Contents 1 Group Financial Highlights 2 Chairman’s Statement 4 Group Chief Executive’s Review 6 Business Review 14 Financial Review 26 Corporate Responsibility Review 28 Board of Directors 30 Corporate Governance Report 33 Remuneration Report 44 Directors’ Report 46 Summary of Statutory Basis Results 47 Consolidated Profit and Loss Account 50 Consolidated Balance Sheet 52 Consolidated Statement of
Also part of M&G Prudential Property Investment Managers Ltd (Pru PIM) PPM Ventures Ltd PPM South Africa
Total insurance sales £6.1 billion up 10% on 2001 excluding sales made through the Direct Sales Force
Gross retail fund inflows £1.2 billion up 11% on 2001 www.pru.co.uk www.prudential.fr www.mandg.co.uk www.mandg-investments.de www.mandg-investments.at www.prupim.com www.ppmventures.com www.ppm-sa.com
Retail products • Open Ended Investment Companies (OEICs) • Unit Trusts • Investment Trusts • Individual Savings Accounts (ISAs) • Personal Equity Plans (PEPs)
JNL is a leading life insurance company in the United States, and has more than 1.5 million policies and contracts in force
JNL offers fixed, indexed and variable annuities, term and permanent life insurance and stable value products
JNL's investment portfolio manager, PPM America Inc., manages some US$62 billion of assets
PCA provides a comprehensive range of savings, protection and investment products tailored to the needs of each local market
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 Ltd for life and mutual funds business in India • Across the region PCA now has a total of 18 bancassurance agreements in 10 countries including Standard Chartered Bank in Hong Kong, Malaysia, Singapore, Taiwan and Thailand 1923 Established first Asian operation 1994 PCA regional office established to build a material Asian business 2002 PCA contributed 40% of Group new business achieved profit 1961 Started business in Jackson, Michigan 1986 Acquired by Prudential 1994 Entered the bank distribution channel, with the establishment of the Institutional Marketing Group 1998 Acquired First Federal Savings and Loan of San Bernardino (renamed Jackson Federal Bank)
Other locations Denver, Colorado Santa Monica, California New York, New York Purchase, New York Brea, California Atlanta, Georgia Roseland, New Jersey Tampa, Florida Appleton, Wisconsin Bismarck, North Dakota
Operating profit before amortisation of goodwill and exceptional items 1,133 1,186 Amortisation of goodwill (98) (95) Short-term fluctuations in investment returns (1,406) (1,402) Effect of change in economic assumptions (467) (482) Merger break fee (net of related expenses) – 338 Profit on sale of UK general business operations 355 –
This is my first statement to shareholders as Chairman of Prudential.
We have given thought in the Board to the Higgs ‘Review of the role and effectiveness of non-executive directors’, both as a major company in our own right and as investor in a very large number of UK listed companies. We are broadly supportive of the Review, although any attempt to define ‘Best Practice’ quickly brings to mind a number of successful companies that do not follow all of the principles outlined. There is no perfect governance model which suits every company at each stage of its development. For that reason we particularly welcome the approach of ‘comply or explain’; and our principal source of concern is that some may quickly seek to turn ‘comply or explain’ into ‘simply comply’.
In recent years Prudential has undertaken a number of far-reaching initiatives which have resulted in a Group with a diversified range of international businesses and strong growth prospects. This strategy is evident in the Group’s results for 2002. The Group achieved significant increases in sales of insurance and investment products and at the same time it expanded its margin on new business.
2002 was a tough year, with market confidence being adversely affected by increased political risk and a deteriorating economic outlook. In February 2003, it was clear that stock markets around the world continued to be volatile and consumer confidence had deteriorated.
SUCCESSFUL STRATEGY 74 PER CENT OF GROUP SALES CAME FROM OUTSIDE THE UK, DEMONSTRATING THE BENEFITS OF THE GROUP’S INTERNATIONAL DIVERSIFICATION.
With 22 operations in 12 countries across the region, its multichannel distribution capability, strong strategic partners, and customer-focused product expertise, PCA is very well placed to deliver profitable growth in the future.
Summary This strong mix of businesses around the world positions us well for the future. We are currently experiencing some of the most volatile market conditions we have seen in decades, but we have a significant advantage in terms of our international reach, and our diversity of earnings. This will continue to be the case as we broaden our geographic presence, distribution channels and range of products.
Building the Brand The life industry in the United Kingdom is undergoing enormous change. The performance of the sector over the course of the year has been affected by concerns including capital adequacy and financial strength in declining equity markets, pressure on margins, and the uncertainty brought about by the various regulatory reviews being undertaken into the UK retail savings and pension industries.
Prudential’s Life Fund remains financially strong and we are well positioned as people place an increasing emphasis on financial strength and trusted brands when making decisions about their long-term savings and investments. Our focus is to grow our UK insurance operations by building the brand and developing our distribution capabilities through partnerships with banks and major companies as well as strong relationships with Independent Financial Advisers. We are also working to improve the service to our customers while at the same time reducing our cost base, delivering greater economies of scale, and ensuring that capital is deployed efficiently within the business.
Elsewhere in the UK, M&G’s market position, investment capabilities and brand strength make it one of the leading fund managers. In the difficult market conditions we witnessed during the year, the priority for the retail business has been to continue growing its market share as well as driving down costs through initiatives such as the outsourcing of administration services. On the institutional side, M&G continues to benefit from its competitive advantage in specialist fixed interest and private finance.
Egg continues to go from strength to strength. The UK business is now profitable as well as having almost 2.6 million customers and a five per cent market share of credit card balances. This is a strong performance considering the business was only launched just over four years ago. Egg has now also successfully launched the first stage of its international expansion in France.
Favourable Demographics The long-term demographic trends in the US, an ageing population and increasing life expectancy, and a relatively low level of social security support for retirement savings, remain favourable for Jackson National Life (JNL) which, with its valuebased approach, has positioned itself to take advantage of the opportunities.
In this market the focus has been on areas where Prudential is able to achieve the highest possible margin and return on capital. Using comparable economic assumptions, the UK insurance operations’ new business margin of 29 per cent is higher than the previous year. The strategic focus is on annuities, corporate pensions, with-profits bonds and Individual Savings Accounts. The UK insurance operations recorded a like-for-like 10 per cent increase in total sales on the previous year as a result of strong sales of bulk and individual annuities throughout 2002.
Prudential believes that with-profits continue to offer an attractive investment option for investors. It expects to remain one of the leading providers of with-profits policies in the future and is developing new products, which offer the advantages of a smoothed investment return, but with increased transparency.
In October 2002 Prudential entered the structured ISA market, launching the first offer of the Prudential Growth and Income Plan, sales of which were encouraging. A further series of offers are planned for 2003, the first of which was launched in January.
Margin: New business achieved profit as a percentage of sales on an annual premium equivalent basis
products and will allow Prudential’s with-profits bonds to be made available for distribution through Abbey National’s extensive high street branch network. Pre-depolarisation, Prudential has entered into a similar distribution arrangement that will meet the current regulatory requirements, and will provide similar benefits. This arrangement was launched on 11 December 2002 and sales have been encouraging.
Since the year-end Prudential has announced a proposed distribution arrangement with Zurich Financial Services, which is expected to further broaden Prudential’s distribution, particularly of annuity products.
This initiative is expected to incur a restructuring charge of approximately £20 million. The current estimated impact on shareholders would be a charge of £5 million against achieved basis operating profit, spread over 2002 and the next two years. However, due to the creation of a lower-cost servicing centre, this charge will be offset by expected annual gross cost savings from 2006 of approximately £16 million, of which £4 million per annum will be attributable to shareholders.
In 2002, profits distributed from Prudential’s main with-profits fund amounted to £2.7 billion, of which £2.45 billion (90 per cent) was added to policies as bonuses, and £273 million (10 per cent) is available for distribution to shareholders.
We believe that the UK market for long-term savings will continue to be difficult in 2003. Prudential with its trusted brand and financial strength is well placed to compete strongly in this environment.
BROADENED DISTRIBUTION PROPOSED RULE CHANGES WILL LIBERALISE SALES CHANNELS FOR INSURANCE PRODUCTS.
During the year, M&G continued to expand its international distribution capability and now has operations in Germany, Austria, Luxembourg and Italy. M&G International has continued to work closely on product strategy with Prudential Corporation Asia to generate fund inflows into M&G’s funds.
Egg Egg plc is an innovative financial services company, providing a range of banking and financial services products through its internet site.
In 2002 it had another successful year with operating income up 73 per cent to £327 million (2001 £189 million). Pre-tax losses were reduced to £17 million from £88 million in 2001 and the total UK customer base increased by 610,000 to almost 2.6 million.
Excluding the exceptional profit from the sale of 15 per cent of Funds Direct to Prudential, pre-tax losses of £20 million are included in the Prudential Group results.
In the UK, Egg delivered a profit of £35 million before tax (£76 million loss in 2001). It is growing customer numbers and revenues in an increasingly competitive marketplace, while at the same time reducing both unit operating costs and marketing acquisition costs. Net interest income increased by 54 per cent to £224 million for the period reflecting an increase in the UK net margin to 2.4 per cent (1.9 per cent). The margin improvement has largely resulted from changes to product pricing on Egg Card and the maturing of the book over the past year. Credit quality remains strong and Egg’s card portfolio continues to outperform the rest of the industry, in terms of lower arrears rates according to benchmarking studies.
Unsecured lending in the UK grew by £936 million leading to a balance of £3.3 billion (2001 £2.4 billion). Personal loans delivered record sales in 2002 with drawdowns of £829 million,
Operating profit, excluding investment income, of £52 million was £2 million higher than 2001, a significant achievement in the context of depressed equity markets, where average market levels as represented by the FTSE All-Share were 17 per cent lower year on year. This reflects M&G’s diversified revenue streams and disciplined cost management. Operating profit was £71 million in 2002.
M&G’s management of the Prudential Assurance Company’s and Scottish Amicable’s long-term funds led to continued outperformance during 2002, generating a performance fee of £20 million, an increase of £1 million on 2001. Over three years, Prudential’s main with-profits fund has generated per annum returns 2.3 per cent higher than its strategic benchmark and 2.5 per cent higher than its competitor benchmark.
Despite prolonged market uncertainty throughout 2002, M&G’s gross retail fund inflows were up 11 per cent on the previous year and net fund inflows increased by 79 per cent.
up 98 per cent on 2001 (£419 million). Card balances grew to £2.3 billion by the year end (December 2001 £1.8 billion).
Egg launched in France at the beginning of November and in the first two months 69,000 people applied for La Carte Egg of which it expects 27,000 to become customers. This gives a total customer base in France of approximately 90,000 following the selective migration of customers from the acquired Zebank portfolio. The French business incurred losses of £46.7 million (¤72.4 million) in 2002. Of this loss, £14.0 million (¤21.9 million) was spent on brand and marketing and £8.7 million (¤13.6 million) on development.
Egg remains committed to delivering long-term value to shareholders through building an international business of scale and leading the industry for innovation in financial services to the ultimate benefit of customers.
Prudential Europe In early 2002 Prudential reviewed its strategy for the Prudential and Scottish Amicable branded long-term business within continental Europe. The review concluded that an organic strategy based on investment in the German and French markets would be unlikely to meet return on capital targets. Analysis indicated that the returns achievable from any available acquisition would be too low to justify the investment of capital.
As a consequence, in November 2002 Prudential agreed to sell its German life business to Canada Life Financial Corporation (Canada Life) for ¤129 million (£82 million). The sale was completed on 1 January 2003. Irish High Court approval for the transfer of the relevant life assurance policies to Canada Life is expected early in the second half of 2003. Prudential will continue to run its existing operations in France for value, but not push for growth.
APE insurance sales in 2002 were £29 million, 12 per cent ahead of the 2001 result.
The US life industry faced another challenging year in 2002, with recession, the third year of a bear market and a crisis of confidence in corporate governance resulting in significant disruption to the capital markets. However, long-term demographic trends in the US remain favourable, and Jackson National Life’s (JNL’s) value-based approach and focus on business fundamentals has positioned it to take advantage of the opportunities that this environment presents.
These strengths have enabled JNL to deliver record sales of £5.8 billion in 2002, up 24 per cent on 2001. Record fixed annuity sales of £2.7 billion during the year were up 43 per cent on 2001. Variable annuity sales of £1.4 billion were up 77 per cent on 2001, despite continued volatility of equity markets in the US. As planned, sales of stable value products of £1.4 billion decreased by 16 per cent on 2001, reflecting JNL’s active management of its capital position during 2002, which will continue in 2003.
In 2002 JNL revamped its annuity product line in anticipation of the changing demands of its customers. The change proved successful, with 54 per cent of annuity sales generated by products introduced during 2002. In particular, 2002 saw the launch of JNL’s Perspective II annuity product. The design of Perspective II allows each investor to select and pay for only the features and benefits he or she wants. It was developed from concept to completion in just six months – highlighting JNL’s ability to adapt quickly to changing market conditions.
JNL’s low cost and flexible infrastructure together with its culture and the company’s realigned service and administrative capabilities contribute to its competitive advantage. JNL has a cost base that is well below the industry average.
This year, JNL is launching Curian Capital LLC, a registered investment adviser providing a managed account fee-based brokerage application. This platform will enable advisers to manage clients’ assets more efficiently and economically, bringing a high net worth service to the mass market.
During 2002, JNL achieved a financial milestone, surpassing $50 billion in total assets (US GAAP), an increase of 75 per cent in just five and a half years. Looking ahead, JNL is focused on profitable new business in its retail markets, with its proven ability to offer the customer a variety of retirement products through multiple distribution channels.
Strong growth in US GAAP assets $m *Excludes FAS-115, FAS-133, reverse repurchase obligations, and securities lending deposits
Prudential Corporation Asia (PCA) continued to strengthen its position in 2002 as a leader in both the life insurance and mutual fund markets across the region. Based on preliminary estimates, PCA believes it ended 2002 with top five market shares in eight Asian life insurance markets, two mutual fund markets and Hong Kong’s Mandatory Provident Fund (MPF) market. This demonstrates its continuing success in building a very strong portfolio of businesses across the region.
The economic environment in 2002 was challenging, but PCA nevertheless delivered a very positive set of results for the year. Insurance sales on an APE basis were £513 million in 2002, up 18 per cent compared to 2001 and new business achieved profits (NBAP) of £307 million increased by 20 per cent. PCA’s average NBAP margin on APE insurance sales remained broadly constant at 60 per cent (59 per cent in 2001). Operating achieved profits before tax, head office expenses and minority interests, were £490 million, up 24 per cent from 2001, and modified statutory basis profits before tax, head office costs and minority interests, for the year were £62 million, up from £25 million in 2001.
PCA’s primary business is the manufacture and distribution of life insurance and medium and long-term savings products through agency and third-party distribution channels. A key driver of our success has been the rate at which it has been able to expand its agency force, and the productivity achieved by its agents. PCA now has 89,000 agents across Asia and regional teams ensure that quality training and best practice are applied consistently. The largest increases in agent numbers in 2002 have been in its recently established operations in Vietnam and India. During the year PCA also made significant progress in enhancing agent productivity through sales and product training programmes in many of its operations.
PCA’s success in markets across the region is in large part due to its product innovation, and its readiness to package and market products to meet specific customer needs. In 2002 PCA continued to leverage its regional leadership in capital efficient unit-linked products with successful launches in India, the Philippines and regular premium unit-linked products in Taiwan. Additionally, PCA LIFE Japan secured regulatory approval for variable annuity products, drawing on technical expertise developed in Jackson National Life in America. Working with JNL on product design and pre-launch preparations meant a successful launch in October 2002 was possible, very soon after regulatory approval was received.
PCA has recently entered the very large and material North Asian markets of Japan and South Korea through the acquisition of small but operationally and financially sound local companies. There are clear plans in place to build significant and sustainably profitable operations over the long term in both countries. In 2002 very good progress was made with management teams being strengthened and the product ranges and pricing structures re-based. The focus is on building distribution and raising brand awareness.
As would be expected in the current economic environment the majority of the funds under management are in lower margin fixed income type products. This, coupled with ongoing investment in the development and start-up of this business, means net MSB profits from PCA’s mutual fund business are currently not material in the Group context.
Products Life: traditional ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■
unit linked ■ ■ ■ ■ ■ ■ ■ ■ ■
Sales Prudential has delivered strong growth in sales during 2002 with total Group insurance and investment sales reaching £27.6 billion, up 29 per cent on last year. Total new business inflows including renewal premiums reached £31.8 billion, 24 per cent ahead of last year.
Total insurance sales increased 12 per cent to £12.8 billion. On the annual premium equivalent (APE) basis sales were up nine per cent to £1.9 billion, reflecting an 18 per cent growth in sales in Asia and an increase of 23 per cent at Jackson National Life (JNL).
Gross investment inflows increased 47 per cent to £14.8 billion. Net investment inflows were £1.4 billion, including net mutual fund sales in Asia of £1 billion.
Achieved Profits Basis Results In reporting the result on the achieved profits basis Prudential includes the results of the Group’s long-term insurance business determined on this 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 business. 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 achieved profits basis provides a realistic reflection of the performance of the Group’s long-term insurance operations. An explanation of the achieved profits basis of reporting is provided on pages 23 to 25. The modified statutory basis (MSB) profit narrative follows this achieved profits basis narrative.
In the UK, the risk margin over the risk-free rate has been maintained at 2.6 per cent. In the US the 10 year Treasury bond rate has fallen by 1.2 percentage points, and the risk margin over the 10 year Treasury bond rate has been increased from 2.6 per cent to 3.1 per cent to reflect the recent volatility in JNL’s operating result.
In 2002 use of the active basis and these risk margins has resulted in a reduction in the risk discount rate applied to the UK and US operations from 7.7 per cent to 7.1 per cent and to 7.0 per cent 14 Prudential plc Annual Report 2002
like-for-like basis, using comparable economic assumptions, margins increased from a restated 28 per cent to 29 per cent in 2002.
Prudential Europe’s new business achieved profit of £11 million is 38 per cent higher than 2001, reflecting a 12 per cent increase in APE sales and higher margins, up from 31 per cent in 2001 to 38 per cent in 2002.
For JNL, in determining the assumptions for achieved profits basis reporting the level of capital required to support the business (the target surplus) has been taken, as in 2001, to be 200 per cent of the Company Action Level Risk Based Capital, calculated in accordance with the National Association of Insurance Commissioners’ risk-based capital standards for life insurance companies.
The equivalent mix in 2001 was 31 per cent, 38 per cent and 31 per cent.
No adjustment has been made to the mortality assumptions following the Continuous Mortality Investigation (CMI) bureau working paper on longevity. Prudential assumes an average 1.84 per cent annual mortality improvement in pricing, against the new CMI suggested mid-point of 1.85 per cent, and reserves on the basis of 2.90 per cent improvement in mortality.
Prudential plc Annual Report 2002 15 respectively, and a reduction in the UK investment return assumption from 7.1 per cent to 6.6 per cent.
In Asia the weighted risk discount rate (determined by weighting each Asian country’s economic assumptions by reference to the achieved profits basis operating results for new business written in 2002) has fallen from 10.1 per cent in 2001 to 9.6 per cent in 2002. The discount rates used vary from 4 per cent to 22 per cent.
Total long-term business 1,307 1,346 Development costs for long-term business (34) (48)
US broker dealer and fund management 14 16 Other income and expenditure (189) (130) Underlying total operating profit 1,149 1,171 UK re-engineering costs (16) (57) Operating profit from continuing operations 1,133 1,114
Development expenses (excluding Asia regional head office expenses) were down from £48 million to £34 million, and comprised £26 million for Asia and £8 million for Europe. The Asian development costs included £20 million in relation to the development of the Japanese business.
The loss in 2002 principally reflects the negative adjustment for short-term fluctuations in investment returns of £1,406 million, including £1,019 million in relation to the UK, £440 million in relation to JNL and positive £66 million in relation to Asia.
The UK component reflects the difference between an actual investment return from the Prudential Assurance’s main withprofits fund of negative 8.1 per cent and the long-term assumed return of positive 6.6 per cent.
The Asia component is principally due to the appreciation in the value of bonds.
Adverse economic assumption changes of £467 million also contributed to the loss and include the effect of the changed assumptions on the active basis mentioned earlier, together with changes to long-term economic assumptions in Asia and the US. In the US, this includes a revised economic assumption in respect of the variable annuity long-term return from eight per cent to seven per cent, including the associated guaranteed minimum death benefits (GMDB) effect. The Asian economic assumption change principally relates to changes in investment return assumptions.
2001 to £133 million in 2002, reflecting the continued poor experience of 2002. The amount charged to operating profit is one-fifth of the gains and losses incurred in the last five years.
In recent years the US operations have invested in technology and the development of its systems platform in order to process efficiently higher volumes of business and this has added to its fixed cost base. With lower total policy counts attributable to higher average annuity policy sizes and lower life sales the business is running below capacity, but as the business grows it will be able to take advantage of lower marginal costs. This has been recognised with a revision to the unit expense assumption resulting in a charge of £54 million as previously reported.
Asia in force profit (before development expenses) has increased significantly from £160 million in 2001 to £209 million in 2002 and includes net favourable assumption changes and one-off adjustments of £101 million (2001 £66 million).
PCA actively reviews the assumptions used for achieved profits to ensure that these remain both realistic and in line with actual experience. The 2002 analysis established that death claim rates were significantly and consistently lower than had previously been assumed, particularly in respect of linked business in Singapore where there is now 10 years’ experience of these products. Overall the net effect of these reviews was a favourable assumption change of £42 million.
A performance fee of £20 million was recognised in the 2002 result (£19 million in 2001) due to the life fund beating its strategic benchmark by 2.3 per cent per annum over the last three years.
When calculating the DAC amortisation the long-term return on variable annuity business is assumed to be 8.4 per cent, gross of investment management and mortality and expense charges. This assumption is implemented through use of a mean reversion methodology. If the mean reversion was eliminated as of 31 December 2002, so that the long-term return on separate account business was assumed to be 8.4 per cent per annum in all future years, DAC values would be reduced by approximately £32 million. Should these assumptions not be met in future periods a further increase in VA DAC amortisation may be required.
Modified Statutory Basis Results – Profit Before Tax MSB profit before tax and minority interests was £484 million in 2002, compared to £385 million in 2001. This increase is due to an improvement in the negative adjustment for short-term fluctuations in investment returns of £275 million, together with £355 million of profit relating to the disposal of the UK General Insurance operations. This was partly offset by lower operating profit and the inclusion of the American General break fee of £338 million in 2001.
Amortisation of goodwill was £98 million against £95 million in 2001.
Modified Statutory Basis Results – Profit After Tax MSB profit after tax and minority interests was £449 million, including a tax charge of £44 million. The effective rate of tax on MSB total profit in 2002 was 9.1 per cent primarily due to tax payable on the profit on disposal of the UK general insurance operations being relieved against capital losses available to the Group.
Earnings Per Share Earnings per share, based on achieved basis operating profit after tax and related minority interests but before amortisation of goodwill, were up 0.9 pence to 42.8 pence. Earnings per share, based on MSB operating profit after tax and related minority interests but before amortisation of goodwill, were down 7.5 pence to 15.8 pence.
Basic earnings per share, based on achieved profits basis loss for the year after minority interests, was a loss of 7.3 pence compared with a loss of 11.0 pence, in 2001. Basic earnings per share, based on MSB profit for the year after minority interests, was 22.6 pence, up 2.9 pence.
The result also includes £355 million profit arising from the sale of the General Insurance operations as previously reported in the interim statement.
Achieved Profits – Result After Tax The result after tax and minority interests was a loss of £145 million after reflecting a tax credit of £329 million and minority interests of £9 million. The effective tax rate at an operating profit level was 25 per cent, down from 31 per cent in 2001, primarily due to lower effective tax rates for JNL and Asia, partially offset by tax rate movements on other non-longterm operations. The JNL rate is lower than in 2001 due to the combined effect of operating assumption changes for expenses, capital charge effects and an exceptional tax credit.
Modified Statutory Basis Results – Operating Profit 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 and short-term fluctuations in investment returns.
UK Insurance Operations’ operating profit (before re-engineering costs) in 2002 was £368 million, £67 million below 2001. This included a reduction of £99 million in the shareholder transfer arising from lower with-profits bonus rates, partially offset by the impact of higher claims.
The US operations result, which is based on US GAAP subject to adjustments, of £153 million was £145 million worse than prior year. This fall principally reflects increases in both the amortisation of deferred acquisition costs (DAC amortisation), costs in respect of the provision of guaranteed minimum death benefits (GMDB), and a £121 million charge in relation to averaged realised gains and losses on bonds. Spread income was higher than 2001 by £29 million, and reflects the benefit from reductions in crediting rates on the in force fixed annuity and life book.
With respect to the methodology for GMDB provisioning, JNL have implemented early the draft guidance in the US prescribed by the AICPA in their 31 July 2002 draft statement of position: ‘Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts.’ GMDB provisions were reviewed at the year end resulting in a total charge, including payments during the year, of £43 million.
The increase in DAC amortisation of £106 million includes an increase of £85 million in respect of variable annuity (VA) products and £16 million in respect of equity-linked indexed annuities. A consequence of the review of GMDB provisions and the resulting strengthening has been a reduction in the expected future gross profits from variable annuity products, which has itself resulted in a higher level of VA DAC amortisation.
Dividend Per Share The final dividend per share is 17.1 pence, resulting in a full year dividend growth of 2.4 per cent to 26.0 pence.
Cash Flow The table below shows the Group holding company cash flow. This is a revised presentation from previous years, which was in the form of a funds flow statement. Prudential believes that this format gives a clearer presentation of the use of the Group’s resources than the FRS 1 statement required for the financial statements.
Tax received 59 (29) Equity (scrip dividends and share options) 40 42 Corporate activities 543 283
Financial Strength of Insurance Operations United Kingdom A common measure of financial strength in the United Kingdom 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 to 2001 the free asset (or Form 9) ratio of the Prudential Assurance Company (PAC) long-term fund was approximately 8.4 per cent at the end of 2002, compared with 12.2 per cent at 31 December 2001. The reduction during the year principally reflects the significant fall in equity markets around the world, together with lower bond yields and price earnings ratios. At the end of 2002 a reorganisation of the life funds saw the transfer of the Scottish Amicable Life (SAL) linked fund into the PAC long-term fund. The impact of this transfer further reduces the PAC free asset ratio to 8 per cent.
The valuation has been prepared on a conservative basis in accordance with the FSA valuation rules, and without use of implicit items. No allowance has been taken for the present value of future profits. The PAC long-term fund has not entered into any financial reinsurance contracts, with the exception of certain treaties with a value of approximately £74 million which were transferred from SAL under the reorganisation mentioned above. On the ’realistic’ basis for solvency the fund is very strong.
For the UK main with-profits fund 88 per cent of the fixed securities investments are investment grade with 30 per cent rated AA or above. For Prudential Annuities Limited 97 per cent of the fixed securities investments are investment grade with 40 per cent rated AA or above. For Prudential Retirement Income Limited 100 per cent of total assets are investment grade with 59 per cent rated AA or above.
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 UK with-profits 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 our 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. The fall in the proportion of investments held in equities in 2002 compared to 2001 reflects the decline in value of the holdings during the year.
Jackson National Life The capital adequacy position of Jackson National Life remains strong, with a risk-based capital ratio more than three 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.
JNL’s invested asset mix on a US regulatory basis (including Jackson National Life of New York and excluding policy loans and reverse repo leverage) is as follows: Bonds: Investment Grade Public 53 58 60 Investment Grade Private 21 22 20 Non Investment Grade Public 5 3 4 Non Investment Grade Private 5 3 3
Private equities and real estate 3 3 3 Equities, cash and other assets 2 2 2
Inherited Estate In order to support our with-profits business, we hold a substantial amount of working capital in PAC’s long-term fund. Without such working capital, we could not provide the benefits associated with smoothing and guarantees, or have investment freedom for the main with-profits fund’s assets, for the benefit of both policyholders and shareholders.
In addition, we can use the inherited estate to absorb the costs of significant events, such as fundamental strategic change in our long-term business and, to the extent that the UK regulator is content, the cost of providing redress for past pension mis-selling, without affecting the level of distributions to policyholders and shareholders. The costs of fundamental strategic change may include investment in new technology, redundancy and restructuring costs, cost overruns on new business and the funding of other appropriate long-term insurance related activities including acquisitions.
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 Phase I and II of the pensions mis-selling review, within the provisions that were established in the long-term fund in 2000.
The 2001 result included a provision of £25 million charged to shareholders’ funds in respect of the possible mis-selling of mortgage endowments for policies sold subsequent to the acquisition of Scottish Amicable in 1997. In March 2003 the FSA fined Scottish Amicable £750,000 in respect of cases where advisers did not place appropriate emphasis on identifying whether
Statutory basis shareholders’ funds, which are not affected by fluctuations in the value of investments in the Prudential Assurance Company (PAC) long-term fund, were £282 million lower at £3.7 billion.
Shareholders’ Borrowings and Financial Flexibility As a result of the holding company’s net funds outflow of £130 million and exchange translation gains of £37 million, net core borrowings at 31 December 2002 were £2,226 million, compared to £2,133 million at 31 December 2001.
After adjusting for holding company cash and short-term investments of £226 million, core structural borrowings of shareholder financed operations at the end of 2002 totalled £2,452 million, compared with £2,152 million at the end of 2001. This increase was funded by the issue of short-term commercial paper. Borrowings at the end of 2002 included £1,686 million at fixed rates of interest with maturity dates ranging from 2005 to 2031, as set out in note 31 on page 80 of the consolidated financial statements. Of these borrowings £310 million were denominated in US dollars, partially to hedge the currency exposure arising from our investment in Jackson National Life. During 2002 the euro-denominated fixed rate notes issued in 2001 were swapped into floating rate pounds sterling borrowings of £305 million (net of £4 million issue costs). Core borrowings also included £420 million short-term commercial paper (of which £334 million was denominated in US dollars) and £41 million floating rate loan notes.
Other than for Egg plc, which is responsible for its own financing, the Group is financed centrally. The Group’s core debt is managed to be within a target level consistent with an AA debt rating. At 31 December 2002, the gearing ratio, including hybrid debt, was 23.6 per cent compared with 20.7 per cent at 31 December 2001. Excluding hybrid debt, the gearing ratio was 14.2 per cent. Although net core debt only increased by £93 million during 2002 (after exchange movements of £37 million) the achieved profits basis shareholders’ funds fell by 12 per cent driven by equity market falls and exchange movements.
Treasury Policy The Group operates a central treasury function, which has overall responsibility for managing its capital funding programme as well as its central cash and liquidity positions.
Defined Benefit Pension Schemes Defined benefit pension schemes are generally required to be actuarially valued every three years to assess the appropriate level of funding for schemes having regard to their commitments. These valuations include assessment of the likely rates of return on the assets held within the separate trustee administered funds.
The Group’s principal defined benefit scheme is the Prudential Staff Pension Scheme (PSPS) in the UK. This was last actuarially valued on 5 April 2002 and this valuation demonstrated the scheme to be 110 per cent funded, with an excess of actuarially determined assets over liabilities of 10 per cent, representing a fund surplus of £376 million. As a result no change in employers’ contributions from the current 12.5 per cent of salaries was required. The position is not believed to be significantly different
Surpluses and deficits on the Group’s defined benefit schemes are attributable to the PAC life fund and shareholders’ funds depending on the activity of the personnel involved.
Such attribution is necessary to properly reflect the allocation of the economic interests in and exposures to the schemes’ financial position. At 31 December 2001 there were FRS 17 basis pension scheme assets attributable to the PAC life fund and shareholders’ funds of £392 million and £101 million respectively. At 31 December 2002 there were FRS 17 basis pension scheme liabilities attributable to the PAC life fund and shareholders’ funds of £380 million and £85 million respectively. These changes are due mostly to the fall in equity markets throughout 2002.
Accounting Policies There has been no significant change in accounting policies required for the preparation of the 2002 results. Prudential adopted in the 2001 accounts the requirements of FRS 19 on deferred tax and with which mandatory compliance was required by 2002.
International Accounting Standards The European Union requires that all European insurers prepare their financial statements using standards issued by the International Accounting Standards Board (IASB) by 2005. Anticipating the likely effects of IAS presents difficulties for insurers. First, because the IASB’s proposed standard on Insurance Contracts will not be implemented until at least 2007, and second because the IASB’s definition of an insurance contract means that some products written by life insurers that do not transfer significant insurance risk are likely to be accounted for as financial instruments.
The eventual standard for insurance contracts that will be issued under ‘Phase 2’ to supersede the interim guidance is expected to be based on an ‘asset and liability’ model with insurance liabilities likely to be measured at a ‘fair value’. The IASB is far from completing the standard, with the result that it is not possible to estimate its impact on Prudential’s statutory results and balance sheet. The standard will require substantial ‘field testing’ before it can be considered to be reliable. In addition, the performance reporting implications have yet to be considered.
However, it is likely that the valuation of an insurance contract on the IASB’s interpretation of a ‘fair value’ basis is unlikely to be comparable to that calculated on the achieved profits basis which the UK industry uses for supplementary reporting, due to significant differences in methodology and the extent of inclusion of projected cash flows on the contracts. As a result it is likely that the industry will continue to publish achieved profits results, in line with the Association of British Insurers’ guidance,
Developments in Regulatory Solvency Requirements The Integrated Prudential Sourcebook (PSB) will be introduced by the FSA for UK insurance companies in 2004. This will introduce the requirement for realistic solvency reporting, through the introduction of risk-based capital approaches allowing for the use of internal capital adequacy models for solvency assessments. The PSB will also pave the way towards a more realistic valuation of liabilities. In the meantime 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.
Risk Management A significant part of the Group’s business involves the acceptance and management of risk. The Group’s risk management model requires the primary responsibility for risk management at an operational level to rest with business unit chief executives. The second line of defence of risk comprises oversight functions reporting to the Group Chief Executive together with business unit risk functions and risk management committees. The third line of defence comprises independent assurance from Internal Audit reporting to business unit and group audit committees.
The Group operates a group risk framework for the identification, prioritisation, management and reporting through the year of the key risks by business units. This process is reviewed regularly by the Board. Controls applicable across the Group are set out in a Corporate Governance Manual.
Asset and liability management is operated by business units locally, reflecting the specific liabilities in each business. The respective responsibilities for investment strategy, compliance and performance are clearly defined. Controls, incorporating procedures and authority levels, are in place governing investment dealing and settlement, including the use of derivatives.
The majority of Prudential branded non-participating business is written in PAC’s long-term fund or by subsidiaries owned by the fund. Prudential’s principal non-participating business is Prudential Annuities Limited, which is wholly owned by PAC’s long-term fund. The profits from this business accrue to the long-term fund. In 2001, Prudential started to write certain annuity business through Prudential Retirement Income Limited (PRIL), from which the profits are attributed solely to shareholders.
Equity-linked indexed annuities are deferred annuities that enable policyholders to obtain a portion of an equity-linked return but provide a guaranteed minimum return. JNL guarantees an annual minimum interest rate of three per cent, but actual earnings may be higher and are based on a participation in an equity index over its indexed option period. JNL’s profit arises from the difference between a) the premiums received plus the associated investment income and b) the combined cost of expenses (general expenses, costs of purchasing fixed interest securities and options) and the policyholder’s account value (which is subject to the minimum guarantee).
Variable annuities are tax advantaged deferred annuities where the rate of return depends upon the performance of the underlying portfolio, similar in principle to UK unit-linked products. They are used for retirement planning and to provide income in retirement. The policyholder’s premiums are held apart from other assets, in a ‘separate’ account, which is analogous to a unit-linked fund. The policyholder can allocate the premiums between a variety of variable sub-accounts with a choice of fund managers and/or to guaranteed fixed-rate options. The value of the portion of the separate account allocated to variable sub-accounts fluctuates with the underlying investment. Variable annuity policies provide for early surrender charges. In most cases, variable annuities also offer various types of death benefits, some of which are elective, guaranteeing that on death the policyholder receives a minimum value regardless of past market performance. 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.
Asia Retail Products and Drivers of Profit The life insurance products offered by Prudential in Asia include a range of with-profits (participating) and non-participating term, whole life and endowment and unit-linked policies. Prudential also offers health, disablement, critical illness and accident covers to supplement its core life products.
Unit-linked products combine savings with protection and the cash value of the policy depends on the value of the underlying unitised funds. Participating products provide savings with protection where the basic sum assured can be enhanced by a profit share (or bonus) from the underlying fund as determined at the discretion of the insurer. Non-participating products offer savings with protection where the benefits are guaranteed or determined by a set of defined market related parameters. Accident and Health (A&H) products provide mortality or morbidity benefits and include health, disablement, critical illness and accident covers. A&H products are commonly offered as supplements to main life policies but can also be sold separately.
Unit-linked products tend to have higher profits on the achieved profits basis of reporting than traditional non-linked products as expenses and charges are better matched and solvency capital requirements are lower. At the end of 2002 PCA offered unit-linked products in nine of the 12 countries in Asia in which it operates.
In addition to the life products described above, Prudential offers mutual fund investment products in India, Taiwan, Japan, Singapore, Malaysia, Hong Kong and Korea, allowing customers to participate in debt, equity and money market investments. PCA earns a fee based on assets under management.
Prudential’s primary financial statements are prepared in accordance with the modified statutory basis (MSB) of reporting of long-term business. This is in accordance with the Statement of Recommended Practice issued by the Association of British Insurers (ABI) in December 1998. In broad terms, MSB profits for long-term business reflect the aggregate of statutory transfers from with-profit funds and profits on a traditional deferred and matching approach for other long-term business. Consequently, in addition to determining the Group’s statutory profit and reserves it informs the Board in determining the Group’s dividend policy.
Since 1997 Prudential and the other major UK quoted groups have additionally 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 contracts. Achieved profits basis financial statements are prepared under guidance issued by the ABI in December 2001.
The achieved profits basis is a value based method of reporting in that it reflects the change in value of the business. The results on the achieved profits basis can be used to demonstrate the underlying development of the business.
The value added from new business (being the present value of the 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 in the year demonstrates how the existing book is being managed.
E Short-term fluctuations in investment return and change in economic assumptions
future investment return, expenses, surrender levels and mortality. These best estimate assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the risks associated with the cash flows. The risk discount rate is determined using the actual yield on long-term government bonds plus a risk margin. The projected future cash flows are prepared on a single set of assumptions and the actual outcome may be different from that projected. Where the actual outcome is different, this will be reflected in the ‘experience variances’ for that year.
The assumptions used for achieved profits basis accounting are set out in the notes that accompany the supplementary achieved profits basis accounts on page 92. An indication of the sensitivity of the result to changes in the key assumptions of discount rate and investment return is also provided on page 100.
Set out (top right) is a profit profile for a typical with-profits product, for illustration purposes only. The pattern of the profit emergence varies by product.
Our Group Code of Conduct lays down the principles of corporate responsibility (CR) at Prudential and provides the basis for our forward planning. Corporate actions have a profound impact on how we are viewed by customers, employees, shareholders, communities, government and others. We believe that having a sound reputation for behaving responsibly provides a strong basis for growth and will enhance our financial success over the long term.
In 2002, we extended measures to ensure that CR is fully integrated across the Company in each of our markets and is overseen at the highest level. We have: • Established a governance structure, which includes a new company-wide CR Policy Group (CRPG), reporting to our Group Finance Director on strategic issues.
Marketplace While we sell different products in each of our markets, we are fundamentally dealing with the universal need for financial security. We aim to help consumers become better informed about financial matters so that they can manage their financial affairs more effectively. Our work in this area includes our ‘Plan from the Pru’ in the UK, which provides a simple, impartial step-by-step guide to planning finances.
Workplace Recruitment, retention and development of the best people is critical to a business such as ours, in order to maintain standards of service and our competitive advantage. Our business units produce and implement local plans in support of this, reflecting overall Group policy in areas such as employee learning and diversity.
• In Asia, PruUniversity continues to offer courses to employees and agents that develop their skills and knowledge in areas essential to their current roles as well as the future needs of the financial services industry. In 2002 this programme was extended to our agents in Malaysia.
We also enhance the sustainability of the communities around our business through support for local projects, many of which also benefit from the support and skills of our employees. In China, PCA supports children in poorer provinces with their tuition fees at CITIC Prudential Hope School. In Vietnam, staff help a wide range of causes by taking part in dedicated volunteering days. In 2002 employees at JNL who volunteer in their local communities participated in Prudential’s volunteer reward programme, which provides grants to community groups supported by members of staff.
Our support for communities consists of cash donations and support in kind, such as office space and computer equipment as well as the time and skills of our employees. In 2002, our community support activity amounted to £3.3 million, of which £1.6 million was spent on charitable donations.
Environment Our direct environmental impact is principally through our UK property investment portfolio and our occupied buildings. We are committed to minimising this through the careful management of our day-to-day business activities and by working with suppliers to improve overall efficiency. We also have an indirect impact on the environment through the investments we make on behalf of customers. M&G, our UK and European fund manager, believes that well-managed and growing businesses will, as a matter of course, take environmental and social issues into account in moving their businesses forward. M&G asks the companies in which it invests for a well-reasoned and practical approach, recognising that this can vary according to each company’s circumstances.
Prudential plc Annual Report 2002 27 *A total of 2,152 adults aged 15+ were interviewed between 22 to 27 November 2001 across 210 sampling points in the UK. Data was then weighted to reflect the national population profile.
FINANCIAL LITERACY Of UK adults, 42 per cent believe that their education has not prepared them well enough to deal with their personal finances and 60 per cent think that the financial services industry together with independent organisations are best placed to provide information and education on matters relating to finance services (MORI, 2002).*
2. Jonathan Bloomer FCA (Age 48) A director since 1995 and Group Chief Executive since March 2000. Previously Deputy Group Chief Executive and Group Finance Director. Non-executive director of Egg plc. Deputy Chairman of the Practitioner Panel of the Financial Services Authority. Board Member of the Association of British Insurers.
3. Philip Broadley FCA (Age 42) Group Finance Director since May 2000.
He specialised in providing services to clients in the financial services industry, including regulators and government agencies in the UK and US.
5. Michael McLintock (Age 41) A director since September 2000. Chief Executive of M&G since February 1997, a position he held at the time of M&G’s acquisition by Prudential in March 1999. Joined M&G in October 1992. Non-executive director of Close Brothers Group plc and CoFunds Holdings Limited.
7. Mark Wood (Age 49) A director and Chief Executive of Prudential Assurance, UK and Europe since June 2001. Non-executive director of European e-commerce technology company Lost Wax since December 2001. 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. Prior to that a director of Guardian Royal Exchange plc, Deputy Chairman of the Association of British Insurers and Chairman of PPP Health Insurance.
10. Ann Burdus CBE (Age 69) A director since 1996. Non-executive director of Next plc. Trustee of the Barts & Royal London Charitable Foundation. Previously a non-executive director of Safeway plc and a committee member of the Automobile Association.
13. Sandy Stewart (Age 69) A director since 1997. Chairman of Murray Extra Return Investment Trust plc and of the Scottish Amicable (supervisory) Board. Previously a practising solicitor and Chairman of Scottish Amicable Life Assurance Society.
The directors support the Combined Code on Corporate Governance annexed to the Listing Rules issued by the Financial Services Authority (the Code). The Company has complied throughout the accounting period ended 31 December 2002 with all the Code provisions set out in Section 1 of the Code, save for the appointment of a senior independent director. We have applied the principles in the manner described below and in the Remuneration Report.
Organisational Structure The organisational structure of the Group is clearly defined by reference to business units for which individual business unit chief executives are responsible. They report to the Group Chief Executive. The Board, the members of which are set out on pages 28 and 29, meets regularly, usually eight times a year with a separate strategy day and additional meetings as and when required. In 2002 the Board met 10 times and there were a further five Board Committee meetings in addition to the regular Board Committees. During 2002, the directors’ average rate of attendance at Board meetings was 95 per cent. The Board determines the objectives and strategy for the Group. It has set out the specific matters which are reserved to it for decision.
All directors have direct access to the advice and services of the Company Secretary who is responsible for advising the Board on procedures and applicable rules and regulations. Papers are provided to all directors approximately one week before the relevant Board or Committee meeting.
Remuneration Committee Roberto Mendoza (Chairman from 1 July 2002) Sir David Barnes (Chairman until 1 July 2002) Bart Becht Ann Burdus Rob Rowley Sandy Stewart
The Remuneration Committee normally has scheduled meetings at least twice a year and a number of ad hoc meetings, as required, to review remuneration policy and determines the remuneration 30 Prudential plc Annual Report 2002
Independent Professional Advice The Board has approved a procedure whereby directors have the right in furtherance of their duties to seek independent professional advice at the Company’s expense.
All directors are required to submit themselves for re-election at regular intervals and at least every three years, and annually at each Annual General Meeting following their reaching the age of 70.
Relations with Shareholders As a major institutional investor, the Company is 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 2002. Information on the Company is also made available on our website at www.prudential.co.uk
The Sarbanes-Oxley Act, 2002 As mentioned above, the Company is monitoring the introduction of this US legislation and the regulations that relate to it. The Company will comply with its requirements, as they affect UK companies. A Disclosure Committee, reporting to the Group Chief Executive, chaired by the Group Finance Director and comprising members of senior management has been established to supervise the Company’s disclosure process and to provide the necessary framework to support the certifications required to be given under 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 47 to 85 and the supplementary information on pages 90 to 101. 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; and to report their opinions to the Company’s shareholders. Their opinions are given on pages 86 and 102.
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.
The Group’s internal control framework includes detailed procedures laid down in financial and actuarial procedure manuals. The Group prepares an annual business plan with three-year projections. Executive management and the Board receive monthly reports on the Group’s actual performance against plan, together with regularly updated forecasts. The Group’s risk management procedures are further described in the Financial Review.
• Explains the policy under which our executive and non-executive directors were remunerated for the year ended 31 December 2002.
Compliance with the Directors’ Remuneration Regulations 2002 This report has been approved by the Board and as required by The Directors’ Remuneration Report Regulations 2002 (the Regulations), a resolution will be put to shareholders at the Annual General Meeting inviting them to consider and approve this report. This report complies with the requirements of the Regulations and KPMG Audit Plc have audited the sections contained in pages 37 to 43 of this report as required by the Regulations.
The Remuneration Committee Role of the Remuneration Committee Your Board believes that a properly constituted and effective Remuneration Committee is key to ensuring that executive directors’ remuneration is aligned to shareholders’ interests and enhances the competitiveness of the Company. The Board has delegated to the Remuneration Committee the setting of the remuneration policy and individual remuneration packages for executive directors. The fees of non-executive directors are a matter for the Board itself.
Membership of the Remuneration Committee The members of the Remuneration Committee during 2002 were all independent non-executive directors, as shown below: Roberto Mendoza (Chairman from 1 July 2002) Sir David Barnes (Chairman until 1 July 2002) Bart Becht (joined the Committee on 9 May 2002) Ann Burdus Rob Rowley Sandy Stewart
The Chairman and the Group Chief Executive attend Remuneration Committee meetings to provide background and context on matters relating to the remuneration of the other executive directors, but do not attend when their own remuneration is discussed. No director is involved in determining his or her own remuneration. The Remuneration Committee meets on at least two occasions each year and more frequently if the need arises.
Advisers to the Remuneration Committee During 2002 the Group Human Resources Director was invited by the Committee to provide her views and advice. The Committee appointed Ernst & Young LLP to provide advice on long-term incentive arrangements. The Company, with the agreement of the Committee, appointed Towers Perrin to provide information on market data and Freshfields Bruckhaus Deringer to advise on legal matters. Ernst & Young LLP also provided consultancy advice to the Company, Towers Perrin provided consultancy advice and salary survey information and Freshfields Bruckhaus Deringer provided other legal advice to the Company.
Remuneration Policy The aim of the policy is to be able to recruit and retain the highest calibre executives. To achieve our objective, Prudential must use remuneration practices relevant to the different markets around the world in which we do business. We need to do this within the context of our UK base, which has its own regulatory framework and shareholder views and we will be guided by UK corporate governance standards.
• A significant element of performance related reward will be provided in the form of shares.
• The total remuneration package for each director will be set against the relevant employment market.
• Performance measures will include both absolute financial measures and comparative measures as appropriate to provide a clear alignment between the creation of shareholder value and reward.
• Performance will be rewarded at both a regional and Group level.
Elements of the remuneration package Basic salary The Remuneration Committee normally reviews, on an individual basis, executive directors’ salaries each year, having regard to business results, individual accountabilities and performance, and market conditions.
Michael McLintock is eligible to receive an annual incentive award in line with remuneration levels in the investment management industry of 300 per cent of basic salary for target performance based on the profits of M&G, the fund performance of M&G and Group and individual performance, with a maximum of 500 per cent of basic salary. Any part of the annual incentive award made for performance above target will be made in Prudential shares. Receipt of these shares is deferred and the shares are normally only released after three years providing the director is still in employment. During the deferral period, dividends accumulate for the benefit of the award holder.
Clark Manning is also eligible to participate in a US tax qualified all-employee profit sharing plan.
The policy for long-term incentive awards and levels in 2003 is set out below, and is the same as the policy in 2002.
Restricted Share Plan The Group’s primary long-term incentive plan is the Restricted Share Plan (RSP) which is designed to provide rewards linked to the returns to shareholders.
Under the RSP executive directors receive annual grants of conditional awards of shares in the Company which are held in trust for three years. At the end of each three-year performance period, a right to receive shares at no cost to the individual may be granted, dependent on the Company’s performance. No rights will be granted if the Company’s TSR performance as ranked against the comparator group is at the 60th percentile or below. The maximum grant will be 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.
In 2003, for the Group Chief Executive, the conditional RSP award is equivalent to 200 per cent of basic salary at the time of the grant of the conditional award. For Philip Broadley, Clark Manning, Mark Tucker and Mark Wood, the award is equivalent to 160 per cent of basic salary. For Michael McLintock the award is equivalent to 80 per cent of basic salary.
Regional and sector focus We believe that to grow the value of Prudential for our shareholders, we need to focus on growing each area of our business. Each executive director that runs an area of our business participates in two long-term incentive plans. To reflect Group responsibilities awards are made under the RSP described above, and awards are also made under the business specific long-term incentive plans described below, reflecting those responsibilities. In all cases the performance period for 2003 awards runs from the beginning of 2003 to the end of 2005.
Mark Tucker To reflect his role as Chief Executive of Asia, Mark Tucker participates in the Asian Long-term Incentive Plan which is a cash-based plan that rewards the growth in value of our major Asian businesses over the three-year performance period. Any award is made following the end of the performance period. No payment under the 2003 plan will be made unless the growth of the Asian business, as measured under the plan, is greater than a growth rate of 15 per cent per annum compound over the performance period. At this level of performance 50 per cent of basic salary may be paid under the plan. The on-target payout that may be made, for which a growth rate of 35 per cent per annum compound is required, is a payment of 100 per cent of basic salary. If a growth rate of 50 per cent per annum compound or more is achieved, a maximum payment of 150 per cent of basic salary may be made. For payouts for performance between these points a sliding scale applies.
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 which 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. 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.
Prior to his appointment as an executive director, Clark Manning participated in the Brooke Holdings Inc Change of Control Severance Plan that provides payments in the event of the termination of his employment within 24 months, resulting from a change of control of Jackson National Life. The compensation to which Clark Manning is entitled under the plan is based on 2.5 times his annual compensation and immediate vesting of his long-term incentive plans. Under the terms of his appointment as an executive director, his participation in the plan ceases on 9 November 2004.
Executive directors with the exception of Michael McLintock are required to give 12 months’ notice of termination to the Company. Michael McLintock is required to give six months’ notice to the Company.
Notes 1. Under the terms of their letters of appointment, the non-executive directors serve for an initial term of three years following their election by shareholders at the Annual General Meeting after their appointment by the Board.
Benefits and Protections Executive directors receive certain benefits, principally the provision of a cash allowance for a car, except for Clark Manning, participation in medical insurance schemes and, in some cases, the use of a car and driver and security arrangements. These benefits are not pensionable. The executive directors’ pension arrangements and life assurance provisions are set out in the Pensions and Life Assurance section.
The basic fee payable to each non-executive director was increased from £32,500 to £40,000 per annum from June 2002. Non-executive directors use the portion of their fees above £25,000 to purchase shares in the Company, on a quarterly basis, that they will hold at least until their retirement from the Board.
The Chairmen of the Audit and Remuneration Committees are each paid an additional fee of £10,000 per annum in respect of their roles and the other members of these Board Committees are each paid an additional fee of £5,000 per annum. The amount of these fees, net of applicable taxes, are used by the non-executive directors to purchase shares in the Company, on a quarterly basis, which will be held at least until their retirement from the Board.
6. Michael McLintock’s bonus for 2001 included a payment of £327,250 pursuant to his contractual arrangements following the purchase of M&G in 1999.
8. Mark Tucker’s 2002 bonus includes a deferred share award of £194,436. His 2001 bonus figure included a deferred share award of £120,000, the details of which are reported in the section on Other Share Awards on page 40. Mark Tucker’s 2001 bonus figure in the 2001 Report also included a payment of £495,350 from his 1999 Asian Long-term Incentive Plan that is now included in the table on Other Long-term Incentive Plans on page 39 and the 2001 figure in the table above has been adjusted accordingly.
10. Sir Roger Hurn’s details, as former Chairman, are reported with the non-executive directors for consistency with the 2001 Report. A car and driver were made available for his use.
Directors’ Long-term Incentive Plans Restricted Share Plan Details of conditional awards made under the Restricted Share Plan are shown below. These shares are held in trust and represent the conditional awards out of which rights may be granted, at the end of the relevant performance period, dependent on the performance conditions as described under the policy on long-term incentive plans on page 34.
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 must be higher than 60th percentile for awards to be made, the 2000 awards have lapsed and rights will not be granted over any of the shares conditionally awarded to executive directors.
The table below shows the outstanding awards made under the Restricted Share Plan: Rights granted under the Restricted Share Plan Rights granted upon vesting in 2002
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 1998 and 1999 cash long-term incentive plans had four-year performance periods ending 31 December 2001 and 31 December 2002 respectively. The payouts in both cases depended on Jackson National Life’s US GAAP net income in the final year and resulted in no payment from either plan.
Michael McLintock Michael McLintock’s 2000 cash long-term incentive plan has a three-year performance period and has the same performance conditions described in the section on long-term incentive plans on page 35. 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.
Mark Tucker Mark Tucker’s 1999 and 2000 cash long-term incentive plans had the same performance conditions as described in the section on long-term incentive plans on page 35. The compound growth rate of the Asia operations was 51.1 per cent per annum for the 1999 plan and 54.3 per cent per annum for the 2000 plan which results in a maximum payment in both cases.
Mark Wood Mark Wood’s cash long-term incentive awards since joining in 2001 are included in the table.
Clark Manning Phantom JNL options 200 Nil – 31 Dec 01 Phantom JNL shares 100 Nil – 31 Dec 01 Phantom JNL options 266 266 31 Dec 02 Phantom JNL shares 133 133 31 Dec 02 Phantom JNL options 532 532 31 Dec 03 Phantom JNL shares 266 266 31 Dec 03 Phantom JNL options 798 798 31 Dec 04 Phantom JNL shares 399 399 31 Dec 04 Business cash LTIP 1,725 1,725 31 Dec 04
Mark Tucker Business cash LTIP 495 495 – 31 Dec 01 Business cash LTIP 540 540 31 Dec 02 Business cash LTIP 600 600 31 Dec 03 Business cash LTIP 600 600 31 Dec 04
In order to secure the appointment of Mark Wood, on joining Prudential he was allocated Prudential plc share awards for no consideration that will be released provided he remains in employment with the Company until the release date.
Conditional Conditional Date of original price at share awards Conditionally Scrip Shares share awards end of Shares date of date of outstanding awarded dividends released outstanding at restricted released Date of award vesting at 1 Jan 2002 in 2002 accumulated in 2002 31 Dec 2002 period in 2002 release (pence) (pence)
Deferred 2001 annual incentive award 6,0461 275 6,321 31 Dec 04 Note 1. The value of deferred share awards from annual incentive plans is included in the bonus figure in the Directors’ Remuneration table.
Directors’ Shareholdings The current shareholding policy is that as a condition of serving, all executive and non-executive directors have been 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 36, 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 and the share awards made to Mark Wood on appointment (described above). In addition, interests include rights granted under the 1997, 1998 and 1999 Restricted Share Plan where the executive has yet to exercise his right to receive shares. Awards that remain conditional under the Restricted Share Plan are excluded.
† Mark Tucker was awarded 57,868 deferred shares under the annual incentive plan for 2002 (included in the Directors’ Remuneration table on page 37).
Options exercise Options outstanding 31 Dec Exercise Earliest Latest outstanding Exercised date forfeit at 31 Dec 2002 price exercise exercise at 1 Jan 2002 in 2002 (pence) in 2002 2002 (pence) (pence) date date *Savings-Related Share Option Scheme.
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 were introduced by the UK Government in 1989 which 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 2002/2003 tax year is £97,200 per annum. For this reason UK executive directors employed since 1989 are offered a combination of Inland Revenue approved pension schemes and supplementary provision.
UK Inland Revenue Approved Pension Schemes Executive directors are eligible for one of two Inland Revenue approved pension schemes on the same basis as other employees.
The Prudential Staff Pension Scheme (PSPS) is a non-contributory defined benefit scheme, which provides a pension of 1/60th of Final Pensionable Earnings for each year of service on retirement at age 60 with an option to commute pension for a tax free cash sum. The scheme also provides on death in service, a lump sum of four times pensionable salary, a spouse’s pension of the greater of 25 per cent of pensionable salary or 54 per cent of prospective pension at 60, and children’s pensions of the greater of 8.33 per cent of pensionable salary or 18 per cent of prospective pension at 60 in accordance with the scheme rules. On death in retirement, a spouse’s pension of 50 per cent of the pension available at retirement before commutation is payable and a lump sum is also payable if death occurs in the first five years of retirement. Some of the pension payable is guaranteed to increase in line with the Retail Prices Index capped at five per cent, but in recent years all pensions in payment have been increased fully in line with the Retail Prices Index.
Clark Manning is provided with life assurance cover of two times basic salary.
Details of directors’ pension entitlements under Inland Revenue approved defined benefit schemes and the pre-tax amount of any salary supplements and/or contributions to FURBS paid by the Company are set out below: Additional pension earned during Transfer value of Amount of Pre-tax salary year ended accrued benefit (B-A) less supplements and 31 Dec 2002 at 31 December contributions contributions Years of Accrued made by to FURBS or pensionable benefit at 2002 2001 directors other pension Age at service at 31 Dec 2002 B A during 2002 arrangements2
David Clementi 53 – – – – – – – 9 Jonathan Bloomer 48 – – – – – – – 218
Principal Activity and Business Review Prudential plc is the Group holding company and the principal activity of its subsidiary undertakings is the provision of financial services in Europe, the US and Asia. Particulars of principal subsidiary undertakings are given in note 30 on page 79. The Group’s business and likely future developments are reviewed in the Chairman’s Statement on pages 2 and 3, the Group Chief Executive’s Review on pages 4 and 5, the Business Review on pages 6 to 13 and the Financial Review on pages 14 to 25.
Financial Statements and Supplementary Information The consolidated balance sheet on pages 50 and 51 shows the state of affairs of the Group at 31 December 2002. The Company’s balance sheet appears on page 53 and the consolidated profit and loss account on pages 47 to 49. Information prepared on the achieved profits basis of financial reporting is provided on pages 89 to 101. A summary of the statutory basis results is shown on page 46. There is a five year review of the Group on pages 87 and 88.
Directors The present directors are shown on pages 28 and 29. Clark Manning and Bart Becht were appointed as directors on 2 January 2002 and 9 May 2002 respectively. In accordance with the Articles of Association, Bart Becht will retire and offer himself for election at the Annual General Meeting. Sir Roger Hurn resigned as Chairman on 30 November 2002. David Clementi was appointed as Chairman on 1 December 2002 and, in accordance with the Articles of Association, he will retire and offer himself for election at the Annual General Meeting. Michael McLintock, Sandy Stewart and Roberto Mendoza will retire by rotation at the Annual General Meeting and offer themselves for re-election. Details of directors’ interests in the share capital of the Company and its listed subsidiary, Egg plc, are set out in the Remuneration Report on pages 40 and 41.
The following table shows the statutory basis results reported in the profit and loss account on pages 47 to 49.
General business: UK Insurance Operations – 79 Re-engineering costs – (7)
Balance on the general business technical account (analysed on page 47) – 72
Long-term business: UK Insurance Operations 368 435 US Operations 139 282 Prudential Asia (net of development expenses of £26m (£19m)) 62 25 Prudential Europe (net of development expenses of £8m (£29m)) 1 (24) UK re-engineering costs attributable to shareholders (14) (41)
Balance on the long-term business technical account before tax (analysed on pages 48 and 49) 556 677
Items excluded from operating profit before amortisation of goodwill: Amortisation of goodwill (98) (95) Short-term fluctuations in investment returns (205) (480) Merger break fee (net of related expenses) – 338 Profit on sale of UK general business operations 355 –
Statutory basis profit on ordinary activities before tax (analysed on page 49) 484 385
Earnings per share Based on operating profit after tax and related minority interests before amortisation of goodwill 15.8p 23.3p Based on total statutory profit for the financial year after minority interests – basic 22.6p 19.7p
Gross premiums written 5 329 390 Outwards reinsurance premiums 34 (329) (333)
Allocated investment return transferred from the non-technical account 10 8 37
Gross premiums written 5 16,669 15,196 Outwards reinsurance premiums (216) (180)
Change in the provision for claims: Gross amount (4) 31 Reinsurers’ share 12 (1)
Net operating expenses (including re-engineering costs of £38m (£193m)) 14 (1,799) (1,982)
Balance on the long-term business technical account 382 442 48 Prudential plc Annual Report 2002
Other charges: UK banking business result 10 (20) (88) Amortisation of goodwill 17 (98) (95)
Profit on ordinary activities before tax 7 484 385 Tax on profit on ordinary activities 16 (44) (21)
Dividends: Interim (at 8.9p (8.7p) per share) (178) (172) Final (at 17.1p (16.7p) per share) (341) (332)
Reconciliation of operating profit before amortisation of goodwill to profit on ordinary activities* Continuing operations 432 550 Discontinued general business operations – 72
Operating profit before amortisation of goodwill based on long-term investment returns 7 432 622 Amortisation of goodwill 17 (98) (95)
Operating profit based on long-term investment returns 334 527 Short-term fluctuations in investment returns 4 (205) (480) Merger break fee (net of related expenses) – 338 Profit on sale of UK general business operations 34 355 –
Based on profit for the financial year after minority interests of £449m (£389m) and 1,988m (1,978m) shares 4 22.6p 19.7p
Diluted earnings per share Based on profit for the financial year after minority interests of £449m (£389m) and 1,991m (1,982m) shares 4 22.6p 19.6p
Dividend per share 26.0p 25.4p *Operating profit includes investment returns at the expected long-term rate of return but excludes amortisation of goodwill and the profit on sale of UK general business operations. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities includes 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 157 163 Long-term business provision 621 589 Claims outstanding 221 221 Technical provisions for linked liabilities 244 330
Prepayments and accrued income Accrued interest and rent 1,156 1,125 Deferred acquisition costs: Long-term business 3,218 3,175 General business – 29
Technical provisions Provision for unearned premiums 163 202 Long-term business provision 99,114 98,511 Claims outstanding 953 980 Equalisation provision – 40
Creditors Creditors arising out of direct insurance operations 252 420 Creditors arising out of reinsurance operations 184 341
Consolidated Statement of Total Recognised Gains and Losses year ended 31 December 2002 £m £m
New share capital subscribed 40 40 Transfer for shares issued in lieu of cash dividends (23) 23 52 Prudential plc Annual Report 2002
Current assets Debtors: Amounts owed by subsidiary undertakings 1,420 1,521 Tax recoverable – 9 Other debtors 28 24
The financial statements on pages 47 to 85 were approved by the Board of directors on 21 March 2003.
Acquisitions, disposals and similar items Net cash inflow from: Acquisition of fund management and long-term business subsidiary undertakings 33 (12) (182) Merger break fee received – 338 Disposal of UK general business operations 33 353 –
FRS 17, ‘Retirement benefits’ was issued in November 2000. This standard specifies how costs of providing retirement benefits, in particular for defined benefit schemes, should be recognised and disclosed in the financial statements. Under FRS 17 none of the requirements need be recognised in the primary financial statements for the years ended 31 December 2002 and 2001. However, for 2002 disclosure is required in respect of the impact of FRS 17 on the opening and closing balance sheet positions, profit and loss account, and statement of total recognised gains and losses to illustrate the effect if the standard had been recognised in these primary financial statements. The Company has adopted the standard in this respect and details are disclosed in note 19.
FRS 19, ‘Deferred tax’ was issued in December 2000. This standard requires deferred tax to be recognised on most types of timing differences, in particular for gains and losses on assets that are continuously revalued to fair value where changes in fair value are recognised in the profit and loss account. The standard is required to be implemented for financial statements relating to accounting periods ending on or after 23 January 2002. However, early adoption was encouraged by the standard. The Company adopted the standard in its financial statements for 2001. Accordingly, the 2002 financial statements, including comparative figures for 2001, have been prepared in accordance with FRS 19.
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 2002. 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.
For the business of Jackson National Life the determination of the expected emergence of margins, against which the amortisation profile of the DAC asset is established, is dependent on certain key assumptions. For single premium deferred annuity business, the key assumption is the expected long-term spread between the earned rate and the rate credited to policyholders. For variable annuity business, the key assumption is the expected long-term level of equity market returns which, for 2002, was 8.4% per annum implemented using a mean reversion methodology. These returns affect the level of future expected profits through their effects on fee income and the required level of provision for guaranteed minimum death benefit claims.
Long-term business provision Prudential’s long-term business written in the UK comprises predominantly life insurance policies under which the policyholders are entitled to participate in the profits of the long-term business supporting these policies. This business is also written in parts of Asia. Such policies are called ‘with-profits’ policies. Prudential maintains with-profits funds within the Group’s long-term business funds which segregate the assets and liabilities and accumulate the profit and loss activity related to that with-profits business. The amounts accumulated in these with-profits funds are available to provide for future policyholder benefit provisions and for bonuses to be distributed to with-profits policyholders. The bonuses, both annual and final, reflect the right of the with-profits policyholders to participate in the financial performance of the with-profits funds. Shareholders’ profits with respect to bonuses declared on withprofits business correspond to the shareholders’ share of the cost of bonuses as declared by the Board of directors. The shareholders’ share currently represents one-ninth of the cost of bonuses declared for with-profits 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. 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. The assumptions to which the estimation of the long-term business provision is particularly sensitive are the interest rate used to discount the provision and the assumed future mortality experience of policyholders. The net premium reserves are calculated 56 Prudential plc Annual Report 2002
For the purpose of calculating the liability using the bonus reserve method, the assumed interest rates range from 3.2% to 5.0%, while future reversionary bonuses are assumed to fall from current levels to zero at 1.5% per year. Additional details for PAC are given in the statutory accounts of that company.
The future policyholder benefit provisions for Jackson National Life’s conventional protection-type policies are determined using the net level premium method, with an allowance for surrenders and claims expenses. Rates of interest used in establishing the policyholder benefit provisions range from 6.0% to 8.4%. Mortality assumptions range from 50% to 90% of the 1975-1980 Basic Select and Ultimate tables, depending on underwriting classification and policy duration. For investment-type products sold by Jackson National Life, the policyholder benefit provision included within technical provisions in the consolidated balance sheet is the policyholder account balance.
The future policyholder benefit provisions for Asian businesses are determined in accordance with methods prescribed by local GAAP. In regions where local GAAP is not well established, US GAAP is used as the most appropriate proxy to local GAAP. The valuation of policyholder benefit provisions may differ from that determined on a UK modified statutory basis.
Claims Claims incurred include settlement and handling costs of paid and outstanding claims arising from events occurring in the year and adjustments to prior years’ claims provisions. Outstanding claims include claims incurred up to, but not paid, at the end of the accounting period, whether or not reported.
Investment returns in respect of long-term business, including that on assets matching solvency capital, are included in the longterm business technical account. Other investment returns are included in the non-technical account.
Investment returns on assets covering general business liabilities are allocated from the non-technical account to the general business technical account. For 2001 the allocated return for, now discontinued, UK personal lines business reflected longer-term returns on assets covering general business liabilities and related solvency capital. 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 longer-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 4.
Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. To the extent that losses of an individual UK company are not offset in any one year they can be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company.
Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19, issued in December 2000. The Company has chosen not to apply the option available under FRS 19 of recognising such assets and liabilities on a discounted basis to reflect the time value of money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed by the balance sheet date.
Deferred tax on changes in the fair value of investments is recognised in the profit and loss account. The deferred tax liability in respect of revaluation of investments is recognised in shareholders’ funds and the fund for future appropriations. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
Pension costs These financial statements have been prepared in accordance with the provisions of SSAP 24, ‘Pension costs’. Disclosures of the movements in the financial position of the Company’s defined benefit schemes, applying the methodology prescribed by FRS 17, are shown in note 19. Contributions to the Group’s defined benefit plans are calculated and expensed on a basis that spreads the costs over the service lives of participants. Contributions in respect of defined contribution plans are accrued by the Group when incurred.
In accordance with SSAP 19, ‘Investment properties’, no depreciation is provided on investment properties (other than Group occupied) as management consider that these properties are held for investment purposes.
Equity securities and debt and other fixed income securities Equity securities are carried at fair value. Debt and other fixed income securities are carried at fair value, except for those held by Jackson National Life, which, subject to provision for permanent diminutions in value, are carried at amortised cost. Fair value is based on quoted market prices for listed securities, and on quotations provided by external fund managers, brokers, independent pricing services or values as determined by management for unlisted securities. Changes in fair value are recognised in investment returns during the year of the change. Debt and other fixed income securities held by Jackson National Life are carried at amortised cost as permitted by paragraph 24 of Schedule 9A to the Companies Act 1985. The amortised cost basis of valuation is appropriate under the provisions of the ABI SORP for Jackson National Life’s redeemable fixed income securities as they are held as part of a portfolio of such securities intended to be held to maturity. Further details of the valuation basis for fixed income securities of Jackson National Life are explained in note 11.
Banking business assets and liabilities Banking business assets consist primarily of certificates of deposit and short-term deposits with credit institutions carried at fair value and mortgage loans carried at recoverable amount, being outstanding principal balances, net of allowances for loan losses. Loan provisions are recorded for the overall loan portfolio to cover bad debts which have not been separately identified but which are known from experience to be present in the portfolio. For loans in default specific loan provisions are recorded. General provisions are raised in respect of losses, which although not specifically identified, are known from experience to be present in any such portfolios. The level of general provision is determined by the application of a number of basis points to the aspects of the portfolio which are not currently identified as delinquent but which experience suggests contains lending which will ultimately lead to losses. The number of basis points applied to the portfolios are regularly assessed against recent experience and adjusted if appropriate. Changes in loan provisions during the year are included in the consolidated profit and loss account.
Assets and liabilities denominated in other than functional currencies are converted at closing exchange rates at the balance sheet date with the related foreign currency exchange gains or losses reflected in the profit and loss account for the year.
Actual gains attributable to shareholders: Longer-term gains credited to operating results: Excess of actual gains over longer-term gains (478) (200) (278) (467) 189
In years prior to 2001, longer-term investment returns for Jackson National Life included within UK basis operating profit were estimated as the aggregate of investment income and averaged realised gains and losses for both debt securities and other types of security. Comparatives for the aggregate longer-term gains credited to operating results for the years 1993 to 2000 in the table shown above have not been restated for the refinement in policy, as the effect is not material.
For 2002, the other principal component of actual gains attributable to shareholders is revaluation gains of fixed income securities of certain Asian operations. For 2001 and earlier years the principal other component that required calculation of the expected long-term rate of return was UK equity securities that were held as portfolio investments backing UK general business liabilities and related solvency capital. This business was disposed of in January 2002. For these investments the long-term rate of return applied in 2001 was 7.5%. The long-term dividend yield was assumed to be 2.6%.
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 exceptional items as management believe that such presentation better reflects the Group’s underlying performance on a statutory basis of measurement.
Operating profit based on long-term investment returns before amortisation of goodwill and exceptional items 622 (174) 12 460 23.3p Amortisation of goodwill (95) – – (95) (4.8)p Short-term fluctuations in investment returns: Other (principally UK general business)* (112) 30 13 (69) (3.5)p
Merger break fee, net of related expenses 338 (6) – 332 16.8p *The adjustment from post-tax longer-term investment returns to post-tax actual investment returns includes investment return that is 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 longer-term to actual investment returns, includes losses of £5m (£13m) attributable to the minority interests in these funds.
Weighted average shares for basic earnings per share 1,988 1,978 Shares under option at end of year (note 27) 14 16 Number of shares that would have been issued at fair value on assumed option exercise (11) (12)
The geographical analysis of gross premiums written and investment product contributions is based on the territory of the operating unit assuming the risk. A similar analysis by territory of risk would not be materially different.
6. Segmental Information – Insurance New Business Premiums and Investment Product Contributions
Department of Social Security rebate business 215 185 – – 22 19
Closed direct sales force distribution – 167 – 18 – 35
Annual premium equivalents are calculated as the aggregate of regular new business premiums and one tenth of single new business premiums.
FUM Gross and other FUM 1 Jan 2002 inflows Redemptions Acquisitions movements 31 Dec 2002 £m £m £m £m £m £m 64 Prudential plc Annual Report 2002
US Operations: Broker dealer and fund management 14 16 14 16
Prudential Asia (net of development expenses of £26m (£19m)) 62 25 62 25
Prudential Europe (net of development expenses of £8m (£29m)) 1 (24) 1 (24)
Group operating profit before amortisation of goodwill – 72 556 677 (124) (127) 432 622
8. Segmental Information – Net Assets A segmental analysis of the fund for future appropriations and the technical provisions net of reinsurance is set out below which, although liabilities, provides a more useful indication of the assets supporting the business: Fund for future appropriations and net technical provisions £m £m
9. Segmental Information – Shareholders’ Funds Core Core structural structural borrowings of borrowings of
Discontinued home and motor business 329 390 – 44 – 28 – 72
11. Jackson National Life – Additional Detail on Basis of Presentation of Results The results of US operations, mainly Jackson National Life, 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 as reported in Jackson National Life’s own financial statements to comply with UK GAAP, with the Group’s accounting policies, and to reflect appropriately the Jackson National Life segmental result, as set out below: Other US GAAP adjustments
Reverse adjusted to comply FAS 133 for minority with and interests and Presentation UK GAAP Segmental result for FAS 115 reversal of of and Group UK Modified Statutory effects Minority FAS 133 and investment accounting Basis GAAP purposes (notes (i) interests FAS 115 returns policies (note (vi))Jackson National Life result – reconciliation of US GAAP and (ii)) (note (iii)) effects (note (iv)) (note (v))
Short-term fluctuations in investment returns (386) (386) (258) Amortisation of goodwill (6) (6) (4)
Profit before tax before minority interests (447) 293 21 (133) (47) (3) (183) (123) Minority interests (note (iii)) 21 (21)
Tax (charge) credit: on realised investment gains and losses and on short-term fluctuations in investment returns 135 135 90
11. Jackson National Life – Additional Detail on Basis of Presentation of Results continued (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.
(iv) Presentation of investment returns within the UK basis performance statements Profit (loss) on ordinary activities before tax With the exception of the elimination of FAS 133 effects, as explained in note (ii), and revaluation gains on certain equity-based securities that are recorded within other comprehensive income under US GAAP, the total profit (loss) under UK GAAP is the same as under US GAAP.
Operating profit Under US GAAP, the convention is to refer to operating income as income before realised gains and losses and related amortisation of acquisition costs. Under UK GAAP, consistent with FRS 3 and the ABI SORP, operating profit is determined after inclusion of longer-term investment returns i.e. investment income and estimated longer-term capital gains. Details of the method for determining longer-term returns for Jackson National Life are explained in note 4.
(v) Other adjustments These comprise: (a) adjustment for the amortisation of goodwill under UK GAAP. Amortisation is normally no longer required under US GAAP
(Losses) gains on the realisation of investments (219) 2,719 198 106 13. 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 11
Shareholder financed business: Non-participating business 24 22 Linked business 14 15
13. Long-term Business Provisions, Premiums and Policyholders’ Bonuses continued (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
Shareholder financed business: Non-participating business 56 49 Linked business 11 11 *The Scottish Amicable Insurance Fund is closed to new business. The assets and liabilities of the fund are wholly attributable to the policyholders of the fund.
(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 £3,009m (£3,536m).
Amortisation of present value of acquired in force business (note 18): Adjustments in respect of acquired in force business of M&G 4 (20) – – Other acquired in force business 18 18 – –
Administrative expenses for 2002 include £38m (£193m) (long-term business) and £nil (£7m) (general business) of UK re-engineering costs. £14m (£48m) of the total costs are borne by shareholder financed operations.
Net operating expenses in the consolidated profit and loss account also include corporate expenditure of £62m (£63m) in the nontechnical account.
Long-term business: UK Operations 106 120 Jackson National Life 48 99 Prudential Asia 19 17 Prudential Europe 1 (1)
Total long-term business 174 235 General business and shareholders (52) (61)
Total tax on operating profit (based on long-term investment returns) 122 174 Tax on short-term fluctuations in investment returns (91) (159) Tax on profit on sale of UK general business operations 13 – Tax on merger break fee – 6
16. Tax continued (i) Profit and loss account tax (credit) charge continued (d) Factors affecting tax charge for period The tax assessed in the period is lower than the standard rate of corporation tax in the UK and the differences are explained below. 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.
(a) By category of timing difference Unrealised gains on investments 759 1,857 Deferred acquisition costs 427 465 Short-term timing differences (625) (471) Long-term business technical provisions and other insurance items 163 186 Capital allowances (28) (32)
(b) By fund Scottish Amicable Insurance Fund 11 145 PAC with-profits fund* 884 1,795 Jackson National Life (207) (45) Other long-term business operations 42 68 Other operations (34) 42 *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.
A potential deferred tax asset of £45m (£17m) relating to trading losses has not been recognised because these losses are not anticipated to be used in the foreseeable future.
(c) Reconciliation of movements in deferred tax Deferred tax liability at beginning of year 2,005 2,777 Exchange movements (3) 0 Deferred tax credited in profit and loss account for the year (1,306) (772)
Balance at beginning of year 1,687 1,611 Additions in respect of acquisitions (note 34): Orico Life Insurance Company, Japan – 139 YoungPoong Life, Korea – 17 Good Morning ITMC, Korea 8 – Zebank, France and Investment Funds Direct Holdings Limited 7 – US banking and broker dealer operations – 3 Other operations – 12
Charge to profit and loss account: Balance at end of year 1,604 1,687
Balance at beginning of year 138 133 Exchange adjustment (10) 4 Amortisation: Pre-tax (22) 2
19. Information on Staff and Pension Costs The average numbers of staff employed by the Group during the year were: UK Operations 12,156 15,266 US Operations 2,661 2,580 Prudential Asia 6,582 4,651 Prudential Europe 531 550
Wages and salaries 656 734 Social security costs 48 61 Other pension costs (see below) 42 48
Actuarial valuation and funding The Group operates a number of pension schemes around the world. The largest scheme is the Prudential Staff Pension Scheme (PSPS). On the FRS 17 basis of valuation described below, 91% of the liabilities of Group defined benefit schemes are accounted for within PSPS.
This Scheme has assets held in separate trustee administered funds and was last subject to full 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.
FRS 17 basis disclosure (i) Basis of valuation and scheme assets and liabilities Using external actuarial advice provided by Watson Wyatt Partners for the valuation of PSPS, and by Aon Limited for the M&G scheme, and internal advice for the Scottish Amicable scheme, the most recent full valuations have been updated to 31 December 2002 applying the principles prescribed by FRS 17.
The present value of the liabilities of the three schemes at 31 December 2002 was £4,117m (31 December 2001 £3,777m). The resulting scheme deficit arising from the excess of liabilities over assets at 31 December 2002 comprised £426m attributable to the PAC with-profit fund and £121m attributable to shareholder operations. At 31 December 2001, the resulting scheme surplus arising from the excess of assets over liabilities comprised £441m attributable to the PAC with-profit fund and £144m attributable to shareholder operations.
19. Information on Staff and Pension Costs continued FRS 17 basis disclosure continued (ii) Pension scheme asset (liability) attributable to shareholder operations if FRS 17 had been adopted Movements on the pension scheme asset (liability) attributable to shareholder operations that would have been recognised in the Group’s primary statements, had FRS 17 been implemented, are as follows: Profit and Net pension loss account Actuarial Net pension asset charge losses liability attributable attributable attributable Contributions attributable to to to paid by to shareholders shareholders shareholders shareholder shareholders 1 Jan 2002 (note a) (note b) operations 31 Dec 2002 £m £m £m £m £m
(a) 2002 profit and loss charge attributable to shareholders This comprises: £m £m
Operating charge (all current service cost) (65) Finance income (expense): Interest on pension scheme liabilities (212) Expected return on pension scheme assets 300
Actual less expected return on pension scheme assets (26% of pension scheme assets) (932) Experience losses on scheme liabilities (1% of the present value of scheme liabilities) (38) Changes in assumptions underlying the present value of scheme liabilities (219)
(iii) Pension scheme asset (liability) attributable to the PAC with-profit fund if FRS 17 had been adopted Movements on the pension scheme asset (liability) attributable to the PAC with-profit fund that would have been recognised in the Group’s primary statements, had FRS 17 been implemented, are as follows: Credit to Net pension long-term Net pension asset technical Actuarial liability attributable account losses Contributions attributable to PAC attributable attributable paid by to PAC with-profit to PAC to PAC PAC with-profit fund with-profit with-profit with-profit fund 1 Jan 2002 fund fund fund 31 Dec 2002 £m £m £m £m £m
SSAP 24 FRS 17 SSAP 24 FRS 17 basis basis basis basis Memorandum Memorandum
Tax credit attributable to long-term business credited to the long-term technical account 659 654 Transfer from fund for future appropriations credited to the long-term technical account 5,520 5,482 Operating profit before amortisation of goodwill 432 440 20. Directors’ Remuneration Information on directors’ remuneration is given in the Remuneration Report on pages 33 to 43. Apart from the transactions with directors shown below, no director had an interest in shares, transactions or arrangements which requires disclosure, other than those given in the above Report.
Statutory audit fees include £0.1m (£0.1m) in respect of the Company. Audit related and consultancy fees payable to KPMG Audit Plc and its associates include £4.9m (£16.6m) for work performed in the UK.
The cost of land and buildings was £7,617m (£7,368m). The value of land and buildings occupied by the Group was £198m (£233m).
Interests in associate undertakings 23 16 12 10 Interests in joint ventures 37 34 37 29
Operating profit for the year after tax – (2) – – (2)
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 38% 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.
Shares and other variable yield securities and units in unit trusts 24,731 25,790 30,007 40,948 Debt securities and other fixed income securities – carried at market value 40,941 36,767 42,604 37,845 Debt securities and other fixed income securities – carried at amortised cost 20,572 21,669 20,596 21,336 Loans secured by mortgages 2,467 2,656 2,503 2,658 Loans to policyholders secured by insurance policies 774 804 774 804
The market value of debt securities and other fixed income securities carried at amortised cost was £21,328m (£21,323m). All debt securities carried at amortised cost are held by long-term business operations.
Movement relating to acquisitions and disposals of businesses (14) 12 Other disposals (133) (80)
At 31 December 2002 there were options subsisting under share option schemes to subscribe for 13,605,456 (15,558,387) shares at prices ranging from 296 pence to 759 pence (201 pence to 759 pence) and exercisable by the year 2009 (2008).
The Company has established trusts to facilitate the delivery of shares under employee incentive plans and savings-related share option schemes. At 31 December 2002, 9.0m Prudential plc shares with a market value of £39m were held in such trusts of which 3.3m shares were held by trusts under employee incentive plans. These shares have been accounted for as own shares in the consolidated balance sheet with a carrying value of £14m.
In addition, 5.7m shares were held by a qualifying employee share ownership trust. At 31 December 2002, these shares were expected to be fully distributed in the future on maturity of savings-related share option schemes. The weighted average exercise price under these schemes was 346 pence and the expected proceeds of £20m relating to these shares have also been accounted for as own shares in the consolidated balance sheet.
28. Investments of the Company Shares in Loans to subsidiary subsidiary undertakings undertakings £m £m
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 USA Prudential Assurance Company Singapore (Pte) Limited* Insurance Singapore *Owned by a subsidiary undertaking of the Company.
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.
Obligations of Jackson National Life under sale and repurchase agreements – 577 – 577
(ii) These borrowings support a short-term fixed income securities reinvestment programme.
(v) The interests of the holders of the Bonds issued by Scottish Amicable Finance plc, a subsidiary of the Scottish Amicable Insurance Fund of The Prudential Assurance Company Limited, are subordinate to the entitlements of the policyholders of that fund.
Litigation Jackson National Life has been named in civil proceedings, which appear to be substantially similar to other class action litigation brought against many life insurers, alleging misconduct in the sale of insurance products. At this time, it is not possible to make a meaningful estimate of the amount or range of loss, if any, that could result from an unfavourable outcome in such actions. In addition, Jackson National Life is a defendant in individual actions that involve similar issues. Several cases, including one which was on appeal to the Supreme Court in the State of Mississippi, were settled in January 2002 for a sum of £7m.
Prudential and its subsidiaries are involved in other litigation arising in the ordinary course of business. Whilst the outcome of such matters cannot be predicted with certainty, management believes that the ultimate outcome of such litigation will not have a material adverse effect on Prudential’s financial condition, results of operations or cash flows.
Balance at start of the year 1,065 1,475 Changes to actuarial assumptions and method of calculation (50) (89) Discount unwind 53 89 Redress to policyholders (292) (273) Payments of administrative costs (46) (137)
Every three months the FSA updates the actuarial assumptions to be used in calculating the provision, including interest rates and mortality assumptions. The pension mis-selling liability 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.
Management believes that, based on current information, the pension mis-selling provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling as well as the costs and expenses of Prudential’s pension review unit established to identify and settle such cases. Such provision presents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased.
Free Standing Additional Voluntary Contribution Business Review In February 2000, the UK regulator ordered a review of Free Standing Additional Voluntary Contribution (FSAVC) business, which constitutes sales of personal pensions to members of company pension schemes. Individuals who have purchased these pensions instead of the Additional Voluntary Contributions (AVC) scheme connected to their company’s pension scheme may have been in a better financial position investing their money, and any matching contributions from their employers, in their company’s AVC scheme. The UK regulator’s review is to ensure that any employees disadvantaged due to not being properly informed of the benefits foregone from not investing in their AVC scheme are compensated.
The review requires companies to identify relevant investors and contact them with an offer to review their individual case. Prudential met an interim deadline set by the FSA of 90% of cases completed by 30 June 2002 and also the deadline for 100% completion by 31 December 2002. As a result of the review, Prudential held a provision of £3m at 31 December 2002.
Jackson National Life has unfunded commitments related to its investments in limited partnerships totalling £300m at 31 December 2002. These commitments were entered into in the ordinary course of business and management does not expect a material adverse impact on the operations to arise from them.
Prudential has provided, from time to time, certain guarantees and commitments to third parties. These arrangements include commitments and guarantees to fund the purchase or development of land and buildings and other commitments related to investments in land and buildings. At 31 December 2002, the aggregate amount of commitments and guarantees in respect of land and buildings was approximately £27m.
Other Matters Prudential Assurance’s inherited estate The inherited estate is the assets of the main with-profits fund within the long-term fund of Prudential Assurance, less non-participating liabilities, the policyholder asset shares aggregated across with-profits policies and any additional amounts expected at the valuation date to be paid to in force policyholders in the future in respect of smoothing costs and guarantees. The inherited estate is thus the assets in the main with-profits fund in excess of what Prudential Assurance expects to pay to policyholders.
Support of long-term business funds from shareholders’ funds As a proprietary insurance company, Prudential is liable to meet its obligations to policyholders even if the assets of the long-term funds are insufficient to do so. The assets, represented by the Fund for Future Appropriations, in excess of amounts expected to be paid for future terminal bonuses and related shareholder transfers (excess assets) in the long-term funds could be materially depleted over time, by, for example, a significant or sustained equity market downturn, significant fundamental strategic change costs, or material increases in the pension mis-selling provision. In the unlikely circumstance that the depletion of the excess assets within the long-term fund was such that Prudential’s ability to satisfy policyholders’ reasonable expectations was adversely affected, it might become necessary to restrict the annual distribution to shareholders or to contribute shareholders’ funds to the long-term funds to provide financial support.
Operating profit before tax before amortisation of goodwill 432 622 Add back interest charged to operating profit 190 162 Adjustments for non-cash items: Tax on long-term business profits (174) (235) Amounts retained and invested in long-term business operations (553) (534) Increase in net banking business assets 72 36 Other items 64 44
Net assets acquired (disposed of) (11) 13 2 182 Cash consideration received (paid) 353 (13) 340 (182)
Movements arising from cash flow (18) (434) Investment appreciation (depreciation) 2 (71) Investments and cash acquired with purchase of businesses 1 – Exchange translation and other (83) (7) Transfer to retained profit in respect of shares issued in lieu of cash dividends 23 20 Portfolio investments net of financing at beginning of year (1,466) (974)
General business and shareholder portfolio investments (as above) 2,736 2,805 Long-term business portfolio investments 112,329 117,010 Investments in participating interests 73 87
The amounts included in the profit and loss account for 2002 in respect of these acquisitions are not material. The goodwill is being amortised from the date of acquisition over a period of up to 20 years.
We have audited the financial statements on pages 47 to 85. We have also audited the information on pages 37 to 43 in the directors’ remuneration report that is described as having been audited.
Respective Responsibilities of Directors and Auditors The directors are responsible for the preparation of 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 read the other information contained in the Annual Report, including the corporate governance statement and the unaudited part of the directors’ remuneration report, and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent mis-statements or material inconsistencies with the financial statements.
Basis of Audit Opinion We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the directors’ remuneration report to be audited. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
Opinion In our opinion: • the financial statements give a true and fair view of the state of affairs of the Company and the Group as at 31 December 2002 and of the profit of the Group for the year then ended; and
Short-term fluctuations in investment returns (205) (480) (48) 28 24 Merger break fee, net of related expenses – 338 – – – Profit on business disposals 355 – 239 – 249
Profit after tax and minority interests: Operating profit (including post-tax long-term investment returns) 314 460 591 507 620 Profit for the year (including post-tax actual investment returns) 449 389 657 472 853
Insurance and investment funds under management (£bn) 155 163 165 170 128
Share statistics Earnings per share: Based on operating profit after tax and related minority interests
Based on profit for the year after tax and minority interests 22.6p 19.7p 33.5p 24.2p 43.9p
Insurance and investment funds under management (£bn) 32 34 30 25 21
Prudential Asia Long-term business: New business: Gross premiums written and investment product contributions 15,557 10,820 3,335 1,237 532 Operating profit before development expenses 88 44 39 27 23
Achieved profits basis capital and reserves 1,407 1,089 793 593 378
Achieved profits basis capital and reserves 108 90 82 68 46
Long-term business 251 303 Broker dealer and fund management 14 16
Operating profit from continuing operations (based on long-term investment returns) before amortisation of goodwill 1,133 1,114
Summarised Consolidated Profit and Loss Account – Achieved Profits Basis year ended 31 December 2002
Loss for the financial year before minority interests (154) (242) Minority interests 9 25
Earnings per Share – Achieved Profits Basis year ended 31 December 2002
Statement of Total Recognised Gains and Losses – Achieved Profits Basis year ended 31 December 2002 £m £m
Reconciliation of Movement in Shareholders’ Capital and Reserves – Achieved Profits Basis year ended 31 December 2002
Total recognised losses relating to the financial year (475) (164) New share capital subscribed 40 42
Shareholders’ capital and reserves at end of year 13,14 7,196 8,150
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.
3. Economic Assumptions Under the ABI guidance, for most countries, the basis for setting long-term expected rates of returns on investments and risk discount rates are set by reference to period end rates of return on fixed interest securities. This ‘active’ basis of assumption setting has been applied in preparing the results of all the Group’s UK, US and European long-term business operations. For the Group’s Asian operations the active basis is appropriate for business written in Japan, Korea and US dollar denominated business written in Hong Kong.
An exception to this general rule is that for countries where long-term fixed interest markets are underdeveloped, investment return assumptions and risk discount rates should be based on an assessment of longer-term economic conditions. Except for the countries listed above, this basis is appropriate for the Group’s Asian operations.
(applying the rates listed above to the investments held by the fund) 6.6% 7.1% Expected long-term rate of inflation 2.5% 2.6%
Risk margin included within the risk discount rate 2.6% 2.6% Risk discount rate(i) 7.1% 7.7%
Prudential Europe Risk discount rate(i) 7.1% 7.7% (i) For all operations, a discount rate is applied to post-tax cash flows to determine post-tax results. For most operations, these results are then grossed up for the effective rate of tax to derive the pre-tax results. For Jackson National Life, pre-tax results are determined by applying the risk discount rate to pre-tax cash flows adjusted for the impact of capital charges.
(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 2002 and 2001.
Adjustment for amortisation of goodwill (98) – (98) – (98) (4.9)p Adjustment from post-tax longer-term investment returns to post-tax actual investment returns (after related
Based on loss for the financial year after minority interests (483) 329 (154) 9 (145) (7.3)p
*The adjustment from post-tax longer-term returns to post-tax actual investment returns includes investment return that is 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 longer-term to actual investment returns includes losses of £5m (£13m) attributable to the minority interests in these funds.
Where solvency capital is held within a with-profits long-term fund, the value placed on surplus assets in the fund is already discounted to reflect its release over time and no further adjustment is necessary in respect of solvency capital.
In determining the cost of capital of Jackson National Life, it has been assumed that an amount equal to 200% of the risk based capital required by the National Association of Insurance Commissioners at the Company Action Level must be retained. The impact of the related capital charge is to reduce Jackson National Life’s shareholders’ funds by £138m (£222m).
7. 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.
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 Operations Unwind of discount(i) 358 384 Cost of strengthened persistency assumption (47) – Change of renewal expense assumption resulting from closure of direct sales force – 15 Cost of strengthened assumption for required capital for shareholder backed business – (16) Experience variances and other items (7) (6)
Prudential Asia Unwind of discount 95 78 Profit arising from reorganisation of long-term funds 59 – Change in operating assumptions (2002 – principally Singapore mortality) 42 66 Other items and experience variances 13 16
Prudential Europe Unwind of discount 9 9 Experience variances (6) (9)
(ii) The spread variance for Jackson National Life shown above has been determined after including longer-term returns on equity based investments. This treatment is consistent with the inclusion of longer-term investment returns within operating profits. 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.
Share of investment return of funds managed by PPM America that are consolidated into Group results but attributable to external investors (5) (13)
(iii) Jackson National Life – Actual investment return on investments less longer-term returns comprises: £m £m
Actual less averaged realised gains and losses (including impairments) for fixed income securities(iv) (156) (295) Actual less longer-term return on equity based investments (128) (124) Investment (depreciation) appreciation on preference shares (11) 6
(iv) Jackson National Life – Actual less averaged realised gains and losses (including impairments) for fixed income securities £m $m equivalent
Averaged realised gains differ from those reported on the statutory basis for the impact of amortisation of policy acquisition costs attributable to realised gains and losses. These have been included in the statutory basis gains averaging calculation for the years 1998 to 2002. On the achieved profits basis deferred acquisition costs do not feature as part of the methodology. Accordingly the realised gains and losses included in the averaging process are exclusive of the amortisation of policy acquisition costs attributable to realised gains and losses.
11. Effect of Revised Economic Assumptions (Losses) profits on change in economic assumptions included within the loss on ordinary activities before tax arise as follows: £m £m
Tax charge on operating profit Long-term business: UK Operations(i) 159 173 Jackson National Life 49 127 Prudential Asia(ii) 123 133 Prudential Europe(ii) 7 (2)
Tax on items not included in operating profit Tax credit on short-term fluctuations in investment returns (447) (422) Tax effect of change of economic assumptions (181) (167) Tax charge on profit on disposal of UK general business operations (after utilisation of available capital losses) 13 – Tax charge on merger break fee, net of expenses (after utilisation of available capital losses) – 6
UK Operations Long-term business operations: Smoothed shareholders’ funds(i) 3,329 3,775 Actual shareholders’ funds less smoothed shareholders’ funds (411) (119)
(ii) In determining the cost of capital of Jackson National Life it has been assumed that an amount equal to 200% of the risk based capital required by the National Association of Insurance Commissioners at the Company Action Level must be retained. The impact of the related capital charge is to reduce Jackson National Life’s shareholders’ funds by £138m (£222m).
Holding company net borrowings (2,071) (1,961) Core structural borrowings – Jackson National Life (155) (172)
Long-term business: Re-engineering costs (16) (16) (16) Asia and Europe development expenses (26) (8) (34) (34)
US broker dealer and fund management 14 14 Other income and expenditure (189) (189)
Intragroup dividends (including statutory transfer) (361) (94) (21) 7 (469) 469 External dividends (519) (519)
Proceeds from issues of share capital by parent company 40 40 Adjustment for European new business sold by UK operations (6) 6
Net (decrease) increase in shareholders’ capital and reserves (738) (26) 318 18 (428) (526) (954)
Shareholders’ capital and reserves at 31 December 2002 2,918 2,657 1,407 108 7,090 106 7,196
Analysed as: Additional shareholders’ interest on achieved profits basis 2,377 283 828 40 3,528 3,528
Estimated Estimated profit from new business pre-tax unwind of Pre-tax Tax Post-tax discount £m £m £m £m
Operating profit *Jackson National Life: Before capital charge 126 Capital charge (41)
Shareholders’ funds If the economic assumptions applied for 2002 had been in place at 31 December 2001 the achieved profits basis shareholders’ funds at that date would have been lower by £286m. This represents a pre-tax loss of £467m less related tax credit of £181m. These figures are analysed by business operation in note 14.
Risk discount rates: Increase in rates of 1% (85) Decrease in rates of 1% 102 31 December 2002 shareholders’ funds Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 750 Decrease in rates of 1% (774)
17. UK Re-engineering Costs Details of the re-engineering costs charged in the year are explained in note 7 on page 65. After including amounts borne by the main with-profits fund but attributed to shareholders, the costs relating to continuing operations recognised on the achieved profits basis were £16m (£57m).
18. Pension Costs The impact of pension costs on the achieved profits basis results of long-term business has been determined in the context of the methodology described in note 2. Accordingly, for long-term business, the achieved profits basis value of new business written in the reporting period, and the value of in force at the balance sheet date have been determined after incorporating projections of attributable pension costs into the estimates of future cash flows for the contracts concerned. Experience variances for expenses include any difference between the actual and assumed contributions to defined benefit pension schemes. The achieved profits basis results and shareholders’ funds for long-term business are, therefore, not affected by whether or not the Group has adopted FRS 17 ‘Retirement benefits’ in preparing its achieved profits basis results.
Further details are shown in note 19 on pages 73 to 76 of the Group’s financial statements.
Statement of Directors’ Responsibilities in Relation to the Achieved Profits Basis Supplementary Information 102 Prudential plc Annual Report 2002
An explanation of the achieved profits basis of reporting is provided on pages 23 to 25 of the Group’s financial statements.
Independent Auditors’ Report to Prudential plc on the Achieved Profits Basis Supplementary Information
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the achieved profits basis supplementary information is free from material mis-statement, whether caused by fraud or other irregularity or error. In forming our opinion, we also evaluated the overall adequacy of the presentation of the supplementary information.
Sharedealing Facilities Stockbrokers Cazenove & Co. offer a postal sharedealing service to Prudential shareholders at competitive commission rates. For details telephone 020 7606 1768 or write to 12 Tokenhouse Yard, London EC2R 7AN.
All enquiries regarding ADR holder accounts should be directed to J P Morgan, the authorised depositary bank, at J P Morgan Service Center, PO Box 43013, Providence, RI 02940-3013, USA, or telephone 00 1 781 575 4328.
Prudential UK & Europe Insurance Operations 3 Sheldon Square London W2 6PR
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