PRUDENTIAL PLC’S STRONG MIX OF BUSINESSES AROUND THE WORLD POSITIONS US WELL TO BENEFIT FROM THE GROWTH IN CUSTOMER DEMAND FOR ASSET ACCUMULATION AND INCOME IN RETIREMENT. OUR INTERNATIONAL REACH AND DIVERSITY OF EARNINGS BY GEOGRAPHIC REGION AND PRODUCT WILL CONTINUE TO GIVE US A SIGNIFICANT ADVANTAGE.
1 Group Financial Highlights 2 Chairman’s Statement 4 Group Chief Executive’s Review 6 Business Review 11 Financial Review 27 Corporate Responsibility Review 30 Board of Directors 32 Corporate Governance Report 38 Remuneration Report 53 Directors’ Report 55 Summary of Statutory Basis Results 56 Consolidated Profit and Loss Account 59 Consolidated Statement of Total
Members of Prudential plc 98 Five Year Review 100 Risk Factors 103 Achieved Profits Basis Supplementary
Losses – Achieved Profits Basis 105 Reconciliation of Movements in Shareholders’ Capital and Reserves – Achieved Profits Basis 105 Summarised Consolidated Balance Sheet – Achieved Profits Basis 106 Notes on the Achieved Profits Basis Supplementary Information 115 Statement of Directors’ Responsibilities in relation to the Achieved Profits Basis Supplementary Information 115 Independent Auditors’ Report to Prudential plc on the Achieved Profits Basis Supplementary Information 116 Shareholder Information IBC How to Contact Us
1848 Prudential founded 1929 Group Pensions established 1997 Scottish Amicable acquired by Prudential 2002 Relaunch of the Prudential brand and launch of ‘The Plan from the Pru’
CUSTOMERS Over three million customers and a market share of nearly six per cent of UK credit card balances
JNL's investment portfolio manager, PPM America Inc., manages around US$68 billion of assets
PCA pioneered a unit-linked product in Malaysia, Indonesia, the Philippines, Singapore and Taiwan
Provident Fund business in Hong Kong • CITIC for life business in China (Guangzhou and Beijing) • ICICI Bank for life and mutual funds business in India • Across the region PCA now has a total of 29 bancassurance agreements in 11 countries including Standard Chartered Bank (SCB) in Hong Kong, Malaysia, Singapore, Taiwan and Thailand
Also part of M&G Prudential Property Investment Managers Limited (PruPIM) PPM Ventures Limited PPM South Africa
Insurance and Investment Funds under Management £168bn £155bn †Operating profit and operating earnings per share include investment returns at the expected long-term rate of return but exclude amortisation of goodwill and exceptional items. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities and basic earnings per share include these items together with actual investment returns. This basis of presentation has been adopted consistently throughout these financial statements.
At our interim results last year in July, we said that we had reviewed our dividend policy to ensure that this reflected both our operating cash flows as well as our strategy of investing in the business for long-term growth. Accordingly, the Board has decided to pay a total dividend for the year of 16 pence per share. We recognise that the dividend payment is very important to many shareholders, large and small alike, and the reduction from last year will be unwelcome. But we believe that the new level is one from which it will be possible to grow the dividend in the future. The level of growth will be determined after considering the opportunities to invest in those areas of our business offering attractive growth prospects, our financial flexibility and the development of our statutory profits over the medium to long-term.
As markets around the world recover, a key issue to be addressed is the need to restore consumer confidence in financial services at a time when saving for long-term security has never been more important. At Prudential, we are very aware of our responsibility to our customers: they have placed their trust in us and we believe that more can be done to help prospective and existing customers understand the nature of the financial decisions they are taking. Our interest in informed and satisfied customers goes beyond our immediate commercial interest. In many of the countries in which we operate, there is a recognition that the financial services industry should work in partnership with government, regulators and consumer groups to raise the basic level of financial skills.
Over the last 12 months, there have been a number of changes to our Board. Mark Tucker resigned as Chief Executive of Prudential Corporation Asia (PCA) with effect from the end of June. Under his leadership, PCA has become the leading European life insurer in the region, and
I would like to thank him for his significant contribution to Prudential and to wish him well for the future. In January 2004, Mark Norbom joined us as Chief Executive of PCA.
Sir David Barnes stood down as a non-executive director at our Annual General Meeting in May, having served on the Board for over four years. Ann Burdus retired as a nonexecutive director at the end of the year, having served on the Board for seven years. I would like to thank them both for their invaluable contribution and to wish them well for the future. Two new non-executive directors were appointed during the year: Kathleen O’Donovan joined us in May; and Bridget Macaskill rejoined us in September having previously been a non-executive director at Prudential for almost two years until March 2001. We were delighted to welcome both of them to the Board.
Since this time last year, the Combined Code for listed companies has been amended to take account of proposals arising from the Report by Sir Derek Higgs on the role and effectiveness of non-executive directors. We support the changes and believe that they represent a fair attempt to capture good governance practice. It is important to remember that the Code is a Code of Good Practice, subject to the principle of ‘comply or explain’; and that ‘best practice’ must depend on the specific circumstances of individual companies. Shareholders still need to look at individual cases and exercise judgement. M&G, our investment management business, is one of the largest investors in UK-listed companies and will continue to exercise such judgement.
In my review in last year’s Annual Report, I talked about the importance of our international reach and diversity of earnings and the need to manage the business prudently in challenging market conditions to preserve our strong competitive position and growth prospects in each of the markets we operate in around the world.
This was particularly important during 2003 when instability in international markets, volatile bond and equity markets and an uncertain economic outlook all had a negative impact on consumer confidence for much of the year. Against this background, we maintained our clear focus on investing for value and allocated capital to those areas of our business generating higher returns.
Specifically, we continued to grow our Asian operations; increased Jackson National Life’s market share in core product areas on a self-financing basis; and grew our shareholder-backed businesses in the UK.
There were some increasingly positive trends in the third and fourth quarters as markets began to stabilise and sales started to recover, and we ended the year in good shape. We have one of the strongest UK life funds in the industry, our capital position is strong and we are well placed to manage the business for growth.
GROUP RESULTS Total Group insurance and investment sales of £31.5 billion were up 11 per cent on 2002 at constant exchange rates (CER). On an annual premium equivalent (APE) basis, insurance sales for the year were down 12 per cent at CER to £1.6 billion but sales in the fourth quarter increased by nine per cent on the third quarter. Total Group insurance and investment funds under management as at 31 December 2003 were £168 billion compared with £150 billion at the end of 2002 at CER.
Modified statutory basis (MSB) operating profits decreased 17 per cent to £357 million at CER, principally due to lower annual and terminal bonus rates in the UK in 2003 which affected the shareholder transfer from the long-term fund.
In these difficult markets, our continued focus on value and in particular higher margin business enabled us to report a Group new business margin of 38 per cent, a level that we have broadly maintained over the last five years.
WE ENDED 2003 IN A STRONG POSITION AND OUR INTERNATIONAL DIVERSIFICATION, FINANCIAL STRENGTH, AND BROAD RANGE OF PRODUCTS AND DISTRIBUTION CHANNELS MEAN WE ARE WELL PLACED FOR FUTURE GROWTH.
since the beginning of 2002, demonstrating its strength in product design and execution. Over recent years, JNL has developed into one of the leading life insurance companies in the fragmented US market and with its low cost base, flexible and innovative product range and broad distribution mix, JNL is well positioned to benefit from the upturn in the US savings market.
The UK remains the toughest market in which we operate. Uncertain equity markets, low interest rates and the continuing government and regulatory reviews on the future of the industry have caused consumer appetite for long-term savings to remain weak.
M&G maintained its good track record of profitable growth and investment performance, increasing its underlying profit by 43 per cent and total funds under management by 12 per cent. This strong result reflects M&G’s focus on effective cost control and the strength of its diversified product range in retail fund management, institutional fixed income, pooled life and pension funds, property and private finance.
Each of our business units around the world is focused increasingly on sharing ideas and expertise in areas such as customer service, product innovation, distribution and sales, and systems development. For example, the opening of our customer service centre in Mumbai was an initiative on which Prudential UK worked closely with PCA who already had considerable experience of the Indian market; PCA used JNL’s product and systems expertise to help launch a new variable annuity product in Japan and Korea; and the launch of the Flexible Investment Plan in the UK was based on the concept behind JNL’s Perspective II variable annuity which allows customers to tailor individual product features and benefits to their specific investment needs. As we continue to grow internationally, this ability to maximise the synergies that exist across our businesses is essential as we look to gain competitive advantage in our markets and grow the value of the Group.
ASIA Prudential Corporation Asia (PCA) is the leading European life insurer in Asia with 23 life and fund management operations across 12 countries. In 2003, PCA delivered a strong set of results with annual premium equivalent (APE) sales of £555 million, up 16 per cent at constant exchange rates (CER) compared with 2002 and new business achieved profit (NBAP) up one per cent to £291 million at CER. This was achieved despite economic uncertainty and the impact of SARS, particularly in the second quarter. PCA’s average NBAP margin on APE sales reduced to 52 per cent (60 per cent in 2002) but was up from the 51 per cent reported at the half-year. At reported exchange rates, APE sales were up eight per cent but NBAP was down five per cent. PCA’s modified statutory basis (MSB) profits (before development costs and PCA head office costs) were £98 million, compared with £88 million in 2002.
PCA continued to strengthen its position as a leader in both the life insurance and mutual fund markets across the region. Based on preliminary estimates, Prudential believes PCA ended 2003 with top-five market shares in eight Asian life insurance markets, two mutual fund markets and Hong Kong’s Mandatory Provident Fund market. This demonstrates PCA’s continuing success in building a very strong portfolio of businesses across the region.
In August, PCA launched its new Beijing life insurance joint venture with its partner CITIC. While the Chinese life insurance market has material long-term potential, success is dependent on having the right people to manage the business. PCA is well placed as it can build on its already successful business in Guangzhou, where it has a 14 per cent market share of new business, and the expertise of its Chinese speaking staff from around the region.
The Singapore life insurance market declined nine per cent in 2003 principally due to a drop in single premium volumes (19 per cent) as there were no additional releases of Central Provident Funds and single premium products looked less attractive to consumers in the challenging economic environment. Despite this market decline, PCA grew APE sales by nine per cent at CER through a consistent focus on higher-margin regular premium business (up 32 per cent at CER). It is now the market leader in this important sector.
Foreign insurers generally grew faster than local companies in Korea during 2003 and, with its very successful and pioneering multi-channel distribution strategy, PCA Life Korea saw the largest rate of growth in premium income during 2003 in the whole of the Korean life market. APE sales at CER were up 239 per cent compared with 2002.
Prudential’s operations in Indonesia delivered 75 per cent growth in APE sales at CER, reflecting its market-leading position in unit-linked products combined with an increase in agent productivity. Combined growth in APE sales across Hong Kong and Taiwan, two of PCA’s largest operations, was more modest. This reflected the tough economic environment that prevailed in these markets in the first half of the year combined with the impact of SARS.
UNITED STATES Over recent years, Jackson National Life (JNL) has successfully grown from a narrow-product, single-channel life insurance company to a multi-product, multi-channel financial services company. Today, JNL offers fixed, equityindexed and variable annuities, term and permanent life insurance and institutional products, through a number of channels. These include independent broker-dealers, independent agents, banks, regional broker-dealers and the registered investment advisor channel.
In January 2002, JNL opened its regional broker-dealer channel and in 2003 sales through this distribution channel were US$500 million, 34 per cent ahead of 2002. In March 2003, JNL entered the registered investment advisor channel with the launch of Curian Capital LLC, which provides innovative fee-based separately managed accounts and investment products to advisors through a state-of-the-art technology platform. At the year-end, retail funds under management had grown to £148 million (US$266 million), more than five times the funds under management at the half-year.
In the testing market conditions of recent years, JNL has focused on its core strengths: strong administrative capabilities; a low cost base; flexible and innovative product range; and its broad relationship-driven distribution model. In addition, it has actively and successfully managed its capital position and is well placed as markets in the US continue to recover.
UNITED KINGDOM AND EUROPE UK and Europe Insurance Operations In 2003, Prudential UK continued to focus on long-term value creation for shareholders rather than short-term sales growth. It remains focused on high-margin products where it has competitive advantage as a result of its scale, brand recognition, financial strength, diversified distribution and low cost base.
Total APE sales in 2003 were £616 million, 21 per cent lower than 2002. This was largely due to the contraction of the with-profit bond market, which according to the Association of British Insurers (ABI) recorded 65 per cent lower sales in 2003 compared with 2002. Prudential leads IFA distribution of with-profit bonds and grew its market share of the IFA market from 25 per cent in the fourth quarter of 2002 to 51 per cent in the fourth quarter of 2003 (source: ABI). The Prospect Bond, which was launched at the end of the third quarter, allows savers to switch from weak or closed life funds into Prudential’s stronger fund and has accounted for 17 per cent of its with-profit bond sales since that time.
‘The Plan from the Pru’ campaign was launched in September 2002, and provides customers with a financial plan to guide them through key financial stages of their lives. It was actively promoted in the press and on television and radio throughout 2003 and contributed to an increased awareness of the Prudential brand during the year.
In 2003, Prudential’s long-term with-profits fund earned an investment return of 16.5 per cent compared with a return of negative 8.1 per cent in 2002. Over the last 10 years, the long-term fund has consistently generated positive returns for
investors with three, five and 10-year annualised compound returns of 1.1 per cent, 4.9 per cent and 8.6 per cent respectively. These returns demonstrate the benefits of Prudential’s diversified investment policy.
In January 2004, Prudential UK announced that the annual bonus for Prudence Bond’s 375,000 policyholders in 2004 would be 3.25 per cent, unchanged from 2003, reflecting the strength of the with-profits fund despite recent weak economic conditions. In February 2004, it announced that the annual bonus for personal pension customers will be 3.25 per cent, 0.25 per cent below last year. In 2003, profits distributed from Prudential’s main withprofits fund amounted to £2.1 billion, of which £1.9 billion (90 per cent) was added to policies as bonuses, and £209 million (10 per cent) is available for distribution to shareholders. Further bonus announcements for pension and endowment products deliver significant year-on-year increases in policy values. For example, 15-year personal pensions (£200 per month regular premium) were up in value 8.5 per cent on 2003 and 10-year endowments (£50 per month regular premium; male aged 30 next birthday) were up in value 12.2 per cent on 2003.
In November 2001, Prudential UK announced a review of operations with a target of reducing annual costs by £175 million to be achieved by the end of 2004. Following the first phase of this work in July 2002 the target was increased to £200 million. This has been achieved in full, 12 months ahead of schedule. Actual savings to the end of 2003 were £175 million, with an annualised value of £201 million. Active cost management will continue.
In May 2003, Prudential UK opened a customer service centre in India. The centre, which at the end of December employed over 800 people and has handled over 500,000 calls since launch, will be fully operational later this year.
This initiative is expected to result in approximately £16 million of additional cost savings per annum by the end of 2006 and is part of Prudential UK’s commitment to improving customer service.
M&G’s operating profit including performance-related fees (PRF) was £83 million in 2003, an increase of £12 million on the previous year. This reflected a 43 per cent increase in underlying profit to £70 million, partly offset by a reduction in the PRF from £22 million achieved in 2002, which recognised the exceptional performance of 2000 in the rolling three-year calculation. This reflects the strengths of M&G’s diversified revenue streams and disciplined cost management. This profit growth was achieved despite difficult market conditions with the FTSE All-Share Index averaging 11 per cent less than in 2002.
M&G recorded gross fund inflows of £3.8 billion in 2003, a slight increase on the previous year. External funds under management, which represent nearly a quarter of M&G’s total funds under management, increased significantly during the year, rising 19 per cent to £24.2 billion due to a combination of net fund inflows from both retail and institutional clients and market gains on existing funds.
In its institutional business, M&G continued to build on its position as a leading innovator in fixed income and private finance. Gross fund inflows were £2.6 billion during the year, a six per cent increase on 2002. Net institutional fund inflows were £1.2 billion.
M&G’s segregated and pooled fixed income institutional business benefited from increased asset allocation into fixed income by pension schemes, with £1.4 billion of gross new mandates won during the year. In addition, M&G’s private finance business closed two new Collateralised Debt Obligations and was awarded the first ever European pension fund mandate to invest in leveraged loans.
In 2003, operating income increased by 30 per cent to £424 million (2002: £327 million). In the UK, Egg more than doubled its operating profit to £73 million and grew its customer base during 2003 by 635,000 to almost 3.2 million. It continued to grow revenues and unsecured lending balances, while at the same time reducing both unit operating costs and marketing acquisition costs. Egg’s pretax losses increased to £34 million from £20 million in 2002.
In the UK, other operating income increased by £54 million to £157 million primarily reflecting fees and commission earned from a larger credit card book and the successful cross-sell of payment protection insurance on credit cards and loans.
In France, Egg ended the year with 130,000 customers and 66,000 credit cards in issue and grew unsecured lending balances to £120 million. Egg France recorded a loss of £89 million in 2003.
Gross insurance premiums including insurance renewal premiums and gross investment inflows were £35.7 billion, an increase of five per cent over 2002.
Total sales of new insurance and investment products from outside the UK represented 74 per cent of the Group total of £31.5 billion, reflecting the international diversification of the Group.
Total insurance sales were down 21 per cent at CER to £9.5 billion, while sales on the annual premium equivalent (APE) basis were down 12 per cent at CER to £1,589 million compared with last year. At reported exchange rates total insurance sales were down 24 per cent and APE insurance sales were down 16 per cent.
Total investment funds under management in 2003 increased by 21 per cent from £25.5 billion to £30.8 billion with net investment flows of £2.9 billion and net market and
Excludes PAC With-Profit Assets M&G 1999 excludes £12bn for institutional equity business sold in 2000 Asia: Life and Mutual Fund FUM
Fu nd s un de r m an ag em en t CAGR: 11%
Accordingly, in common with other listed UK life assurers, Prudential also reports supplementary results for its long-term operations on the achieved profits basis. These results are combined with the statutory basis results of the Group’s other operations, including investment and banking products and other non-insurance investment management businesses. Reference to operating profit relates to profit including investment returns at the expected long-term rate of return but excludes amortisation of goodwill, exceptional items, short-term fluctuations in investment returns and the effect of changes in economic assumptions.
The active basis is applied to the UK and the US operations, and those countries in Asia where there are well-developed government bond markets (Japan, Korea and US$denominated business in Hong Kong). Assumptions in other Asian countries continue to be based on an assessment of long-term economic conditions.
In 2003, use of the active basis resulted in an increase in the risk discount rate applied to the UK and the US operations from 7.1 and 7.0 per cent respectively to 7.4 per cent, and an increase in the UK investment return assumption for the PAC with-profits fund from 6.6 per cent to 6.8 per cent.
TOTAL ACHIEVED OPERATING PROFIT Total achieved operating profit was £794 million, down 27 per cent from 2002 at CER. At reported exchange rates the result was 30 per cent lower.
Results from other operations including M&G, Egg and US broker-dealer and fund management were £46 million, £19 million lower than 2002 (£65 million). This reflects increased profits from M&G and Egg’s UK operations offset by development expenses associated with Egg’s French operation and Curian, the US managed account provider to registered investment advisors.
Other income and expenditure of negative £181 million was £8 million lower than the £189 million incurred in 2002. This reflected an increase in investment return and other income offset by higher interest payable and head office costs.
UK and Europe Insurance Operations’ NBAP of £166 million was 29 per cent lower than 2002. This reflected a 21 per cent fall in APE sales, revised economic assumptions and an adverse movement in sales mix resulting from reduced levels of higher margin with-profit bonds being sold. The new business margin moved from 30 per cent in 2002 to 27 per cent in 2003 and reflects the revised economic assumptions and adverse sales mix relative to 2002.
The increasing proportion of shareholder-backed annuities has more than compensated for the lower proportion of high margin Department for Work and Pensions rebates in the second half of the year compared with the first half. The new business margin in the second half of the year was 28 per cent compared with 27 per cent in the first half.
The 31 per cent fall in JNL’s NBAP to £148 million at CER was due to a 24 per cent reduction in APE sales and a reduction in the new business margin from 39 per cent to 35 per cent. The margin reduction reflects the net change in economic assumptions offset by certain targeted revisions to annuity commissions. At reported exchange rates, JNL’s NBAP was down 37 per cent. In 2003, new business spread for fixed annuities was 155 basis points trending to 175 basis points over five years.
IN-FORCE ACHIEVED PROFIT The unwind of the discount (including return on surplus assets over target surplus for JNL) in 2003 was £636 million compared with £659 million in 2002, reflecting reductions in the UK and the US offset by an increase in Asia. In the UK, the decline reflects lower shareholders’ funds at the start of the year, partially offset by the increase in the discount rate. In the US, the fall in the unwind of the discount is primarily due to foreign exchange movements. In Asia the unwind has increased principally due to the higher opening shareholders’ funds.
UK and European Insurance Operations’ in-force profit of £193 million was down 32 per cent on 2002 (after development and re-engineering charges), principally reflecting lower expected returns from business in force due to the lower opening embedded value and an increase in negative assumption changes and experience variances.
In addition, other positive assumption changes of £30 million were recorded.
Prudential UK incurred a charge for persistency experience variance of £35 million, primarily reflecting the impact of negative market sentiment on surrender volumes. However, Prudence Bond persistency experience has improved significantly since the first quarter and subsequently was in line with long-term assumptions.
PCA’s in-force profit (before development expenses) decreased significantly from £209 million in 2002 to £87 million in 2003 largely due to the positive £101 million of assumption changes included in the 2002 result. This assumption change in 2002 primarily related to Singapore and included £59 million relating to sub-divisions of longterm funds and £42 million due to a revision in the death claims rate assumptions. This compares to assumption changes in 2003 of negative £27 million, primarily reflecting expense assumption changes in Japan following the impact of the strategic review conducted during the year. In 2003, the unwind of the discount increased by £20 million to £115 million reflecting higher opening shareholder funds.
NON-INSURANCE OPERATIONS M&G’s profit including performance-related fees (PRF) was £83 million in 2003, an increase of £12 million on the previous year. This reflected a 43 per cent increase in underlying profit to £70 million and was partly offset by a reduction in the PRF from the £22 million achieved in 2002, which recognised the exceptional performance of 2000 in the rolling three-year calculation. A performance fee of £13 million was earned in 2003 as a result of investment out-performance for the Prudential Life and Annuity Funds and the profitable realisation of several investments by PPM Ventures.
Egg’s UK banking operations continued their profit growth, generating a £73 million operating profit. Egg’s French business recorded an £89 million loss in 2003. Egg’s pre-tax losses increased to £34 million from £20 million in 2003.
PCA’s development expenses (excluding Asia regional head office expenses) were £27 million compared to £26 million in 2002. This development expense principally relates to the new Japan strategy and building agency forces.
The UK component of short-term fluctuations in investment returns of £531 million reflects the difference between an actual investment return of 16.5 per cent and the long-term assumed return for with-profit business of 6.8 per cent.
The US component of £132 million primarily includes a positive £98 million in respect of the difference between actual bond losses and the five-year average amount included in operating profit, and a positive £36 million in relation to changed expectations of future profitability on variable annuity business in-force due to the actual separate account return exceeding the long-term return reported within operating profit.
Adverse economic assumption changes of £540 million reflect changes in assumptions for future investment returns, discount rate and similar items.
The UK component of negative £122 million reflects increases in the risk discount rate of 0.3 per cent and in the investment return assumption of 0.2 per cent in accordance with the increases in the gilt yield during the year. In the US the change in economic assumptions has had a negative £263 million impact. This primarily reflects the reductions in the projected fund earned and crediting rates on in-force business which result in lower projected policyholder liabilities on which future spread will be earned, together with increases in the risk discount and inflation rates. In Asia, the impact of change in economic assumptions is a negative £155 million. This principally reflects the net impact of revisions to the underlying long-term investment return assumptions and discount rate combined with the impact of the introduction of a risk-based capital regime by the Taiwanese regulator.
Group operating profit on the modified statutory basis (MSB) of £357 million was £72 million lower than 2002 at CER. At reported exchange rates operating profit was £92 million lower than 2002.
UK and Europe Insurance Operations’ operating profit in 2003 was £256 million, £116 million below the restated 2002 figure. This included a reduction of £90 million from the PAC with-profits fund due to lower annual and terminal bonus rates announced earlier in the year partially offset by higher funds under management and increased claims. Losses on shareholder-backed businesses increased by £26 million as a result of increased new business volumes which carry a significant new business strain. The 2002 result has been restated for a £17 million positive adjustment (2003: £10 million) in respect of the financing element of certain reinsurance contracts. This is required by changes to the Statement of Recommended Practice (SORP) for accounting for insurance business, which was issued by the Association of British Insurers in November 2003. The revised SORP is required practice for 2004, but early adoption is encouraged, which Prudential has chosen to do.
MODIFIED STATUTORY BASIS RESULTS – PROFIT BEFORE TAX MSB profit before tax and minority interests was £350 million in 2003, compared with £501 million in 2002. The 2002 result included £355 million relating to the disposal of the UK General Insurance operations. The 2003 result was offset by an improvement in the adjustment for short-term fluctuations in investment returns from a negative adjustment of £205 million in 2002 to a positive adjustment of £91 million in 2003.
Within the improvement in the adjustment for short-term fluctuations, the US result has improved from a loss of £258 million in 2002 to a gain of £93 million in 2003. The short-term fluctuations in Asia principally reflect the fiveyear averaging impact of an appreciation in bond values.
Amortisation of goodwill was £98 million in both 2003 and 2002.
Basic earnings per share, based on achieved basis profit for the year after minority interests were 24.3 pence compared with a loss of 7.3 pence in 2002. Basic earnings per share, based on MSB profit for the year after minority interests were down 13.1 pence to 10.4 pence.
DIVIDEND PER SHARE The final dividend per share is 10.7 pence, resulting in a full year dividend of 16.0 pence, compared with a full year dividend for 2002 of 26.0 pence.
During 2003, the Group invested £173 million (2002: £675 million) in its business units, including £145 million in Asia. Prudential expects to invest approximately the same amount in each of 2004 and 2005. In 2006, based on current plans and expectations, Prudential expects PCA to be a net capital provider to the Group. In 2002, JNL received £321 million (2003: nil) to support high volumes of fixed annuity business, additional GMDB reserves and to replace capital consumed by bond losses and impairments.
However, in 2003 due to significant improvements in the credit cycle, JNL returned to its normal self-funding operating model.
In aggregate this gave rise to an increase in cash of £4 million (2002: reduction of £130 million).
FINANCIAL STRENGTH OF INSURANCE OPERATIONS United Kingdom A common measure of financial strength in the UK for long-term insurance business is the free asset ratio. The free asset ratio is the ratio of assets less liabilities to liabilities, and is expressed as a percentage of liabilities. On a comparable basis with 2002 the free asset (or Form 9) ratio of the Prudential Assurance Company (PAC) long-term fund was approximately 10.5 per cent at the end of 2003, compared with 8.4 per cent at 31 December 2002.
In addition to taking account of asset values and interest rates at the valuation date, the reserves held to cover the fund’s liabilities must also make prudent provision against future changes in asset values in a variety of resilience scenarios. The most severe resilience test applied at this year-end is: • a fall in equity values of 19 per cent; • a fall in property values of 20 per cent; • an increase in interest rates of two per cent.
The fall in property values is also more stringent than the 15 per cent fall assumed last year.
The fund is very strong with an inherited estate measured on an essentially deterministic valuation basis of more than £6 billion compared with approximately £5 billion at the end of 2002. On a realistic basis, with liabilities recorded on a market consistent basis calculated using the approach set out in the ABI guidance for reporting at the 2003 yearend the free assets are valued at around £5 billion before a deduction for the risk capital margin. The approach to realistic reporting adopted may change pending confirmation of the FSA regulations and guidelines.
With-profits contracts are long-term contracts with relatively low guaranteed amounts, the nature of which permits Prudential to invest primarily in equities and real estate. However, over the period from 1999 to mid-2001 the fund reduced its exposure to equities. There was also a re-weighting within equities out of the UK and into overseas equities. This change in asset mix reflected Prudential’s view that equity valuations were high and that other assets, particularly corporate bonds, were relatively attractive. The change within equities improved diversification and reduced expected fund volatility. The change in asset mix in recent years has had a substantial beneficial impact on investment returns. The broad asset mix will continue to be reviewed as the economic environment and market valuations change.
United States The capital adequacy position of Jackson National Life remains strong, with a strong risk-based capital ratio more than 3.5 times the NAIC Company Action Level Risk Based Capital. As a core business to the Group, JNL’s financial strength is rated AA by Standard & Poor’s.
accumulated asset shares plus any additional payments that may be required by way of smoothing or to meet guarantees. The balance of the assets of the With-Profits Sub-Fund is called the ‘inherited estate’ and represents the major part of the working capital of Prudential’s long-term fund which enables the Company to support with-profits business by: • providing the benefits associated with smoothing and guarantees; • providing investment flexibility for the fund’s assets; • meeting the regulatory capital requirements, which demonstrate solvency; • absorbing the costs of significant events, or fundamental changes in its long-term business without affecting bonus and investment policies.
The size of the inherited estate fluctuates from year to year depending on the investment return and the extent to which it has been required to meet smoothing costs, guarantees and other events.
The costs associated with the mis-selling review of Prudential’s with-profits personal pensions have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders' pay-out values have been unaffected by personal pension mis-selling.
The maximum amount of capital support available under the terms of the assurance will reduce over time as we pay claims on the policies covered by it.
CONDUCT OF BUSINESS The FSA has required all UK life insurance companies to review their potential cases of pensions mis-selling and pay compensation to policyholders where necessary. The Group has met the FSA target for completion of Phases I and II of the pensions mis-selling review, within the provisions that were established in the fund in 2000.
Prudential's main exposure to mortgage endowment products is through business written by Scottish Amicable.
SHAREHOLDERS’ BORROWINGS AND FINANCIAL FLEXIBILITY As a result of the holding company’s net funds inflow of £4 million and exchange translation gains of £87 million, net core borrowings at 31 December 2003 were £2,135 million, compared with £2,226 million at 31 December 2002.
After adjusting for holding company cash and short-term investments of £432 million, core structural borrowings of shareholder-financed operations at the end of 2003 totalled £2,567 million, compared with £2,452 million at the end of 2002. This increase reflected the issue of US$1 billion Perpetual Subordinated Capital Securities in Asia, partly offset by the repayment of short-term commercial paper. The perpetual subordinated capital was issued with a coupon of 6.5 per cent and subsequently Prudential entered into an interest rate swap in respect of this debt and is currently paying three-month US$ Libor plus 80 basis points, currently 1.97 per cent. Core borrowings at the end of 2003 included £1,656 million at fixed rates of interest with maturity dates ranging from 2005 to 2031, as set out in note 32 on page 90 of the consolidated financial statements. £827 million of the core borrowings were denominated in US dollars, to hedge partially the currency exposure arising from the Group’s investment in Jackson National Life (JNL).
The Group is funded centrally, except for Egg, which is responsible for its own financing. The Group’s core debt is managed to be within a target level consistent with its current debt ratings. At 31 December 2003, the gearing ratio, including hybrid debt (net of cash and short-term investments) was 23 per cent compared with 24 per cent at 31 December 2002. Excluding hybrid debt, the gearing ratio was seven per cent.
Based on the achieved operating profits from continuing operations and interest payable on core structural borrowings, interest cover is 6.6 times in 2003 compared with 9.7 times in 2002.
In the UK and Asia, Prudential uses derivatives to reduce equity risk, interest rate and currency exposures, and to facilitate efficient investment management. In the US, JNL uses derivatives to reduce interest rate risk, to facilitate efficient portfolio management and to match liabilities under equity-indexed policies.
The employers' contribution is required to be paid as a minimum in future years irrespective of assets in the Scheme and, under the current Scheme rules, access to the surplus through refunds from the Scheme is not available.
If FRS 17 had been fully implemented for 2003 an £8 million shareholder charge (after tax) in the profit and loss account, and a shareholder charge of £16 million (after tax) in the statement of total recognised gains and losses would have been reported. In addition the difference between FRS 17 basis assets and liabilities can be volatile for value movements in assets and a basis of setting inflation assumptions that is referenced to market expectations implied within indexlinked bonds. For those schemes such as PSPS, which hold a significant proportion of their assets in equity investments, the volatility can be particularly significant.
ACCOUNTING POLICIES There has been no change in accounting policies for the preparation of the 2003 results with the exception of the changes for accounting for certain reinsurance contracts as required by changes to the Statement of Recommended Practice (SORP) for accounting for insurance business issued by the Association of British Insurers (ABI) in November 2003. The revised SORP is required practice for 2004, but early adoption is encouraged, which Prudential has chosen so to do. This resulted in a £17 million positive adjustment to the UK modified statutory basis result for
These standards are then required to be subjected to a process of review under EU auspices before they can be recommended for approval by the EU's Accounting Regulatory Committee.
When the process is fully complete the IASB's standards for the consolidated financial statements of listed groups will replace the UK Accounting Standards Board’s (ASB) standards and the ABI and British Banking Association Statements of Recommended Practice on accounting for insurance and banking business. However, the UK framework, including any UK ASB changes to gradually migrate its standards towards those of the IASB will continue to apply at UK subsidiary company level unless those companies choose to apply the DTI's proposed option of applying EU approved IFRS.
Prudential’s assessment of the changes arising from IFRS and its project plan are well advanced. On the basis of the currently available information, assuming all IAS standards are approved by the EU, the tentative high level assessment of the impact on the Group’s financial reporting is as follows: Insurance operations Contract accounting Under ED 5, for those contracts with significant insurance risk and those with discretionary participating features, the UK GAAP will continue to apply until the IASB introduces a comprehensive (Phase 2) standard for insurance contracts.
Movements in fair value are recorded in either the profit and loss account or directly to shareholder reserves in the balance sheet depending upon the designation and the impact of hedge accounting rules. Derivative instruments are also carried at fair value with movements in value being recorded in the profit and loss account. Hedge accounting, whereby value movements on derivatives and hedged items are recorded together in the performance statements, is permissible only if certain matching criteria are met.
Banking operations For Egg, the Group’s main banking operation, the impact of IAS is also uncertain for the issues surrounding hedge accounting that are described above, as in common with other banks, Egg uses derivatives to manage interest rate risk. Egg's IAS basis results may also be affected by IAS 39 requirements in respect of provisioning, calculation of effective interest rates, and other detailed valuation rules.
Other issues Two other areas are likely to involve significant change on the adoption of IAS, namely goodwill accounting and pension cost accounting. For goodwill, subject to regular impairment testing, amortisation charges will normally no longer be necessary. For pension cost accounting, IAS 19 has some common features to the requirements of FRS 17.
DEVELOPMENTS IN REGULATORY SOLVENCY REQUIREMENTS The Integrated Prudential Sourcebook (PSB) will be introduced by the Financial Services Authority (FSA) for UK insurance companies in 2004. This will formalise the requirement for realistic solvency reporting. For all business, with-profits or otherwise, a risk-based capital approach will be required to develop an internal capital adequacy solvency assessment. The FSA has announced that it will permit life companies to apply for a waiver from existing solvency requirements if they can demonstrate that they have adequate models for realistic capital reporting.
PROCUREMENT During the year Procurement’s activity focused on securing significant cost reductions for UK Insurance Operations, identifying opportunities to leverage spend across the Group and improving its core processes to ensure deals are established following commercial best practice to minimise regulatory and commercial risks. Procurement has also continued to develop its environmental supply chain programme, exceeding the supplier environmental improvement targets set at the beginning of the year.
The insurance operations of the Group all prepare a financial condition report which is reported on to the Board who receive regular reports from the Group Finance Director on the financial position of the Group.
The Group’s risk management procedures are further described in the Corporate Governance Report.
UK PRODUCTS AND DRIVERS OF PROFIT In common with other UK long-term insurance companies, Prudential’s products are structured as either with-profits (or participating) products or non-participating products, including unit-linked products. Depending upon the structure, the level of shareholders’ interest in the value of policies and the related profit or loss varies.
These guaranteed death benefits might be expressed as the return of original premium, the highest past anniversary value of the policy, or as the original premium accumulated at a fixed rate of interest. JNL earns fee income on the underlying investment, earns profits from the spread between what it earns on investments in fixed rate accounts and the interest credited, and premium income for certain additional performance guarantees in the contract.
Prudential's business in Asia is focused on regular premium products that provide both savings and protection benefits. In 2003, the new business achieved profit mix was 45 per cent unit-linked, 28 per cent non-linked and 27 per cent Accident and Health products.
The profits from participating policies are shared between the policyholder and insurer (typically in a 90:10 ratio) in the same way as with-profits business in the UK. Under unit-linked products the profits that arise from managing the policy, its investments and the insurance risk accrue entirely to shareholders, with investment gains accruing to the policyholder within the underlying unitised fund. The profits from non-participating products consist of any surplus remaining after paying the defined policy benefits.
Prudential’s primary financial statements are prepared in accordance with the MSB of reporting of long-term business, in full compliance with the revised Statement of Recommended Practice issued by the Association of British Insurers (ABI) in November 2003. In broad terms, MSB profits for long-term business reflect the aggregate of statutory transfers from with-profits funds and profits on a traditional deferral and matching approach for other longterm business. It serves the dual purpose of determining the Company’s statutory profit and reserves and informing the Board when setting the Company’s dividend policy.
Therefore, since 1997 Prudential and other major UK quoted financial groups have adopted the achieved profits basis as a supplementary accounting measure in order to give a better reflection of the value attaching to long-term insurance business. Achieved profits basis financial statements are prepared under guidance issued by the ABI in December 2001.
The achieved profits method not only provides a good indicator of the value being added by today’s management in a given accounting period but it also demonstrates whether shareholder capital is being deployed to best effect. Indeed insurance companies in many countries use comparable bases of accounting for management purposes. Prudential believes that the achieved profits basis provides useful information for shareholders. In contrast, for many types of contract, the MSB result does not reflect the long-term benefit that will arise in the future from current management initiatives and capital expenditure in the year under review, as it focuses instead on the amounts accruing to shareholders in the current year only from business already in-force.
The achieved profits basis is a value based method of reporting in that it reflects the change in value of the business over the accounting period. This value is called the shareholders’ funds on an achieved profits basis which, at a given point in time, is 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. In determining these expected cash earnings Prudential makes full allowance for the risks attached to their emergence and associated cost of capital and takes into account recent experience in assessing likely future persistency, mortality and expenses. Economic assumptions as to future investment returns and inflation are based on market data.
The value added from new business (being the present value of the future cash flows arising from new business written in the year) is a key metric used in the management of the business. The change in value of business in-force at the start of the year demonstrates how the existing book is being managed. Together they provide management and shareholders with valuable information about the underlying development of the business and the success or otherwise of management actions.
The assumptions used for the achieved profits basis of accounting are set out on page 106 in the notes that accompany the supplementary achieved profits basis accounts. An indication of the sensitivity of the results to changes in the key assumptions of interest rate and investment return is provided on page 114.
The different timing of profit recognition under the two bases is demonstrated in the next chart, which shows the cumulative level of profit recognition for the yearly profits shown in the previous chart. It illustrates that under the achieved profits basis profits emerge earlier, but the eventual total profit is the same under both bases.
Acting Responsibly Is Good For Business Our focus on corporate responsibility is nothing new, though subject to continuous improvement. It is a philosophy that has shaped our policies and practices throughout our history. In the UK, companies are increasingly expected to report on the social, ethical and environmental issues material to their business and to demonstrate how they are responding to these. We believe that economic factors will remain the fundamental basis of consumer choice in future years. However, we also recognise the growing body of research pointing to the fact that a company's intangible assets – its corporate standards and its social and environmental performance – are becoming increasingly significant differentiators. Consumers will increasingly support those organisations that exhibit and define values around trust, ethics and environmental responsibility.
Why Focus On Financial Literacy? Financial hardship can affect anyone. Careful forward financial planning is required if the standards of living of individuals are not to be hit by, for example, too much debt or by inadequate provision for longer retirement.
Given our expertise in financial planning, we are well positioned to contribute to help consumers, customers and our employees make informed choices that reflect their needs and aspirations. In parallel with our financial literacy work, we seek continuously to improve the clarity of the information we provide about our products and services in order that they are clear and easily understood.
Since 2002, Prudential Property Investment Managers Limited (PruPIM) have been involved with Kingston University in a major industry research project to: • establish the sustainable characteristics of individual properties; • identify how these should be evaluated in investment appraisals; • ascertain how to measure the performance of a wide range of properties and portfolios with varying levels of sustainable characteristics.
Workplace/Employees Ensuring that our employees enjoy a safe and healthy working environment is of great importance to Prudential.
The courses cover management and leadership, technical and business skills as well as a comprehensive range of self-improvement material including language courses.
Environment/Sustainable Development The Belfry Shopping Centre at Redhill in the UK – part of PruPIM’s property portfolio – in 2003 became one of the first shopping centres in the UK to switch to receiving all its electricity from renewable sources, saving 600 tonnes of CO2 every year. The Belfry was also the first shopping centre in the UK to achieve ISO 14001, the internationally recognised standard for environmental management, in 2000.
In India, one of our most rapidly expanding markets and where we have had a long-standing presence, approximately 60 million children aged 6 to 14 are not in school. We are helping to tackle this issue through our support of the Commonwealth Education Fund (CEF), which acts as a catalyst to emphasise the importance of universal primary education. We are specifically supporting work to build national coalitions on education, deliver training for parents on education spending and increase access for marginalised children who are excluded from school. The CEF operates in 17 Commonwealth countries in Asia and Africa. This programme is managed through Action Aid, Save the Children and Oxfam.
Working with Stakeholders We consult regularly with our key stakeholders – such as our customers, our employees and local communities. We are also involved in a growing number of partnerships with national and international bodies in order to contribute to debate on key policy issues: • we are sponsoring a major international research study being undertaken by the Organisation for Economic Co-operation and Development (OECD) to identify levels of financial literacy and education in OECD and selected non-OECD Asian markets and to develop guidelines on effective financial literacy strategies; • in the UK we have partnered with the Scottish Council Foundation to identify a way forward for improved financial education in Scotland; • during 2003 PruPIM joined the Institutional Investors Group on Climate Change; and
1. SIR DAVID CLEMENTI Chairman (Age 55) Chairman since 1 December 2002. In July 2003 he was appointed by the Secretary of State for Constitutional Affairs to carry out a review of the regulation of legal services in England and Wales. In February 2003 he joined the Financial Reporting Council. He is also a non-executive director of Rio Tinto plc which he joined in February 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 1997 he worked for the Kleinwort Benson Group, latterly as Chief Executive.
2. JONATHAN BLOOMER FCA (Age 49) Group Chief Executive. Appointed as a director in January 1995 and as Group Chief Executive in March 2000. He was previously Deputy Group Chief Executive and Group Finance Director. He is a non-executive director of Egg plc. He is also Chairman of the Practitioner Panel of the Financial Services Authority and a Board Member of the Association of British Insurers.
4. CLARK MANNING (Age 45) Executive director. Appointed in January 2002. He is also President and Chief Executive Officer of Jackson National Life. He was previously Chief Operating Officer, Senior Vice President and Chief Actuary of Jackson National Life, which he joined in 1995. Prior to that he was Senior Vice President and Chief Actuary for SunAmerica Inc, and prior to that Consulting Actuary at Milliman & Robertson Inc. He is a Fellow of the Society of Actuaries and a Member of the American Academy of Actuaries.
6. MARK NORBOM (Age 46) Executive director. Appointed in January 2004. He is also Chief Executive, Prudential Corporation Asia. He was previously President and Chief Executive Officer of General Electric Japan, and a Company Officer of General Electric Company. He has spent the last 10 years with General Electric in Taiwan, Indonesia, Thailand and Japan. Prior to that, his career was with General Electric in various posts in the US.
7. MARK WOOD (Age 50) Executive director. Appointed in June 2001. He is also Chief Executive of Prudential Assurance, UK and Europe. In May 2002 he became a member of the Life Insurance Committee of the Association of British Insurers. He was previously Chief Executive of Axa UK plc (formerly Sun Life & Provincial Holdings plc) and Axa Equity and Law plc, and Managing Director of AA Insurance.
9. BRIDGET MACASKILL (Age 55) Independent non-executive director. Appointed in September 2003. She rejoined the Board of Prudential plc having previously resigned due to a potential conflict of interest in March 2001. She is a non-executive director of J Sainsbury plc. She was previously Chairman and Chief Executive Officer of OppenheimerFunds Inc, a major New York based investment management company.
10. ROBERTO MENDOZA (Age 58) Independent non-executive director and Chairman of the Remuneration Committee. Appointed in May 2000. He is the nonexecutive Chairman of Egg plc. He is also a non-executive director of Reuters Group PLC and The BOC Group plc. He is a founder member of Integrated Finance Limited and a member of the World
Bank-IFC Bank Advisory Group. He was previously Vice Chairman and director of JP Morgan & Co, Inc., and a managing director of Goldman Sachs.
11. KATHLEEN O'DONOVAN (Age 46) Independent non-executive director. Appointed in May 2003. She is a non-executive director of EMI Group plc and Great Portland Estates PLC. She is also a non-executive director of the Court of the Bank of England. She was previously Finance Director at BTR and Invensys. Prior to that she was a partner at Ernst & Young.
The directors are committed to high standards of corporate governance and support the Combined Code on Corporate Governance issued in 1998 and appended to the Listing Rules of the Financial Services Authority (the Code). The Company has complied throughout the financial year ended 31 December 2003 with all the Code provisions set out in Section 1 of the Code (which applied to listed companies whose reporting year commenced prior to 1 November 2003), save for the appointment of a senior independent director for the whole of the year under review.
We have applied the principles of the Code in the manner described below and in the Remuneration Report.
THE BOARD As at 31 December 2003, the Board comprised the Chairman, five executive directors and seven independent non-executive directors. Following recent changes, there are currently six executive directors and six non-executive directors. These non-executive directors bring a wide range of business, financial and global experience to the Board. Biographical details of the current Board members appear on pages 30 and 31. The roles of Chairman and Group Chief Executive are separate and clearly defined, so that no individual has unfettered powers of decision. The Chairman is responsible for the leadership and governance of the Board as a whole and the Group Chief Executive for the management of the Group, the implementation of Board strategy and policy on the Board’s behalf. In discharging his responsibility, the Group Chief Executive is advised and assisted by the Group Executive Committee, comprising all the business unit heads and a Group head office team of functional specialists. On 4 December 2003 Rob Rowley was appointed as the Company’s Senior Independent Director, to whom concerns may be conveyed by shareholders if they are unable to resolve them through normal channels, or where such channels are inappropriate.
A corporate governance framework has been approved by the Board which maps out the internal approvals processes and those matters which are delegated to business units.
These principally relate to the operational management of the Group’s businesses and include predetermined authority limits delegated by the Board to the Group Chief Executive for further delegation by him in respect of capital, commitments and other matters which are essential to the effective day-to-day running and management of the business.
The Chief Executive of each business unit, who in respect of his business unit responsibilities reports to the Group Chief Executive, has authority for management of that business unit and has established a management board comprising its most senior executives. Following enhancements to the Group governance framework during 2003, business unit Chief Executives are now required to certify annually their compliance with the requirements of the framework.
All directors have direct access to the services of the Company Secretary who advises them through the Chairman on all corporate governance matters, on Board procedures, and on compliance with applicable rules and regulations. In order to ensure good information flows, full Board and Committee papers are provided to the directors by the Company Secretary approximately one week before each Board or Committee meeting. The Company Secretary also supports the Chairman in providing tailored induction programmes for new directors and on-going professional development for all directors.
Other commitments of the Chairman and changes during the year are detailed in his biography on page 30.
BOARD COMMITTEES The Board has established the following standing committees of non-executive directors: Audit Committee Rob Rowley (Chairman) Bart Becht (until 8 May 2003) Ann Burdus (until 31 December 2003) Kathleen O’Donovan (from 8 May 2003) Sandy Stewart
The terms of reference of the Audit Committee include reviewing with the management of the Company and the external auditors the performance of the external auditors and the extent of non-audit services; and the value for money obtained from auditors’ fees for both statutory audit work and non-audit work. The terms of reference were amended in February 2003 to ensure they comply with the provisions of the US Sarbanes-Oxley Act of 2002, which affect UK companies with a dual listing in the US, and the proposed guidance in Sir Robert Smith’s report ‘Audit Committees – Combined Code Guidance’, published in January 2003 and incorporated into the revised Combined Code issued in July 2003.
The policy sets out four key principles which underpin the provision of non-audit services by the external auditors: the auditor should not audit its own firm’s work, make management decisions for the Group, have a mutuality of financial interest with the Group, or be put in the role of advocate for the Group. These principles are consistent with the Smith guidance on audit committees referred to above and with the Sarbanes-Oxley Act.
Depending on the outcome of these assessments, and at least once every five years, the Audit Committee undertakes a formal review to assess whether the external audit should be re-tendered.
The Audit Committee reviews the internal audit programme and ensures that the internal audit function is adequately resourced and has appropriate standing within the Group. The Committee reviews the effectiveness of the Group’s internal auditors annually, and reports to the Board.
The minutes of Audit Committee meetings are circulated to the Board after each meeting and the Audit Committee Chairman draws the attention of the Board to any matters of particular significance.
Remuneration Committee Roberto Mendoza (Chairman) Sir David Barnes (until 8 May 2003) Bart Becht Ann Burdus (until 31 December 2003) Bridget Macaskill (from 1 September 2003) Kathleen O'Donovan (from 8 May 2003) Rob Rowley Sandy Stewart
The Remuneration Committee normally has scheduled meetings at least four times a year and a number of ad hoc meetings, as required, to review remuneration policy and determine the remuneration packages of the Chairman and executive directors. During 2003 a total of seven meetings were held. In framing its remuneration policy, the Committee has given full consideration to the provisions of Section 1B of and Schedules A and B to the Code. The Remuneration Report prepared by the Board is set out on pages 38 to 52. In preparing the Report, the Board has followed the provisions of Schedule B to the Code and The Directors' Remuneration Report Regulations 2002.
Except in relation to the remuneration of the Group Chief Executive, when only the Chairman is consulted, the Remuneration Committee consults the Chairman and the Group Chief Executive about the Committee's proposals relating to the remuneration of all executive directors. In 2003, following the publication of the revised Combined Code, the terms of reference of the Committee were reviewed and amended. They were widened to include monitoring the level and structure of remuneration for a defined population of senior management as determined by the Board. The Committee agreed principles for the level and structure of remuneration for this population. The Committee has access to professional advice inside and outside the Company.
Nomination Committee Sir David Clementi (Chairman) Sir David Barnes (until 8 May 2003) Jonathan Bloomer (from 6 November 2003) Ann Burdus (until 31 December 2003) Bridget Macaskill (from 18 March 2004) Rob Rowley Sandy Stewart
During 2003 the Committee held two formal meetings resulting in the appointment by the Board of two new non-executive directors. Kathleen O’Donovan, whose biographical details are set out on page 31, was appointed with effect from the conclusion of the Annual General Meeting on 8 May 2003 and Bridget Macaskill, whose biographical details are set out on page 31, rejoined the Board on 1 September 2003. Members of the Board also reviewed the appointment of Mark Norbom, who joined the Board on 1 January 2004.
DIRECTORS’ INDEPENDENCE, DEVELOPMENT AND RE-ELECTION Throughout the year all the non-executive directors were considered by the Board to be independent. A cross-directorship existed between Roberto Mendoza and Jonathan Bloomer who both sit on the board of Egg plc, the Company’s 79 per cent owned subsidiary which has its own listing on the London Stock Exchange. Under the Company’s Relationship Agreement with Egg, established prior to its flotation in 2000, the Company has the right, while it continues to own more than 10 per cent of the voting shares, to appoint one director and also, while it continues to own more than 15 per cent of the voting shares, to nominate the Chairman of the board. Jonathan Bloomer was accordingly appointed as the Company’s nominated director and Roberto Mendoza was appointed as the
Chairman of the board of Egg. Consequently, Mr Mendoza discloses his interest as Chairman of Egg and if a conflict of interest arises Mr Mendoza will withdraw from any decisionmaking by the Board of Prudential in respect of matters regarding Egg. The Board does not consider that this relationship in any way affects his status as an independent director of Prudential.
Non-executive directors are appointed initially for a threeyear term. Their appointment is reviewed towards the end of this period against performance and the requirements of the Company's business. Upon appointment, all nonexecutive directors embark upon a wide-ranging induction programme covering, amongst other things, the principal bases of accounting for the Group’s results, the role of the Audit Committee and the ambit of the Internal Audit function. In addition, they receive detailed briefings on the Group’s principal businesses, its product range, the markets in which it operates and the overall competitive environment. Other areas addressed include legal issues particular to directors of financial services companies, the Group’s governance arrangements, its Investor Relations programme, as well as its remuneration policies.
Attendance at Board and Committee Meetings The number of Board and Committee meetings attended by each director during 2003 was as follows: Audit Remuneration Nomination Board Committee Committee Committee meetings meetings meetings meetings
Jonathan Bloomer3 10 n/a n/a 0 Philip Broadley 10 n/a n/a n/a
A programme of ongoing professional development has been established for all directors for 2004, which will cover sector specific issues, as well as legal, accounting and regulatory changes and developments.
The evaluation was carried out by the Chairman, canvassing the views of Board members on the performance of the Board and its Committees against a range of objectives, including conformance with related terms of reference. The Chairman met individually with each non-executive director to discuss performance issues. The overall results of the evaluation were reviewed by the Board in January 2004.
The non-executive directors met once during the year, under the leadership of the Senior Independent Director, and reviewed the performance of the Chairman.
RELATIONS WITH SHAREHOLDERS As a major institutional investor, the Company is acutely aware of the importance of maintaining good relations with its shareholders. The Company regularly holds discussions with major shareholders and a programme of meetings took place during 2003. In addition, regular reviews are carried out by the Board of the progress of the programme and the views of the Company’s major shareholders, including a presentation by its external Investor Relations adviser of the results of their annual shareholder survey. Board Members also regularly receive copies of the latest analysts’ and brokers’ reports on the Company and the sector, to further develop their knowledge and understanding of external views about the Company.
Annual Review and Summary Financial Statement, at least 20 working days before the meeting. At the 2004 Annual General Meeting, as with last year’s meeting, shareholders will be given the opportunity to put questions to the Board.
Further information on the Company’s Financial Calendar is available on our website at www.prudential.co.uk
SARBANES-OXLEY ACT 2002 The Sarbanes-Oxley Act 2002 was passed by the US Congress in July 2002 to establish new or enhanced standards for corporate accountability in the US. As a result of the listing of its securities on the New York Stock Exchange, the Company must comply with the relevant provisions of the Act.
In particular, a Disclosure Committee has been established, reporting to the Group Chief Executive, chaired by the Group Finance Director and comprising members of senior management. The objectives of this Committee are: • to assist the Group Chief Executive and the Group Finance Director in designing, implementing and periodically evaluating the Company’s disclosure controls and procedures; • to monitor compliance with the Company’s disclosure controls and procedures; • to review and provide advice to the Group Chief Executive and Group Finance Director with regard to the scope and content of all public disclosures of the Company which are of material significance to the market or investors; • to review and consider, and where applicable follow up on, matters raised by other components of the disclosure process, including assessments made by the Group Audit Committee, the Internal Auditor or the External Auditor of the Company’s internal controls to the extent they are relevant to the disclosure process.
In discharging these objectives, the Committee helps to support the Group Chief Executive’s and the Group Finance Director’s certifications of the effectiveness of disclosure procedures and controls required by Section 302 of the Act.
FINANCIAL REPORTING The directors have a duty to report to shareholders on the performance and financial position of the Group and are responsible for preparing the financial statements on pages 56 to 96 and the supplementary information on pages 103 to 114. It is the responsibility of the auditors to form an independent opinion, based on their audit of the financial statements and their review of the supplementary financial statements. Their opinions are given on pages 97 and 115.
After making appropriate enquiries, the directors consider that the Group has adequate resources to continue its operations for the foreseeable future. They therefore continue to use the going concern basis in preparing the financial statements.
INTERNAL CONTROL AND RISK MANAGEMENT The Board has responsibility for the Group’s system of internal control and for reviewing its effectiveness. The control procedures and systems the Group has established are designed to manage, rather than eliminate, the risk of failure to meet business objectives and can only provide reasonable and not absolute assurance against material misstatement or loss. The system of internal controls includes financial, operational and compliance controls and risk management.
The Group Risk Framework, adopted in 1999, requires that all of the Group’s businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group. The Group risk categorisation model breaks risk down into risk classes, risk categories and risk components. The seven risk classes cover business environment risk, strategic risk, credit risk, regulatory compliance risk, investment risk, underwriting risk and operational risk, and are intended to encompass all risks faced by the Group. They are used by the business units and Group during risk identification, analysis, aggregation and reporting of risk.
Also in 2003, a Group Asset Liability Committee was established. Its membership includes business unit and Group management involved in the operation of the asset liability, credit and insurance risks framework. The Group Asset Liability Committee is the senior management forum responsible for oversight of asset-liability mismatch, solvency, market, credit and insurance risks across the Group. The Group Asset Liability Committee reports to the Group Chief Executive.
In addition, Internal Audit executes a comprehensive risk based audit plan throughout the Group, from which all significant issues are reported to the Audit Committee.
REMUNERATION REPORT FOR YEAR ENDED 31 DECEMBER 2003 38 PRUDENTIAL PLC ANNUAL REPORT 2003
(resigned from the Committee on 8 May 2003) Bart Becht Ann Burdus
Advisers to the Remuneration Committee During 2003 the Group Human Resources Director was invited to provide the Committee with her views and advice on matters considered by the Committee. The Committee has appointed Towers Perrin to provide market data and Freshfields Bruckhaus Deringer to advise on legal matters. Towers Perrin also provided the Company with consultancy advice and salary survey information and Freshfields Bruckhaus Deringer provided other legal advice.
Compliance with the Combined Code During the year, the Company has complied with Schedule A and Schedule B and the provisions relating to the Principles of Good Governance and Code of Best Practice of the Combined Code then in force regarding directors’ remuneration.
The Board welcomes the introduction of the revised Combined Code which comes into effect in 2004 and has reviewed the provisions in Schedule A, Schedule B and Schedule C and the revised Combined Code’s provisions relating to the Code on Corporate Governance and Code of Best Practice regarding directors’ remuneration. In the 2004 Annual Report, the Company will fully set out its compliance together with explanations.
The Remuneration Committee recognises that a successful remuneration policy needs to be sufficiently flexible to take account of changes in the Company’s business environment. The Committee will keep the policy under review, consulting with major shareholders over any proposed changes. Any changes to the policy will be described in future Remuneration Reports.
Remuneration policy for executive directors in 2003 The policy on remuneration levels and elements of the remuneration package that were in place in 2003 are set out below. This policy is unchanged for 2004 except for the amendment to the Restricted Share Plan described in the section on remuneration policy for executive directors in 2004 on page 41.
Annual incentive plans The annual incentive plans for executive directors are designed to reward the creation of value during the year, while supporting sustained long-term value creation. Annual incentive payouts for all executive directors depend on performance. Performance is measured against the stretching quantitative financial targets and business objectives in our business plans. Personal performance is also taken into account. Annual bonus awards are not pensionable.
Mark Tucker’s 2003 award was on a similar basis, but has been prorated to reflect his departure during 2003.
Clark Manning is eligible to receive an annual bonus which provides for a percentage share of a bonus pool geared to the profits of Jackson National Life. In addition, his targets include elements that depend on Group and individual performance which provide 100 per cent of basic salary for on-target performance with a maximum of 120 per cent. Clark Manning is also eligible to participate in a US tax qualified all-employee profit sharing plan.
Long-term incentive plans Our long-term incentive plans are designed to drive the underlying financial performance of the business, i.e. both value creation and relative Total Shareholder Return (TSR). The plans also recognise that strong regional performance is critical to Group performance.
This important performance-related element of the total reward package for executive directors rewards the achievement of TSR relative to other companies that were in the FTSE 100 at the beginning of each three-year performance period. This performance measure was chosen when the RSP was introduced as it reflected a combination of market practice, an assessment of Prudential’s main competitors and the focus of UK investors at that time.
For any awards under the RSP to vest, the Remuneration Committee must be satisfied with the Company’s underlying financial performance over the three-year performance period. At the end of each performance period, executive directors may be granted a right to receive shares at no cost to the individual, dependent on the Company’s performance. For RSP awards prior to 2004, no rights are granted if the Company’s TSR performance as ranked against the comparator group is at the 60th percentile or below. The maximum grant is made only if the TSR ranking of the Company is 20th percentile or above. Between these points, the size of the grant made is calculated on a straight line sliding scale. In normal circumstances, directors may take up their right to receive shares at any time during the following seven years.
Michael McLintock To reflect his role as Chief Executive of M&G, Michael McLintock participates in the M&G Chief Executive Long Term Incentive Plan that provides a cash reward through phantom M&G share awards and phantom M&G share options. The change in the phantom share price equals the change in M&G profit, modified up or down by the investment performance of M&G, over the relevant period. The phantom share awards have a performance period of three years and the award vests at the end of the performance period. For 2003 the face value of the award was £225,000. Provided the phantom share options have value, they may be exercised in part or in full during annual exercise periods after three to seven years from the start of the performance period. For 2003 the phantom option award has a face value of £367,800.
For payouts for performance between these points a sliding scale applies.
Vestings are conditional on Mark Norbom being employed by Prudential at the date of vesting (other than the compensation for the loss of supplemental pension rights from his previous employer, which vests on his leaving Prudential providing it is after 20 February 2013) unless there are exceptional circumstances or there is a change of control of Prudential or an internal reorganisation or a sale of all or a substantial part of the Asian business, which leads to his termination or material reduction in duties or responsibilities. In the case of a change of control he will be entitled to retain any unvested awards of Prudential restricted shares and each of these awards will continue to vest in accordance with its applicable vesting schedule or at such earlier time or times as the Remuneration Committee may in its discretion decide.
He was also compensated for the loss of a portion of his 2003 bonus award and his 2003 long-term incentive award from his previous employer with a total cash sum of £152,410.
REMUNERATION REPORT CONTINUED FOR YEAR ENDED 31 DECEMBER 2003 42 PRUDENTIAL PLC ANNUAL REPORT 2003
DIRECTORS’ SERVICE CONTRACTS AND LETTERS OF APPOINTMENT Executive directors have contracts that terminate on their normal retirement date, which is the date of their 60th birthday. The normal notice of termination that the Company is required to give executive directors is 12 months, although for newly appointed directors there may be an initial contractual period of up to two years before the 12 months’ notice period applies. The service contracts for all current executive directors contain a 12 months’ notice period from the Company, including that for Mark Norbom, who was appointed to the Board in 2004. When considering termination of service contracts, the Remuneration Committee will have regard to the specific circumstances of each case, including a director’s obligation to mitigate his loss.
2. During the year Ann Burdus’ contract was extended to the end of 2003.
Up to April 2003 chairmanship fees of £10,000 per annum were paid in respect of the Remuneration and Audit Committees. From April 2003 the Remuneration Committee chairmanship fee was increased to £20,000 per annum and the Audit Committee chairmanship fee was increased to £40,000 per annum. The Chairman of the Remuneration Committee has waived the increase to the chairmanship fee.
Up to June 2003 additional fees of £5,000 per annum were paid to the other members for membership of each of the Remuneration and Audit Committees. From June 2003 the additional fee of £5,000 per annum continues to be paid to members of the Audit Committee only, with no additional fee now paid for membership of the Remuneration Committee.
Prior to the change in policy, the non-executive directors used the net value of the portion of their fees above £25,000 to purchase shares in the Company. Following the change in policy, the non-executive directors use the net value of £25,000 of their total annual fees to purchase shares in the Company on a quarterly basis. These shares will be held at least until retirement from the Board.
Roberto Mendoza, as Chairman of Egg, receives a fee of £75,000 per annum and Sandy Stewart, as Chairman of the Scottish Amicable (supervisory) Board, receives a fee of £30,000 per annum.
PERFORMANCE GRAPHS The line graphs below represent the comparative Total Shareholder Return (TSR) of the Company during the five years from 1 January 1999 to 31 December 2003.
Dec 99Dec 98 Dec 00 Dec 01 Dec 02 Dec 03
Mark Tucker (resigned 30 June 2003, notes 7, 8 & 9) 235 169 50 454 913
Sir Roger Hurn (resigned 30 November 2002) – – – – 292
Bridget Macaskill (appointed 1 September 2003) 17 – – 17 – Kathleen O’Donovan (appointed 8 May 2003) 35 – – 35 –
Total non-executive directors 465 – – 465 653 *Mark Norbom’s salary on joining the Board on 1 January 2004 was £475,000 per annum.
In respect of awards made in 2000 under the Restricted Share Plan, the Company's TSR was ranked 62nd out of the 88 relevant comparator companies remaining in the FTSE 100 (i.e., the 70th percentile) for the three-year performance period ended on 31 December 2002. As Prudential’s position was lower than 60th percentile, the 2000 awards lapsed and rights were not granted over any of the shares conditionally awarded to executive directors.
Conditional 2003 award granted Conditional Date of share awards Conditional on date upon share awards end of outstanding award of grant vesting outstanding at performance at 1 Jan 2003 in 2003 (pence) in 2003 31 Dec 2003 period
3. Mark Tucker’s conditional RSP awards made in 2001, 2002 and 2003 lapsed as Prudential’s performance against the comparator companies at the time of his leaving was below 60th percentile in each case.
Rights granted under the Restricted Share Plan upon vesting prior to 31 December 2002 and not yet exercised are shown in the following table: Market RSP rights RSP rights Exercise price at Earliest Latest outstanding at outstanding at Price paid price 31 Dec 2003 exercise exercise 1 Jan 2003 31 Dec 2003 for award (pence) (pence) date date
Clark Manning Prior to 2002, Clark Manning participated in the JNL cash long-term incentive plan that provided phantom share awards and phantom options. His 1999 and 2000 cash long-term incentive plans had four-year performance periods ending 31 December 2002 and 31 December 2003 respectively. The payouts in both cases depended on Jackson National Life’s US GAAP net income in the final year. For the 1999 award the results led to no payments while the 2000 awards led to a payment from only the phantom share award of £107,639.
Michael McLintock Michael McLintock’s 2000 and 2001 cash long-term incentive plan had a three-year performance period and the same performance conditions described in the section on long-term incentive plans on page 40. For the 2000 award the phantom share price at the beginning of the performance period was £1 and as a result of M&G’s profit growth and fund performance of M&G over the three years, the phantom share price at the end was £1.36. This resulted in a payment from the phantom share award of £306,000 and a phantom option award of 367,800 units, of which he exercised 183,900 valued at £66,204. For the 2001 award, the phantom share price at the beginning of the performance period was £1 and as a result of M&G’s profit growth and fund performance of M&G over the three years, the phantom share price at the end was £1.20. This resulted in a payment from the phantom share award of £270,000.
Mark Tucker Mark Tucker’s 2000 and 2001 cash long-term incentive plans had the same performance conditions as described in the section on long-term incentive plans on page 41. Under the 2000 plan the compound growth rate of the Asia operations was 54.3 per cent per annum and a maximum payment of £540,000 was paid in 2003 in respect of the award. In respect of the 2001 plan the compound growth rate of the Asia operations at the end of 2003 was 37.7 per cent per annum. The award will be prorated for Mark Tucker’s service to 30 June 2003 during the performance period and was subject to Mark Tucker satisfying certain non-competition and non-solicitation conditions. The payment of £363,267 is expected to be made on or around 30 June 2004. On leaving, Mark Tucker’s 2002 and 2003 awards lapsed.
Mark Wood Mark Wood’s 2001 cash long-term incentive plans had the same performance conditions as described in the section on long-term incentive plans on page 41. The compound growth rate of the UK appraisal value was below the threshold for a payment to be made in respect of the award.
Mark Tucker Business cash LTIP 540 540 – 31 Dec 02 Business cash LTIP 600 –2 31 Dec 03 Business cash LTIP 600 –3 31 Dec 04 Business cash LTIP 705 –3 31 Dec 05
Mark Wood Business cash LTIP 450 450 31 Dec 03 Business cash LTIP 450 450 31 Dec 04 Business cash LTIP 470 470 31 Dec 05
Total cash payments made in 2003 912 Notes 1. The face values of the awards for Clark Manning are converted at the average exchange rate for 2003 (US$1.6351 = £1).
2. Mark Tucker’s award under his 2001 Business cash LTIP was prorated for his service during the performance period up to 30 June 2003 and was subject to his satisfying certain non-competition and non-solicitation conditions. It is expected to be paid to him on or around 30 June 2004.
OTHER SHARE AWARDS Under the Company’s previous short-term deferred bonus plan, known as the Share Participation Plan (SPP) there are deferred share awards held in trust for five years, which are shown in the table on page 48.
The table also includes the share awards that have been deferred from annual incentive plan payouts. The values of the deferred share awards are included in the bonus and total figures in the Directors’ Remuneration table on page 44. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual financial results for the relevant year. For the 2002 awards the average share price was 336 pence.
In order to secure the appointment of Mark Wood, on joining Prudential he was allocated Prudential plc share awards for no consideration which have now been released to him.
Mark Wood Awards under appointment terms 15,080 15,080 – 31 Jul 03 15,080 31 Jul 03 861 427.75
Deferred 2001 annual incentive award 6,321 349 6,670 31 Dec 04 Notes 1. The value of the 2002 deferred share award from the annual incentive plan is included in the total 2002 figure in the Directors’ Remuneration table on page 44.
2. Subject to his satisfying certain non-competition and non-solicitation conditions, Mark Tucker’s deferred awards under the 2001 and 2002 annual incentive plans are expected to be released to him on or around 30 June 2004.
DIRECTORS’ SHAREHOLDINGS The current shareholding policy is that as a condition of serving, all executive and non-executive directors are required to hold 2,500 shares in the Company. These shares must be acquired within two months of appointment to the Board if the director does not own that number upon appointment. As stated on page 43, non-executive directors have also used a proportion of their fees to purchase additional shares in the Company on a quarterly basis.
The interests of directors in shares of the Company are shown below. These interests include shares awarded under the Share Participation Plan, the deferred annual incentive awards, shares held for Michael McLintock in an M&G all-employee trust established prior to the acquisition of M&G in 1999 and the awards made to Mark Wood under his appointment terms (described above). In addition, interests include rights granted to Jonathan Bloomer under the 1997, 1998 and 1999 Restricted Share Plan where he has yet to exercise his right to receive shares. Awards that remain conditional under the Restricted Share Plan are excluded.
Sir David Clementi 6,742 10,742 10,742 *Or date of appointment if later.
3. Roberto Mendoza’s shareholding at 1 January 2003 includes 949 shares received as a result of scrip dividends that were not reported in the 2002 Annual Report.
3. No price was paid for the award of any option.
DIRECTORS’ PENSIONS AND LIFE ASSURANCE It is the Company’s policy to offer executive directors the facility to save for retirement through efficient pension vehicles. Changes introduced by the UK Government in 1989 restrict the pension provision which can be made under Inland Revenue approved pension schemes for new entrants after 31 May 1989 to benefits on annual basic salary up to a threshold known as the earnings cap. The earnings cap for the 2003/2004 tax year is £99,000 per annum. For this reason UK executive directors employed since 1989 are offered a combination of Inland Revenue approved pension schemes and supplementary provision. The Government’s changes to these regulations will take effect from April 2006. The Company will consider any necessary changes to its policy and the provision of benefits once the details of these changes are confirmed.
pension payable is guaranteed to increase in line with the Retail Prices Index capped at five per cent. In recent years all pensions in payment have been increased fully in line with the Retail Prices Index. No employees with employment offers after 30 June 2003 are eligible for membership of the DB Section of this scheme.
These directors may elect to have this salary supplement paid directly to them or to a Funded Unapproved Retirement Benefit Scheme (FURBS) established in their name. In either case it is a taxable emolument.
Clark Manning participates in the JNL Defined Contribution Retirement Plan which is a US tax qualified defined contribution plan (a 401k plan) under which the total company contribution for 2003 was £13,455. He is also provided with life assurance cover of two times basic salary.
Years of Accrued earned to earned to made by to FURBS or pensionable benefit at 31 Dec 31 Dec 2003 2002 directors other pension
Sir David Clementi 54 – – – – – – – 116 Jonathan Bloomer 49 – – – – – – – 244
Total contributions to directors’ pension arrangements were £905,000 (2002: £760,000), of which £320,000 (2002: £271,000) related to money purchase schemes.
DIVIDENDS The directors have declared a final dividend for 2003 of 10.7 pence per share payable on 26 May 2004 to shareholders on the register of members at the close of business on 19 March 2004. The total dividend for the year, including the interim dividend of 5.3 pence per share paid in 2003, amounts to 16.0 pence per share compared with 26.0 pence per share for 2002. The total cost of dividends for 2003 was £320 million.
Kathleen O’Donovan, Bridget Macaskill and Mark Norbom were appointed as directors on 8 May 2003, 1 September 2003 and 1 January 2004 respectively. In accordance with the Articles of Association, Kathleen O'Donovan, Bridget Macaskill and Mark Norbom will retire and offer themselves for election at the Annual General Meeting on 6 May 2004. Sir David Barnes resigned as a director on 8 May 2003, Mark Tucker resigned as a director on 30 June 2003 and Ann Burdus resigned as a director on 31 December 2003. Jonathan Bloomer, Philip Broadley and Rob Rowley will retire by rotation at the Annual General Meeting and offer themselves for re-election. Sandy Stewart, having completed two three-year terms as a director, will retire from the Board at the conclusion of this year’s Annual General Meeting. Details of directors’ interests in shares and debentures of the Company and its listed subsidiary, Egg plc, are set out in the Remuneration Report on page 49.
In 2003 employees were again invited to participate in the Prudential Savings-Related Share Option Scheme (the Scheme). The Scheme has now been operating for over 20 years and a majority of UK staff currently participate. The Prudential International Savings-Related Share Option Scheme (ISSOS) for employees has been operating since 2000 in Hong Kong, Malaysia and Singapore, since 2001 in Taiwan and India, and since 2003 in Korea. On average 37 per cent of employees in those countries covered by the ISSOS currently participate.
SHAREHOLDERS The number of accounts on the share register at information about shareholdings in the Company is given on page 116. As at 12 March 2004 the Company had received notification in accordance with Sections 198 to 208 of the Companies Act 1985 from Fidelity Investments and Legal & General Investment Management Limited of a holding of 4.01 and 3 per cent respectively of the Company’s share capital.
The following table shows the statutory basis results reported in the profit and loss account on pages 56 to 58.
It does not form part of the statutory financial statements. Restated £m £m
Long-term business: UK and Europe Insurance Operations* 256 372 US Operations 165 139 Prudential Asia (net of development expenses of £27m (£26m)) 71 62
Balance on the long-term business technical account before tax (analysed on pages 57 and 58)* 492 573
Items excluded from operating profit before amortisation of goodwill: Amortisation of goodwill (98) (98) Short-term fluctuations in investment returns 91 (205) Profit on sale of UK general business operations – 355
Statutory basis profit on ordinary activities before tax (analysed on page 58)* 350 501
Tax on profit on ordinary activities: Tax on operating profit before amortisation of goodwill* (106) (120) Tax on items excluded from operating profit before amortisation of goodwill (38) 78
Statutory basis profit for the financial year after minority interests: Operating profit after tax and related minority interests before amortisation of goodwill* 257 333 Items excluded from operating profit after tax before amortisation of goodwill (49) 135
Total statutory basis profit for the financial year after minority interests* 208 468
Balance on the long-term business technical account* 338 401 *The 2002 figures for these lines have been restated (see note 4).
Profit for the financial year before minority interests* 206 459 Minority interests 2 9
Reconciliation of operating profit before amortisation of goodwill and exceptional items to profit on ordinary activities†
Operating profit based on long-term investment returns before amortisation of goodwill and arising wholly from continuing operations* 8 357 449
Operating profit based on long-term investment returns* 259 351 Short-term fluctuations in investment returns 5 91 (205) Profit on sale of UK general business operations 11 – 355
Basic earnings per share Based on operating profit after tax and related minority interests before amortisation of goodwill of £257m (£333m) and 1,996m (1,988m) shares* 5 12.9p 16.7p Based on profit for the financial year after minority interests of £208m (£468m) and
Diluted earnings per share Based on profit for the financial year after minority interests of £208m (£468m) and
†Operating profit and related earnings per share include investment returns at the expected long-term rate of return but exclude amortisation of goodwill and exceptional items. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities and related earnings per share include these items together with actual investment returns. This basis of presentation has been adopted consistently throughout these financial statements.
Reinsurers’ share of technical provisions Provision for unearned premiums – 155 Long-term business provision* 499 545 Claims outstanding 151 223 Technical provisions for linked liabilities 274 244
Debtors Debtors arising out of direct insurance operations: Debtors arising out of reinsurance operations 19 23 Other debtors: Tax recoverable 158 212
Prepayments and accrued income Accrued interest and rent 1,131 1,156 Deferred acquisition costs* 2,952 3,222 Other prepayments and accrued income 138 95
Total assets* 161,726 151,991 *The 2002 figures for these lines have been restated (see note 4).
Creditors Creditors arising out of direct insurance operations 382 252 Creditors arising out of reinsurance operations 12 184
Total liabilities* 161,726 151,991 *The 2002 figures for these lines have been restated (see note 4).
Fixed assets Investments: Shares in subsidiary undertakings 29 4,000 5,500 Loans to subsidiary undertakings 29 2,526 2,160
Current assets Debtors: Amounts owed by subsidiary undertakings 1,072 1,420 Other debtors 32 28
The financial statements on pages 56 to 96 were approved by the Board of directors on 19 March 2004.
Acquisitions and disposals Net cash inflow from: Acquisition of subsidiary undertakings – (12) Disposal of UK general business operations 11 – 353 Disposal of European businesses, net of reinsurance payments 35 27 –
The net cash inflow (outflow) was invested (financed) as follows: Portfolio investments Purchases: Ordinary shares 1 39 Fixed income securities 962 3,209
Net sales of portfolio investments 34 (149) (83) Increase in cash and short-term deposits, net of overdrafts 34 481 26
The results of US operations and certain Asian operations are prepared on the basis of US GAAP, with non-insurance balances adjusted where necessary to comply with UK GAAP.
The consolidated financial statements of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Prudential has a controlling interest, using accounts drawn up to 31 December 2003. The results of subsidiaries are included in the financial statements from the date acquired to the effective date of disposal. All intercompany transactions are eliminated on consolidation except for investment management fees charged by M&G and the Group’s US and Asia fund management operations to long-term business funds.
3. SIGNIFICANT ACCOUNTING POLICIES Long-term business The results are prepared in accordance with the modified statutory basis of reporting as set out in the revised Statement of Recommended Practice issued by the Association of British Insurers in November 2003.
Deferred acquisition costs Costs of acquiring new business, principally commissions, marketing and advertising costs and certain other costs associated with policy issuance and underwriting that are not reimbursed by policy charges are specifically identified and capitalised as deferred acquisition costs (DAC), which are included as an asset in the balance sheet. The DAC asset is amortised against margins in future revenues on the related insurance policies, to the extent that the amounts are recoverable out of the margins. Recoverability of the unamortised DAC asset is assessed at the time of policy issue, and reviewed if profit margins have declined.
The overwhelming majority of the liabilities for business in-force of UK insurance operations are held by Prudential Assurance Company (PAC) and its subsidiaries Prudential Annuities Limited (PAL) and Prudential Retirement Income Limited (PRIL). The key features of the liabilities of these companies are as follows: Conventional with-profits and other protection-type policies The future policyholder benefit provisions on conventional with-profits and other protection-type policies are calculated using the net premium method. The net premium is calculated such that it would be sufficient at the outset of the policy to provide only for the discounted value of the original guaranteed death and maturity benefits on the chosen valuation assumptions. The provision is then calculated by subtracting the present value of future net premiums from the present value of future benefits (including vested bonuses) using a prudent discount rate.
For PAC business, the provision has been taken as the lower of: • the accumulated fund or the value at the bid price of the notional number of units allocated to policyholders, in both cases excluding final bonus; and • the surrender or transfer value which, having regard to policyholders’ reasonable expectations, would be payable at the valuation date, or, if greater, the value of the guaranteed liabilities excluding final bonus calculated on a gross premium bonus reserve method.
For the purpose of calculating the liability using the bonus reserve method, the assumed interest rates range from 3.0% to 5.0% at 31 December 2003 and 31 December 2002, while future reversionary bonuses are assumed to fall from current levels to zero in steps of 1.5% per year. There have been no significant changes of assumption for accumulating with-profits business.
Prudential Asia The future policyholder benefit provisions for Asian businesses are determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with UK GAAP. For the Hong Kong business, which is a branch of the Prudential Assurance Company, and the Singapore and Malaysian operations the valuation principles and sensitivities to changes of assumptions of conventional with-profits and other protection-type policies are similar to those described above for equivalent products written by the UK operations. For Hong Kong business the interest rate has reduced to 3.6% at 31 December 2003 from 3.75% at 31 December 2002 for traditional business and to 3.25% at 31 December 2003 from 3.75% at 31 December 2002 for accumulating with-profits assurances. For Singapore and Malaysia there have been no significant changes of assumption. Interest rates of 3.5% to 4.0% in Singapore and 4.0% in Malaysia have been used in accordance with local regulations.
Linked business For all insurance operations, segregated accounts are established for policyholder business for which policyholder benefits are wholly or partly determined by reference to specific investments or to an investment-related index. The assets and liabilities of this linked business are reported as summary totals in the consolidated balance sheet.
Revenue recognition Premiums are recognised when risks are assumed. The proportion of premiums written relating to periods of risk beyond any year end is recorded as an unearned premium provision and subsequently recognised in earnings proportional to the period of the risk. Premiums are presented gross of commission and exclude any taxes or duties assessed based on premium.
An unexpired risks provision is established for any excess of expected claims and deferred acquisition costs over unearned premiums and investment returns. The assessment of expected claims involves consideration of claims experience up to the end of the accounting period. No specific provision is made for major events occurring after this date.
Realised investment gains and losses represent the difference between the net sale proceeds and the cost of acquisition. Unrealised investment gains and losses represent the difference between the carrying value at the previous year end (or purchase value during the year) and the carrying value at the current year end.
Investment returns on assets covering general business liabilities are allocated from the non-technical account to the general business technical account. Investment returns are also allocated between the long-term business technical account and the non-technical account for the difference between the actual investment rate of return of the long-term business technical account and the long-term rate of return on the assets backing shareholder financed long-term business (primarily Jackson National Life and certain Asian operations). Further details are provided in note 5.
The tax charge for long-term business included in the long-term business technical account 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.
In December 2003, Urgent Issues Task Force abstract 38 (UITF 38) on accounting for Employee Share Ownership Trusts was issued. The main effect of UITF 38 is to extend the UITF approach of deducting the carrying value of shares from shareholders’ funds rather than accounting for the shares as an asset. An additional impact is that, although the effect is expected to be minor, UITF 38 necessitates the calculation of certain adjustments to the amounts recorded in the profit and loss account. In recognition of the timing of issue of UITF 38, compliance with the abstract is not mandatory for 2003 reporting. The Company has chosen not to adopt the provisions of UITF 38 in its 2003 results but will do so in its 2004 results.
Securities lending The Group is party to various securities lending agreements under which securities are loaned to third parties on a short-term basis. The loaned securities are not removed from the Group’s consolidated balance sheet; rather, they are retained within the appropriate investment classification. The Group’s policy is that collateral in excess of 100% of the fair value of securities loaned is required from all securities borrowers and typically consists of cash, debt securities, equity securities or letters of credit.
In cases where the Group takes possession of the collateral under its securities lending programme, the collateral is included in other financial investments in the consolidated balance sheet with a corresponding liability being recorded to recognise the obligation to return such collateral. To further minimise credit risk, the financial condition of counterparties is monitored on a regular basis.
Further details of UK banking business assets and liabilities are contained in note 11.
Foreign currency translation The profit and loss accounts of foreign subsidiaries are translated at average exchange rates for the year. Assets and liabilities of foreign subsidiaries are translated at year end exchange rates. Foreign currency borrowings that have been used to finance or provide a hedge against Group equity investments in overseas subsidiaries, are translated at year end exchange rates. The impact of these currency translations is recorded as a component of shareholders’ funds within the statement of total recognised gains and losses.
The summary effects of the changes on the Group's earnings, assets and liabilities and shareholders' funds are shown below: Revised basis of recognition after implementing the revised SORP
Profit for the year before minority interests 206 459 Minority interests 2 9
Profit on ordinary activities before tax 340 484 Tax (147) (44)
The overwhelming majority of long-term gains and losses, and the difference between actual and long-term gains, arises from the accounting treatment of averaging realised gains and losses of Jackson National Life's fixed income securities over a five-year period within operating results. The only significant part of the investment portfolio for shareholder backed business where an assumed rate has been applied in the calculation of long-term gains to be included in operating profits is the aforementioned 7.75% for equity-related investments of Jackson National Life. For this part of the portfolio, a 1% change would alter operating results by approximately £4m.
In addition to the adjustments made for investment returns, as described above, operating profit excludes amortisation of goodwill and gains on business disposals and similar items.
In accordance with FRS 3, the presentation of additional supplementary earnings per share information is permitted provided the earnings basis used is applied consistently over time and is reconciled to consolidated profit for the financial year. In determining operating profit, the Group has used the expected long-term investment return and excluded amortisation of goodwill and exceptional items as the directors believe that such presentation better reflects the Group’s underlying performance on a statutory basis of measurement.
5. SUPPLEMENTAL EARNINGS INFORMATION CONTINUED The Group’s supplemental measure of its results and reconciliation of operating profit based on long-term investment returns before amortisation of goodwill and exceptional items to profit on ordinary activities, including the related basic earnings per share amounts, are as follows: Before Basic tax Tax Minority earnings
Operating profit based on long-term investment returns before amortisation of goodwill and exceptional items 357 (106) 6 257 12.9p Amortisation of goodwill (98) (98) (4.9)p Short-term fluctuations in investment returns: 2002 (restated*) Operating profit based on long-term investment returns before amortisation of goodwill and exceptional items* 449 (120) 4 333 16.7p Amortisation of goodwill (98) (98) (4.9)p Short-term fluctuations in investment returns: Profit on sale of UK general business operations 355 (13) 342 17.2p *The 2002 figures for these lines have been restated (see note 4).
†The adjustment from post-tax long-term investment returns to post-tax actual investment returns includes investment returns that are attributable to external equity investors in two investment funds managed by PPM America. These two funds are consolidated as quasi-subsidiaries but, except to the extent of Prudential Group participation in the funds, they have no net impact on pre-tax or post-tax operating profit. Total profit, before and after tax, incorporating the adjustment from long-term to actual investment returns, includes gains of £4m (losses of £5m) attributable to the minority interests in these funds.
A reconciliation of the weighted average number of ordinary shares used for calculating basic and diluted earnings per share is set out below: Millions Millions
Weighted average shares for diluted earnings per share 1,998 1,991 6. SEGMENTAL INFORMATION – ANALYSIS OF LONG-TERM BUSINESS GROSS PREMIUMS WRITTEN
74 PRUDENTIAL PLC ANNUAL REPORT 2003 7. SEGMENTAL INFORMATION – INSURANCE AND INVESTMENT PRODUCTS NEW BUSINESS Insurance Products and Investment Products
Insurance Products Investment Products Total £m £m £m £m £m £m
Department of Work and Pensions rebate business 103 90 – – 10 9
Partnerships Life and individual annuities 98 11 – – 10 1
1 Jan 2003 inflows Redemptions movements 31 Dec 2003 £m £m £m £m £m
UK and Europe Operations 20,284 3,797 (2,444) 2,555 24,192 Prudential Asia 5,232 18,157 (16,635) (158) 6,596 8. SEGMENTAL INFORMATION – PROFIT ON ORDINARY ACTIVITIES BEFORE TAX
Balance on Balance on long-term general business business technical technical account account before tax Other activities Total
UK and Europe Insurance Operations* 0 0 256 372 256 372 M&G 83 71 83 71 Egg (34) (20) (34) (20)
US Operations: Jackson National Life 165 139 165 139 Broker-dealer and fund management (3) 14 (3) 14
Other income and expenditure: Investment income (including realised gains)† 60 223 60 223 Unrealised losses on investments (10) (217) (10) (217) Allocations to technical accounts 70 (207) 70 (207)
Investment return and other income† 29 3 29 3 Interest payable on core structural
Profit on sale of UK general business operations (note 11) – 355 – 355
Statutory basis profit on ordinary activities before tax* 0 0 492 573 (142) (72) 350 501 *The 2002 figures for these lines have been restated (see note 4). †Investment income is shown after deducting interest payable on non-core borrowings, as described in note 16.
76 PRUDENTIAL PLC ANNUAL REPORT 2003 9. SEGMENTAL INFORMATION – NET ASSETS A segmental analysis of the fund for future appropriations and the technical provisions net of reinsurers’ share is set out below which, although liabilities, provides a more useful indication of the assets supporting the business: Restated
US Operations†: Jackson National Life (note 12) 2,398 (140) 2,258 2,529 (155) 2,374 Broker-dealer and fund management (note 12) 71 71 75 75
Other operations: Total* 5,845 (2,567) 3,278 6,065 (2,452) 3,613 *The 2002 figures for these lines have been restated (see note 4). †Total goodwill comprises amounts included in: £m £m
Other operations relating to M&G and acquired Asian businesses 1,445 1,540 US operations relating to broker-dealer and banking businesses 53 58 Egg relating mainly to Zebank, France 6 6
In 2002 the Company sold its UK home and motor business for a consideration of £353m. After allowing for the costs of sale and other related items, the profit on sale was £355m before tax. As part of the sale arrangements, the insurance liabilities of the business at the end of 2001 and gross premiums written in 2002 were fully reinsured. This business is now in run-off, as is the Group’s UK commercial business that was closed to new business in 1992.
Interest receivable from: Loans and advances to customers 470 376 Debt securities 177 189 Other 184 100
Administrative expenses (288) (234) Provision for bad and doubtful debts (137) (85) Other expenses (33) (28)
78 PRUDENTIAL PLC ANNUAL REPORT 2003 12. US OPERATIONS – ADDITIONAL DETAIL ON BASIS OF PRESENTATION OF RESULTS The results of US Operations, mainly Jackson National Life (JNL), are consolidated into the Group accounts based on US Generally Accepted Accounting Principles (US GAAP). However, certain adjustments are made in the Group’s consolidated financial statements to the US GAAP results reported in Jackson National Life’s own financial statements in order to comply with UK GAAP, with the Group’s accounting policies, and to reflect appropriately the US Operations segmental result, as set out below: Reverse FAS 115 US GAAP
Profit and loss account Operating profit: Jackson National Life 729 (340) 389 (120) 269 165 Broker-dealer and fund management 23 (27) (4) (3)
Profit before tax before minority interests 512 (196) 316 21 73 410 250 Minority interests (note (iii)) (15) 15 –
Profit before tax after minority interests 497 (181) 316 21 73 410 250
Comprising: Jackson National Life 4,042 2,258 Broker-dealer and fund management 127 71
(iii) Minority interests The UK GAAP results are determined after adjustment for minority interests. For UK reporting purposes the segmental result of Jackson National Life reflects its proportionate interests in the results of two investment funds that are consolidated as quasi-subsidiaries.
Income from: 6,684 6,715 101 85 Gains (losses) on the realisation of investments 651 (219) 5 198 Exchange gains 687 520 0 0
80 PRUDENTIAL PLC ANNUAL REPORT 2003 14. LONG-TERM BUSINESS PROVISIONS, PREMIUMS AND POLICYHOLDERS’ BONUSES (i) Technical provisions and technical provisions for linked liabilities The following table provides an analysis of technical provisions between with-profits and non-participating business: Scottish Amicable Insurance Fund^ 10 10
Shareholder financed business: Non-participating business 23 24 Linked business 17 14
(ii) Gross premiums The following table provides an analysis of gross premiums between with-profits and non-participating business: Scottish Amicable Insurance Fund^ 2 2
Financed by with-profits funds: With-profits business 25 30 Non-participating business† 1 1
(iii) Policyholders’ bonuses Bonuses declared for the year in respect of the Group’s with-profits business are included in the change in long-term business provision or, where the policy is no longer in force, in claims incurred. The total cost of policyholders’ bonuses was £2,280m (£3,009m).
15. NET OPERATING EXPENSES Long-term business General business technical account technical account
Acquisition costs 1,188 1,315 – – Change in deferred acquisition costs* (3) (225) – – Administrative expenses 633 688 3 3 Amortisation of present value of acquired in-force business (note 27)* 26 27 – –
Net operating expenses in the consolidated profit and loss account also include corporate expenditure of £67m (£62m) in the non-technical account.
Interest payable on core structural borrowings – – 143 130 Interest on bank loans and overdrafts 40 35 0 0 Interest on other borrowings 92 112 46 60
Pension costs The Group has chosen not to fully implement FRS 17 ‘Retirement benefits’ for the 2003 financial statements. Pension costs shown above have been determined applying the principles of SSAP 24 ‘Pension costs’. £32m (£34m) of the costs related to defined benefit schemes and £16m (£13m) to defined contribution schemes. In addition, £12m (£11m) of the costs related to overseas schemes.
This Scheme has assets held in separate trustee administered funds and was last subject to full triennial actuarial valuation as at 5 April 2002 by P N Thornton, a qualified actuary and a partner in the firm of Watson Wyatt Partners. The principal actuarial assumptions adopted were investment return 6.6% per annum, pensionable earnings growth 4.5% per annum, increases to pensions in payment 2.5% per annum and dividend growth 3.5% per annum.
The market value of Scheme assets as at that date was £4,034m and the actuarial value of the assets was sufficient to cover 110% of the benefits that had accrued to members, allowing for expected future increases in earnings. As a result of the actuarial valuation, the employers’ contribution rate has continued at the minimum prescribed under the Scheme rules, which is 12.5% of salaries.
82 PRUDENTIAL PLC ANNUAL REPORT 2003 17. INFORMATION ON STAFF AND PENSION COSTS CONTINUED Pension costs continued The position at 31 December 2003, applying the methodology used for the valuation at 5 April 2002, has not been calculated and no external advice has been taken in this regard. On an indicative basis only, the funding level is expected to have reduced since the time of the 2002 valuation from the 110 per cent level, but an update of the valuation results to 31 December 2003 would be expected to reveal a more balanced funding level than the FRS 17 balance sheet disclosure (see below) suggests. This is primarily as a result of adopting an investment return assumption for funding which is based on the long-term expected returns on the assets held by the Scheme, rather than bond assumptions prescribed by FRS 17.
The employers’ contribution is required to be paid as a minimum in future years irrespective of the excess of assets in the Scheme and, under the current Scheme rules, access to the surplus through refunds from the Scheme is not available. Accordingly the surplus is not recognised as an asset in the Group’s financial statements and the pension cost charge has been determined on an accrued payable basis without regard to the spreading of the surplus in the fund that would normally be appropriate under the requirements of SSAP 24.
(a) Profit and loss charge attributable to shareholders This comprises: £m £m
(b) Actuarial losses attributable to shareholders This comprises losses charged to the statement of total recognised gains and losses, after adjusting for amounts attributable to the PAC with-profits fund: £m £m
84 PRUDENTIAL PLC ANNUAL REPORT 2003 17. INFORMATION ON STAFF AND PENSION COSTS CONTINUED Comparison of FRS 17 basis results with results on SSAP 24 basis Balance sheet
SSAP 24 FRS 17 SSAP 24 FRS 17 basis basis basis basis
Pension scheme liability attributable to shareholders and PAC with-profits fund (net of related deferred tax) Nil† (512) Nil† (465)
†Surplus on actuarial basis of valuation not recognised due to minimum contribution requirement under Scheme rules (see page 82).
Pensions costs charged to technical accounts and non-technical account for defined benefit and defined contribution schemes (48) (39)
Mortgages and other borrowings from Egg plc at 31 December 2003 4 311
Audit services: Statutory audit fees 3.6 3.3 US GAAP work 0.7 0.6 Achieved profits basis audits 0.1 0.1 Audit related regulatory reporting 0.5 0.7 4.9 4.7 Further assurance services: Regulatory reviews – 1.3 Acquisitions and disposals due diligence – 0.4
20. TAX (i) Profit and loss account tax charge (credit) The tax expense for certain long-term business operations is attributable to shareholders and policyholders. The shareholders’ portion of tax is determined using the long-term tax rate of the underlying business applied to the profits transferred to the non-technical account. A summary of the tax expense attributable to the long-term business technical account and shareholders’ profits in the non-technical account is shown below: Long-term business Non-technical account technical account (attributable to (attributable to shareholders’
Shareholder tax attributable to balance on the long-term business technical account: Restated
Tax on profit on ordinary activities (including tax on actual investment returns)* 144 42 *The 2002 figures for these lines have been restated (see note 4).
(d) Factors affecting tax charge for the period The tax assessed in the period is higher (lower) than the standard rate of corporation tax in the UK and the differences are explained on the following page. The standard rate of tax has been determined by using the UK rate of corporation tax enacted for the period for which the profits will be taxed.
86 PRUDENTIAL PLC ANNUAL REPORT 2003 20. TAX CONTINUED (d) Factors affecting tax charge for the period continued
Profit on ordinary activities multiplied by standard rate of corporation tax in the UK of 30% (30%)* 105 150 Effects of: Utilisation of capital losses against profit on sale of UK general business operations – (97) Other differences in basis between taxable gains and book gains 3 (15) Different tax rates on overseas earnings 13 (15) Deferred tax not recognised on tax losses carried forward 21 28 Different tax bases of long-term insurance (current and deferred) (12) (29) Taxable foreign exchange losses not recognised in accounts – (12) Non-taxable amortisation of goodwill 30 29 Adjustments in relation to prior years (10) (3) Capital allowances for period in excess of depreciation for the period (4) (2) Effect of short-term timing differences 11 13 Unrealised gains on general business and shareholder investments – 57 Other* 18 (18)
(e) Factors that may affect future tax charges The possible tax benefit of approximately £427m (£427m), which may arise from capital losses valued at approximately £1.7bn (£1.7bn), is sufficiently uncertain that it has not been recognised. The circumstances in which the amount would be recoverable are a combination of the following: the agreement of the value of the losses with the Inland Revenue, the availability of future capital profits that are within the charge to capital gains tax and the agreement of the Inland Revenue to the utilisation of the losses against certain capital gains arising in the UK long-term business operations.
(a) By category of timing difference Unrealised gains on investments 1,205 759 Deferred acquisition costs 408 427 Short-term timing differences (626) (625) Long-term business technical provisions and other insurance items 204 163 Capital allowances (37) (28)
Total 1,154 696 †Includes deferred tax charges in respect of non-participating annuity business written by a subsidiary, Prudential Annuities Limited, financed by the PAC with-profits fund.
Movements in year (2) (1) (3) Balance at beginning of year 6 (5) 11 12
The associate undertakings at the end of the year comprise: (a) IfOnline plc, a company whose principal activity is mortgage intermediation. Egg plc has a 39% share in the share capital of IfOnline plc; (b) Hazell Carr Pensions Consulting plc (HCPC), a company whose principal activity is the administration of defined benefit pension schemes. Prudential Pensions Administration Limited has a 25% share in the share capital of HCPC.
In accordance with FRS 9, ‘Associates and joint ventures’, investments held as part of the investment portfolio, rather than as undertakings through which the Company carries out its business, are accounted for as other financial investments in note 24 and not as investments in participating interests.
25. ASSETS HELD TO COVER LINKED LIABILITIES Cost Current value £m £m £m £m
Cost: Balance at beginning of year 460 553 Exchange movement (17) (22)
27. PRESENT VALUE OF ACQUIRED IN-FORCE LONG-TERM BUSINESS Restated £m £m
Balance at end of year* 108 133 *The 2002 figures for these lines have been restated (see note 4).
At 31 December 2003 there were options subsisting under share option schemes to subscribe for 15,788,315 (13,605,456) shares at prices ranging from 280 pence to 759 pence (296 pence to 759 pence) and exercisable by the year 2010 (2009).
In addition, 5.6m shares were held by a qualifying employee share ownership trust. At 31 December 2003, these shares were expected to be fully distributed in the future on maturity of savings-related share option schemes. The expected weighted average exercise price under these schemes was 298 pence and the expected proceeds of £17m relating to these shares have also been accounted for as own shares in the consolidated balance sheet.
29. INVESTMENTS OF THE COMPANY Shares in Loans to subsidiary subsidiary undertakings undertakings £m £m
At beginning of year 5,500 2,160 Transfer to other subsidiary undertaking (1,500) – Exchange rate movements – (19) Advances of new loans – 460 Provision against loans – (75)
At end of year 4,000 2,526 30. PROFIT OF THE COMPANY The profit of the Company for the year was £186m (£327m). After dividends of £320m (£519m) and a transfer from the share premium account of £27m (£23m) in respect of shares issued in lieu of cash dividends, retained profit at 31 December 2003 amounted to £969m (£1,076m).
The Prudential Assurance Company Limited Insurance England and Wales Prudential Annuities Limited† Insurance England and Wales Prudential Retirement Income Limited† Insurance Scotland M&G Investment Management Limited† Investment management England and Wales Egg Banking plc† Banking England and Wales Jackson National Life Insurance Company† Insurance US Prudential Assurance Company Singapore (Pte) Limited† Insurance Singapore †Owned by a subsidiary undertaking of the Company.
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for Prudential Retirement Income Limited which operates mainly in England and Wales. Egg Banking plc is a subsidiary of Egg plc, a listed subsidiary of the Company. The ordinary shares of Egg plc, of which there is only one class, are 79% owned by the Company and 21% owned by shareholders external to the Prudential Group.
Core structural borrowings of shareholder financed operations: Holding company and finance subsidiaries: US$250m 7.125% Bonds 2005^ 140 155 140 155 £150m 9.375% Guaranteed Bonds 2007 150 150 150 150 £250m 5.5% Bonds 2009^ 250 250 250 250 ¤500m 5.75% Subordinated Notes 2021^†
Capital Securities^† (note (ii)) 547 – 547 – Floating Rate Guaranteed Unsecured
Jackson National Life: Currency translation asset on swap transaction (note (i)) (20) (17) (20) (17)
Total core structural borrowings of shareholder financed operations 2,552 2,008 15 444 2,567 2,452
Other borrowings of shareholders’ funds: Bank loans and overdrafts 16 1 16 1 Obligations under finance leases 3 3 3 3 Commercial paper 2004 (note (iii)) 1,041 1,212 1,041 1,212 Medium Term Notes (note (iii)) 10 25 10 25 Currency translation net liability on swap transactions (note (iii)) 23 13 23 13 Non-recourse borrowings of investment subsidiaries managed by PPM America (note (iv)) 153 292 61 73 214 365
Shareholders’ funds 2,863 2,055 172 296 1,150 1,767 4,185 4,118 Long-term business operations 240 255 20 – 260 255
(i) At 31 December 2003, the ¤500m 5.75% borrowings had been swapped into borrowings of £333m with interest payable at 6 month £Libor plus 0.962%.
(ii) At 31 December 2003, interest on the US$1,000m 6.5% borrowings had been swapped into floating rate payments at 3 month US$Libor plus 0.80%.
(iii) These borrowings support a short-term fixed income securities reinvestment programme.
(iv) Non-recourse borrowings issued by investment subsidiaries managed by PPM America include secured senior and subordinated debt and a revolving credit facility. The senior debt is secured on the investments held by the relevant subsidiaries. The interests of the holders of the subordinated debt issued by these subsidiaries are subordinate to the entitlements of the holders of the senior debt. The terms of the revolving credit facility include a cross default provision with the subordinated notes. In addition to the debt of these subsidiaries, PPM America manages investment companies with liabilities of £943m (£1,048m) pertaining to debt instruments issued to external parties. In all instances the holders of the debt instruments issued by these subsidiaries and other companies do not have recourse beyond the assets of those subsidiaries.
(v) The interests of the holders of the Notes issued by Egg plc as structured debt capital are subordinate to the entitlements of other creditors of that operation. At 31 December 2003, Egg had also issued unsubordinated debt securities totalling £1,423m (£1,015m) and sold securities under agreements to repurchase totalling £829m (£nil) as part of its trading activities.
92 PRUDENTIAL PLC ANNUAL REPORT 2003 33. CONTINGENCIES AND RELATED OBLIGATIONS Consistent with FRS 12, ‘Provisions, contingent liabilities and contingent assets’, appropriate provision has been made in the financial statements where the Group has an obligation arising from the events or activities described below where a realistic estimate of the obligation can be made, but not for contingent liabilities.
The Group is involved in other litigation arising in the ordinary course of business. Whilst the outcome of such matters cannot be predicted with certainty, the directors believe that the ultimate outcome of such litigation will not have a material adverse effect on the Group’s financial condition, results of operations or cash flows.
Pension Mis-selling Review In 1988, the UK government introduced new pensions legislation intended to encourage more individuals to make their own arrangements for their pensions. During the period from April 1988 to June 1994, many individuals were advised by insurance companies, Independent Financial Advisers and other intermediaries to not join, to transfer from or to opt out of their occupational pension schemes in favour of private pension products introduced under the UK Income and Corporation Taxes Act 1988. The UK insurance regulator (previously the Personal Investment Authority, now the Financial Services Authority, (FSA)) subsequently determined that many individuals were incorrectly advised and would have been better off not purchasing the private pension products sold to them. Industry participants are responsible for compensating the persons to whom private pensions were missold. As a result, the FSA required that all UK life insurance companies review their potential cases of pension mis-selling and pay compensation to policyholders where necessary and, as a consequence, record a provision for the estimated costs. The Group met the requirement of the FSA to issue offers to all cases by 30 June 2002.
Every year the FSA updates the actuarial assumptions to be used in calculating the provision, including interest rates and mortality assumptions. The pension mis-selling provision represents the discounted value of future expected payments, including benefit payments and all internal and external legal and administrative costs of adjudicating, processing and settling those claims. To the extent that amounts have not been paid, the provision increases each year reflecting the shorter period of discount.
The Group’s main exposure to mortgage endowment products is in respect of policies issued by Scottish Amicable Life plc (SAL) and policies issued by Scottish Amicable Life Assurance Society (SALAS) and transferred into the Scottish Amicable Insurance Fund (SAIF). The FSA issued a report in March 2001 raising concerns regarding the conduct of sales of these products by tied agents of SAL and in March 2003 it fined SAL £750,000 in respect of cases where advisers did not place appropriate emphasis on identifying whether a customer was prepared to take the risk that their mortgage might not be repaid at the end of the term. A provision of £25m was made in 2001 in SAL for cases that may require redress. At 31 December 2003, the provision was £8m. At the FSA’s request, wording is also being included (for a period of one year) in the annual re-projection letters issued to policyholders of both SAL and SAIF, whose policy was sold to them by tied agents of SALAS, inviting them to respond if they feel that the policy was mis-sold. In anticipation of the response to these letters, a provision of £31m was set up in SAIF at 31 December 2003. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund, this provision has no impact on shareholders. Scottish Amicable withdrew from the mortgage endowment product market in April 2001 and disbanded its network of tied agents in October 2001.
Jackson National Life has commitments for future payments related to equity index call options totalling £12m at 31 December 2003. These commitments are accounted for on a deferred basis and therefore are off-balance sheet. The commitments were entered into in the normal course of business to hedge obligations associated with the issuance of equity index-linked immediate and deferred annuities and fall due for payment over the next four years.
The Group has provided, from time to time, certain guarantees and commitments to third parties including funding the purchase or development of land and buildings and other related matters. At 31 December 2003, the aggregate amount of commitments and guarantees in respect of land and buildings was approximately £51m.
94 PRUDENTIAL PLC ANNUAL REPORT 2003 33. CONTINGENCIES AND RELATED OBLIGATIONS CONTINUED Other Matters Prudential Assurance’s inherited estate The assets of the main with-profits fund within the long-term fund of Prudential Assurance comprise the amounts that the Company expects to pay out to meet its obligations to existing policyholders and an additional amount used as working capital. The amount payable over time to policyholders from the with-profits fund is equal to the policyholders’ accumulated asset shares plus any additional payments that may be required by way of smoothing or to meet guarantees. The balance of the assets of the with-profits fund is called the ‘inherited estate’ and has accumulated over many years from various sources.
The inherited estate represents the major part of the working capital of Prudential Assurance’s long-term fund which enables the Company to support with-profits business by providing the benefits associated with smoothing and guarantees, by providing investment flexibility for the fund’s assets, by meeting the regulatory capital requirements that demonstrate solvency and by absorbing the costs of significant events or fundamental changes in its long-term business without affecting the bonus and investment policies. The size of the inherited estate fluctuates from year-to-year depending on the investment return and the extent to which it has been required to meet smoothing costs, guarantees and other events.
Net cash inflow from operating activities 88 31 *The 2002 figures for these lines have been restated (see note 4).
Net assets (disposed of) acquired after expenses and tax: Goodwill on acquisitions – 8 Cash and short-term deposits – 1 Amounts retained in long-term business operations (27) – Other net assets – (7)
Represented by: Investments (including short-term deposits) 2,271 2,736 Cash at bank and in hand 410 332 Borrowings (4,185) (4,118) Share capital and share premium (653) (650) Cumulative charge to Group profit and loss account reserve in respect of shares issued to qualifying employee share ownership trust 159 159
Shareholders’ funds (as above) 4,185 4,118 Long-term business operations 260 255
36. JACKSON NATIONAL LIFE SECURITISATION TRANSACTION In November 2003, Jackson National Life completed a securitisation of asset-backed securities referred to as the Piedmont CDO transaction. Under this transaction, Jackson National Life contributed US$1,160m of asset-backed securities, ultimately to Piedmont, which issued several classes of debt to acquire such securities. Jackson National Life retained beneficial interests of approximately 80% in the contributed asset-backed securities by acquiring certain securities issued by Piedmont. These interests remain on the balance sheet and are accounted for in accordance with the policy applied generally to Jackson’s securities as explained in notes 2 and 12.
Company law requires the directors to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss for that period. In preparing those financial statements, the directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; • prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group will continue in business.
The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Group and to enable them to ensure that the financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS The directors are responsible for preparing the Annual Report and the directors’ remuneration report. As described above, this includes responsibility for preparing the financial statements in accordance with applicable United Kingdom law and accounting standards. Our responsibilities, as independent auditors, are established in the United Kingdom by statute, the Auditing Practices Board, the Listing Rules of the Financial Services Authority, and by our profession’s ethical guidance.
We review whether the statement on pages 32 to 37 reflects the Company’s compliance with the seven provisions of the Combined Code specified for our review by the Listing Rules, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures.
• the financial statements and the part of the directors' remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985.
Results for the year Long-term business: New business: Operating profit before amortisation of goodwill and exceptional items: US broker-dealer and fund management (3) 14 16 7 (6)
Shareholders’ investment return and other income 29 3 51 64 84 Interest payable on core structural borrowings (143) (130) (118) (131) (122)
Total operating profit (based on long-term investment returns) before amortisation of goodwill and exceptional items 357 449 626 772 776
Profit on ordinary activities before tax (including actual investment returns) 350 501 389 879 750
Insurance and investment funds under management (£bn) 168 155 163 165 170
Based on profit for the year after tax and minority interests 10.4p 23.5p 20.0p 29.4p 24.2p
US Operations Long-term business: New business: Operating profit (including long-term investment returns): Broker-dealer and fund management (3) 14 16 7 (6)
Prudential Asia Long-term business: New business: Operating profit before development expenses 98 88 44 39 27
Achieved profits basis capital and reserves 1,419 1,407 1,089 793 593
The International Organisation of Securities Commissions (IOSCO) has recommended that annual reports of publicly held companies include a section on risk factors which discuss inherent risks in the business and trading environment. The US Securities and Exchange Commission (SEC) has implemented this recommendation with respect to annual statements filed with it by listed companies such as Prudential and the concept of risk factors is also reflected in the EU Prospectus Directive (due to be implemented by mid-2005). Prudential has therefore decided voluntarily to follow this recommendation and to include in the Annual Report a description of risk factors; a similar description will be included in Prudential’s US filing.
The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as at 19 March 2004, is not updated, and any forward-looking statements are made subject to the reservations specified on the inside back cover of the Annual Report.
Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. In the UK, this is largely because Prudential’s shareholders’ profit is related to bonuses for policyholders declared on its with-profits products, which are broadly based on historic and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns.
In the US, fluctuations in prevailing interest rates can affect results from Jackson National Life which is predominantly a spread-based business with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products in Jackson National Life expose the Group to the risk that changes in interest rates which are not fully reflected in the interest rates credited to customers will reduce spread. The spread is the difference between the amounts that Jackson National Life is required to pay under the contracts, and the rate of return it is able to earn on its general account investments to support the obligations under the contract. Declines in spread from these products or other spread businesses that Jackson National Life conducts could have a material impact on its businesses or results of operations.
In all markets in which Prudential operates, its businesses are susceptible to general economic conditions, which can change the level of demand for Prudential’s products. Past uncertain trends in international economic and investment climates which have adversely affected Prudential’s business and profitability could be repeated. This adverse effect would be felt principally through reduced investment returns and credit defaults in fixed interest corporate bonds, and may continue to affect the business unless conditions improve. In addition, falling investment returns could impair Prudential’s operational capability, including its ability to write significant volumes of new business.
Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its business. Due to the geographical diversity of Prudential’s businesses, it is subject to the risk of exchange rate fluctuations. Prudential’s international operations in the US, Asia and Europe, which represent a significant proportion of operating profit and shareholders’ funds, generally write policies and invest in assets denominated in local currency. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential’s consolidated financial statements upon translation of results into pounds sterling. The currency exposure relating to the translation of reported earnings is not separately managed. Consequently, this could impact on the Group’s gearing ratios. The impact of gains or losses on currency translations is recorded as a component of shareholders’ funds within the consolidated statement of total recognised gains and losses. The impact of exchange rate fluctuations in 2003 is discussed in the Financial Review.
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations in the markets in which it operates. Changes in government policy, legislation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates may adversely affect Prudential’s product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. These changes include possible changes in government pension arrangements and policies, the regulation of selling practices and solvency requirements. For instance, in the UK the Financial Services Authority’s (FSA) proposals on reforming the UK polarisation regime and consultation paper on treating with-profits policyholders fairly and the HM Treasury report on medium and long-term retail savings could have a significant effect on types of products sold by Prudential, how its products are priced, distributed and sold and on shareholders’ return on withprofits business.
Within the UK, Prudential’s principal competitors in the life market include many of the major stock and mutual retail financial services companies including, in particular, Aviva, Legal & General, Scottish Widows and Standard Life.
Jackson National Life’s competitors in the US include major stock and mutual insurance companies, mutual fund organisations, banks and other financial services companies. Jackson National Life’s principal life insurance company competitors in the US include AXA, Lincoln National Corporation, Transamerica Corporation, Nationwide Financial Services, Inc., SunAmerica, Inc. and Hartford Life, Inc.
Prudential is a major participant in the UK pensions annuity market. In exchange for a premium equal to the capital value of their accumulated pension fund, each pension annuity policyholder receives a guaranteed payment, usually monthly, for as long as they are alive. For a smaller monthly payment, certain annuity contracts extend the right to the payment to surviving spouses. As part of its pension annuity pricing and reserving policy Prudential assumes that current rates of mortality continuously improve over time. Annuity mortality assumptions have been revised in 2003 to assume future improvements in mortality for males and females at levels projected on the Continuous Mortality Investigations (CMI) medium cohort table as published by the Institute and Faculty of Actuaries.
UK and Europe Operations New business 8 166 233 Business in-force 9 193 283
US Operations New business 8 148 234 Business in-force 9 71 17
Other income and expenditure Investment return and other income 29 3 Interest payable on core structural borrowings (143) (130) Corporate expenditure: Group Head Office (43) (36) Asia Regional Head Office (24) (26)
SUMMARISED CONSOLIDATED PROFIT AND LOSS ACCOUNT – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2003
UK and Europe Operations 408 567 US Operations 216 265 Prudential Asia 378 516 Other income and expenditure (including Asia development expenses) (208) (215)
Operating profit before tax before amortisation of goodwill and exceptional items† 794 1,133 Amortisation of goodwill (98) (98) Short-term fluctuations in investment returns 10 682 (1,406) Effect of changes in economic assumptions 11 (540) (467) Profit on sale of UK general business operations – 355
Profit (loss) on ordinary activities before tax (including actual investment returns) 838 (483)
Retained profit (loss) for the financial year 165 (664) †Operating profit and related earnings per share include investment returns at the expected long-term rate of return but exclude amortisation of goodwill and exceptional items. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities and related earnings per share include these items together with actual investment returns. This basis of presentation has been adopted consistently throughout this achieved profits basis supplementary information.
Based on operating profit after tax and related minority interests before amortisation of goodwill and exceptional items of £527m (£851m) 5 26.4p 42.8p
Profit (loss) for the financial year after minority interests 485 (145) Exchange movements, net of related tax (348) (330)
Total recognised gains (losses) relating to the financial year 137 (475)
RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' CAPITAL AND RESERVES – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2003
Shareholders’ capital and reserves 13 7,043 7,196 *The 2002 figures for these lines have been restated as a result of the altered accounting policy for certain reinsurance contracts. However, neither profit nor total net assets on the achieved profits basis has changed.
1. BASIS OF PREPARATION OF RESULTS The achieved profits basis results include the results of the Group’s long-term business operations on the achieved profits basis. These results are combined with the statutory basis results of the Group’s other operations including banking, unit trusts, mutual funds and other non-insurance investment management business. The achieved profits basis results for long-term business for 2003 and 2002 have been prepared in accordance with the guidance issued by the Association of British Insurers (ABI) in December 2001 ‘Supplementary Reporting for Long-Term Insurance Business (the Achieved Profits Method)’. The information is supplementary to the financial statements on pages 56 to 96.
2. METHODOLOGY The achieved profits basis results incorporate best estimate assumptions of future rates of investment return, proprietor’s spread (in the case of Jackson National Life), policy discontinuances, mortality, expenses, expense inflation, taxation, bonus rates, surrender and paid up bases, and statutory valuation bases. In adopting these assumptions, account has been taken of recent experience and general economic conditions, together with inherent uncertainty. It has been assumed that the bases and rates of taxation, both direct and indirect, will not change materially in the countries in which the Group operates.
The profit and loss account charge in respect of the effect of changes in economic assumptions, which is shown as an item excluded from operating profit, as shown in note 14, reflects the effect on shareholders’ funds at the start of the reporting period.
The key economic assumptions are described below: UK and Europe Insurance Operations Pre-tax expected long-term nominal rates of investment return: UK equities 7.3% 7.0% Overseas equities 6.6% to 7.9% 7.0% to 7.8%
Risk margin included within the risk discount rate 2.6% 2.6% Risk discount rate(i) 7.4% 7.1%
(ii) The Prudential Asia economic assumptions shown above have been determined by weighting each country’s economic assumptions by reference to the achieved profits basis operating results for new business written in the relevant year.
4. INVESTMENT RETURN (i) Profit before tax With the exception of fixed interest investments held by Jackson National Life, investment gains and losses during the period (to the extent that changes in capital values do not directly match changes in liabilities) are included in the profit for the year and shareholders’ funds as they arise.
5. SUPPLEMENTAL EARNINGS INFORMATION The Group’s supplemental measure of its results and reconciliation of achieved profits basis operating profit based on long-term investment returns before amortisation of goodwill to achieved profits basis profit on ordinary activities, including the related basic earnings per share amounts, are as follows: Basic Before Minority earnings tax Tax Post-tax interests Net per share(ii)
Based on profit for the financial year after minority interests 838 (355) 483 2 485 24.3p
Based on operating profit after tax and minority interests before amortisation of goodwill and exceptional items 1,133 (286) 847 4 851 42.8p Adjustment for amortisation of goodwill (98) (98) (98) (4.9)p Adjustment from post-tax long-term investment returns to post-tax actual investment returns (after related
Effect of changes in economic assumptions (467) 181 (286) (286) (14.4)p Profit on sale of UK general business operations 355 (13) 342 342 17.2p
(i) The adjustment from post-tax long-term returns to post-tax actual investment returns includes investment returns that are attributable to external equity investors in two investment funds managed by PPM America. These two funds are consolidated as quasi-subsidiaries but, except to the extent of Prudential Group participation in the funds, they have no net impact on pre-tax or post-tax operating profit. Total profit, before and after tax, incorporating the adjustment from long-term to actual investment returns includes gains of £4m (losses of £5m) attributable to the minority interests in these funds.
(ii) The average number of shares for 2003 is 1,996m (1,988m).
108 PRUDENTIAL PLC ANNUAL REPORT 2003 6. COST OF CAPITAL A charge is deducted from the annual result and the balance sheet value for the cost of capital supporting solvency requirements for the Group’s long-term business. This cost is the difference between the nominal value of solvency capital and the present value, at risk discount rates, of the projected release of this capital and investment earnings on the capital.
As explained in note 1, the achieved profits basis results include statutory basis results for operations other than those conducting long-term business. In preparing results for these operations the Group has continued to apply SSAP 24.
Further details are shown in note 17 on pages 82 to 84 of the Group's financial statements.
(i) Jackson National Life net of tax profit: Before capital charge 95 142 Capital charge (note 6) (19) (24)
In determining the achieved profits basis value of new business written in the year the policies incept, premiums are included in projected cash flows on the same basis of distinguishing annual and single premium business as set out on page 74.
9. OPERATING PROFIT FROM BUSINESS IN-FORCE Operating profits from new business are measured using the revised economic assumptions shown in note 3 and after applying any revised operating assumptions. The profit and loss account impact for revised operating assumptions is shown below: £m £m
UK and Europe Insurance Operations Unwind of discount(i) 343 367 Cost of strengthened persistency assumption(ii) (50) (47) Other items(ii) (100) (37)
(ii) The £50m cost of strengthened persistency assumption for 2003 relates to personal pension policies sold by the now discontinued direct salesforce. The £100m charge for other items for 2003 includes a £35m adverse experience variance for persistency which is not expected to recur; a £29m restructuring charge; an adverse annuitant mortality assumption change of £18m; a strengthening of renewal expense assumptions of £29m; other positive assumption changes of £30m; and £19m of other negative items and experience variances. For 2002, the £37m for other items includes £16m of UK re-engineering costs.
(iii) The presentation of Jackson National Life's operating profit has been revised from that applied in the 2002 Annual Report so as to be consistent with the basis introduced for Interim 2003 reporting. The charge for average realised losses shown above is as compared to the long-term default assumption for fixed income securities, which is now presented as part of the determination of spread variance. In previous periods the experience variance for spread was presented before deduction of the default assumption for fixed income securities. The charge for the default assumption is calculated using a weighted risk margin reserve (RMR) approach. An RMR charge is individually assigned to asset classes based on credit ratings and, where necessary, credit analysis. This is then weighted by reference to the carrying value of the investments. This revised presentation has no impact on operating profit.
(iv) The spread variance shown above has been determined after including long-term returns on equity based investments. This treatment is consistent with the inclusion of long-term investment returns within operating profit. Short-term fluctuations in investment returns, including those for equity based investments, are excluded from operating profit but included within the total profit or loss for the reporting period. An analysis of the short-term fluctuations in investment returns is shown in note 10.
110 PRUDENTIAL PLC ANNUAL REPORT 2003 10. SHORT-TERM FLUCTUATIONS IN INVESTMENT RETURNS
Long-term business: UK and Europe Insurance Operations(i) 531 (1,021) Jackson National Life(ii) 132 (440)
Share of investment return of funds managed by PPM America that are consolidated into Group results but attributable to external investors (note 5) 4 (5)
(i) Short-term fluctuations in investment returns represent for UK and Europe Insurance Operations the difference between actual investment returns attributable to shareholders on the achieved profits basis and the expected returns as described in note 3. The £531m of positive fluctuations in 2003 reflect the difference between the PAC with-profits fund actual investment return of 16.5% and the long-term assumed rate of 6.8%.
Gains (losses) arising in years 1999 to 2003 1999 3 2000 (90)
Actual less averaged losses excluded from operating result but included in profit before tax 159 98
11. EFFECT OF CHANGES IN ECONOMIC ASSUMPTIONS The losses on changes in economic assumptions included within the profit (loss) on ordinary activities before tax arise as follows: £m £m
12. TAXATION CHARGE The profit for the year is in most cases calculated initially at the post-tax level. The post-tax profit is then grossed up for presentation purposes at the effective rates of tax applicable to the countries and periods concerned. For Jackson National Life the profit is calculated at the pre-tax level and the effective tax rate is the rate expected to be applicable on average over the remaining lifetimes of the policies.
Tax charge on operating profit Long-term business: UK and Europe Insurance Operations 133 166 Jackson National Life 67 49 Prudential Asia(i) 121 123
Tax on items not included in operating profit Tax charge (credit) on short-term fluctuations in investment returns 212 (447) Tax credit on effect of changes in economic assumptions (130) (181) Tax charge on profit on disposal of UK general business operations – 13
Total tax charge (credit) on items not included in operating profit 82 (615)
UK and Europe Operations Long-term business operations: Smoothed shareholders’ funds(i) 3,469 3,437 Actual shareholders’ funds less smoothed shareholders’ funds (45) (411)
Jackson National Life (net of core structural borrowings of £140m (£155m))(iii)
After capital charge 2,419 2,657 Broker-dealer and fund management 71 75
(i) UK long-term business smoothed shareholders’ funds reflect an adjustment to PAC Life Fund assets, for the purposes of determining the unwind of discount included in operating profits, to remove the effects of short-term volatility in market values of assets.
Held within other operations relating to M&G and acquired Asian businesses 1,445 1,540 Held within US operations relating to purchase of broker-dealer and banking businesses 53 58 Held within Egg 6 6
Holding company cash and short-term investments 432 226 Core structural borrowings – central funds (2,427) (2,297)
UK and Europe Jackson long-term Insurance National Prudential business Other Group
Operating profit (loss) before amortisation of goodwill 359 219 351 929 (135) 794
Short-term fluctuations in investment returns (note 10) 531 132 1 664 18 682 Effect of changes in economic assumptions (note 11) (122) (263) (155) (540) (540)
Profit (loss) on ordinary activities before tax (including actual investment returns) 768 85 197 1,050 (212) 838
Profit (loss) for the financial year 510 64 71 645 (160) 485
Adjustment for net of tax start-up losses of broker-dealer subsidiary owned by JNL (10) (10) 10 Proceeds from issues of share capital by parent company 30 30
Net increase (decrease) in shareholders’ capital and reserves 398 (238) 12 172 (325) (153)
Shareholders’ capital and reserves at 31 December 2003 (note 13) 3,424 2,419 1,419 7,262 (219) 7,043
Analysed as: Statutory basis shareholders’ funds 612 2,258 627 3,497 (219) 3,278 Additional shareholders’ interest on achieved profits basis 2,812 161 792 3,765 3,765
Achieved profits basis shareholders’ funds 3,424 2,419 1,419 7,262 (219) 7,043
(ii) Estimated impact on 2003 and 2002 results based on alternative assumptions The key assumptions that affect the Group’s results are economic, in particular expected rates of investment return and risk discount rates. The sensitivities of the 2003 and 2002 results to changes in these assumptions are set out below: £m £m
Risk discount rates: Increase in rates of 1% (488) (417) Decrease in rates of 1% 572 474 16. FOREIGN CURRENCY TRANSLATION Foreign currency revenue has been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year end rates of exchange.
We have audited the supplementary information on pages 103 to 114 in respect of the year ended 31 December 2003. The supplementary information has been prepared in accordance with the guidance issued in December 2001 by the Association of British Insurers entitled ‘Supplementary Reporting for LongTerm Insurance Business (the Achieved Profits Method)’ (the guidance) using the methodology and assumptions set out on page 106. The supplementary information should be read in conjunction with the primary financial statements which are on pages 56 to 63.
This report is made solely to the Company in accordance with the terms of our engagement. Our audit work has been undertaken so that we might state to the Company those matters we have been engaged to state in this report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company, for our audit work, for this report, or for the opinions we have formed.
OPINION In our opinion, the achieved profits basis supplementary information for the year ended 31 December 2003 has been properly prepared in accordance with the guidance using the methodology and assumptions set out on page 106.
The guidance issued in December 2001 by the Association of British Insurers entitled 'Supplementary Reporting for LongTerm Insurance Business (the Achieved Profits Method)' (the guidance) requires the directors to prepare supplementary information presented under the achieved profits method in accordance with the guidance.
In preparing the achieved profits basis supplementary information, the directors are required to: • select suitable methodologies and then apply them consistently; • determine assumptions on a realistic basis, having regard to past, current and expected future experience and to any relevant external data, and then apply them consistently; • state whether applicable accounting standards have been followed in relation to the residual assets, subject to any material departures disclosed and explained in the supplementary information; • prepare the supplementary information on the going concern basis unless it is inappropriate to presume that the Group will continue in business.
INDEPENDENT AUDITORS' REPORT TO PRUDENTIAL PLC ON THE ACHIEVED PROFITS BASIS SUPPLEMENTARY INFORMATION
SHAREHOLDER ENQUIRIES Lloyds TSB Registrars The Causeway Worthing West Sussex BN99 6DA
SCRIP DIVIDEND ALTERNATIVE The Company will again be offering a scrip dividend alternative in respect of the final dividend of 10.7 pence per ordinary share for the year ending 31 December 2003. The number of new shares each shareholder who elects to take scrip will be entitled to receive, is calculated by dividing the total cash dividend due on each holding of shares as at the record date (17 March 2004) by the reference price for each new ordinary share.
SHARE DEALING SERVICES The Company’s Registrars, Lloyds TSB Registrars, offer a postal dealing facility for buying and selling Prudential plc ordinary shares, telephone 0870 242 4244. They also offer a telephone and internet dealing service, Shareview, which provides a simple and convenient way of selling Prudential plc ordinary shares. For telephone sales call 0870 850 0852 between 8.30am and 4.30pm, Monday to Friday, and for internet sales log on to www.shareview.co.uk/dealing
SHAREGIFT Shareholders who only have a small number of shares whose value makes it uneconomic to sell them may wish to consider donating them to charity through ShareGift, an independent charity share donation scheme. The relevant share transfer form may be obtained from Lloyds TSB Registrars. ShareGift is administered by the Orr Mackintosh Foundation, registered charity number 1052686. Further information about ShareGift may be obtained on 020 7337 0501 or from www.ShareGift.org There are no implications for capital gains tax purposes (no gain or loss) on gifts of shares to charity and it is now also possible to obtain income tax relief.
AMERICAN DEPOSITARY RECEIPTS (ADRs) The Company's ordinary shares are also listed on the New York Stock Exchange in the form of American Depositary Shares, evidenced by ADRs and traded under the symbol PUK. Each American Depositary Share represents two ordinary shares.
ANNUAL REVIEW AND SUMMARY FINANCIAL STATEMENT Any shareholder wishing to receive copies of the Group’s Annual Review and Summary Financial Statement in place of an Annual Report for all future years may do so by contacting Lloyds TSB Registrars in writing at the address above.
PRUDENTIAL UK & EUROPE INSURANCE OPERATIONS 3 Sheldon Square London W2 6PR
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.
PRUDENTIAL PLC Registered office: Laurence Pountney Hill London EC4R 0HH United Kingdom www.prudential.co.uk