Our Group capital and cash position remains robust with an Insurance Groups Directive (IGD) capital surplus estimated at £1.7 billion.
Our financial strength, prudent management of capital resources, geographic spread, trusted brands and relentless focus on seizing profitable opportunities in the pre- and post-retirement market has once again proved to be a successful formula, even amid the exceptional economic conditions of 2008.
O verv iew 80 Board of directors 83 Governance report: • Corporate governance • Risk governance • Corporate responsibility governance 99 Additional disclosures 100 Index to principal Directors’ Report disclosures 2 There’s more to Prudential 6 Chairman’s statement 10 Group Chief Executive’s report 20 Chief Financial Officer’s overview 34 Risk and capital management: • Risk oversight • Capital management 44 Business unit review: • Insurance operations: Asia, US, UK • Asset management: M&G, Asia, US
The directors’ report of Prudential plc for the year ended 31 December 2008 is set out on pages 1 to 100 and on pages 360 to 363, and includes the sections of the Annual Report referred to in these pages.
M&G is our UK and European fund management business, responsible for £141 billion of investments as at 31 December 2008 on behalf of both internal life and pension funds and external clients. We aim to maximise profitable growth by operating in markets where we have a leading position and competitive advantage including retail fund management, institutional fixed income, pooled life and pension funds, and private finance. Through M&G we add value to our Group by generating attractive returns on internal funds as well as growing profits from the management of third-party assets. These external funds now represent £47 billion of M&G’s total funds under management.
Prudential UK is a leading provider of retirement solutions and life assurance focusing on products where we can best capitalise on our longevity experience, trusted brand and financial strength. These include products and services such as annuities, pensions, bonds, as well as protection, equity release and health insurance products. These products are distributed through direct sales, financial advisers and partnerships. We remain the largest annuity provider in the UK, with approximately 1.5 million annuities in payment and one of the market leaders in with-profits products, the corporate pensions market and the emerging equity release market.
Hong Kong (Reader’s Digest Trusted Brands Awards, 2008) • IRR over 20 per cent in 2008
• 35 per cent of retail funds delivered top-quartile investment performance over three years
• Record gross inflows of £16.2 billion, an increase of 10 per cent on the previous year
• Ranked first for net and gross UK retail sales in the fourth quarter of 2008
• Rated first amongst Life and Pension providers for professional authority, trustworthiness and customers’ choice for retirement needs among 45+ age group (Source: HPI Brand Tracking Research, 2008)
• Ranked top insurance company for sales support satisfaction in the Financial Research Corporate Adviser Insight Series on Marketing Effectiveness
• Rated as a ‘World Class’ service provider for four successive years by Service Quality Management
• Record total APE retail sales of £596 million – highest level in Jackson’s history
Successive generations have looked to Prudential to safeguard their financial security – from industrial workers and their families in Victorian Britain to over 21 million customers worldwide today.
During our 160-year history, we have protected the interests of our policyholders and shareholders through a series of external crises, from the sudden downturn in 1857, through two World Wars, to today’s global financial volatility. Our financial strength, heritage, prudence, and relentless focus on our customers’ long-term needs ensure that people continue to turn to our trusted brands to help them plan for today – and tomorrow.
‘We are well positioned to continue to achieve growth in profitable market share, even in these very challenging market conditions.’
Despite the unprecedented turmoil in the global financial markets, 2008 was another successful year for Prudential, sustaining our consistently strong financial performance over the past four years. Throughout that time, our business has been differentiated from its competitors by our diversified but selective geographic reach, in particular our involvement in Asia; our focus on the retirement opportunity; our outstanding product expertise; and the strength of the leadership team built under our Group Chief Executive, Mark Tucker. I also want to acknowledge the outstanding contribution made to the Group by my predecessor, Sir David Clementi, over the past six years.
We are well positioned to continue to achieve growth in profitable market share, even in these very challenging market conditions. Our prudent but proactive risk-based approach to capital management has ensured that our position remains robust and resilient.
Given this performance, the Board has been able to recommend a full-year dividend of 18.90 pence per share, an increase of five per cent on 2007.
Looking forward, we fully expect global economic conditions to remain highly challenging for some time. However, we remain very well positioned to outperform over the market cycle and our confidence is strengthened by the continued momentum across our businesses, which confirms that our strategy, operating model and execution are right. Everywhere you look in our Group, there are success stories characterised by growth generated in local markets in the face of tough conditions.
During the year we continued to bring new blood into our senior management team. In March 2008 we announced the appointment of Tidjane Thiam as our new Chief Financial Officer. Tidjane brought with him a richly-deserved reputation for driving performance and value, and we knew his talents and experience were well-suited to help lead Prudential in the next stage of its development.
Tidjane’s capabilities have been further underlined in 2009, with his appointment to succeed Mark Tucker as Group Chief Executive from 1 October 2009.
Mark has decided to leave Prudential after 25 years with the Company and I would like to thank him for his immense contribution to the Group. As Chief Executive of Prudential Corporation Asia from 1994 to 2003 he established Prudential as the leading international life company in the region. Under his leadership as Group Chief Executive since 2005 the business has taken maximum advantage of the opportunities for profitable growth arising from its diversified geographic spread. Tidjane’s appointment has the full support of the whole Board, and the availability of such an outstanding internal candidate reflects both the strength in depth of our management team and the effectiveness of our succession planning.
Promoting financial capability remained at the heart of our international Corporate Responsibility programme. Highlights included our collaboration with Citizens Advice Bureau in the UK, the ‘Investing in our Future’ seminars in Asia, and our new online retirement planning tools in the US.
When my appointment as Chairman was announced in August 2008, I said I was excited at the prospect. Since then, my sense of anticipation and enthusiasm has grown even stronger. I am energised by the prospects for Prudential, and am confident that we have the right positioning, skills and capabilities to continue to create sustainable value over the economic and financial cycle. I would like to thank all our people around the world for playing their full part in this continuing success.
This achievement once again demonstrated the soundness of the strategy the Group has followed in recent years. Our selective spreading of geographic risk across different continents and types of economy, our focus on the most profitable opportunities in the pre- and post-retirement sector in each of our chosen markets, and our resolute refusal to pursue sales volume targets at the expense of profit have once again proved their worth. We have said in the past that this is a formula for outperformance, and this has held true amid the particularly testing conditions of recent months.
As well as reaffirming our strategy, these results also reflect the operational expertise and excellence that our operating divisions around the world bring to bear, and fully justify our commitment to nurturing the financial strength of the Group through prudent management of capital resources.
Before describing our performance for 2008 in detail, I would like to make a brief comment on my decision to leave Prudential at the end of September 2009 after four and a half years as Group Chief Executive and a total of 25 years with the Group. This was not an easy decision, but I believe the Group’s continued progress in 2008 confirms the success of the measures taken over the last four years to strengthen the Group’s financial and strategic positioning, and having achieved this the time seems opportune to step aside so that the Board can entrust the next stage of the Group’s development to a successor with a full term ahead of him.
I am deeply proud of what the team here has achieved under my leadership, and am also deeply impressed by the quality of my successor, our current Chief Financial Officer, Tidjane Thiam. Going forward, I know Tidjane will do an outstanding job as Group Chief Executive.
On the statutory International Financial Reporting Standards (IFRS) basis, operating profit before tax from continuing operations increased by 12 per cent to £1,347 million. As a result, our IFRS operating profit before tax has now grown at a compound annual rate of 21 per cent since the end of 2004.
Operating profit in the Group’s asset management operations increased by £11 million to £345 million in very difficult trading conditions in all markets. Net inflows at M&G were £3.4 billion and our asset management business in Asia recorded net inflows of £0.9 billion.
Equally important, our Group capital position remains robust. Using the regulatory measure of the Insurance Groups Directive (IGD), the Group’s capital surplus was estimated at £1.7 billion with a solvency ratio of 162 per cent. Through an innovative transaction we have been allowed by the regulator to include £0.3 billion of the shareholders’ economic interest in the future transfers from the UK With-Profits Fund, which in total was worth £1.7 billion at 31 December 2008. Going forward, there is the opportunity to develop similar transactions which may allow us to access more of the residual £1.4 billion if required.
We also retain significant flexibility and capacity for other management actions to improve and protect our position still further, were the need to arise.
Taking all these factors into account alongside our proactive approach to risk management, we are confident that our Group remains resilient to any further deterioration in market conditions across all asset classes.
Our cash flow position has been improving over a number of years, and in 2008 we achieved our target of being operating cash flow positive at the Group level, with a cash surplus of £54 million.
Given this robust financial position, the Board has recommended a final dividend of 12.91 pence per share, bringing the full-year dividend to 18.90 pence per share, an increase of five per cent. The dividend is covered 2.24 times by post-tax IFRS operating profit from continuing operations.
The bedrock of our strategy is to be both highly international and very selective. We look to maintain an internationally diverse portfolio of businesses, embracing countries that are at different stages of economic development but which all share one key attribute: the opportunity for us to build a market-leading operation with prospects for sustainable long-term profitable growth and a superior rate of return on capital. In every market we choose to enter, we also benefit from an operating model that enables each of our businesses to stay close to its customers and their needs when formulating product and distribution strategies, while taking a consistent, disciplined Group-wide global approach to managing risk, capital and cash.
Within this proven framework, we maintain a strong and consistent focus on the retirement savings, income and protection sectors. This has many different facets, ranging from providing regular savings products that accumulate funds for retirement, through healthcare protection at all ages, to helping those entering or already in retirement to organise their finances so as to secure an efficient retirement income. As demographic and welfare trends worldwide continue to reinforce the need for personal savings to provide income in retirement, and as the ‘baby-boomer’ generation in the Western world makes the transition from employment into retirement, our strong presence, assets and capabilities in the sector will position us to capture a disproportionate share of this growing profit pool over the coming years.
The Group’s particularly strong association with the Asian region, which has been our primary focus for investment and expansion in recent years, has also been vindicated by recent events. Of course, Asian markets did feel the impact of the global financial turmoil in mid-2008, and the region’s economic performance has undoubtedly suffered as a consequence of the downturn in Western markets for its goods. Nevertheless, Asia was the only region worldwide to record high single-digit economic growth in 2008. Going forward, we believe that Asia’s fundamentals of continued economic growth, increasing mass affluence and shifting demographics will continue to be powerful drivers of profitable growth in the future. In line with our stated strategy to review acquisition opportunities, we did look at AIA's assets in Asia. Following careful consideration against our strict financial criteria and our strategic objectives, we decided not to proceed with an offer for any of these assets.
Overall we believe that our strategy, and the consistency with which we execute it, are the core factors that differentiate us from our peers.
Product and distribution strategy In all our operations, our aim is to have a suite of products that delivers good value and meets customers’ needs without being unduly capital intensive or leaving the Group overly exposed to the economic cycle. While we would not claim to be recession-proof, we have shown that we are recessionresistant. The need to fund retirement savings and provide for income in retirement is not going to go away – and this makes our revenue streams highly resilient, even though at different points in the cycle customers may prefer to achieve their goals through different products and investment options.
In the US, the prevailing economic uncertainty and equity market volatility had a negative impact on variable annuity sales in 2008. However, fixed annuity product sales increased as customers became more risk averse. Jackson’s strength across the annuity product range enabled us to anticipate this change and meet shifting demand. We executed this change while maintaining our disciplined approach to pricing, despite intense price pressures in the variable annuity market. Our successful hedging of variable annuity guarantees meant our equity hedging gains more than offset the drop in equity markets during the year.
During 2008, Prudential's UK Insurance Operations benefited from our strength in the individual annuity market, supported by a significant flow from internal vesting pensions and continuing high conversion rates.
Our operating model also enables us to be flexible in distribution, identifying and developing the specific distribution mix that will create the optimal value in each market. In Asia, for example, we are unique in that we have developed both the largest regional network of tied agents and also excellent partnerships with Standard Chartered and many other banks across the region. In the United States, our highly successful distribution model focuses on our industry leading wholesaler teams, who offer genuine added-value to the independent financial advisor channel while also distributing products through Regional Broker Dealers and banks. In the UK, we have a diverse multi-channel approach including direct sales, financial advisers and partnerships.
Risk and capital management The events of 2008 have put the balance sheets and capital positions of all insurance companies under close scrutiny. Few anticipated the depth of the banking crisis or the speed of onset of recession in the western economies. But at Prudential we entered 2008 in a generally defensive mode in expectation of a general downturn in the economic outlook – and this certainly stood us in good stead as events unfolded.
Despite the downturn, the capital position of the Group remained strong in 2008, in the face of a testing combination of highly volatile and declining equity markets, falling interest rates, widening spreads on corporate bonds, and rapidly deteriorating credit conditions. Our defensive stance on credit exposure in particular served us well – as did the comprehensive equity hedging strategies that we had put in place in the US to protect against product guarantees.
The retirement and near-retirement population will represent the fastest-growing segments of the market over the next 10 years.
2025 816m 2020 714m 2015 615m 2010 535m 2005 452m 2025 109m 2020 101m 2015 91m 2010 80m 2005 70m 2025 24m 2020 23m 2015 21m 2010 19m 2005 18m
Given the crisis in the global banking industry in 2008, it is worth restating the fundamental differences between life insurers and banks – a distinction that extends to the two industries’ business models, capital ratios and regulatory needs. Insurers do not borrow short and lend long, do not give out credit, are structurally long in terms of liquidity, and are much better able to hold assets to maturity without risk of forced selling at depressed prices.
During the year we also took the decision not to proceed with the reattribution of the inherited estate in the UK With-Profits Sub-Fund of Prudential Assurance Company. This decision was taken after an exhaustive review of the potential benefits and disadvantages of such a move for policyholders and shareholders, the conclusion from which was that it would be in their best long-term interests to maintain the strength and stability inherent in the status quo. This cautious approach on behalf of policyholders and investors was supported at the time by most market commentators, and has been amply vindicated by subsequent events.
• Maximise the potential from non-agency distribution and add new partners
• Build on our strengths in the retirement market and risk products
• Deliver on the cost reduction programme including the outsource programme
• Determine whether it is in the best interests of policyholders and shareholders to pursue a reattribution of the inherited estate
• The surplus will increase by approximately £0.8 billion on completion of disposal of the Group’s agency business in Taiwan
• Continued to develop and launch new retirement orientated products. For example in Korea and Malaysia variable annuity products were launched that provide a guaranteed minimum income on retirement
• Health products have been incorporated into agency incentive programmes, a standalone health care product was launched into the SCB channel with simplified underwriting and eye-catching media campaigns to capture direct business and provide leads for other channels
• Jackson recognised as World Class service provider by the Service Quality Management in its latest benchmarking study of North American contact centres
• Retained and strengthened distribution relationships by providing the resources, guidance and services, advisers need most during difficult times
• The agreement with Capita to outsource a large proportion of our policy administration began in April 2008 and we are on track to deliver the targeted £195 million of cost savings from the end of 2010
• After extensive assessment, we concluded that maintaining the current operating model for the With-Profits Sub-Fund was in the best long-term interest of both our current and future policyholders as well as our shareholders. We announced in June 2008 that we would not be proceeding with a reattribution of the inherited estate
• M&G had a very strong year in 2008 posting record gross fund inflows of £16.2 billion, an increase of 10 per cent on 2007
Investing for the future Amid all the turmoil in the global markets, it is imperative that we continue to invest for the future to ensure we are positioned to accelerate out of the economic slowdown and maintain our record of outperformance.
Key to this will be our ability to prepare for, identify and capture emerging growth opportunities. With this in mind, in 2008 we continued to reinforce the already strong positions of our businesses in our chosen markets – and these efforts have continued into 2009, with a particular focus on recruiting the best talent.
Outlook It is clear that 2009 will be a challenging year. Indeed, there is an increasing likelihood that in some parts of the world recession will continue into 2010. However, the global economy will ultimately rebound – albeit at different times and different speeds in different markets.
Given the uncertainty in the operating environment we have taken a prudent approach to our plans for 2009. This means focusing on balancing new business with cash generation, and making it our absolute priority to ensure that our balance sheet and capital position remain robust. At the same time, we will continue to position our businesses to take advantage of any improvement in market conditions.
• Make the most of our core capabilities and assets including our longevity experience, multi-asset investment expertise, brand, financial strength and large customer base
• Maintain superior investment performance for both internal and external funds
We have also continued to act on our commitment to increased transparency, by giving additional disclosures on International Financial Reporting Standard (IFRS) basis results and free surplus generation.
On the statutory IFRS basis our operating profit increased by 12 per cent to £ 1.3 billion. A particularly significant factor in this increase was a rise of 70 per cent in our Asia IFRS operating profit. After tax and minority interest the Group saw a loss of £396 million largely driven by short-term fluctuations. As with EEV reporting, positive and negative short-term fluctuations are expected in an insurance company.
Annual premium equivalent (APE) sales 3,025 2,868 5 3,003 1 Present value of new business premiums (PVNBP) 22,529 21,308 6 22,348 1
IGD capital surplus (as adjusted*) (£bn) 1.7 1.9 (11) 1.9 (11)
8 The 2007 comparative for new business sales and premiums have been adjusted to reflect the inclusion of sales for the Group’s UK health insurance joint venture operation, PruHealth. The presentation of the operating profit for 2007 has been adjusted to allocate £10 million of profit from the result of new to in-force business to prevent distortion to the published new business margin, so as to reflect consistently in the 2008 and 2007 results the 50 per cent economic interest in the Group’s China joint venture.
Risk and capital Our capital position is strong, driven by our conservative risk and capital management. Our Insurance Groups Directive (IGD) capital surplus is estimated at £1.7 billion before allowing for the 2008 final dividend, giving a solvency ratio of 162 per cent. This total is composed of our IGD surplus at 31 December 2008, estimated at £1.4 billion; together with an additional £0.3 billion that the FSA has subsequently allowed us to include in our IGD surplus going forward as a result of an innovative structure we have developed. Our IGD capital surplus on a consistent basis (i.e. before allowing for a dividend) was £1.9 billion at the end of 2007 and £1.4 billion at the end of the third quarter of 2008.
In addition to this strong capital position, the total credit reserve for the UK shareholder annuity funds stood at £1.4 billion at the end of the year. We increased this credit reserve by £0.8 billion in 2008, and it is now equivalent to 80bps per annum over the lifetime of the assets. This reserve would allow us to withstand a recurrence of the average Moody’s default experience during the Great Depression, occurring every year for the remaining life of the book.
The global debt markets have experienced unprecedented conditions in 2008, with illiquidity and credit spreads reaching all-time highs. Our debt portfolio on an IFRS basis was approximately £95 billion at 31 December 2008. Total defaults experienced for shareholder backed business on the book in 2008 were £174 million (0.4 per cent of the portfolio).
In 2008, Prudential Group’s total EEV basis operating profit from continuing operations based on longer-term investment returns was £2,961 million, up 17 per cent from 2007.
During the year, the Group generated long-term profits of £2,906 million, comprising new business profits of £1,307 million (2007: £1,205 million), in-force profits of £1,625 million (2007: £1,319 million) and Asia development costs of £26 million (2007: £15 million). New business profit from insurance business, at £1,307 million, was eight per cent higher than in 2007, reflecting a resilient sales performance in Asia and sales in the US and UK broadly in line with the previous year. The average Group new business profit margin was 43 per cent (2007: 42 per cent) on an APE basis and 5.8 per cent (2007: 5.7 per cent) on a PVNBP basis. This rise reflects an increase in the average margin in Asia, partly offset by a slight decline in the average US and UK margin. In-force profit increased by 23 per cent on 2007 to £1,625 million. In aggregate, net assumption changes had an impact of £118 million positive, and experience variances and other items were £271 million positive.
Other income and expenditure totalled a net expense of £302 million compared with £297 million in 2007. This result primarily consists of interest payable on core structural borrowings of £172 million (2007: £168 million), Group Head Office costs of £130 million (2007: £129 million) and Asia Regional Head Office costs of £41 million (2007: £38 million), offset by investment return and other income of £47 million (2007: £49 million). Investment return income includes a one-off profit of £47 million crystallised on the sale of a seed capital investment in an Indian mutual fund, partly offset by lower interest income.
Total EEV basis operating profit from continuing operations 2,993 2,550 17 2,696 11
In our US business, short-term fluctuations in investment returns were negative £1,344 million, primarily consisting of: a negative £412 million resulting from the difference between the actual investment returns included in operating profit in respect of fixed income securities and the assumed long-term investment return; a negative £733 million resulting from the capitalisation changes in the expectations of future profitability on variable annuity business in force, due to the return on the actual variable investment account (‘separate account’) being lower than the long-term return reported within operating profit, offset by the impact of the associated hedging position; and a negative £199 million resulting from the difference between the actual investment returns and the longer-term returns included within operating profit relating to equity-type investments and other items.
In our UK business, the short-term fluctuations in investment returns were negative £2,407 million. This figure primarily reflects the difference between the actual investment return of negative 19.7 per cent for the with-profits life fund and the long-term assumed return of positive 6.6 per cent. Short-term fluctuations on the shareholder-backed annuity business of negative £213 million represent negative investment return on surplus assets and default experience. Short-term fluctuations on the unit linked business of negative £111 million represent the capitalised reduction in future fees arising from the fall in market values experienced during the year.
The actuarial loss of £15 million (2007: loss of £5 million) included in total profit reflects the shareholders’ share of actuarial gains and losses on the Group’s defined benefit pension schemes.
In our UK business, economic assumption changes were negative £783 million, primarily reflecting the net effect of changes to the assumed fund earned rate and the risk discount rate due to the reduction in gilt rates. The impact of these effects on with-profits business is negative £466 million. The economic assumption changes relating to the shareholder annuity business is negative £317 million.
The effective tax rate at an operating tax level was 26 per cent (2007: 27 per cent), generally reflecting the expected tax rates. The effective tax rate at a total EEV level was 37 per cent (2007: 25 per cent) on a loss of £2,106 million, primarily reflecting that there is no deferred tax charge associated with the mark to market value movement on core borrowings.
Total EEV basis operating profit from continuing operations after restructuring costs 2,961 2,530 17
Effect of change in time value of cost of options and guarantees: (31) 0
IFRS results Group operating profit before tax from continuing operations based on longer-term investment returns on the IFRS basis after restructuring costs was £1,347 million an increase of 12 per cent on 2007.
Our US business’s IFRS operating profit of £406 million was down by nine per cent on 2007. This was mainly due to accelerated levels of Variable Annuities DAC amortisation as a result of large negative equity market movements. These impacts were partially offset by positive operating derivative income on variable annuity business, reflecting the increase in market value of the net short derivative positions due to falling equity prices. The decision to acquire additional hedging protection in the derivatives markets in 2007 at favourable prices demonstrated its value amid the falling equity markets experienced in 2008. The US operation’s results are based on US GAAP, adjusted where necessary to comply with IFRS, as the Group’s basis of presenting operating profit is based on longer-term investment returns. Longer-term returns for the US operation’s fixed income securities incorporate a risk margin reserve (RMR) charge for longer-term defaults and amortisation of interest-related realised gains and losses. Jackson’s hedging of its variable annuity guarantees offset the effect of the 38.5 per cent drop experienced in the US equity markets in 2008.
In our UK business, total IFRS operating profit increased by 12 per cent in 2008 to £589 million. The increase of four per cent achieved for the long-term business reflected profits attributable to the with-profits business of £395 million together with 15 per cent growth from the long-term shareholder backed business. IFRS profits from the shareholder annuity business includes the impact of strengthening the allowance for credit defaults partly offset by profits emerging from a rebalancing of the asset portfolio. Non-long-term business IFRS profit reflected profit from General Insurance commission which increased to £44 million, with cash beginning to emerge following the 2002 sale of the business to Churchill.
The Asian asset management operations reported operating profits of £52 million, down by 28 per cent on 2007, reflecting decreases in funds under management and performancerelated fees due to market volatility.
IFRS basis operating profit on longer-term investment returns from continuing operations
Total IFRS basis operating profit based on longer-term investment returns before restructuring costs 1,347 1,201 12 1,262 7
The total loss before tax and minority interests on an IFRS basis was £450 million in 2008, compared with a profit of £1,063 million for 2007. This reduction primarily reflects adverse short-term fluctuations experienced in investment returns.
In calculating the IFRS operating profit, we use longer-term investment return assumptions rather than actual investment returns achieved. The actual movements in asset values beyond the longer-term assumptions appear in the profit and loss account as short-term fluctuations in investment returns, with the exception of Jackson, where unrealised gains or losses on debt securities feature directly as movements in shareholder reserves.
The £1,783 million charge for short-term fluctuations in investment returns mainly comprises £200 million, £1,058 million and £212 million relating to our Asian, US and UK operations respectively.
Our UK operations’ short-term fluctuations charge of £212 million reflects asset value movements, principally for the shareholder-backed annuity business, of negative £170 million and £42 million for the effect of credit downgrades on the measurement of annuity liabilities.
Other short-term fluctuations charge of £313 million include £190 million for unrealised value movements in Prudential Capital and £71 million on the sale of an investment in an Indian Mutual Fund.
Shareholders’ share of actuarial and other gains and losses on defined benefit pension schemes (14) (1)
(Loss) profit from continuing operations for the financial year after tax (391) 709 (155)
(Loss) profit for the year attributable to equity holders of the company (396) 947 (142)
EPS based on Operating Profit from continuing operations after Tax and minority interest
Dividend per share The directors recommend a final dividend for 2008 of 12.91 pence per share payable on 22 May 2009 to shareholders on the register at the close of business on 14 April 2009. The interim dividend for 2008 was 5.99 pence per share. As a result, the total dividend for the year, including the interim dividend and the recommended final dividend, amounts to 18.90 pence per share compared with 18.00 pence per share for 2007, an increase of five per cent. The total cost of dividends in respect of 2008 was £469 million.
Dividend cover is calculated as operating profit after tax on an IFRS basis, divided by the current year interim dividend plus the proposed final dividend.
Shareholders’ funds On the EEV basis, which recognises the shareholders’ interest in long-term businesses, shareholders’ funds at 31 December 2008 were £15.0 billion, an increase of £0.4 billion from the 2007 year end level (2007: £14.6 billion). This two per cent increase primarily reflects the following components: a total EEV basis operating profit of £2,961 million; a positive impact of exchange movements of £2,010 million; a tax credit of £771 million; a positive movement on the mark to market of core debt of £656 million; partially offset by a £5,127 million adverse movement in short-term fluctuations in investment returns and dividend payments of £453 million which is itself partially offset by proceeds for new share capital subscribed of £170 million.
The shareholders’ funds of £15.0 billion at year end 2008 comprised: • £5.3 billion for our Asian long-term business operations; • £4.3 billion for our US long-term business operations; • £4.9 billion for our UK long-term business operations; and • £0.5 billion for our other operations.
Analysis of movement in EEV shareholders’ funds: 31 December 2007 to 31 December 2008 £m
At the year end, the embedded value for the Asian long-term business was £5.3 billion. The established markets of Hong Kong, Singapore and Malaysia contributed £3,982 million to the embedded value generated across the region. Korea (£338 million), Indonesia (£314 million) Vietnam (£269 million) also made substantial contributions. Prudential’s other Asian markets, excluding Taiwan, contributed an aggregate £567 million in embedded value. Taiwan had a negative embedded value of £205 million.
Statutory IFRS basis shareholders’ funds at 31 December 2008 were £5.1 billion, compared with £6.1 billion at 31 December 2007. This result represented a decrease of £1.0 billion, reflecting operating profit of £1,347 million, a foreign exchange credit of £631 million, and a tax credit of £747 million; offset by unfavourable movement in short-term fluctuations in investment returns of negative £1,783 million, a net unrealised value change on Jackson debt securities of negative £1,640 million and the balance of dividend payments of £453 million partially offset by proceeds of new share capital subscribed of £170 million.
Unrealised value change on Jackson debt securities Dividends net of new shareholder capital subscribed Foreign exchange
Our Group holding company received £1,033 million in cash remittances from the various business units in 2008, up from £711 million in 2007. This figure includes the shareholders’ statutory life fund transfer of £279 million from the UK business.
The remainder was predominately due to business-driven cash injections to support new business growth. Capital of £126 million was injected into UK shareholder-backed business, mainly to support new business. Jackson’s capital position remained robust in 2008, and no capital injection was required.
After dividends and net interest paid, there was a net cash inflow of £619 million (2007: £372 million). There was a significant take-up of scrip dividends in 2008 and 2007.
In aggregate, there was an operating cash inflow of £54 million in 2008, compared to an outflow of £82 million in 2007.
Free surplus generation Sources and uses of free surplus generation for the Group’s life and asset management operations Free surplus generation for the Group’s life business represents the free surplus generated from the in-force operations during the period less the investment in new business.
Free surplus is used by our life companies for investment in new business, and to provide for specific items, such as the provision established in 2008 for additional credit reserves under statutory reporting. In 2008 we invested £825 million of free surplus (2007: £544 million) in new business and established £770 million (2007: nil) for statutory credit reserves on a Pillar 1 statutory basis.
Free surplus generated in the period prior to methodology changes (983) 985
Gross cash remitted by business units (1,033) (711) Capital injected by business units 518 294
Free surplus at 31 December* 859 1,915 *Includes IFRS net assets excluding goodwill for asset management.
The negative £1,068 million of market-related movements in 2008 includes £268 million of bond losses in the US; £268 million in respect of the drop in interest rates in Taiwan, including the impact of extending out the phased bond yield progression period by five years from 2013 to 2018; and £532 million of other short-term fluctuations in investment returns.
Other movements comprised reallocations of certain statutory reserves and required capital from value in-force to net worth of £187 million in 2008, foreign exchange movements, the mark to market of Jackson’s assets backing surplus and required capital, and other capital movements.
The table below shows Group free surplus generated for life and asset management operations, as defined above, over the last four years.
Overall, our Group wrote £3,025 million of sales on an APE basis during the year. To support these sales, we invested £825 million of capital (2007: £544 million). This amount covers both new business strain, including commissions, of £353 million and the required capital of £472 million. The total capital investment for new business amounted to approximately £27 million per £100 million of APE sales (2007: £19 million). These sales provided a post-tax new business contribution to embedded value of £937 million (2007: £858 million).
In Asia, capital was invested to support sales at an average rate of £18 million per £100 million of APE sales. (2007: £15 million).
In the US, capital was invested to support sales at an average rate of £40 million per £100 million of APE sales (2007: £30 million).
In the UK, capital was invested to support sales at an average rate of £31 million per £100 million of APE sales (2007: £16 million).
As a signatory to the European Chief Financial Officers’ (CFO) Forum’s EEV Principles, Prudential also reports supplementary results on an EEV basis for the Group’s long-term business. We combine these results with the IFRS basis results of the non long-term businesses to provide a supplementary operating profit under EEV. References in this report to operating profit relate to profit based on long-term investment returns.
Expected in-force cash flows (including expected return on net assets)* 1,744 1,299 1,182 992 5,217
Changes in operating assumptions and variances (64) 89 (29) 46 42
Provision for additional allowance on credit risk (770) 0 0 0 (770) Changes in non-operating assumptions and variances (1,068) 141 56 (189) (1,060)
Reallocations between net worth and value in-force (187) 0 0 0 (187)
Free surplus generated in the period (1,170) 985 655 287 757 *Expected in-force cash flow includes asset management IFRS operating profits and GI commission.
In broad terms, IFRS profits for long-term business contracts reflect the aggregate of statutory transfers from with-profits funds and profits on a traditional accounting basis for other long-term business. Although the statutory transfers from with-profits funds are closely aligned with cash flow generation, the pattern of IFRS profits over time from shareholder-backed long-term businesses will generally differ from the cash flow pattern. Over the life of a contract, however, aggregate IFRS profits will be the same as aggregate cash flow.
Life insurance products are long-term by their nature, and the profit on them is generated over several years. In Prudential’s opinion, accounting under IFRS alone does not fully reflect the inherent value of these future profit streams.
The preliminary announcement for the year ended 31 December 2008 does not constitute statutory accounts as defined in section 240 of the Companies Act 1985. The results on an IFRS basis for the full year 2008 and 2007 have been audited by KPMG Audit Plc. The auditor has reported on the 2008 and 2007 financial statements and the report was unqualified and did not contain a statement under section 237(2) or (3) of the Companies Act 1985. The Group’s 2007 Report and Accounts have been filed with the Registrar of Companies.
Net worth invested in new business (201) (24) (128) (353) (173) (17) (46) (236) Value of in-force created by new business 751 214 325 1,290 646 202 246 1,094
Post tax new business profit for the period 550 190 197 937 473 185 200 858
*In 2007, the UK IRR excluding the Equitable Life deal was 14%.
To maximise this advantage, we have embedded a risk and capital management framework and culture that drives the rigorous risk and capital management and optimisation of risk adjusted returns across the Group.
Risk oversight Group risk appetite We define and monitor aggregate risk limits for our earnings volatility and our capital requirements: a Earnings volatility: the objectives of the limits are to ensure that (a) the volatility of our earnings is consistent with our stakeholders’ expectations, (b) the Group has adequate earnings (and cash flows) to service debt, expected dividends and to withstand unexpected shocks, and (c) earnings (and cash flows) are managed properly across geographies and are consistent with our funding strategies. The two measures we apply to monitor the volatility of our earnings are European Embedded Value (EEV) operating profit and International Financial Reporting Standards (IFRS) operating profit.
b Capital requirements: the limits aim to ensure that (a) the Group meets its solvency capital requirements at all times, (b) the Group achieves its desired target rating to meet its business objectives, and (c) supervisory intervention is avoided. The two measures we apply are the EU Insurance Groups Directive (IGD) capital requirements and economic capital requirements.
Local limits are agreed with each of our business units to ensure that the aggregate risk exposure remains within the defined Group-level risk appetite. Each business unit determines its own individual risk position by calculating the impacts (on earnings and capital measures) of a shock to its market, credit, insurance and operational risk exposures and agrees them with Group Risk and the Group Asset and Liability Committee (ALCO).
Secondly, the impact on the risk position is considered as part of Group Risk’s scrutiny of large transactions or departures from plan proposed by individual business units.
The continuing market dislocation and the increased risk of default has increased emphasis on the management of market and credit risk in the course of 2008. Market risk is managed such that as conditions evolve the risk profile is maintained within risk appetite, and in addition to business unit operational limits on credit risk, we set counterparty risk limits at Group level. Limits on our total Group-wide exposures to a single counterparty are specified within different credit rating ‘categories’. Group Risk and the Group ALCO monitor our actual exposures against these limits on a monthly basis.
It is our philosophy not to compete on price. Our individual guarantees tend to be more expensive than the market average, because we seek to sell at a price where we can hedge or reinsure our risks.
We do not actively market GMIB, and where it is selected we reinsure. We use reinsurance to cover both the in-force book and new business for the life of the policy. If reinsurance were not available, we would not sell GMIB options.
Financial risks Market risk The risk that arises from adverse changes in the value of, or income from, assets and changes in interest rates or exchange rates
Strategic risk Ineffective, inefficient or inadequate senior management processes for the development and implementation of business strategy in relation to the business environment and the Group’s capabilities
A combination of Jackson’s sales approach, disciplined pricing and dynamic hedging of its variable annuity guarantees meant that Jackson’s equity hedging gains offset the effect of the 38.5 per cent drop experienced in US equity markets in 2008 on a statutory capital basis. This outcome compared favourably to the industry as a whole. Indeed, Jackson was one of only a handful of US life insurance companies to achieve this level of success with its variable annuity hedging programme in 2008.
Interest rate risk Interest rate risk arises primarily from Prudential’s investments in long-term debt and fixed income securities. Interest rate risk also exists in policies that carry investment guarantees on early surrender or at maturity, where claim values can become higher than the value of backing assets as a result of rises or falls in interest rates.
Of this total, £59 billion was in the UK insurance operations, of which £38 billion was within the UK with-profits fund. The fund also includes a large inherited estate – estimated at £5.4 billion. Outside the with-profits fund, £4 billion was held in unit-linked funds where the shareholder risk is limited, and there was £17 billion backing the shareholder annuity business and other non-linked business, of which £13 billion related to corporate bonds and £4 billion was in government securities, or equivalent.
Within the UK shareholder annuity funds, we have built up a significant credit reserve of £1.4 billion to allow for future defaults on a statutory basis. This reserve can withstand the equivalent of the average default experience during the Great Depression occurring every year over the life of the portfolio.
In 2008, we have experienced credit defaults for UK operations of £93 million that relate to shareholder funds (0.5 per cent of the portfolio).
Asia’s debt portfolio totalled £11 billion at 31 December 2008. Of this, approximately 64 per cent was invested in Unit-Linked and with-profits funds with minimal shareholder risk. The remaining 36 per cent is shareholder exposure and is invested predominantly (85 per cent) in government bonds. For Asia, the portfolio has performed very well, with 2008 defaults totalling only £20 million.
The US Corporate Debt portfolio of £16 billion is 92 per cent investment grade. Concentration risk is low, with the top 10 holdings accounting for only five per cent of the portfolio. The high-yield portfolio is also well diversified with an average holding of £8 million. Our single largest sector exposure in the investment grade portfolio is Utilities at 13 per cent. We actively manage the portfolio and will sell exposure as events dictate; for example, we reduced our holding in both Lehman and Washington Mutual early in 2008.
The CMBS £2 billion portfolio is performing strongly, with 85 per cent of the portfolio being AAA and only one per cent below investment grade. We materially reduced our non-AAA purchases after 2004 in response to the significant deterioration in underwriting standards observed in the market and in line with rating agencies’ guidelines. The entire portfolio has an average credit enhancement level of 30 per cent. This provides significant protection, since it means the bond has to incur a 30 per cent loss, net of recoveries, before we are at risk.
In 2008, Jackson’s total defaults were £78 million of which £5 million were incurred in the fourth quarter. As part of our active management of the book we incurred net losses of £127 million on the sale of impaired bonds, of which £67 million was incurred in the fourth quarter of 2008.
IFRS write-downs excluding defaults for the year were £419 million, an increase of £228 million in the fourth quarter of 2008.
The impairment process reflects a rigorous review of every single bond and security in our portfolio. We believe that the accounting rules for impairments are necessarily conservative and not always consistent with economic losses. So, while the accounting requires us to book them as losses through our income statement, we would expect only a proportion of these impairments eventually to turn into defaults, and some of the impaired securities to recover in price over time.
In considering potential future losses for Jackson, it is essential to examine the key components of the debt portfolio. As at 31 December 2008, 93 per cent of Jackson’s total debt portfolio of £24 billion consisted of investment grade securities and seven per cent were high yield. To put potential future losses in context, global annual default rates over the past 50 years have averaged 0.5 per cent for investment grade and 10 per cent for high yield. Historically, the highest global annual default rates during a recession have averaged 1.6 per cent for investment grade and 15.4 per cent for high yield, although not necessarily in the same year (Source: Moody’s Global Corporate Finance – February 2008).
Unrealised credit losses Jackson’s gross unrealised losses moved from £439 million at 31 December 2007 to £3,178 million at 31 December 2008.
This change was largely due to a market-wide re-pricing of risk and not to specific problems within Jackson’s portfolio. The entire market for fixed income securities has been re-priced downwards from historically tight spreads of approximately 100 bps during the first half of 2007 to historically wide spreads of over 640 bps on investment grade paper at the end of 2008.
Insurance risk The processes of determining the price of our products and reporting the results of our long-term business operations require us to make a number of assumptions. In common with other industry players, the profitability of our businesses depends on a mix of factors including mortality and morbidity trends, persistency, investment performance, unit cost of administration and new business acquisition expenses.
For example, the assumption that we make about expected levels of mortality is particularly relevant for our UK annuity business, where in exchange for their accumulated pension fund pension annuity policyholders receive a lifetime guaranteed payment. We conduct rigorous research into longevity risk using data from our substantial annuitant portfolio. As part of its pension annuity pricing and reserving policy, Prudential UK assumes that current rates of mortality continuously improve over time, at levels based on adjusted data from the Continuous Mortality Investigations (CMI) projections published by the Institute and Faculty of Actuaries.
Non-financial risk Prudential is exposed to operational, business environment and strategic risk in the course of running its businesses. We process a large number of complex transactions across numerous and diverse products, and are subject to a number of different legal and regulatory regimes. We also have a significant number of third-party relationships that are important to the distribution and processing of our products, both as market counterparties and as business partners. More detail on the risk factors that may affect Prudential’s operating results and financial condition, and accordingly the trading price of our shares, is provided under Additional Information on pages 360 to 363.
We use quantitative analysis of operational risk exposures material to the Group to inform our decisions on the overall amount of capital held and the adequacy of the corporate insurance programme.
The IGD capital adequacy requirements involves aggregating surplus capital held in our regulated subsidiaries, from which Group borrowings, except those subordinated debt issues that qualify as capital, are deducted. No credit for the benefit of diversification is allowed for under this approach. The IGD test is passed when this aggregate number is positive. A negative result at any point in time is a notifiable breach of UK regulatory requirements.
The £0.3 billion additional IGD capital reflects our ability to realise a portion of the shareholders’ economic interest in the future transfers from the UK with-profits fund, which in total was worth £1.7 billion at 31 December 2008. Going forward, we have the opportunity to develop similar transactions, enabling us to access more of the residual £1.4 billion if we decide to do so.
In addition to this strong capital position, the total credit reserve for the UK shareholder annuity funds was £1.4 billion at the end of the year. We have increased this credit reserve by £0.8 billion in 2008 and it is equivalent to 80bps per annum over the lifetime of the assets. This reserve would allow us to withstand a repeat of the average Moody’s default experience during the Great Depression, occurring every year throughout the life of the book.
These factors, together with our Group’s strong underlying earnings capacity, our established hedging programmes and our additional areas of financial flexibility, position us to withstand possible significant further deterioration in market conditions (see also Stress testing).
A key aspect of Solvency II is that the focus on risks and capital requirements will be aligned more closely with economic capital methodologies. Solvency II will encourage companies to improve their risk management processes and may allow companies to make use of internal economic capital models if approved by the local Regulator.
Our capital performance metrics are based on economic capital, which provides a view of our capital requirements across the Group, allowing for realistic diversification benefits. Economic capital also provides valuable insights into our risk profile and is used both for risk measurement and capital management.
Stress testing We use regular stress testing and sensitivity analysis to monitor the robustness of the Group’s regulatory and economic capital position.
We also test the impact of a range of ‘shock’ scenarios on the Group’s regulatory and economic capital. The scenarios for this testing are selected using both in-house views and external assessments such as the FSA’s annual Financial Risk Outlook. The purpose is to assess the resilience of the Group’s capital position to a range of key threat scenarios.
Following the implementation of the IGD, raising our long-term debt in hybrid form benefits us from a regulatory capital standpoint. We intend to do this by taking advantage of favourable market conditions as they arise.
The balance sheet includes unallocated surplus for the PAC with-profits fund that has yet to be allocated either to policyholders or shareholders. These assets are not generally available to the Group, other than as they emerge through the statutory transfer of the shareholders’ share of the surplus as declared from the fund over time. The EEV shareholders’ equity reflects the value of future shareholder cash flows from in-force business. In determining these cash flows, the shareholders’ interest is derived by increasing final bonus rates so as to exhaust the surplus over the lifetime of the in-force with-profits business, other than in extreme scenarios where the excess cost of meeting policyholder claims is fully attributed to shareholders.
We manage our Group’s core debt within a target level consistent with our current debt ratings. At 31 December 2008, the gearing ratio (debt, net of cash and short-term investments, as a proportion of EEV shareholders’ funds plus debt) was 10.7 per cent, compared with 6.6 per cent at 31 December 2007.
Prudential plc has strong debt ratings from Standard & Poor’s, Moody’s and Fitch. Prudential’s long-term senior debt is rated A+ (stable outlook), A2 (stable outlook) and AA- (stable outlook) from Standard & Poor’s, Moody’s and Fitch, while short-term ratings are A-1, P-1 and F1+.
Jackson’s financial strength is rated AA (stable outlook) by Standard & Poor’s and A1 (stable outlook) by Moody’s.
Risk mitigation and hedging We manage our actual risk profile against our tolerance of risk. To do this, we maintain risk registers that include details of the risks we have identified and of the controls and mitigating actions we employ in managing them. Any mitigation strategies involving large transactions – such as a material derivative transaction – are subject to scrutiny at Group level before implementation.
We use a range of risk management and mitigation strategies. The most important of these include: adjusting asset portfolios to reduce investment risks (such as duration mismatches or overweight counterparty exposures); using derivatives to hedge market risks; implementing reinsurance programmes to limit insurance risk; implementing corporate insurance programmes to limit the impact of operational risks; and revising business plans where appropriate.
We have contingency plans in place for a range of operational risk scenarios, including incident management and business continuity plans. As a contingency plan for liquidity risk, the Group has arranged access to committed revolving credit facilities and committed securities lending facilities.
Our current strategy in Asia is to leverage our platform to generate further shareholder value by continuing to increase the scale of our operations. This is reflected in the following strategic commitments: further increasing agency scale and productivity, continuing to build distribution through partnerships, sharpening the focus on health and protection products, developing segmented retirement solutions and strengthening customer relationships.
Although externally the highest profile measure of success is new business volumes and how this translates into market share, Prudential’s internal focus is on EEV NBP. Our business in Asia maintains strict financial disciplines to ensure that there is always a strong correlation between business volumes and the value generated, as reflected in the shareholders’
Initiatives in 2008 Agency During the year, Prudential increased its average number of agents in the Asia region by 21 per cent to 425,000, with the largest increases in Indonesia (up 43 per cent to 57,000) and India (up 21 per cent to 287,000). With the exception of Thailand, all of our Asian operations expanded their agency forces during 2008.
However, for us as an EU domiciled group we are subject to the requirements of the IGD in measuring solvency. For IGD purposes the liability on the back book is crystallised at around £800 million, with the potential to increase significantly under the proposed Solvency II valuation rules. In reviewing the allocation of capital across the Group, we saw an opportunity to materially improve our capital position by releasing the economic capital supporting the agency distribution business. Therefore on 20 February 2009, we announced that we had agreed to transfer the assets and liabilities of the agency distribution business in Taiwan, including the capital consuming back book, to China Life Insurance Ltd (Taiwan) subject to regulatory approval. The transfer will include all policies previously issued by agency, the agency contracts and the agency related support operations. Upon completion there will be a one-off negative IFRS impact of approximately £595 million after restructuring costs. Free surplus for Life and asset management business at 31 December 2008 including Taiwan was £859 million and £1.8 billion excluding it.
We will continue to be an active and committed player in the Taiwanese life insurance market through our successful bancassurance, direct marketing and other non-agency distribution channels. Bank and direct sales accounted for 29 per cent of our new business in Taiwan in 2008.
During 2008 and in early 2009 we expanded and extended our successful bank distribution agreement with Standard Chartered Bank (SCB). We now work with SCB in nine markets1 and are currently exploring further opportunities for protection and Takaful products. SCB Taiwan had a particularly impressive fourth quarter, and Prudential’s overall new business from SCB in Asia increased by 35 per cent during 2008.
Critical factors in our success in health and protection, include integrating the product initiatives with the distribution channels, and tailoring sales support activities to the agency, bank and direct channels. For example, health products have been incorporated into agency incentive programmes, and a standalone health care product was launched into the SCB channel with simplified underwriting and compelling media campaigns to capture direct business and provide leads for other channels.
During 2008 new business APE was up 34 per cent, reflecting these products’ particular suitability to challenging economic conditions, with their emphasis on protection rather than savings and their lower average premiums. The results from India (up 259 per cent) and Malaysia (up 49 per cent) were particularly encouraging.
Retirement Like the West, Asia has rapidly ageing populations and a growing need for financial advice and products to help people save for retirement, secure an income during retirement and protect their financial well being throughout life.
Although market conditions have not been conducive to major new initiatives in the retirement space during 2008, Prudential continues to develop and launch new retirement orientated products. For example, in Korea and Malaysia we launched variable annuity products that provide a guaranteed minimum income on retirement.
Financial performance In 2008, Prudential delivered new business APE of £1,362 million in Asia, representing growth averaging six per cent over 2007. Although some official market statistics are not yet available, Prudential estimates that it is the leading foreign company or joint venture in seven of its 12 life markets. Prudential grew market share in six of our 12 countries during 2008.
The industry in Korea saw a shift away from variable unitlinked products, and towards risk-based and interest-sensitive products. PCA Life Korea, however, remained diligently focused on value not volume. In Taiwan, Prudential had a very successful retirement campaign launch in May and June 2007 that was not repeated in 2008. However, there was encouraging momentum, particularly in the bank distribution channel in the final quarter with sales up 83 per cent over the third quarter of 2008. In Singapore regular premium sales were resilient and remained at the same level as 2007, but total APE was depressed by lower single premium sales, following changes to the Central Provident Fund rules.
Total new business profits increased by 15 per cent as the average profit margin increased from 50 per cent to 54 per cent. This profit enhancement was mainly due to changes in product mix, country mix and economic assumptions. Of the six markets we disclose separately, five (China, Hong Kong, India, Indonesia and Taiwan) reported increases in new business profit margins compared with 2007.
The IFRS operating profit for long-term business increased from £189 million in 2007 to £321 million in 2008. In Indonesia the results increased from £35 million to £55 million whilst in the established operations (Singapore, Hong Kong and Malaysia) the growth was more muted, growing from £153 million to £162 million.
Korea 14th 1 Weighted by country mix excluding Japan. 2 Foreign Companies only.
The US remains the largest retirement market in the world. Innovation in product design and speed to market continue to be key drivers of Jackson’s competitive advantage – demonstrated by its ability to anticipate, and respond quickly, to the increased demand for fixed annuities as customers became more risk averse in response to market turmoil. B
The United States is the world’s largest retirement savings market, and is continuing to grow rapidly. As 78 million baby boomers1 reach retirement age, their retirement assets will shift from asset accumulation to income distribution. There are already $2 trillion of assets generating retirement income in the US – and this amount is forecast to rise to some $7.3 trillion by 2029.2
During 2008, the US financial services industry faced an unprecedented array of challenges: the S&P 500 index fell by 38.5 per cent (compared to a 3.5 per cent increase in 2007); governmental interest rates fell to historic lows; and global markets experienced a significant increase in volatility, particularly during the last four months of the year. In addition, credit markets seized and global credit spreads widened to historic levels. As a result of these conditions, many financial service businesses sought to raise new capital in order to maintain their solvency.
These factors caused uncertainty in the market, as consumers and producers tried to anticipate future equity movements and questioned the financial stability of product providers. At the same time, however, increasing credit spreads and falling equity markets created favourable market conditions for the sale of fixed annuities. These developments provided a competitive advantage to companies able to participate in both the variable and fixed annuity spaces.
Notes 1 Source: US Census Bureau 2 Source: Tiburons Strategic Advisers, LLC
Innovation Innovation in product design and speed to market continue to be key drivers of Jackson’s competitiveness in the variable annuity market. High-quality and cost-effective technology has allowed Jackson to offer a comprehensive product portfolio that can be customised to meet the needs of individual customers. We offer products on an unbundled basis, enabling customers to select those benefits that meet their unique financial requirements and to pay only for those benefits they truly desire. In our view, leveraging this advantage is a more sustainable long-term strategy than competing on price – Jackson will not sacrifice product economics for a short-term increase in market share.
In 2008, Jackson maintained its track record of continued product innovation by enhancing our variable annuity offering with the addition of three new guaranteed minimum withdrawal benefits (GMWB) and eight new portfolio investment options. We also introduced two fixed annuity products designed specifically for the bank channel, and a fixed index annuity that offers a choice between two market indexes and two contract lengths.
In 2008, the FRC Adviser Insight Series on Marketing Effectiveness found that Jackson was rated as number one in ‘Sales Support Satisfaction’, and was the only VA provider rated in the top 10 for ‘Overall Satisfaction’ among advisers.
*Based on longer-term investment returns excludes broker-dealer, fund management and Curian.
Variable annuity APE sales of £349 million in 2008 were down 23 per cent from 2007, reflecting continued volatility in US equity markets and intense price competition. Throughout the year, we maintained our disciplined approach to the pricing of our variable annuities. In the first three quarters of 2008, we ranked fourth in variable annuity net flows in the US, and experienced a very low level of outflows as a proportion of inflows compared to the rest of the industry. During the fourth quarter, Jackson’s quarterly VA sales declined by six per cent from the third quarter (at CER) due to the severe equity market disruption, compared to an industry decline of 12 per cent.3
Fixed index annuity (FIA) APE sales of £50 million in 2008 were up 11 per cent over 2007. In late 2007, we introduced a new FIA product for the independent broker-dealer channel and, in April 2008, launched a new FIA for the bank channel. Our new FIA products have been very well received by advisers and helped drive the year-on-year increase in FIA sales.
Our retail annuity net flows increased by six per cent, reflecting continued low levels of surrender activity.
The fixed annuity new business margin increased from 28 per cent to 37 per cent, primarily as a result of a decrease in the risk discount rate, partially offset by our refinement of assumptions about policyholder behaviour.
The new business margin on institutional business declined from 58 per cent in 2007 to 26 per cent in 2008, due to the combined effects of shorter average maturity and a lower discount rate.
Total EEV basis operating profit for the long-term business in 2008 was £586 million, compared to £627 million in 2007. In-force EEV profits of £293 million were 14 per cent below the 2007 profit of £342 million. Experience variances were £40 million lower in 2008 at AER, due primarily to a smaller spread variance.
At 31 December 2008, Jackson had more than £52 billion in US GAAP assets, including £15 billion in separate account assets. Through the first eight months of 2008, our separate account assets were an average of £112 million higher than during the same period of 2007, reflecting continued sales and limited fund value losses. As a result, our earnings from fee-based products increased during 2008.
‘Prudential UK has a unique combination of competitive advantages including its longevity experience, multi-asset investment capabilities, brand and financial strength. These put us in a strong position to pursue a value driven strategy.’
Prudential UK has a unique combination of competitive advantages including its longevity experience, multi-asset investment capabilities, brand and financial strength. These put us in a strong position to pursue a value driven strategy that generates attractive returns across our Retail and Wholesale businesses.
Prudential UK’s with-profits business performed particularly strongly during 2008. With-profits, when invested in an actively managed, and financially strong fund like Prudential’s, continues to be an attractive medium to long-term investment, offering annualised returns which compare favourably with other investment options. Our UK with-profits fund has delivered investment returns of 67.2 per cent over 10 years compared with the FTSE All-share index (total return) of 12.4 per cent over the same period.
Within corporate pensions, we will continue to look for growth from our existing DC schemes, refresh our contract-based DC proposition, and build our presence through new scheme wins.
In the key area of with-profits annuities, we can bring our core manufacturing strengths to bear while also capitalising on people’s need for protection from inflation through increasingly long periods of retirement. We have been operating in the UK with-profits annuity market since 1991 and are now the market leader with a market share of over 85 per cent.
In the second half of 2008, Prudential UK introduced lifestyle rating using postcodes for pricing non-profit individual annuities. The introduction of lifestyle pricing allows us to price in a manner more reflective of risks associated with the business we are writing.
Given the UK’s compulsory annuitisation age of 75, an increasingly sophisticated consumer population, and the rising incidence of second careers and semi-retirement as a result of increasing longevity, the market has seen good growth in the ‘bridge’ between pensions and annuities through income drawdown products. We launched our new income drawdown product in late 2007 and achieved sales of £8 million APE in 2008 compared to £3 million in the previous year. This product helps customers manage their pension through the various stages of retirement, and also offers flexibility while providing potential for capital growth.
Building share of the equity release market Prudential UK entered the equity release market three years ago, and grew its share of this market to 23 per cent by the end of 2008. Investing in property has been an increasingly important component for many people saving for their retirement. With around £700 billion owned by pensioners in property in the UK, pensioners can consider options such as equity release to help deliver an adequate income in retirement. This is likely to become increasingly important as people live longer and the cost of living continues to rise. In an environment of falling house prices and the associated risk of negative equity, we reduced our maximum loan-to-value ratio, which impacted sales in the latter part of 2008. We will continue to maintain a disciplined approach to lending in this market.
The sales growth across Prudential UK’s with-profits range has been achieved on the back of sustained strong investment performance in its Life Fund over a number of years, reflecting the benefits of its diversified investment policy. We believe this market will continue to see further growth as investors turn to trusted and financially strong brands and products offering an element of capital protection.
Maintaining strict focus on value in the bulk annuity and back-book markets Prudential UK maintained its strict focus on value in the bulk annuity and back-book markets in 2008, completing transactions totalling APE £142 million. These included the bulk annuity buy-in agreements with Goldman Sachs for the reinsurance of APE £30 million of Rothesay Life’s non-profit annuity business and with the Trustee of the Cable & Wireless Superannuation Fund for the reinsurance of APE £106 million of liabilities relating to the scheme’s pensioners in payment.
The latter represented the largest ever bulk annuity buy-in deal in the UK and the biggest bulk annuity deal to be announced in 2008, demonstrating our ability to complete complex and innovative transactions.
In the Wholesale market, we are maintaining a strict focus on value and will only participate in transactions that meet our return on capital requirements.
Cost management Prudential UK has continued to make good progress against its cost reduction plans. As announced in Prudential’s 2007 full-year results, the first phase of our UK cost reduction programme delivered savings of £115 million per annum. The agreement with Capita, which commenced in April 2008, will ultimately deliver a further £60 million per annum of savings and will enable our UK business to achieve its total cost savings target of £195 million by the end of 2010.
The Capita contract also provides a significant reduction in long-term expense risk, by providing Prudential UK with certainty on per-policy costs as the number of policies in the mature life and pensions book decreases over the coming years.
Over time, the Capita contract will result in the migration of approximately seven million in-force policies from a number of Prudential legacy IT systems to two Capita proprietary platforms, significantly enhancing operational performance.
Financial performance In an environment of unprecedented volatility in capital and equity markets, a declining housing market and general economic uncertainty, Prudential UK performed strongly in 2008.
There was a slight decrease in EEV new business profits to £273 million in 2008 from £277 million in 2007, reflecting a decline in new business margin to 29 per cent from 30 per cent. The lower new business margin largely reflects allowances for higher credit risk on individual annuity business, and a lower level of wholesale bulk annuity and insurer back book sales in 2008. New business profits relating to the Retail business increased slightly to £226 million from £223 million.
In 2002 Prudential UK transferred its general insurance business to Churchill. We receive a commission payment for Prudential-branded general insurance products, and in 2008 this arrangement resulted in a net payment to Prudential of £44 million.
Prudential UK writes with-profits annuity, with-profits bond and with-profits corporate pensions business in its life fund, with other products backed by shareholder capital. The weighted average post-tax IRR on the shareholder capital allocated to new business growth in the UK was 14 per cent.
M&G remains at the forefront of investment thinking – constantly seeking out new ways of managing its funds and developing its product range to realise the best investment opportunities over the long term.
M&G’s institutional strategy centres on leveraging capabilities developed primarily for internal funds into higher margin external business opportunities. In recent years this has allowed us to operate at the forefront of a number of specialist fixed income strategies, including leveraged finance and infrastructure investment. The recent chaos in capital markets has resulted in a renewed focus on more traditional credit and equity mandates, again drawing on our core research and investment expertise.
Prudential’s various asset management businesses operate using different models and under different brands, all tailored to their particular markets and unique strengths. However, they continue to work together by managing money for each other with clear regional specialisation, distributing each others’ products, and sharing vital knowledge and expertise in areas such as credit research.
Initiatives in 2008 The global financial crisis has had a negative impact on asset values across classes and geographies. At M&G, this has a direct impact on our FUM as well as important consequences for new business sales and existing client persistency. In this challenging environment investment performance is more critical than ever, further illustrating the value of our core strategy.
In the three years to December 2008, 35 per cent of M&G’s retail funds delivered top-quartile investment performance1.
In Europe, the asset management industry has seen net outflows of ¤334 billion2 in 2008, while the IMA reported £2.1 billion of net outflows from UK asset managers across Retail and Institutional funds3.
Against this background M&G performed extremely well in 2008, with record gross inflows from external customers of £16.2 billion, up from £14.7 billion in 2007. Higher redemption rates resulted in somewhat lower net inflows of £3.4 billion, compared to £4.9 billion in 2007 and £6.1 billion in 2006, which was M&G’s record year to date.
Our strategy of maximising diversity across the business proved its worth in 2008, as demonstrated by increased net inflows to retail bond funds of £1.4 billion, up from £0.2 billion in 2007. These helped to offset a decline in equity fund net inflows, which fell to £0.7 billion, down from £1.7 billion in 2007.
A key cost management initiative in 2008 was the outsourcing of M&G Retail’s direct customer servicing. As well as generating immediate annual savings of around £3 million, this will allow us to move from a fixed to a variable cost base for this channel.
Financial performance In the face of a very challenging economic environment, M&G recorded record profits in 2008, with an operating result of £228 million, up from £203 million in 2007. This means our profit has grown by 21 per cent compounded annually since 2004. Our underlying profit growth, which excludes volatile
performance related fees (PRFs) and carried interest earned on private equity investments, has grown by 23 per cent compounded annually over the same period to reach £185 million in 2008, up from £175 million in 2007.
In 2008 M&G benefited from – and continued to promote – greater diversity in terms of profit-generating activities and the chart illustrates how our profitability is well spread across internal, retail and institutional markets.
We achieved net investment inflows for the year in both the retail (£2.1 billion, down from £2.7 billion in 2007) and institutional (£1.3 billion, down from £2.2 billion in 2007) markets, while our overall external FUM was negatively impacted by falls in the value of underlying assets.
M&G’s total FUM at the end of 2008 was £141 billion, down 15 per cent from the start of the year.
Our cost/income ratio was 60 per cent in 2008, down from 66 per cent in 2007, having improved from 75 per cent in 2004.
M&G continues to provide capital efficient profits and cash generation for the Prudential Group, as well as strong investment returns on our long-term business funds. Return on capital of 91 per cent and cash remittances of £106 million in 2008 provided strong support for the Group’s corporate objectives.
The business has continued to grow in terms of investment, infrastructure and personnel in a controlled way, while maintaining the dynamism and flexibility necessary to identify and realise opportunities for profit. Prudential Capital is committed to working more closely with other business units across the Group to exploit opportunities and improve value creation for Prudential as a whole. At Prudential Capital, we are also taking a more holistic view on hedging strategy, liquidity and capital management for the Group.
In addition to retail funds, Prudential’s Asian asset management business manages funds for Prudential’s Asian and UK Life businesses. It further supports the Asian Life Business with the design of funds for investment linked products. Prudential is also growing its third-party institutional and pension fund management business.
Initiatives in 2008 In Taiwan, PCA Securities Investment Trust successfully introduced the PCA Green Solution Fund, the third-largest IPO launched in the country. On the institutional client front, we secured a domestic equity mandate from Taiwan’s New Labour Pension Fund, for £63 million (TWD 3 billion) of assets. Similarly, in China, the Triple Benefit Bond Fund and Blue Chip Equity Fund launched in 2008 by CITIC-Prudential Fund Management Company Limited raised over £253 million despite the bearish market conditions. In Korea, the focus on providing innovative variable annuities, variable unit linked and corporate pension products to third-party insurance institutions succeeded in building a more persistent customer base. The Japanese business is now the largest India funds provider in Japan, following the successful launch of the fourth India-themed fund (India Consumer Fund). Additionally, the Employees Provident Fund Organisation in India approved ICICI-Prudential Fund Management as one of the three private sector asset management companies to manage incremental flows into its fund.
Prudential continues to explore opportunities in Islamic funds, and in the UAE it signed a Memorandum of Understanding to expand marketing co-operation and distribution of Shariah funds in Malaysia and the Middle East. Prudential’s property fund management business PRUPIM, delivered solid performance that included raising £97 million for a new Vietnam Property Fund launched in 2008.
The asset management business requires very little capital to support its growth, and in 2008 it remitted a net £36 million to the Group.
Year end 2008 funds under management of £46 billion were as follows: PPMA Funds under management £bn Asia US UK Total
National Planning Holdings (NPH) is Jackson’s affiliated independent broker-dealer network. The business is comprised of four broker-dealer firms, including INVEST Financial Corporation, Investment Centers of America, National Planning Corporation, and SII Investments.
Financial performance NPH generated record revenues of £328 million during the year, up from £300 million in 2007, on gross 2008 product sales of £8 billion. Our network continues to experience profitable results, with 2008 IFRS operating profit of £8 million, an 11 per cent decrease at AER from £9 million in 2007. We also increased the number of registered advisers in our network to approximately 3,165 at the end of 2008.
Financial performance Curian’s results during 2008 improved, despite the significant impact of falling equity markets on its assets under management. Our effective management of costs and an eight per cent increase in average assets under management contributed to this result. At the end of 2008, we had total assets under management of £1.8 billion, compared to £1.7 billion at the end of 2007 (£2.4 billion at CER). We generated deposits of £591 million in 2008, down 11 per cent on 2007. The decline in both deposits and assets under management at CER were mainly due to difficult conditions in the equity markets, with the S&P 500 index falling 38.5 per cent during 2008.
Financial instruments Our Group is exposed to financial risk through our financial assets, financial liabilities, and policyholder liabilities.The key financial risk factors that affect us include market risk, credit risk and liquidity risk. Information on our Group’s exposure to financial risk factors, and our financial risk management objectives and policies, is provided both in the Risk and Capital Management section of this Business Review and in Section C of the financial statements on pages 177 to 180.
Further information on the sensitivity of our Group’s financial instruments to market risk and our use of derivatives is also provided in notes D1 to D4 and G2 and G3 of the financial statements, which are on pages 181 to 230 and pages 256 to 261 respectively.
Treasury policy The Group operates a central treasury function, which has overall responsibility for managing our capital funding programme as well as our central cash and liquidity positions.
It is Prudential’s policy that derivatives are only used to hedge exposures or facilitate efficient portfolio management.
Due to the geographical diversity of our businesses, we are subject to the risk of exchange rate fluctuations. Our international operations in the US and Asia generally write policies and invest in assets denominated in local currency.
Unallocated surplus of with-profits During 2008, the unallocated surplus, which represents the excess of assets over policyholder liabilities for the Group’s with-profits funds on a statutory basis, decreased from £14.0 billion at 1 January to £8.4 billion at 31 December.
Inherited estate of Prudential Assurance The assets of the with-profits sub-fund (WPSF) within the long-term fund of The Prudential Assurance Company Limited (PAC) are comprised of the amounts that it expects to pay out to meet its obligations to existing policyholders and an additional amount used as working capital. The amount payable over time to policyholders from the WPSF is equal to the policyholders’ accumulated asset shares plus any additional payments that may be required by way of smoothing or to meet guarantees. The balance of the assets of the WPSF is called the ‘inherited estate’ and has accumulated over many years from various sources.
Our overriding priority is to maintain the long-term financial security of the WPSF and to continue delivering strong performance for the benefit of its policyholders.
Defined benefit schemes in the UK are generally required to be subject to full actuarial valuation every three years to assess the appropriate level of funding for schemes having regard to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. PSPS was last actuarially valued as at 5 April 2005 and this valuation demonstrated PSPS to be 94 per cent funded, with a shortfall of actuarially determined assets to liabilities of six per cent, representing a deficit of £243 million.
As a result, changes were made to the basis of funding for PSPS with effect from that date. Deficit funding amounts designed to eliminate the actuarial deficit over a 10-year period have been and are being made. Following these changes, total contributions to PSPS for deficit funding and employer’s contributions for ongoing service for current employees were expected to be of the order of £70-75 million per annum, subject to a reassessment when the subsequent valuation is completed.
In 2008, the Group adopted IFRIC 14, ‘IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’ (IFRIC 14). IFRIC 14 provides guidance on the recognition of IAS 19 surpluses in, and funding obligations for, defined benefit pension schemes. As a result of the adoption of IFRIC 14, in respect of the position at 31 December 2008, the Group has not recognised its interest in the underlying PSPS pension surplus of £615 million net of related tax relief, reflecting the difference between the market value of the scheme assets and the discounted value of the liabilities, which would have otherwise been recognised as an asset on its balance sheet under the previous policy. In addition, the Group has recognised a provision for deficit funding to 5 April 2010 of £55 million net of related tax relief in respect of PSPS. The underlying assets and liabilities of PSPS are unaffected by the adoption of IFRIC 14.
Unit-linked products combine savings with protection, with the cash value of the policy depending 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. Nonparticipating products offer savings with protection where the benefits are guaranteed or determined by a set of defined market-related parameters. Accident and health products provide mortality or morbidity benefits and include health, disablement, critical illness and accident cover. These products are commonly offered as supplements to main life policies, but can also be sold separately.
United States Jackson’s product offerings include variable, fixed and fixed index annuities, as well as life insurance, retail mutual funds and institutional products.
Fixed annuity policies are subject to early surrender charges for the first six to nine years of the contract. In addition, the contract may be subject to a market value adjustment at the time of surrender. During the surrender charge period, the contract holder may cancel the contract for the surrender value. Our profits on fixed annuities come primarily from the spread between the return we earn on investments and the interest credited to the contract holder’s account (net of any surrender charges or market value adjustment) less expenses. Our fixed annuities continue to be a profitable book of business, benefiting from favourable spread income in recent years. However, the continued low interest rate environment could have an impact on the fixed annuity portfolio as lower crediting rates could result in increased surrenders and lower sales as customers seek alternative investment opportunities. That said, if the recent equity market volatility has the effect of making customers more risk averse, they may view fixed annuities as an attractive alternative to variable annuities.
As the investment return on the separate account assets is attributed directly to the contract holders, Jackson’s profit arises from the fees charged on the contracts, less the expenses incurred, which include the costs of guarantees. In addition to being a profitable book of business in its own right, the variable annuity book also provides an opportunity to utilise the offsetting equity risk among various lines of business cost effectively to manage our equity exposure. We believe that the internal management of equity risk, coupled with the use of external derivative instruments where necessary, continues to provide a cost-effective method of managing equity exposure. Profits in the variable annuity book of business will continue to be subject to the impact of market movements both on sales and allocations to the variable accounts and the effects of the economic hedging programme.
With-profits policies are supported by a with-profits sub-fund and can be single premium (for example, Prudence Bond) or regular premium (for example, certain corporate pension products).
Our primary with-profits sub-fund is part of PAC’s long-term fund. The return to shareholders on virtually all our with-profits products is in the form of a statutory transfer to PAC shareholders’ funds. This is analogous to a dividend from PAC’s long-term fund, and is dependent upon the bonuses credited or declared on policies in that year. In this context, there are two types of bonuses – ‘annual’ and ‘final’. Annual bonuses are declared once a year, and are determined as a prudent proportion of the long-term expected future investment return on the underlying assets. Once credited, annual bonuses are guaranteed in accordance with the terms of the particular product. In contrast, ‘final’ bonuses are only guaranteed until the next bonus declaration, and are primarily determined on the actual smoothed investment return achieved over the life of the policy. Prudential’s with-profits policyholders currently receive 90 per cent of the distribution from the main with-profits sub-fund as bonus additions to their policies, while our shareholders receive 10 per cent as a statutory transfer.
The profits from almost all of our new non-participating business accrue solely to shareholders. Such business is written in the non-profit sub-fund within PAC’s long-term fund, or in various shareholder-owned direct or indirect subsidiaries. The most significant of these is Prudential Retirement Income Limited (PRIL), which also writes all new immediate annuities arising from vesting deferred annuity policies in the withprofits sub-fund of PAC.
• sufficient disclosure to enable informed investors to understand the key risks within the business and the basis of preparation of the results.
The EEV basis is a value-based method of reporting in that it reflects the change in value of the business over the accounting period. This value is called the shareholders’ funds on the EEV basis which, at a given point in time, is the value of future profits expected to arise from the current book of longterm insurance business plus the net worth of the company. In determining these expected profits, we make full allowance for the risks attached to their emergence and the associated cost of capital, and take into account recent experience in assessing likely future persistency, mortality and expenses.
Corporate Responsibility (CR) is a philosophy that is firmly embedded in Prudential’s business, and has become an integral part of how we think and behave.
Prudential’s main focus in 2008 was to ensure that our CR strategy continued to align with our business objectives and with our stakeholders’ concerns and interests.
Customer focus Prudential has over 11 million customers in Asia, nearly 2.8 million policies and contracts in force across the US through Jackson, over seven million customers in the UK through Prudential UK and around 0.5 million customers through M&G Investments.
Customers are at the heart of our business. Over 160 years on from our foundation, we remain committed to treating all of our customers fairly and believe that honesty, openness and transparency in all our dealings with customers are vital, both before and after they buy from us. We maintain effective relationships through regularly monitoring customers’ satisfaction levels and responding accordingly.
We never underestimate how important the customer is to us. We work hard to make sure we understand the individual needs of our customers around all of our markets.
A demonstration of this commitment to customers is Prudential Corporation Asia’s continued efforts to improve customer satisfaction. In 2008 we conducted a study on customer behaviour and perceptions of Prudential Corporation Asia across 11 markets, in particular assessing whether existing customers would be inclined to recommend its products and services to others, and areas where service could be improved. The study reaffirmed our focus on extensive agency training, as customers told us they attached a high priority to the provision of informed advice and guidance in assisting them with their financial objectives.
Jackson’s commitment to achieving continuous improvement in the service and experience that we offer customers was recognised in 2008 in a leading annual study of call centres. The Service Quality Management Group (SQMG) gave Jackson the 2008 award for highest customer satisfaction in the financial services industry in North America in its annual survey. SQMG carries out benchmarking surveys covering more than 250 of North America’s leading call centres in various industries. Jackson also achieved ‘World Class’ status in the survey – the fourth year out of five that we have received the highest possible designation. For World Class status to be awarded to a provider, at least 80 per cent of all its customers in the survey have to rate themselves as ‘very satisfied’ with their experience.
Building financial capability In 2008, the Group’s core financial education programme continued to focus on the need to play our part in enabling consumers to make the right decisions for their individual financial/savings needs. The decisions people face in this area range from debt management to saving for retirement. Informing and empowering consumers to make better decisions on key issues such as these will, we believe, build better and more permanent relationships between consumers and providers, as well as benefiting the wellbeing of both parties in the long term.
In the UK, we work through partnerships with a diverse range of organisations such as Citizens Advice, the Personal Finance Education Group (pfeg), the Specialist Schools and Academies Trust, and the National Institute of Adult Continuing Education. As a result of these collaborative initiatives, thousands of adults and children are now benefiting from learning how to make decisions that will have a profound effect on their financial wellbeing.
The charities that Prudential supports through The Chairman’s Award programme were selected following a Group-wide survey of employees. This identified our employees’ preference for projects that address the needs of children and the elderly within their local community. In line with this, we have identified sustainable projects which, where possible, have education at their core. This focus lies at the heart of our CR programme to raise levels of financial capability worldwide. In 2008, over 2,200 employees registered to engage in volunteering, and The Chairman’s Award programme supported over 50 projects around the world.
Similarly, Jackson has a strong tradition of giving back to the communities in which it operates. The Jackson National Community Fund was launched in 2007 and makes numerous grants to charities focused on children and the elderly.
Employee practices At Prudential, we do all we can to create an environment that enables us to attract and retain the right people – those who are committed and able to deliver top performance for our customers and shareholders. To achieve our aim of being a leading international retail financial services company, and to sustain the relative outperformance we achieved in our chosen markets in 2008, we need to have the right talent in the right places at the right time.
With this requirement in mind, our primary objective in Human Resources (HR) is to deliver the leaders and leadership the Prudential Group needs – and will continue to need – now and into the future. Our HR Strategy is to achieve this by focusing on five key challenges: • Getting the right people into the business; • building and rewarding performance; • growing a strong talent pipeline; • developing credible successors; and • developing an organisation that works.
We will now look at how we continued to tackle each of these challenges during 2008.
Our diversity programme has particular application to international operations in areas where the equal opportunities culture is less well embedded than in the UK. Our Business Units also continued to drive numerous diversity initiatives. For example, ICICI Prudential Life in India built on the successful launch of EGDE, its diversity initiative, with new policies on flexible working including part-time employment and additional maternity leave. In the UK, PRUPIM employees provided mentoring to students as part of the Ethnic Minority Undergraduate Scheme run by the National Mentoring Consortium (NMC). Also, in the US, Jackson participated in the Gateway Leadership Programme through the Money Management Institute.
Building and rewarding performance As part of our reward practices we believe it is important to enable employees to share in the success of the Group through share ownership. In the UK we operate two all employee share plans; a share investment plan and a ‘save as you earn’ (SAYE) scheme. Over 55 per cent of eligible employees in the UK participate in the SAYE scheme and nearly 30 per cent in the share investment plan. In Asia we operate two SAYE schemes similar to the UK scheme; one for employees and one for agents. Over 23 per cent of eligible employees and almost 10 per cent of eligible agents participate in these schemes.
In 2008 we continued to refine our reward policies to help us deliver a fair and transparent reward system to all our employees. We believe employees should be rewarded for the contribution they make to our business as a whole and we are committed to rewarding both the ‘what’ (results) and the ‘how’ (behaviour and competencies). As part of our reward practices, we regularly review and update our remuneration policies and procedures to ensure they are competitive against the market and support the growth of our businesses. We continued to do this in 2008.
To monitor our people’s level of engagement with Prudential as an employer, and identify areas for improvement, we conduct employee surveys in our businesses around the world. These show us how effectively our organisational elements are working, and help us take a ‘temperature-check’ of our culture to chart our progress towards embedding our four target behaviours – deliver, inspire, challenge and connect.
Reducing our environmental footprint Protecting the environment is essential to sustaining the quality of life of current and future generations. The challenge is to combine continuing economic growth with long-term sustainable development. Prudential is committed to ensuring that its policies and business actions promote the consideration of the environment.
Under the European Union Energy Performance of Buildings Directive, Energy Performance Certificates (EPCs) will be required for any building that is constructed, sold, or rented. EPCs will rate the energy performance of a building, enabling both property investors and prospective occupiers to consider energy efficiency ratings and levels of carbon emissions. We will be introducing EPCs, initially in the UK, for our commercial investment property portfolio and our occupied property portfolio. We will also implement the directive elsewhere in accordance with national regulations.
Sustainability is critical to our business model and we are in the process of formally integrating it into our investment process. PRUPIM was one of the first property companies to achieve the international environment management standard ISO14001 for its UK portfolio. In 2007, PRUPIM set up an innovative project called the Improver Portfolio to examine ways it can reduce a ‘typical’ property portfolio’s carbon footprint while maintaining or even enhancing investment returns. The Improver Portfolio consists of 25 PRUPIMmanaged properties covering all sectors.
In the US, Jackson has carefully monitored and worked to minimise any negative environmental impact since it moved to its current headquarters in 2000, working with state and local authorities on new projects which protect the environment. In 2008, all of Prudential’s North America operations – including Jackson, PPM America and PRUPIM’s investment properties – formally joined the US Climate Leaders programme, an Environmental Protection Agency (EPA) industry/government partnership that works with companies to develop comprehensive climate change strategies.
In Asia, we are currently in the process of grading our buildings using a clear and transparent environmental classification system. Where opportunities arise, we then intend to improve our overall environmental performance by migrating to properties in the highest category for environmental performance.
With this in mind, our policy is to work in partnership with our suppliers who operate with policies and procedures consistent with the standards set out in our Group Code of Business Conduct, and to help them reduce their impact on the environment. Procurement practices in Prudential UK have been successfully accredited with the Chartered Institute of Purchasing and Supply (CIPS) certification, an industry benchmark of recognised good practice.
Donations Prudential is committed to supporting the communities where it is an employer. In 2008, our Group spent £5.3 million in support of our various communities. Our direct donations to charitable organisations amounted to £3.5 million, of which approximately £1.9 million came from EU operations.
1 Giving consumers in each country where we operate the confidence and tools they need to protect and nurture their financial security through building their financial capability.
The approach we take to delivering against these priorities is closely aligned with our operating model. This means our CR activities are managed by our businesses, locally, since it is they who are closest to their customers and communities and therefore best positioned to deliver the most positive impact possible. Meanwhile, the Group sets the overarching strategy and governance, provides support tools and advice, manages external reporting and benchmarking, and drives Group-wide programmes such as The Chairman’s Award.
Further information can be accessed at www.prudential.co.uk/prudential-plc/cr/ Hard copies of the report are available from the Group’s CR team: Prudential plc, Laurence Pountney Hill, London EC4R 0HH.
Michael McLintock Executive director Michael McLintock has been an executive director of Prudential since September 2000. He is also Chief Executive of M&G, a position he held at the time of M&G's acquisition by Prudential in 1999. Michael joined M&G in 1992. He previously also served on the board of Close Brothers Group plc as a non-executive director (2001-2008). Since October 2008 he has been a Trustee of the Grosvenor Estate.
Barry Stowe Executive director Barry Stowe has been an executive director of Prudential since November 2006, and Chief Executive, Prudential Corporation Asia since October 2006. He has also been a director of the Life Insurance Marketing Research Association (LIMRA) and the Life Office Management Association (LOMA) since October 2008. Previously, Barry was President, Accident & Health Worldwide for AIG Life Companies. He joined AIG in 1995, and prior to that was President and CEO of Nisus, a subsidiary of Pan-American Life, from 1992-1995. Before joining Nisus, Barry spent 12 years at Willis Corroon in the US.
James Ross Senior Independent non-executive Director and member of the Remuneration and Nomination Committees James Ross has been an independent non-executive director since May 2004 and the Senior Independent Director since May 2006. He holds non-executive directorships with McGraw Hill in the United States and Schneider Electric in France. He is also Chairman of the Leadership Foundation for Higher Education and of the Liverpool School of Tropical Medicine. James was previously a non-executive director of Datacard Inc in the United States, and prior to that Chairman of National Grid plc and Littlewoods plc. He was also Chief Executive of Cable and Wireless plc and Chairman and Chief Executive of BP America Inc., and a Managing Director of the British Petroleum Company plc.
The Board has overall responsibility for the system of internal control and risk management and for reviewing its effectiveness. The framework setting out the Group’s approach to internal control, risk management and corporate responsibility comprises the following: • Group governance framework: Documents the Group’s internal control policies and processes in an online manual, including the Group’s risk framework, code of business conduct and detailed policies on certain operational and financial risks. Business units are also required to follow any additional processes necessary to comply with local statutory and regulatory requirements.
The Business Review provides further detail on Prudential’s risk appetite and exposures (pages 34 to 41) and corporate responsibility activities (pages 74 to 78).
The Board may appoint directors, up to a maximum total number of 20 as set out in the Company’s Articles of Association, and any director appointed by the Board will retire at the first Annual General Meeting following his or her appointment and offer himself or herself for election by shareholders. Accordingly, Harvey McGrath will retire and offer himself for election at the Annual General Meeting on 14 May 2009.
Under the current Articles of Association of the Company, all directors must retire as directors at least every three years, and accordingly Mark Tucker, Michael McLintock and Nick Prettejohn will retire and offer themselves for re-election at the Annual General Meeting on 14 May 2009.
Powers of directors The management and control of the business and affairs of the Company are vested in the Board. The Board may exercise all powers conferred on it by the Memorandum of Association, the Articles of Association, and the Companies Acts. This includes the powers of the Company to borrow money and to mortgage or charge any of its assets (subject to limitations in the Companies Acts and the Articles) and to give a guarantee, security or indemnity in respect of a debt or other obligation of the Company. The Board may exercise all powers and do everything within the powers of the Company, other than matters required by the Companies Acts to be dealt with in general meeting.
Board and committee meetings and attendance During 2008, the Board met 8 times and held a separate strategy meeting. A detailed forward agenda has been in operation for a number of years, which is continually updated to reflect not only scheduled regular items of business but also any topical matters that have arisen. Each year, at least one of the Board meetings is held at one of the Group’s business operations to facilitate a fuller understanding of the business. In June 2008, a Board meeting was held at Jackson’s offices in the US, where the Board met with senior members of the US management team and attended a series of presentations on the US distribution model and the challenges and opportunities facing the US business. In September 2008, the Board met at the UK business’ offices in London, meeting senior members of the UK management team and receiving a presentation on the UK business. In November 2008, the Board held its annual strategy meeting in Hong Kong. Whilst they were there, the directors met senior members of the Asian management team, attended part of the Asian Leadership Meeting and received presentations on the Asian business.
The majority of directors attended all 7 scheduled Board meetings occurring during the period. There was 1 additional Board meeting, and the majority of the directors attended that meeting. Where directors were not able to attend a meeting, their views were canvassed by the Chairman prior to the meeting. The table on page 85 details the number of Board and Committee meetings attended by each director throughout the year. A further 10 ad hoc Board Committee meetings took place during the year, which had been convened to finalise arrangements for matters discussed by the Board, such as final approvals of periodic financial reports or finalising transactions. The Chairman usually meets formally, at least annually, with the non-executive directors without the executive directors being present. During 2008, the Chairman held a number of meetings with non-executives individually or in groups without the executives being present. It was decided in the light of these meetings that no additional formal meeting would be required. The Chairman Designate also had a number of meetings with non-executive directors without the executives being present. G
Clark Manning 8(8) n/a n/a n/a Harvey McGrathnote 7 2(2) n/a n/a n/a Michael McLintock 8(8) n/a n/a n/a
Barry Stowenote 9 7(8) n/a n/a n/a Tidjane Thiamnote 10 6(6) n/a n/a n/a Mark Tucker 8(8) n/a n/a n/a
*During 2008 there were 7 scheduled Board meetings and 1 additional Board meeting. In addition, there was a strategy event attended by all directors. † During 2008 there were 6 scheduled Audit Committee meetings. ‡ During 2008 there were 4 scheduled Remuneration Committee meetings and 4 additional meetings.
4 Attended all meetings except two Board meetings and two Remuneration Committee meetings due to prior commitments and the terrorist activities in Mumbai.
Board independence The Company follows the Combined Code when determining the independence of its non-executive directors, and in addition to that guidance Prudential is required to affirm annually the independence of its Audit Committee members under Sarbanes-Oxley legislation. Where necessary, the Board ensures that appropriate processes are in place to manage any possible conflict of interest.
In line with the principles of the Combined Code, both the Chairman in office during the year and his successor from 1 January 2009 were independent on appointment. Throughout the year all non-executive directors were considered by the Board to be independent in character and judgement, and independent in accordance with the Combined Code.
Keki Dadiseth and Barry Stowe also serve as non-executive directors of ICICI Prudential Life Insurance Company Limited, an Indian company which is owned 26% by Prudential, and in addition Keki serves at Prudential’s request as a non-executive director of ICICI Prudential Trust Limited, an Indian company which is owned 49% by Prudential. The Board does not consider that these appointments in any way affect Keki’s status as an independent director of Prudential.
Sir Winfried Bischoff has been Chairman of Citi Europe and a Member of The Management, Operating and Business Heads Committees of Citigroup Inc. since May 2000. He is also Chairman of the European Advisory Board of Citigroup Inc. He was the acting Chief Executive Officer of Citigroup Inc. from November 2007 to December 2007 when he was appointed Chairman of Citigroup Inc. Sir Win relinquished his chairmanship of Citigroup Inc. on 23 February 2009, but remains a director. Prudential has a number of business relationships with Citi. The Board believes that, in respect of the Combined Code, these business relationships are not sufficiently material to compromise his independence in matters relating to Prudential.
Our directors may, from time to time, hold directorships or other significant interests with companies outside of the Prudential Group, which may have business relationships with the Group.
Details of any fees retained are included in the Directors’ Remuneration Report on page 118, and major commitments of our executive directors are detailed in their biographies on page 81.
Our non-executive directors may serve on a number of other boards, provided that they are able to demonstrate satisfactory time commitment to their role at Prudential, and that they discuss any new appointment with the Chairman prior to accepting. This ensures that they do not compromise their independence and that any potential conflicts of interest and any possible issues arising out of the time commitments required by the new role can be identified and addressed appropriately. The major commitments of our non-executive directors are detailed in their biographies set out on pages 81 and 82.
Ongoing development Throughout their period in office, directors are continually updated on the Group’s businesses and the regulatory and industry-specific environments in which it operates, as well as on their legal and other duties and obligations as directors where appropriate. These updates can be in the form of written reports to the Board, or presentations by senior executives or external sources where appropriate. Non-executive directors serving on key committees are also updated regularly on matters specific to the relevant committee in order to enhance their knowledge and effectiveness throughout their term in office, and receive presentations from senior executives on topics of interest to them.
Performance evaluation Prudential continued its programme of annual evaluations of the performance of the Board and its committees in respect of 2008, in line with the requirements of the Combined Code. The aim was to improve the effectiveness of the Board and its committees, and enhance the Group’s performance.
In addition, the performance of the non-executive directors and the Group Chief Executive was evaluated by the Chairman in individual meetings. The Group Chief Executive individually appraised the performance of each of the executive directors.
The Board has approved a procedure whereby directors have the right to seek independent professional advice at the Company’s expense where this is appropriate to enable the directors, either individually or as a group, to properly fulfil their obligations.
Copies of any instructions and advice given by an independent professional adviser to a director are supplied by the director to the Company Secretary who will, where appropriate, circulate to other directors sufficient information to ensure that other members of the Board are kept informed on issues arising which affect the Company or any of its subsidiaries.
These indemnities were in force during 2008 and remain in force.
Further details on the procedures for the management of risk and the systems of internal control operated by the Group are given in the section on Risk Governance on pages 96 and 97. The governance framework principally relates to the operational management of the Group’s businesses and includes pre-determined authority limits delegated by the Board in respect of matters which are necessary for the effective day-to-day running and management of the business. The Group Chief Executive has been delegated management authority by the Board, and in turn grants authority to the executive, including the chief executive officers of each business unit, who report to him for the management of that business unit. In addition, each of those chief executives has established a management board comprising the business unit’s most senior executives.
The chief executive and chief financial officer of each business unit certified compliance with the Group’s governance, internal control and risk management requirements. The risk management function reviewed any matters identified by business units in their certification, and also assessed the risk and control issues that arose and were reported during the year. This included: routine and exception-based risk reporting; matters identified and reported by other Group Head Office oversight functions and the findings from the work of the internal audit function, who execute risk-based audit plans throughout the Group. The results were reported to and reviewed by the Group Audit Committee, whose role is described on pages 89 to 91 and by the Board where appropriate.
In line with the Turnbull guidance, the certification provided above does not apply to certain material joint ventures where the Group does not exercise full management control. In these cases, the Group satisfies itself that suitable governance and risk management arrangements are in place to protect the Group’s interests. In addition, the relevant Group company which is party to the joint venture must, in respect of any services it provides in support of the joint venture, comply with the requirements of the Group’s internal governance framework.
Disclosure of information to auditor The directors who held office at the date of approval of this Directors’ Report confirm that, so far as they are each aware, there is no relevant audit information of which the Company’s auditor is unaware; and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 234ZA of the Companies Act 1985.
Meetings The Committee met six times during the year. By invitation, the Chairman of the Board, the Chief Financial Officer, the Company Secretary and Group Legal Services Director, the Group-wide Internal Audit Director, and other senior staff from the internal audit, risk, compliance and security functions where appropriate, as well as the lead partner of the external auditor attended meetings. Other audit partners also attended some of the meetings to contribute to the discussions relating to their area of expertise.
A detailed forward agenda has been in operation for a number of years which is continually updated to ensure all matters for which the Committee is responsible are addressed at the appropriate time of year. The Committee’s principal business during the year consisted of the following: • Review of half-year and full-year results, the annual report and accounts, and other significant announcements where appropriate; • examination of critical accounting policies and key judgmental areas; • review of changes in and implementation of Group Accounting Policies in compliance with International Accounting Standards and practices; • approval of external auditor’s management representation letter, review of external auditor’s full-year memorandum, external audit opinion and final management letter; • review of US filings and related external audit opinion; • monitoring of auditor independence and the external auditor’s plans and audit strategy, the effectiveness of the external audit process, the external auditor’s qualifications, expertise and resources, and making recommendations for the re-appointment of the external auditor; • monitoring of the framework and effectiveness of the Group’s systems of internal control, including the Turnbull compliance statement and Sarbanes-Oxley procedures; • monitoring the effectiveness of both the Group’s risk framework and the management of key financial and operational risks; • review of the internal audit plan and resources, and monitoring of the audit framework and internal audit effectiveness; • monitoring the effectiveness of compliance processes and controls, and performance against the Group Compliance Plan; • review of anti-money laundering procedures, and allegations received via the employee confidential reporting lines; and
• review of its own effectiveness and its terms of reference.
The Committee recognises the need to meet without the presence of executive management. Such sessions were held in March 2008 with the external and internal auditors, and in July 2008 with the external and internal auditors and the head of the security function. At all other times, management and auditors have open access to the Chairman.
Financial reporting As part of its review of financial statements prior to recommending their publication to the Board, the Committee focused on: critical accounting policies and practices and any changes; decisions requiring a major element of judgement; unusual transactions; clarity of disclosures; significant audit adjustments; the going concern assumption; compliance with accounting standards; and compliance with obligations under the Combined Code and other applicable laws and regulations.
Confidential reporting At each meeting, the Committee received and reviewed a report on calls to the confidential reporting line, which is made available to employees to enable them to communicate confidentially on matters of concern, and actions taken in response to these calls. The Committee also considered whether any internal control implications arose from communications received. No internal control implications were raised from calls to the confidential helpline. During the year, the Chairman reviewed the procedures adopted by the Company on the methods of handling calls to the confidential reporting line across the Group with the Group-wide Internal Audit Director and the head of the security function.
Internal control and risk management The Committee reviewed the Group’s statement on internal control systems prior to its endorsement by the Board. It also reviewed the policies and processes for identifying, assessing and managing business risks. Throughout the year, the Committee received the minutes of the Disclosure Committee and the Group Operational Risk Committee and noted their activities. Further information on the Disclosure Committee and on risk governance appears on pages 94 to 95 and pages 96 to 97 respectively.
Pursuant to the requirements of Section 404 of the SarbanesOxley Act, the Group must undertake an annual assessment of the effectiveness of internal control over financial reporting. Further details are provided on page 95.
Internal audit The Committee regards its relationship with the internal audit function as pivotal to the effectiveness of its own activities. Group-wide Internal Audit plays an important role in supporting the Committee to fulfil its responsibilities under the Combined Code and the Sarbanes-Oxley Act, and provides independent assurance on the Company’s processes of identification and control of risk. The Committee agreed the work programme of the internal audit function to be undertaken during 2008. Each of the Group’s business units has an internal audit team, the heads of which report to the Group-wide Internal Audit Director. Internal audit resources, plans and work are overseen by the Committee and by business unit audit committees. Across the Group, total internal audit headcount stands at 120. The Group-wide Internal Audit Director reports functionally to the Committee and for management purposes to the Chief Financial Officer.
All services provided by the auditor in accordance with this policy are pre-approved by the Committee. The Committee regularly reviews and updates the policy to ensure alignment with the latest standards and best practice in establishing, maintaining and monitoring auditor independence and objectivity.
Auditor performance and independence As part of its work during 2008, the Committee assessed the performance of the external auditor, its independence and objectivity, and the effectiveness of the audit process. In addition to questioning the external auditor and the Chief Financial Officer, which is a regular feature of meetings, the review of the effectiveness of the external audit process was conducted through a questionnaire-based exercise administered by Group-wide Internal Audit, supplemented by interviews with senior finance staff and Committee members. In addition, the Committee received the results of an internal review carried out by the external auditor in respect of its services to the Group. The Committee also reviewed the external audit strategy and received reports from the auditor on its own policies and procedures regarding independence and quality control, including an annual confirmation of its independence in line with industry standards.
Review of Committee effectiveness During the year, the Committee undertook an in-depth performance assessment in-house by way of a detailed questionnaire, administered by Group Secretariat, addressing both compliance with various regulations and codes of conduct, and qualitative aspects of the Committee’s performance during the year. The results were discussed at a Committee meeting in January 2009 and reported to the Board in February 2009. Recommendations to improve processes identified by the review are being implemented, and the Committee is satisfied, based on the findings of this review, that it had been operating as an effective audit committee throughout the year, meeting all applicable legal and regulatory requirements. Further reviews of the effectiveness of the Committee will be undertaken regularly, and will from time to time be conducted by external consultants.
The terms of reference comply with all significant aspects of relevant investor guidelines, and are benchmarked against others in similar industries. The terms require the Committee to ensure that when setting remuneration policy, the Company provides reward for enhancing shareholder value responsibly in relation to executive directors’ individual contributions, which we believe is the appropriate policy to support our business.
Membership The Committee is comprised exclusively of independent non-executive directors of the Company, as set out below: Bridget Macaskill (Chairman) Keki Dadiseth FCA Michael Garrett James Ross
Meetings The Committee normally has scheduled meetings at least four times a year and a number of additional meetings, as required, to review remuneration policy and the application of that policy. While the Chairman and Group Chief Executive are not members, they attend meetings unless they have a conflict of interest. During 2008, a total of eight Committee meetings were held.
Harvey McGrath (Chairman from 1 January 2009) Bridget Macaskill James Ross
Full biographical details of Harvey are set out on page 81.
The process of evaluating the skills and composition of the Board is ongoing, and is kept under regular review in order to ensure appropriate plans for succession to the Board are in place.
Relations with shareholders Communication with shareholders As a major institutional investor, the Company is very aware of the importance of maintaining good relations with its shareholders. We regularly hold discussions with major shareholders and a programme of meetings took place during 2008. A perception survey into the views of the Company’s major investors is undertaken on an annual basis by an independent firm, and the results of this survey are presented to the Board. Board members also regularly receive copies of the latest analysts’ and brokers’ reports on the Company and the sector, to further develop their knowledge and understanding of external views about the Company. The Chairman and the non-executive directors provided feedback to the Board on topics raised with them by major shareholders.
The Group maintains a corporate website containing a wide range of information of interest to private and institutional investors, including the Group’s financial calendar. The shareholder information section on pages 364 and 365 contains further details which may be of interest to shareholders.
At its Annual General Meeting in 2008, the Company continued its practice of calling a poll on all resolutions. The voting results, which included all votes cast for and against each resolution at the meeting, and all proxies lodged prior to the meeting, were indicated at the meeting and published on the Company’s website as soon as practicable after the meeting. The Company also disclosed the number of votes withheld at the meeting and on its website. This practice provides shareholders present with sufficient information regarding the level of support and opposition to each resolution, and ensures all votes cast either at the meeting or through proxies are included in the result.
Any change to the Memorandum or the Articles must be approved by special resolution of the shareholders in accordance with the provisions of the Companies Acts.
Share capital On 31 December 2008, the Company’s issued share capital, which is set out in Note H11, consisted of 2,496,947,688 ordinary shares of 5 pence each, all fully paid up and listed on the Main Market of the London Stock Exchange. The number of accounts on the share register at 31 December 2008 was 75,438 (2007: 75,948). The Company is listed on the New York Stock Exchange in the form of American Depositary Shares, referenced to its ordinary shares, under a depositary agreement with JP Morgan.
Rights to dividends under the various schemes are set out in Note I2.
Restrictions on transfer In accordance with English company law, shares may be transferred by an instrument of transfer or through an electronic system (currently CREST), and transfer is not restricted except that the directors may in certain circumstances refuse to register transfers of shares, but only if such refusal does not prevent dealings in the shares from taking place on an open and proper basis. If the directors make use of that power, they must send the transferee notice of the refusal within two months.
Powers of directors to buy back shares The directors also require authority from shareholders in relation to the buying back of shares by the Company. The Company seeks authority by special resolution on an annual basis for the buyback of its own shares in accordance with the relevant provisions of the Companies Acts and other related guidance. The Company has not made use of that authority since it was last granted at its Annual General Meeting in 2008. This existing authority is due to expire at the end of this year’s Annual General Meeting. A special resolution to approve the renewal of this authority will be put to shareholders at the Annual General Meeting on 14 May 2009.
Risk management: As described in the corporate governance report above, primary responsibility for strategy, performance management and risk control lies with the Board, Group Chief Executive and the chief executives of each business unit.
• Balance Sheet and Capital Management Committee: Meets monthly to manage the Group’s balance sheets and to oversee the activities of the Prudential Capital business unit.
The committees’ oversight is supported by the Group Chief Risk Officer, with functional oversight provided by: • Group Security: Develop and deliver appropriate security measures to protect the Group’s staff, physical assets and intellectual property.
• Group Risk: Establish and embed a capital management and risk oversight framework and culture consistent with Prudential’s risk appetite that protects and enhances the Group’s embedded and franchise value.
Material risks will only be retained where this is consistent with Prudential’s risk appetite framework, ie: • The retention of the risk contributes to value creation; • the Group is able to withstand the impact of an adverse outcome; and • the Group has the necessary capabilities, expertise, processes and controls to manage the risk.
b Monitoring: Establish a ‘no surprises’ risk management culture by identifying the risk landscape, assessing and monitoring risk exposures and understanding change drivers.
c Control: Implement risk mitigation strategies and remedial actions where exposures are deemed inappropriate and manage the response to extreme events.
The Corporate Responsibility team, which is located in Group Head Office, develops Prudential’s CR strategy and works closely with individual business units to provide advice. The team also assists with the development and adaptation of Group-wide initiatives so that they not only fit with our overall Group principles but are also adapted to meet local needs.
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 131 to 315 and the supplementary information on pages 318 to 356. It is the responsibility of the auditor to form independent opinions, based on its audit of the financial statements and its review of the EEV basis supplementary information; and to report its opinions to the Company’s shareholders and to the Company. Its opinions are given on pages 317 and 358.
After making enquiries, the directors have a reasonable expectation that the Company and the Group have adequate resources to continue its operations for the foreseeable future. The directors therefore have continued to use the going concern basis in preparing the financial statements.
Significant agreements that take effect, alter or terminate upon a change of control of the Company following a takeover bid Under the agreements governing Prudential Corporation Holdings Limited’s life insurance and fund management joint ventures with China International Trust & Investment Corporation (CITIC), if there is a change of control of the Company, CITIC may terminate the agreements and either (i) purchase the Company’s entire interest in the joint venture or require the Company to sell its interest to a third-party designated by CITIC or (ii) require the Company to purchase all of CITIC’s interest in the joint venture. The price of such purchase or sale is to be the fair value of the shares to be transferred, as determined by the auditor.
Post-balance sheet events Note I10 of the Notes on the Group financial statements and Additional disclosures 99, 305
Future developments of the business of the Company Business review 18-78
Creditors – policy on payment and practice Corporate responsibility review 78
Structure of share capital, including restrictions on the Corporate governance 93-94 transfer of securities, voting rights and significant shareholders
Significant agreements impacted by a change of control Additional disclosures 99
Agreements for compensation for loss of office or Additional disclosures 99 employment on takeover
D irecto rs’ rem u n eratio n rep o rt
As I indicated in last year’s Report, in 2008 the Committee undertook a full review of the remuneration policy for the executive directors. The results of the review clearly indicated that there are areas of our executive directors’ remuneration which are below market, particularly incentive levels. However when considering the findings of the review, we have been very conscious of the current economic climate, both globally and in each region in which we do business. Hence the Committee considers that this is not an appropriate time to make changes to executive compensation. In reaching this decision we have been particularly mindful of the interests and perspectives of shareholders.
• we have not changed the levels of long-term incentive awards for 2009.
During 2008 we also reviewed our incentive arrangements to ensure that they do not encourage inappropriate behaviour, especially in terms of short-term risk taking. The annual bonus plan measures for 2009 place particular emphasis on generation of cash and preservation of capital, as discussed on page 105 to reflect the importance of these factors to the Group. The Committee is satisfied that the structure of the incentive arrangements is appropriate but will continue to keep this under review during the year.
Thus the policy aims to comply with good practice in the UK, whilst not losing sight of the need to take account of competitive conditions in the local market in which an individual works.
The Remuneration Principles which the Committee has applied are: • A high proportion of total remuneration will be delivered through performance-related reward with high levels of reward only being paid for high levels of achievement; • a significant element of performance-related reward will be provided in the form of shares; • the total remuneration package for each executive director will be set in relation to the relevant employment market; • the performance of business unit executives will be measured at both a business unit and Group level; • performance measures will include absolute financial measures and relative measures as appropriate, to provide alignment between achieving results for shareholders and the rewards for executives; and
The members of the Remuneration Committee during 2008, listed below, are all independent non-executive directors: Bridget Macaskill (Chairman) Keki Dadiseth Michael Garrett James Ross (joined 1 January 2008)
The Committee meets on at least four occasions each year and more often when necessary. In 2008 the Committee met eight times. The Chairman and the Group Chief Executive are invited to attend the meetings and are asked to provide their views as appropriate. The Committee decides the remuneration of the Chairman and the executive directors, including the Group Chief Executive, but in no case is any person present when their own remuneration is discussed.
Each year the Committee reviews the remuneration of senior management throughout the Group.
It has been announced that Tidjane Thiam will succeed Mark Tucker as Group Chief Executive from 1 October 2009. The details of the remuneration terms which the Committee has agreed for Tidjane Thiam and the arrangements for Mark Tucker following his resignation have been included on page 114 in this Report.
The Committee sought the views and assistance of Priscilla Vacassin, Group Human Resources Director, Hilary Oliver, Director of Group Reward and Employee Relations, Philip Broadley, Group Finance Director until May 2008 and Tidjane Thiam, Chief Financial Officer from May 2008. In making its decisions, the Committee also requested consultancy assistance from Deloitte LLP and PricewaterhouseCoopers LLP, reviewed market data from Deloitte LLP, Towers Perrin and McLagan Partners and obtained legal advice, including employment law and advice on the operation of the Company’s share plans from Slaughter and May and Linklaters. Some of these companies also provided other services to the Company: Deloitte LLP, PricewaterhouseCoopers LLP and Slaughter and May in relation to advice on taxation and finance matters, Towers Perrin in relation to advisory work on finance matters and Slaughter and May in relation to advice on commercial and corporate law and general legal advice.
I remain fully confident the Committee’s approach is fully aligned with the Company’s business plans and shareholder interests, and rewards Prudential’s executive directors appropriately for their performance.
The Remuneration Committee’s terms of reference are available on the Company’s website and a copy may be obtained from the Company Secretary.
The Committee’s objectives include: • Determining the remuneration framework for the Chairman and the executive directors; • reviewing the design of all long-term incentive arrangements applying to the executive directors; • approving the design and targets for any performancerelated pay plans for the executive directors and individual payments made under the plans; • setting the Chairman’s fees and executive directors’ annual remuneration packages; • reviewing the terms of the executive directors’ service agreements; • monitoring the remuneration of a defined population of senior executives; • reviewing the design of all share incentive plans operating over Prudential plc shares; • determining the structure and quantum of any severance packages for executive directors; and
The Company’s Remuneration Policy applies the Remuneration Principles as described in the letter from the Chairman of the Remuneration Committee, including the principle of setting remuneration structures of individual executive directors by reference to their different roles and the markets in which they operate.
Michael McLintock’s business unit annual plan includes growth in third-party funds, M&G investment performance and M&G IFRS profit.
*The proportions for Clark Manning’s annual bonus include a Jackson senior management bonus pool which is based on Jackson financial performance. The proportions shown in the table incorporate a notional level for this pool, and in a year when Jackson has superior performance the percentage of his reward based on Jackson business would be substantially higher.
2008 and 2009 Business Unit Performance Plan (BUPP) awards The 2007 Directors’ Remuneration Report noted that the Company was planning to change its reporting basis to Market Consistent Embedded Value (MCEV) for European insurers. This would have meant that the Committee needed to review the BUPP performance measure which is Shareholder Capital Value on an European Embedded Value (EEV) basis. However in December 2008, the CFO Forum, representing the leading insurance companies in Europe, expressed its concern about the appropriateness of MCEV principles in the current market environment, especially its suitability in periods of economic turmoil, and announced that a further review would take place
The performance measures which will be used in the 2009 long-term incentive plans for the executive directors are as follows: D irecto rs’ rem u n eratio n rep o rt
Clark Manning President and Chief Executive Officer Jackson TSR Jackson SCV growth Michael McLintock Chief Executive M&G TSR M&G IFRS Profit and
Fund performance Nick Prettejohn Chief Executive Prudential UK and Europe TSR UK SCV growth Barry Stowe Chief Executive Prudential Corporation Asia TSR Asia SCV growth Tidjane Thiam Chief Financial Officer TSR n/a
As Mark Tucker is leaving Prudential in 2009 he will not receive a long-term incentive award for 2009.
The proportions of the elements in the annual incentive plans are set out in the section on ‘Performance measures in 2009 annual bonus plans’ on page 105.
Total Compensation levels are compared with: • Median of the FTSE 50 for executive directors whose remuneration is benchmarked against the UK market; • Median of the LOMA data for insurance companies for the executive director based in the US; and
• Median of fund management market data for the Chief Executive of M&G.
The Remuneration Committee reviews salaries annually. Any changes in basic salary for the Group Chief Executive and the executive directors are effective from 1 January.
No increases to basic salaries are proposed for executive directors or senior executives for 2009.
It is anticipated that the pay review for other employees will result in average increases of approximately 2.5% in the UK, 3.5% in Asia, and 3% in the US.
The table below sets out the purpose and practice for each element of remuneration for 2008 and 2009. Total remuneration for our executive directors is made up of the elements set out below. All elements are reviewed annually.
Provides a retention element from annual reward which helps alignment with shareholders’ interests.
Group Performance Share Plan For all executive directors: relative TSR performance against peer group.
Business plans: For business unit executive directors: BUPPs: Growth in SCV on an EEV basis. M&G Executive LTIP: M&G profit and fund performance.
Practice 2009 bonus deferrals The current Group Chief Executive leaves Prudential on 30 September 2009 hence any pro-rated bonus for 2009 will be paid fully in cash.
The new Group Chief Executive will be required to defer 50% of any bonus awarded for this role post the date of appointment.
• Chief Executive of M&G: deferral of 50% of any award above £500,000. This deferral level is unchanged from 2008.
2008 bonus deferrals (where different from 2009): • Group Chief Executive: deferral of bonus above 75% of salary; • Chief Financial Officer and the Chief Executives of UK and
of salary excluding the payment from a Jackson senior management bonus pool.
Clark Manning1 President and Chief Executive Officer Jackson $1,050,000 c3201 230 230 460
Barry Stowe Chief Executive Prudential Corporation Asia £550,000 110 130 130 260
Notes 1 Clark Manning’s annual bonus figure includes a notional figure for his 10% share of the Jackson senior management bonus pool based on the performance of Jackson. 2 Michael McLintock’s annual bonus is based on M&G’s performance both in absolute terms and relative to its peers with bonus amounts determined by an assessment of market competitive rewards for median and superior performance. In line with practice in the asset management sector there is no specified maximum annual bonus award. Total remuneration is subject to an overriding cap such that his total remuneration should not be greater than three per cent of M&G’s annual IFRS profits.
Superior performance leads to maximum annual bonus and maximum LTIP vesting.
Group Chief Executive 2009 proportions based on remuneration policy Fixed/variable %
Proportions of cash and shares The distribution between cash and shares in reward for our executive directors is set out below. The chart reflects the 2009 changes in the level of deferrals into shares from annual bonuses described in the section on ‘Remuneration policy in practice’ on page 106.
Notes 2009 awards under the Group Performance Share Plan are 100% in shares. 2009 awards under the Business Unit Performance Plan for the Chief Executives of the US, UK and Asia are 100% in shares. The long-term incentive plan for the Chief Executive of M&G is cash based.
Group Chief Executive 2009 proportions based on remuneration policy Cash/shares %
The vesting schedule is set out in the following table and graph. The unvested portion of any award lapses. The companies in the index for both the 2008 and 2009 awards are: Aegon, Allianz, Aviva, Axa, Friends Provident, Generali, ING, Legal & General, Manulife, Old Mutual and Standard Life.
Compound annual growth in shareholder capital value over three years % vesting
The Remuneration Committee must also be satisfied that the quality of the underlying financial performance of each business unit justifies the level of award delivered at the end of the performance period and may adjust vesting levels accordingly at its discretion.
To ensure close alignment with our shareholders’ long-term interests, participants receive the value of reinvested dividends over the performance period for those shares that vest.
The number of phantom shares in the award depends on the performance of M&G in the financial year prior to the award being made and an assessment of Michael McLintock’s contribution. Thus the base value of the award to be made in 2009 relates to the business performance in 2008. As disclosed in the 2007 Directors’ Remuneration Report, in recognition of M&G’s strong performance in 2007, an award of 1,141,176 phantom shares of £1 with an anticipated value of £1,940,000 was made in 2008. Based on 2008 performance, an award of 2,282,353 phantom shares of £1 and an anticipated value of £1,940,000 will be made in 2009.
The number of phantom shares subject to the award will be adjusted at the end of the three-year performance period to take account of the performance of M&G both in terms of levels of profitability and maintaining strong fund investment performance as follows: Profit growth • Awards will be scaled back based on profit performance achieved if profits in the third year are less than the average of the profits over the prior year and the performance period; • The scaling back will be on a straight line basis from 0% to 100% of the award between zero profit and the achievement of profits equal to the average; • No award will vest in the event of a loss or zero profit, irrespective of fund performance; and
Investment performance • Where investment performance over the three-year performance period is in the top two quartiles the number of phantom shares vesting will be enhanced. A sliding scale will apply up to 200% of the annual award, which is awarded when top quartile performance is reached; and
All-employee plans UK-based executive directors are eligible to participate in the Prudential HM Revenue and Customs (HMRC) approved UK Savings Related Share Option Scheme (SAYE scheme) and the Asia-based executive director can participate in the equivalent International SAYE scheme. The schemes allow employees to save towards the exercise of options over Prudential plc shares, at an option price set at the beginning of the savings period at a discount of up to 20 per cent to the market price. Savings contracts may be up to £250 per month for three or five years, or additionally in the UK scheme seven years. On maturity at the end of the set term, participants may exercise their options within six months of the end of the savings period and purchase Prudential plc shares. If an option is not exercised within six months, participants are entitled to a refund of their cash contributions plus interest if applicable under the rules. Shares are issued to satisfy options that are exercised. No options may be granted under the schemes if the grant would cause the number of shares which have been issued, or which remain issuable pursuant to options granted in the preceding 10 years under the scheme and other share option schemes operated by the Company, or which have been issued under any other share incentive scheme of the Company, to exceed 10 per cent of the Company’s ordinary share capital at the proposed date of grant.
Pensions policy The Chief Executive of Jackson is eligible to participate in Jackson’s Defined Contribution Retirement Plan, a qualified 401(k) retirement plan on the same basis as all other US-based employees. Company matching contributions of 6% of basic salary up to a maximum of $13,800 were made in 2008. He is also eligible to participate in the profit sharing element of the plan that provides eligible participants with an annual profit sharing contribution, depending on the financial results of Jackson for the plan year, with a maximum of four per cent of salary capped at $9,200 in 2008.
The Chief Executive of Asia is eligible to receive a 25 per cent cash salary supplement for pension purposes.
For UK executive directors hired after 30 June 2003 the Company’s policy is to provide a supplement of 25 per cent of salary. This includes, where relevant, any Company contributions to the staff defined contribution pension plan, which UK executive directors may choose to join. This plan has no salary cap.
Harvey McGrath joined as a non-executive director on 1 September 2008 and became Chairman from 1 January 2009. He is paid an annual fee and has a contractual notice period of 12 months by either party. He is entitled to participate in a medical insurance scheme and to the use of a car and driver but did not take up either of these benefits in 2008. He is provided with life assurance cover of four times his annual fees in lieu of death in service benefit. He is not a member of any Group pension scheme providing retirement benefits. His annualised fee is £500,000 which is fixed for three years. No pension allowance is paid.
Clark Manning 7 May 2002 12 months* 12 months* Michael McLintock 21 November 2001 6 months 12 months Nick Prettejohn 26 September 2005 12 months 12 months Barry Stowe 18 October 2006 12 months 12 months Tidjane Thiam 20 September 2007 12 months 12 months Mark Tucker 24 March 2005 12 months 12 months *The contract for Clark Manning is a renewable one-year fixed-term contract. The contract is renewable automatically upon the same terms and conditions unless the Company or Clark Manning gives at least 90 days’ notice prior to the end of the relevant term. In the case of the former, Clark Manning would be entitled to continued payment of salary and benefits for the period of one year from the day such notice is delivered to him. Payments of Clark Manning’s salary during the period following the termination of employment would be reduced by the amount of compensation earned by him from any subsequent employer or from any person for whom he performs services. Benefits to be provided during such period would also be cancelled to the extent that comparable benefits were available to him from these alternative sources.
Sir Winfried Bischoff 2 August 2007 AGM 2008 AGM 2011 Keki Dadiseth 1 April 2005 AGM 2008 AGM 2011 Michael Garrett 1 September 2004 AGM 2008 AGM 2011 Ann Godbehere 2 August 2007 AGM 2008 AGM 2011 Bridget Macaskill 1 September 2003 AGM 2007 AGM 2010 Harvey McGrath† 1 September 2008 AGM 2009 AGM 2012 Kathleen O’Donovan 8 May 2003 AGM 2007 AGM 2010 James Ross 6 May 2004 AGM 2008 AGM 2011 Lord Turnbull 18 May 2006 AGM 2006 AGM 2009 *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. Thereafter, the Board may invite the directors to serve for an additional period.
Mark Tucker Following Mark Tucker’s resignation no special remuneration arrangements have been put in place.
After leaving, the deferred share awards in connection with the 2007 and 2008 bonus will be released in accordance with the scheme rules.The 2007 and 2008 LTIP awards under the Group Performance Share Plan (Group PSP) will vest at the end of the relevant three year performance period pro-rated for service, 33/36ths and 21/36ths respectively. Vesting will remain dependent on performance achieved over the performance periods to 31 December 2009 and 31 December 2010. Any shares which vest will be released at the same time as for all other participants in the Group PSP.
Tidjane Thiam’s 2009 annual bonus will be based on the performance measures described in the section on ‘Performance measures in 2009 annual bonus plans’ on page 105. His current maximum bonus for his role as Chief Financial Officer is 110 per cent. The total bonus for 2009 will be determined by considering the period of time in the two roles performed in 2009, taking into account any handover period required, the performance of Prudential and the maximum award level for each role. There will be a compulsory deferral of 30 per cent of any bonus awarded for his CFO role and 50 per cent of any bonus awarded for his CEO role.
Subject to the Group Chief Executive’s approval, executive directors are able to accept external appointments as nonexecutive directors of other organisations. Any fees paid may be retained by the executive director.
Non-executive directors do not have service contracts but are appointed pursuant to letters of appointment with notice periods of six months without liability for compensation with the exception of Harvey McGrath whose notice period is 12 months.
Annual Annual fee as at fee as at 1 January 1 January
Shareholding guidelines As a condition of serving, all executive and non-executive directors are currently required to have beneficial ownership of 2,500 ordinary shares in the Company. This interest in shares must be acquired within two months of appointment to the Board if the director does not have such an interest upon appointment.
Directors’ shareholdings The interests of directors in ordinary shares of the Company are set out below and include shares acquired under the Share Incentive Plan, the deferred annual incentive awards detailed in the table on ‘Other Share Awards’ on page 124, and interests in shares awarded on appointment.
The interests of directors in shares of the Company include changes between 31 December 2008 and 18 March 2009. All interests are beneficial.
Notes 1 The shares in the table include shares purchased under the Prudential
‡2007 figures include deferred share awards made from 2007 annual incentive plans which are detailed in the section ‘Other Share Awards’ on page 124. §Value of anticipated LTIP releases is the total of cash paid plus, for shares released, the value of the released shares based on the share price at 31 December 2008. All executive directors participate in long-term incentive plans and the details of share releases from awards with a performance period ending 31 December 2008 are provided in the footnotes to the table on share awards on pages 120 to 123. Executive directors’ participation in all-employee plans are detailed on page 126.
Notes continued 3 Clark Manning’s bonus figure excludes a contribution of US$13,800, from a profit sharing plan, which has been made into a 401K retirement plan.
11 Keki Dadiseth was paid allowances totalling £12,063 in 2008 in respect of his accommodation expenses in London whilst on the Company’s business, in lieu of reimbursing hotel costs as is the usual practice for directors who are not resident in the UK.
Michael McLintock’s 2006 LTIP payout will be made in cash. Mark Tucker’s 2008 bonus was paid fully in cash.
For all the executive directors, individual strategic goals formed the objectives against which individual performance was assessed. These included each executive director’s contribution to the group strategy as a member of the plc Board and the specific goals related to their functional and/or business unit roles.
IFRS profit on continuing operations £1,347m £589m £347m £286m EEV profit on long-term business £2,906m £1,037m £1,309m – Net cash flow £54m (£80)m £5m –
IFRS profit on continuing operations 7 12 27 13 EEV profit on long-term business 10 21 15 –
UK Net cash flow excludes the With-profits transfer of £279m. 4 Under the Asia annual plan, performance against IFRS and EEV versus the targets was strong but the Asia cash flow achieved did not result in a payment.
5 Michael McLintock’s annual bonus plan performance measures include, as well as IFRS profits, growth in third-party funds under management and comparative fund investment performance. Performance achieved against IFRS profits was good and hence triggered a payment for this measure and fund performance at 68th percentile was very strong. As for all fund management firms, 2008 saw a fall in the value of funds under management because of the fall in the FTSE. However, M&G significantly increased market share which was a considerable achievement during such a period of economic turmoil.
Notes *Full year equivalent basis – Philip Broadley’s actual bonus and salary were pro-rated for service in 2008. † Includes $1,448,900 from the Jackson bonus pool. ‡ Guaranteed bonus for 2008.
Group Performance Share Plan 2008 182,262 674.50 182,262 31 Dec 10
In determining the 2008 conditional share awards the shares were valued at the average share price for the 30 days immediately following the announcement of Prudential’s 2007 results, and the price used to determine the number of shares was 662.11 pence.
Business Unit Performance Plan Awards under the 2008 Business Unit Performance Plan are described in the section on ‘2008 and 2009 Business Unit Performance Plan (BUPP) awards’ on page 105. The performance measures for awards for 2006 and 2007 were the same.
2 Group Performance Share Plan 2006 At 31 December 2008 Prudential’s TSR performance was 117 per cent of the TSR performance of the index. As a result, it is anticipated that awards over 92.4 per cent of the maximum number of shares will be earned, resulting in 311,428 shares for Mark Tucker, 157,197 shares for Philip Broadley, 223,067 shares for Clark Manning, 59,319 shares for Michael McLintock, and 138,566 shares for Nick Prettejohn.
For the 2005 award the results led to a payment of US$4,416,308. The face values of the awards for Clark Manning have been converted at the average exchange rate for 2008 which was US$1.8518 = £1 (2007: US$2.0015 = £1).
Michael McLintock Michael McLintock’s 2005 and 2006 cash long-term incentive awards were under the M&G Chief Executive Long-Term Incentive Plan that provides a cash reward through phantom M&G share awards and options. For these awards, the phantom share price at the beginning of the performance period was £1. The change in the phantom share price equals the change in M&G profit, modified up or down by the investment performance of M&G, over the performance period. For each year the face value of the share award was £225,000 and the phantom option award had a face value of £367,800. Provided the phantom share options have value, they may be exercised in part or in full during annual exercise periods after three to seven years from the start of the performance period.
Under the rules of Michael McLintock’s 2001 phantom option award, a payment of £845,940 was made at the end of the seven year exercise period. An award under the share element of the M&G Chief Executive Long-Term Incentive Plan with a face value of £1,333,000 was made in 2007. Following consultations with shareholders an award with a face value of £1,141,176 was made in 2008 under the M&G Executive Long-Term
Other share awards The table below sets out the share awards that have been made to executive directors under their appointment terms and those deferred from annual incentive plan payouts. The values of the deferred share awards are included in the bonus and total figures in the Directors’ remuneration table on page 117. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual financial results for the relevant year. For the awards from the 2007 annual incentives, made in 2008, the average share price was 618.50 pence.
Deferred 2006 annual incentive awardnote 1 2007 83,450 2,479 85,9291,4 31 Dec 09
Deferred 2006 annual incentive awardnote 1 2007 12,128 359 12,487 31 Dec 09
Deferred 2007 annual incentive awardnote 1 2008 40,551 1,204 41,7551,6 31 Dec 10
Conditional Conditional share share awards out- Cond- Scrip awards out- Market Market standing itionally dividends Shares standing Shares price at price at at 1 Jan awarded accumu- released at 31 Dec Date of released original date of Year of 2008 in 2008 lated in 2008 2008 end of in 2008 date of vesting or initial (Number (Number (Number (Number (Number restricted (Number Date of award release grant of shares) of shares) of shares) of shares) of shares) period of shares) release (pence) (pence)
Mark Tucker annual incentive award 2006 38,125 1,132 39,257 1 31 Dec 08 39,257 31 Dec 08 715.5 416.5
Deferred 2007 annual incentive awardnote 1 2008 73,576 2,185 75,7611,7 31 Dec 10
Directors’ remuneration table on page 117. The exchange rate used was US$2.0015 = £1. 4 In 2008, a deferred share award from his 2007 annual bonus valued at £640,000 was made to Michael McLintock. This is included in the 2007 total in the Directors’ remuneration table on page 117. 5 In 2008, a deferred share award from his 2007 annual bonus valued at £307,625 was made to Nick Prettejohn. This is included in the 2007 total in the
Directors’ remuneration table on page 117. 6 In 2008, a deferred share award from his 2007 annual bonus valued at £250,000 was made to Barry Stowe. This is included in the 2007 total in the
Directors’ remuneration table on page 117. 8 In order to secure the appointment of Nick Prettejohn, he was awarded rights to Prudential plc shares that vest as set out in the table. In normal circumstances, releases are conditional on Nick Prettejohn being employed by Prudential at the date of vesting. If there is a change of control of Prudential he may be entitled to retain any unvested awards.
10 In order to secure the appointment of Tidjane Thiam, the following awards were made
These awards were valued taking the relative share prices of his previous employer on the day prior to his last working day and the Company on his first working day.
Options Market Options Market adjusted out- price on out- price at Original for 2004
Year of standing exercise Options Options standing 31 Dec exercise Rights Earliest Latest initial at 1 Jan Exercised date forfeit granted at 31 Dec 2008 price Issue exercise exercise grant 2008 in 2008 (pence) in 2008 in 2008 2008 (pence) (pence) (pence) date date
Dilution Prudential currently meets its obligations under its share plans by funding an employee trust which acquires shares on the open market either at the time of grant or by maintaining sufficient shares in the trust to meet the requirements as awards vest. Shares relating to options granted under all-employee share plans are satisfied by new issue shares. The combined dilution from all outstanding options at 31 December 2008 was 0.02 per cent of the total share capital at the time.
Philip Broadley participated in a non-contributory scheme that provided a pension of 1/60th of Final Pensionable Earnings for each year of service on retirement at age 60.
Michael McLintock participates in a contributory scheme that provides a target pension of 2/3rds of Final Pensionable Earnings on retirement at age 60 for an employee with 30 years or more potential service, for which his contribution is four per cent of basic salary. In both cases Final Pensionable Earnings are capped by a notional scheme earnings cap which replicates the HMRC earnings cap in force before A-Day (6 April 2006).
Michael McLintock is entitled to supplements based on the portion of his basic salary not covered for pension benefits under a HMRC approved scheme. He is also provided with life assurance cover of four times salary.
Nick Prettejohn and Tidjane Thiam are entitled to a total salary supplement of 25 per cent of basic salary. They have both opted to become members of the staff defined contribution pension plan, which provides death in service benefits including life assurance of four times salary. The company contributions to the pension plan are included in the supplement.
Barry Stowe is paid a salary supplement of 25 per cent of his salary. He is also provided with life assurance cover of four times salary.
Years of inflation for inflation contributions to pension pensionable Accrued on pension on pension made by and life
Age at service at benefit at earned to earned to directors assurance 31 Dec 2008 31 Dec 2008 31 Dec 2008 31 Dec 2007 31 Dec 2007 2008 B 2007 A during 2008 arrangements note 1 note 2 note 4
2 As required by the Companies Act remuneration regulations. 3 The transfer value equivalent has been calculated in accordance with Actuarial Guidance Note GN11. 4 Supplements in the form of cash are included in the Directors’ remuneration table on page 117.
(Loss) profit after tax attributable to equity holders of the Company IFRS income statement 131 £(396)m £947m
Operating profit from continuing operations based on longer-term investment returns 319 £2,961m £2,530m
Notes IFRS basis results The preparation of statutory IFRS basis results and supplementary IFRS basis information is consistent with that applied for the 2007 results and financial statements, except for the effect of the adoption of IFRIC 14 for pension schemes. EEV basis results The EEV basis results are extracted from supplementary information and are not results that form part of the Group’s financial statements. Supplementary information The results shown above distinguish ‘operating profits based on longer-term investment returns’ from ‘profits before tax’. The reconciling items are presented in accordance with the Group’s policy as described in the Group’s financial statements and supplementary information. Items excluded from operating profit based on longer-term investment returns represent primarily the effects of altered investment market conditions (short-term fluctuations) and actuarial and other gains and losses on defined benefit pension schemes. For EEV, the operating profit based on longer-term investment returns figure also excludes the mark to market value movements on core borrowings, the effect of changes in economic assumptions and the time value of the cost of options and guarantees.
Summary of statutory and supplementary IFRS and EEV basis results Year ended 31 December 2008
F in an cial statem en ts 130 Index to Group financial statements 131 Consolidated income statement 132 Consolidated statement of changes in equity 134 Consolidated balance sheet 136 Consolidated cash flow statement 137 Notes on the Group financial statements 306 Balance sheet of the parent company 307 Notes on the parent company financial statements 316 Statement of directors’ responsibilities in respect of the
Annual Report and the financial statements 317 Independent auditor’s report to the members of Prudential plc 318 EEV basis supplementary information 322 Notes on the EEV basis supplementary information 357 Statement of directors’ responsibilities in respect of the
EEV basis supplementary information 358 Independent auditor’s report to Prudential plc on the
Primary statements 131 Consolidated income statement 132 Consolidated statement of changes in equity 134 Consolidated balance sheet 136 Consolidated cash flow statement
Section F: Income statement notes 244 F1: Segmental information 245 F2: Revenue 246 F3: Acquisition costs and other operating expenditure 246 F4: Finance costs: Interest on core structural borrowings of shareholder-financed operations 246 F5: Tax
Section G: Financial assets and liabilities 252 G1: Financial instruments – designation and fair values 256 G2: Market risk 259 G3: Derivatives and hedging 261 G4: Derecognition and collateral 262 G5: Impairment of financial assets
Section H: Other information on balance sheet items 263 H1: Intangible assets attributable to shareholders 266 H2: Intangible assets attributable to with-profits funds 267 H3: Reinsurers’ share of insurance contract liabilities 268 H4: Tax assets and liabilities 269 H5: Accrued investment income and other debtors 270 H6: Property, plant and equipment 271 H7: Investment properties 273 H8: Investments in associates and joint ventures 275 H9: Assets held for sale 275 H10: Cash and cash equivalents 275 H11: Shareholders’ equity: Share capital, share premium and reserves 277 H12: Insurance contract liabilities and unallocated surplus of with-profits funds 278 H13: Borrowings 280 H14: Provisions and contingencies 284 H15: Other liabilities
Section I: Other notes 285 I1: Staff and pension plans 297 I2: Share-based payments 300 I3: Key management remuneration 301 I4: Fees payable to auditor 301 I5: Related party transactions 301 I6: Subsidiary undertakings 303 I7: Commitments 304 I8: Cash flows 304 I9: Discontinued banking operations 305 I10:Post balance sheet events
Parent company 306 Balance sheet of the parent company 307 Notes on the parent company financial statements 316 Statement of directors’ responsibilities in respect of the Annual Report and the financial statements 317 Independent auditor’s report to the members of Prudential plc
European Embedded Value (EEV) basis supplementary information 318 Operating profit from continuing operations based on longer-term investment returns 319 Summarised consolidated income statement – EEV basis 319 Earnings per share – EEV basis 319 Dividends per share 320 Movement in shareholders’ equity (excluding minority interests) – EEV basis 321 Summarised consolidated balance sheet – EEV basis 322 Notes on the EEV basis supplementary information 357 Statement of directors’ responsibilities in respect of the European
Benefits and claims 4,620 (26,224) Outward reinsurers’ share of benefits and claims 389 (20) Movement in unallocated surplus of with-profits funds H12 5,815 (541)
(Loss) profit before tax (being tax attributable to shareholders’ and policyholders’ returns)† (2,074) 1,058 Tax credit attributable to policyholders’ returns 1,624 5
(Loss) profit before tax attributable to shareholders B1 (450) 1,063 Tax credit (charge) F5 1,683 (349) Less: tax credit attributable to policyholders’ returns (1,624) (5) Tax credit (charge) attributable to shareholders’ profits F5 59 (354)
Earnings per share (in pence) Basic (based on 2,472m and 2,445m shares respectively): Based on (loss) profit from continuing operations attributable to the equity holders of the Company (16.0)p 28.8p
Diluted (based on 2,473m and 2,448m shares respectively): Based on (loss) profit from continuing operations attributable to the equity holders of the Company (16.0)p 28.8p Based on profit from discontinued operations attributable to the equity holders of the Company – 9.8p *The Company has adopted the principles of IFRIC 14 in accounting for pension schemes. The adoption gives rise to consequential changes to the comparative results for 2007. Note I1 explains the effect of the change.
†This measure is the formal (loss) profit before tax measure under IFRS but is not the result attributable to shareholders.
Related change in amortisation of deferred income and acquisition costs H1 1,070 1,070 1,070
Total items of income and expense recognised directly in equity 750 (1,071) (321) (321)
Total income and expense for the year (396) 750 (1,071) (717) 5 (712)
Reserve movements in respect of share-based payments 18 18 18 Change in minority interests arising principally from purchase and sale of property partnerships of the PAC with-profits fund and of other consolidated investment funds (50) (50)
Net increase (decrease) in equity 2 12 (697) 750 (1,071) (1,004) (47) (1,051) At beginning of year: Effect of adoption of principles of
IFRIC 14 for accounting for pension schemes I1 (139) (139) (139)
Share Share Retained lation securities Hedging holders’ Minority Total Note capital premium earnings reserve reserve reserve equity interests equity
Reserves Profit for the year 947 947 3 950 Items recognised directly in equity: Movement on cash flow hedges (3) (3) (3) Unrealised valuation movements on securities classified as available-for-sale of discontinued banking operations (2) (2) (2)
Total income and expense for the year 947 13 (105) (2) 853 3 856
Reserve movements in respect of share-based payments 18 18 18 Change in minority interests arising principally from purchase and sale of venture investment companies and property partnerships of the PAC with-profits fund and of other consolidated investment funds (28) (28)
Share capital and share premium New share capital subscribed H11 1 181 182 182 Transfer to retained earnings in respect of shares issued in lieu of cash dividends H11 (175) 175
Intangible assets attributable to shareholders: Deferred acquisition costs and other intangible assets H1(b) 5,349 2,836
Other non-investment and non-cash assets: Property, plant and equipment H6 635 1,012 Reinsurers’ share of insurance contract liabilities H3 1,240 783 Deferred tax assets H4 2,886 951 Current tax recoverable H4 657 285 Accrued investment income G1,H5 2,513 2,023 Other debtors G1,H5 1,232 909
Held for sale assets H9 – 30 Cash and cash equivalents G1,H10 5,955 4,951
Liabilities Policyholder liabilities and unallocated surplus of with-profits funds: Insurance contract liabilities H12 136,030 132,776 Investment contract liabilities with discretionary participation features G1 23,446 29,550 Investment contract liabilities without discretionary participation features G1 14,501 14,032 Unallocated surplus of with-profits funds H12 8,414 13,959
Core structural borrowings of shareholder-financed operations: Subordinated debt H13 1,987 1,570
Other non-insurance liabilities: Obligations under funding, securities lending and sale and repurchase agreements G1 5,572 4,081 Net asset value attributable to unit holders of consolidated unit trusts and similar funds G1 3,843 3,556 Current tax liabilities H4 842 1,237 Deferred tax liabilities H4 3,229 3,402 Accruals and deferred income 630 599 Other creditors G1 1,496 1,020
Total equity and liabilities 215,542 219,382 *The Company has adopted the principles of IFRIC 14 for pension schemes, giving rise to consequential changes to the comparative results and balances of 2007. Note I1 explains the effect of the change.
The consolidated financial statements on pages 131 to 305 were approved by the Board of directors on 18 March 2009.
Harvey McGrath Mark Tucker Tidjane Thiam Chairman Group Chief Executive Chief Financial Officer
Total (loss) profit before tax (2,074) 1,280 Changes in operating assets and liabilities: Other non-investment and non-cash assets (1,659) (466) Policyholder liabilities (including unallocated surplus) (26,987) 11,845 Other liabilities (including operational borrowings) (631) 902
Interest income and expense and dividend income included in profit before tax (4,989) (8,201) Other non-cash items (74) (141) Operating cash items: Interest receipts 2,937 5,541 Dividend receipts 2,019 2,732 Tax paid (653) (624)
Cash flows from investing activities Purchases of property, plant and equipment H6 (240) (231) Proceeds from disposal of property, plant and equipment 11 61 Acquisition of subsidiaries, net of cash balances I6(iv) – (77) Disposal of Egg, net of cash balances I9 – (538) Disposal of other subsidiaries, net of cash balances I6(iv) – 157 Deconsolidation of investment subsidiaries I6(iv) – (91)
Equity capital: Issues of ordinary share capital H11 12 6 Dividends paid B3 (297) (255)
Net increase (decrease) in cash and cash equivalents 454 (160) Cash and cash equivalents at beginning of year 4,951 5,071 Effect of exchange rate changes on cash and cash equivalents 550 40
Cash and cash equivalents at end of year H10 5,955 4,951 *The Company has adopted the principles of IFRIC 14 for pension schemes, giving rise to consequential changes to the 2007 comparative results. Note I1 explains the effect of the change.
†This measure is the formal (loss) profit before tax measure under IFRS but it is not the result attributable to shareholders.
The consolidated financial statements consolidate the Group and the Group’s interest in associates and jointly-controlled entities. The parent company financial statements present information about the Company as a separate entity and not about the Group.
The consolidated financial statements have been prepared and approved by the directors in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). The Company has elected to prepare its parent company financial statements in accordance with UK Generally Accepted Accounting Practice (GAAP). These are presented on pages 306 to 315.
A3: Critical accounting policies, estimates and judgements a Critical accounting policies Prudential’s discussion and analysis of its financial condition and results of operations are based upon Prudential’s consolidated financial statements, which have been prepared in accordance with IFRS adopted for use in the EU. Were the Group to apply IFRS as published by the IASB, as opposed to EU-adopted IFRS, no additional adjustments would be required.
In this regard, the issues surrounding IAS 39 application are very similar to those considered by other US life insurers when the US financial reporting standard FAS 133 was first applied for US GAAP reporting. Taking account of these considerations the Group has decided that, except for certain minor categories of derivatives, it is not appropriate to seek to achieve hedge accounting under IAS 39. As a result of this decision the total income statement results are more volatile as the movements in the value of Jackson’s derivatives are reflected within it.
Supplementary analysis of results and earnings attributable to shareholders The Group uses operating profit based on longer-term investment returns as a supplemental measure of its results. The basis of calculation is disclosed in note A4(d).
b Critical accounting estimates and judgements Investments Determining the fair value of financial investments when the markets are not active The Group holds certain financial investments for which the markets are not active. These include financial investments which are not quoted on active markets and financial investments for which markets are no longer active as a result of market conditions e.g. market illiquidity. When the markets are not active, there is generally no or limited observable market data for the financial investments. The determination of whether an active market exists for a financial investment requires management’s judgement.
If the market for a financial investment of the Group is not active, the fair value is determined in full or in part by using valuation techniques. The Group establishes fair value for these financial investments by using quotations from independent thirdparties, such as brokers or pricing services or by using internally developed pricing models. Priority is given to publicly available prices from independent sources, when available but overall, the source of pricing and/or the valuation technique is chosen with the objective of arriving at a fair value measurement which reflects the price at which an orderly transaction would take place between market participants on the measurement date. The valuation techniques include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option adjusted spread models and, if applicable, enterprise valuation and may include a number of assumptions relating to variables such as credit risk and interest rates. Changes in assumptions relating to these variables could positively or negatively impact the reported fair value of these instruments.
The fair values of financial investments, net of derivative liabilities, valued using a valuation technique either internally by the Group or by independent third-parties at 31 December 2008 was £40,252 million (2007: £33,822 million). Of these amounts, financial investments net of derivative liabilities with a fair value of £24,833 million (2007: £19,748 million) were held by the US operations. Financial investments valued using valuation techniques held by UK operations were £15,399 million (2007: £14,139 million) and of this amount £14,695 million (2007: £13,580 million) related to securities held by with-profits operations and £704 million (2007: £559 million) related to securities held by the UK shareholder-backed business. Debt securities of US insurance operations valued internally using valuation techniques in 2008 include certain asset-backed securities which had previously been valued using prices provided by a pricing service or brokers in the context of active markets. The current market dislocations have caused a reassessment of the valuation process for these asset-backed securities. In particular, beginning the end of the third quarter of 2008, the external prices obtained for certain asset-backed securities were deemed to be inappropriate in the current market conditions. For the valuations at 31 December 2008, the US operations have therefore utilised internal valuation models, provided by PPM America, to derive fair values for all non-agency residential mortgage-backed securities and asset-backed securities and certain commercial mortgage-backed securities. The techniques used by PPM America include cash flow models based on spreads and, when available, market indices. Additional details are explained in note G1.
Changes in the estimates of credit risk in any reporting period could result in a change in the allowance for losses on the loans and advances.
Notes on the Group financial statements A: Background and accounting policies continued
Insurance contracts Product classification IFRS 4 requires contracts written by insurers to be classified as either ‘insurance contracts’ or ‘investment contracts’ depending on the level of insurance risk transferred. Insurance risk is risk, other than financial risk, transferred from the contract holder to the contract issuer. If significant insurance risk is transferred by the contract then it is classified as an insurance contract. Contracts that transfer financial risk but not significant insurance risk are termed investment contracts. Furthermore, some contracts, both insurance and investment, contain discretionary participating features representing the contractual right to receive additional benefits as a supplement to guaranteed benefits: a that are likely to be a significant portion of the total contract benefits; b whose amount or timing is contractually at the discretion of the insurer; and c that are contractually based on asset or fund performance, as discussed in IFRS 4.
Accordingly, insurers must perform a product classification exercise across their portfolio of contracts issued to determine the allocation to these various categories. IFRS 4 permits the continued usage of previously applied GAAP for insurance contracts and investment contracts with discretionary participating features. Except for UK regulated with-profits funds, as described subsequently, this basis has been applied by the Group.
This lack of sensitivity reflects the with-profits fund structure, basis of distribution, and the application of previous GAAP to the unallocated surplus of with-profits funds as permitted by IFRS 4. Changes in liabilities of these contracts that are caused by altered estimates are absorbed by the unallocated surplus of the with-profits funds with no direct effect on shareholders’ equity. The Company’s obligations and more detail on such circumstances are described in note H14.
Jackson Jackson offers individual fixed annuities, fixed index annuities, immediate annuities, variable annuities, individual and variable life insurance and institutional products. With the exception of institutional products and an incidental amount of business for annuity certain contracts, which are accounted for as investment contracts under IAS 39, all of Jackson’s contracts are accounted for under IFRS 4 as insurance contracts by applying US GAAP, the previous GAAP used before IFRS adoption. Under US GAAP the requirements of SFAS 60 ‘Accounting and Reporting for Insurance Enterprises’ and SFAS 97 ‘Accounting and Reporting by Insurance Enterprises for certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments’ apply to these contracts. The accounting requirements under these standards and the effect of changes in valuation assumptions are considered below for fixed annuity, variable annuity and traditional life insurance contracts.
The principal non-participating business in the Group’s Asian operations, for which changes in estimates and assumptions are important from year to year, is the traditional whole-life business written in Taiwan. The premiums for the in-force business for these contracts have been set by the regulator at different points for the industry as a whole. Premium rates were set to give a guaranteed minimum sum assured on death and a guaranteed surrender value on early surrender based on prevailing interest rates at the time of policy issue. Premium rates also included an allowance for mortality and expenses. The required rates of guarantee have fallen over time as interest rates have reduced from a high of eight per cent to current levels of around 1.4 per cent. The current low bond rates in Taiwan gives rise to a negative spread against the majority of these policies. The current cash costs of funding in-force negative spread in Taiwan is around £50 million a year.
The profits attaching to these contracts are particularly affected by the rates of return earned, and estimated to be earned on, the assets held to cover liabilities and on future investment income and contract cash flows. Under IFRS, the insurance contract liabilities of the Taiwan business are determined on the US GAAP basis as applied previously under UK GAAP. Under this basis the policy liabilities are calculated on sets of assumptions, which are locked-in at the point of policy inception, and a deferred acquisition cost asset is held in the balance sheet.
The adequacy of the insurance contract liabilities is tested by reference to best estimates of expected investment returns on policy cash flows and reinvested income. The assumed earned rates are used to discount the future cash flows. The assumed earned rates consist of a long-term best estimate determined by consideration of long-term market conditions, and rates assumed
to be earned in the trending period. In determining the long-term estimate, external advice of expert macroeconomic consultants has been obtained. At 31 December 2008 it has been assumed that the longer-term bond rate of 5.5 per cent will be attained by 31 December 2018 (2007: 5.5 per cent by 31 December 2013).
The deferral and amortisation of acquisition costs is of most relevance to the Group’s results for shareholder-financed long-term business of Jackson and Asian operations. The majority of the UK shareholder-backed operations is for individual and group annuity business where the incidence of acquisition costs is negligible.
For variable annuity business, the key assumption is the expected long-term level of equity market returns as described above. The level of acquisition costs carried in the balance sheet is also sensitive to unrealised valuation movements on debt securities held to back the liabilities and solvency capital. Further details are explained in notes D3(i) and H1.
In 2008, a number of changes have been made to the basis of estimating the level of deferred acquisition costs, as described in note D4(i)(b).
In the case of PSPS, movements in the apportionment of the surplus or deficit for PSPS between the WPSF and shareholders’ funds in 2008 reflect the 70/30 ratio applied to the base deficit position as at 31 December 2005 but with service cost and contributions for ongoing service apportioned by reference to the cost allocation for activity of current employees. For SAPS the ratio is estimated to be 50/50 between the WPSF and shareholders’ funds.
On 1 January 2008, the Group adopted IFRIC 14 ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’. IFRIC 14 provides guidance on the recognition of IAS 19 surpluses in, and funding obligations for, defined benefit pension schemes. As a result of the adoption of this interpretation, in respect of the position at 31 December 2008, the Group has not recognised the underlying PSPS pension surplus of £728 million (£615 million net of deferred tax), reflecting the difference between the market value of the scheme assets and the discounted value of the liabilities, which would have otherwise been recognised as an asset on its balance sheet under the previous policy. In addition, the Group has recognised a liability for deficit funding to 5 April 2010 of £65 million (£55 million net of deferred tax) in respect of PSPS. Of these, the amounts attributable to shareholders are £223 million (£160 million net of deferred tax) for the surplus not recognised as an asset and £20 million (£15 million net of deferred tax) for the additional liability for deficit funding. In total the impact on shareholders’ equity at 31 December 2008 is a reduction of £175 million.
ii Financial investments on an available-for-sale basis – this comprises assets that are designated by management and/or do not fall into any of the other categories. These investments are carried at fair value. Interest income is recognised on an effective interest basis in the income statement. Except for foreign exchange gains and losses on debt securities, not in functional currency, which are included in the income statement, unrealised gains and losses are recognised in equity. Upon disposal or impairment, accumulated unrealised gains and losses are transferred from equity to the income statement as realised gains or losses.
All derivatives that do not meet the relevant hedging criteria are carried at fair value with movements in fair value being recorded in the income statement.
Embedded derivatives Embedded derivatives are held by various Group companies including Jackson. They are embedded within other non-derivative host financial instruments to create hybrid instruments. Where economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risks of the host instrument, and where the hybrid instrument is not measured at fair value with the changes in fair value recognised in the income statement, the embedded derivative is bifurcated and carried at fair value as a derivative in accordance with IAS 39.
In Jackson, for 2008 and subsequently, the embedded derivative liabilities for Guaranteed Minimum Withdrawal Benefit (GMWB), Guaranteed Minimum Income Benefit (GMIB) reinsurance, and Fixed Index Annuity business are valued by reference to AA corporate bond rates. Previously, the liabilities had been measured by reference to swap rates. The reason for the change is the anomalous swap curves applying in the current dislocated credit markets. Further details are provided in note D3 (g).
Derecognition of financial assets and liabilities The Group’s policy is to derecognise financial assets when it is deemed that substantially all the risks and rewards of ownership have been transferred. The Group also derecognises a financial asset when the contractual rights to the cash flows from the financial asset expire. Where the Group neither transfers nor retains substantially all the risks and rewards of ownership, the Group will derecognise the financial asset where it is deemed that the Group has not retained control of the financial asset.
Borrowings Although initially recognised at fair value, net of transaction costs, borrowings, excluding liabilities of consolidated collateralised debt obligations, are subsequently accounted for on an amortised cost basis using the effective interest method. Under the effective interest method, the difference between the redemption value of the borrowing and the initial proceeds (net of related issue costs) is amortised through the income statement to the date of maturity.
b Long-term business contracts Income statement treatment Premiums and claims Premium and annuity considerations for conventional with-profits policies and other protection type insurance policies are recognised when due. Premiums and annuity considerations for linked policies, unitised with-profits and other investment type policies are recognised when received or, in the case of unitised or unit-linked policies, when units are issued. These amounts exclude any taxes or duties assessed based on premiums.