterministic valuation on best estimate assumptions (the intrinsic value). The other part arises from the variability of economic outcomes in the future (the time value).
They are determined by considering how the profits from each product are affected by changes in expected returns on various asset classes. By converting this into a relative rate of return it is possible to derive a product specific beta.
Malaysia Philippines Singapore Taiwan Thailand Vietnam Malaysia Philippines Singapore Taiwan Thailand Vietnam notes iv,v notes iv,v notes ii,v notes iv,v notes iv,v notes ii,v
– other business 6.25 5.3 Expected long-term rate of inflation 3.2 3.1
iv Subsequent to 29 September 2007, following expiry of the previous management agreement, CITIC-Prudential Life Insurance Company Ltd (CITIC-Prudential), the Group’s life operation in China, has been accounted for as a joint venture. Prior to this date, CITIC-Prudential was consolidated as a subsidiary undertaking. The amounts in the table above include 100 per cent of the total premiums for this operation up to 29 September 2007 and 50 per cent thereafter, being the Group’s share after this date.
Operating EPS from continuing operations: Operating profit before tax 2,542 2,133
US operations Jackson (net of surplus note borrowings of £147m (2006: £158m):note iv
Expected return on existing businessnote vi 99 48 147 706 853 Changes in operating assumptions and experience
Embedded value of Interest rates long-term 1% 1% operations increase decrease 2007 £m £m £m
Embedded in the in the value at starting starting 31 Dec 2006 bond rate bond rate £m £m £m ii UK insurance operations 2006 comparatives for the sensitivity to interest rate changes have been adjusted from previously published data for the effect of revisions to the calculation for the with-profits fund.
In preparing the EEV supplementary information, the directors have: — Prepared the supplementary information in accordance with the EEV Principles; — identified and described the business covered by the EVM; — applied the EVM consistently to the covered business; — determined assumptions on a realistic basis, having regard to past, current and expected future experience and to any relevant external data, and then applied them consistently; — made estimates that are reasonable and consistent; and — described the basis on which business that is not covered business has been included in the supplementary information, including any material departures from the accounting framework applicable to the Group’s financial statements.
Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential outsources several operations, including in the UK a significant part of its back office and customerfacing functions as well as a number of IT functions. In turn, Prudential is reliant upon the operational processing performance of its outsourcing partners.
A further example is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (persistency). This is particularly relevant to its lines of business other than its UK annuity business. Prudential’s persistency assumptions reflect recent past experience for each relevant line of business. Any expected deterioration in future persistency is also reflected in the assumption. If actual levels of future persistency are
A dditional inform ation significantly lower than assumed (that is, policy termination rates are significantly higher than assumed), Prudential’s results of operations could be adversely affected.
Prudential plc is a holding company, some of whose subsidiaries are authorised and regulated by the Financial Services Authority (FSA)