PRUDENTIAL PLC, THROUGH ITS BUSINESSES IN EUROPE, THE US AND ASIA, PROVIDES RETAIL FINANCIAL PRODUCTS AND SERVICES AND FUND MANAGEMENT TO MANY MILLIONS OF CUSTOMERS WORLDWIDE.
01 GROUP FINANCIAL HIGHLIGHTS 02 CHAIRMAN’S STATEMENT 03 GROUP CHIEF EXECUTIVE’S REVIEW 06 BUSINESS REVIEW 14 FINANCIAL REVIEW 21 CORPORATE SOCIAL
MEMBERS OF PRUDENTIAL PLC 72 FIVE YEAR REVIEW 74 ACHIEVED PROFITS BASIS
85 INDEPENDENT AUDITORS’ REPORT ON THE ACHIEVED PROFITS BASIS SUPPLEMENTARY INFORMATION
• Its products are distributed through a number of channels including direct to customers (telephone, internet and mail), through intermediaries including Independent Financial Advisers and consulting actuaries, through the workplace to its corporate pensions customers and via affinities and banks.
• The business currently employs some 8,000 staff located in offices in Stirling, Reading, Belfast and London.
Prudential Europe was formed in 1999 to spearhead Prudential’s expansion into continental Europe. Its operations encompass both the manufacture and distribution of Prudential branded products in France and Germany.
• M&G’s retail investment products include unit trusts, PEPs (Personal Equity Plans), ISAs (Individual Savings Accounts), OEICs (Open Ended Investment Companies) and investment trusts. Its institutional business focuses on segregated fixed interest and pooled pension funds.
• M&G employs some 1,300 staff and services more than 906,000 unit holder accounts.
• Prudential Property Investment Managers, the largest institutional property investor in the UK, and PPM Ventures, a private equity investment business, are also part of the M&G group.
Prudential began its first Asian operations in India in 1923. Today, it is Europe’s leading life insurance company in Asia, employing around 5,000 staff and serving more than 2.2 million customers.
– China International Trust and Investment Corporation (CITIC) for life insurance.
• PCA’s distribution is predominantly through some 60,000 agents, but also through a growing number of other distribution channels including its successful bancassurance relationship with Standard Chartered Bank (SCB).
• JNL’s investment portfolio is managed by PPM America Inc., which manages some US$57 billion of US assets.
• Egg plc provides banking, insurance, investments, mortgages and a shopping portal through its internet site and other distribution channels.
• Egg plc has more than two million customers and employs some 2,200 staff mostly based at its call centres in Derby and Dudley.
Achieved profits basis results Operating profit before tax UK Insurance Operations: Long-term business 620 708 General business 79 33
Banking deposit balances under management £6.5bn £7.6bn 01 Prudential plc Annual Report 2001
Keith Bedell-Pearce retired from the Board at the end of the year. Keith had been with Prudential for almost 30 years and he made an enormous contribution to the development of the Company. I have personally appreciated his wise counsel since I joined the Board.
We welcomed Mark Wood to the Board in June. Mark joined the Group from AXA UK as Chief Executive of Prudential’s UK and European Insurance Operations. In November, we appointed Clark Manning President and Chief Executive Officer of Jackson National Life and Chief Executive Officer of our North American operations.
I am delighted to report that 2001 has been another strong year for the Group with achieved basis operating profit (after restructuring costs) up 15 per cent to £1,186 million and record total Group insurance and investment sales of £21.5 billion, an increase of 54 per cent on 2000.
The proposed merger with American General early in the year was consistent with our strategic approach and demonstrated our focus on growth across the Group. As we indicated at the time, the transaction was not about our position in the United States in 2001 or the year ahead – it was about the positioning of the business in four or five years time. It was an excellent opportunity for Prudential and while we were clearly disappointed that the transaction did not proceed, it is important to remember that we already have an excellent business in the US in Jackson National Life. Going forward, we will continue to look for opportunities to grow the business.
The benefits of our strategy are clear. We are a leading international financial services company with significant brand, distribution and product capabilities in each of our chosen markets, and when combined with our financial strength and efficient cost base, we are very well placed to deliver superior investment returns to our customers and shareholders.
Sir Roger Hurn, Chairman 02 Prudential plc Annual Report 2001 25.4p TOTAL DIVIDEND UP 3.7%
In my review in last year’s Report and Accounts, I said that the real challenge for the Group was to use our considerable achievements in 2000 as a springboard for further growth and success in 2001, and I am delighted to report that this is exactly what we have done.
This performance was particularly pleasing because it was achieved against a backdrop of tough market conditions for many areas of our business. Turbulence in capital markets has led to credit losses and a fall in embedded value. However, the overall Group results reflect the fact that Prudential is a financially strong company with outstanding businesses and a broad international base.
WE ARE EXTREMELY WELL POSITIONED TO BENEFIT FROM THE GROWTH IN CUSTOMER DEMAND FOR ASSET ACCUMULATION AND INCOME IN RETIREMENT WITH A BUSINESS MODEL THAT HAS FINANCIAL STRENGTH AND DIVERSITY OF EARNINGS BY GEOGRAPHIC REGION AND PRODUCT.
Our UK Insurance Operations have undergone an enormous transformation in recent years and the development of our business model in the UK to improve our service offering to over seven million customers continued in 2001. We made changes to our direct sales channels and customer service operations and set out a more focused strategic direction for the business, creating further cost efficiencies and bringing together the operating units under the powerful Prudential brand.
M&G’s market position, investment capabilities and brand strength make it one of the leading fund managers in the UK. The successful integration with Prudential Portfolio Managers has created a focused business with strong positions in all of its markets. Investment performance continued to be encouraging against difficult market conditions. Within the retail market, M&G materially increased market share during the year, and on the institutional side won a number of sizeable new fixed income mandates on the back of the growing trend among defined benefit pension schemes to seek to cap their liabilities.
Since we launched Egg in 1998, it has become one of the UK’s leading e-commerce financial brands and the leading digital bank is performance delivery and our ability to develop the business so that growth will continue after the four year period, and one which is consistent with our focus on delivering value.
The markets in which we operate around the world are experiencing significant change, bringing challenges but also enormous opportunities. This change is being driven by a number of factors including demographic shifts, changing regulation and government policy, different consumer attitudes, greater consumer sophistication, market reform and liberalisation, and increasing competition. Prudential, with its AAA financial strength, comprehensive distribution, product innovation and scale operations is well placed to meet these challenges and take advantage of the opportunities they present.
In recent years, the market has changed significantly. The responsibility for providing an income in retirement is gradually shifting from the state and employers to individuals.
With the burden of future retirement provision too much for most state schemes and with a growing equity culture emerging in many markets, the outlook for the retail savings markets in Europe is likely to remain positive for sometime to come, bringing with it significant growth potential for new and established financial services providers.
2000 Household Annual asset assets1 ($ trillion) 2000 per capita ($000) growth (1995-2000)
Retirement Other Retirement Other Retirement Other 1 Includes equities, bonds, cash, annuities, personal pensions, private equity (except UK) and trusteed pension assets. Excludes government sponsored trusts. 2 CAGR% 97-99 Source: Goldman Sachs Global Aging Report, Merrill Lynch Banks Review, Asia Demographics Ltd.
The fastest growing age group in the US is the 40+ population who control by far the largest share of total net worth and should offer significant opportunities in the asset accumulation products markets. It is anticipated that over 40 million baby boomer households will move into retirement in the next 20 years and that 21 per cent of Americans will be over 65 years of age in 2050 compared to 12 per cent today. We believe that the growth prospects that will be generated by these favourable demographic trends over the medium to long-term are very positive and represent a significant opportunity for high quality businesses like Jackson National Life (JNL).
In JNL, we have one of the top 20 life insurance companies in the United States in terms of total assets. Since we acquired it in 1986, JNL has been transformed into a market leading provider in its chosen product lines and distribution channels.
While its performance during the year was affected by the continued market volatility in the US, particularly in areas such as variable and equity-linked products, JNL’s broad product and distribution mix enabled it to deliver strong results in other areas including fixed annuities and stable value products.
Asia 2001 was another year of success and impressive growth for the Group in Asia. Prudential Corporation Asia (PCA) now operates in 12 countries, having added Japan and Korea to its geographic mix during the year, and it already has top-five market positions in eight operations across the region. Through its extensive network of life insurance and mutual funds operations committed to meeting customers’ needs, PCA is very well positioned to capture a significant part of Asia’s fast-growing financial services market.
Summary 2001 has been another year of considerable success and achievement for the Group and the benefits of our strategy of diversification by product and distribution channel internationally are very clear. The implementation and delivery of this strategy has, of course, been made possible by the hard work and drive of our staff and I would like to thank them all for their continued support throughout the year.
Prudential is one of only 10 insurance companies worldwide with AAA financial strength ratings from both Standard & Poor’s and Moody’s. We have some truly outstanding businesses across the Group and through our focus on value rather than volume as well as our active management of capital, I believe that we are very well placed for the future.
RATIO OF WORKING-AGE ADULTS (AGED 15-64)� TO THE ELDERLY (AGED 65 AND OVER) IN THE� DEVELOPED WORLD O
During the year, we announced changes to our customer services operations, including the closure of our direct sales force, to enable us to meet changing customer needs and to continue to operate cost-effectively as a scale player in the UK market. We also transferred our general insurance operations to Winterthur Insurance, while forming an alliance with its UK subsidiary, Churchill, to continue to offer Prudential-branded general insurance products in the UK, while benefiting from Winterthur’s market-leading expertise and capabilities in this sector. The transaction, which completed in January 2002, is expected to generate approximately £810 million for Prudential over time, and reflects our strategy of deploying capital where it will deliver the most value. Profit arising from the transaction will be accounted for in 2002.
We have an excellent brand and marketleading positions in a number of product areas. Our future strategic focus will be on high growth medium to long-term savings products, including annuities, pensions, with-profits bonds and ISAs. We believe this product mix offers the 06 Prudential plc Annual Report 2001
Size of circle represents new business size in Annual Premium Equivalent in 2000. Market growth is estimate for next 10 years. Circles represent Prudential’s target markets. Annuities includes Single Premium Individual Pensions.
(NHS), giving us access to over a million NHS employees. In addition, we have around a 50 per cent share of the local government AVC market. In 2001, we further improved our service to customers by enabling them to carry out transactions to their pensions on-line through their company intranet, with employers benefiting from the ability to automatically collect contributions direct from the payroll system.
Sales of our with-profits bonds through IFAs were up 33 per cent to a record £2 billion. 2001 marked the tenth anniversary of Prudence Bond, and in January 2002, we launched an enhanced with-profits product to build on the success of Prudence Bond. It provides greater flexibility and clarity to customers and will enable us to continue to build on our market-leading position within the with-profits market.
Prudential has seven million customers in the UK giving us a presence in one in five households. Prudential is ranked number one in brand awareness in the 45+ age group, which accounts for 70 per cent of the savings market and is a key focus for us in growing the business.
best growth prospects in the market by meeting customer needs for long-term savings and retirement income.
Sales of individual annuities totalled £1.3 billion during the year, up 17 per cent. We launched an impaired life annuity, which offers higher income to those with chronic conditions, and a Flexible Retirement Income Account offering customers a greater degree of freedom in their pension arrangements. We wrote an increasing volume of shareholder backed annuity business during the year which will result in a greater portion of the economic benefits flowing directly to shareholders.
As well as seeing a shift from defined benefit to defined contribution schemes for employees, we expect that over time the bulk annuities market will grow to an estimated £300 billion as trustees seek to manage remaining liabilities under defined benefit schemes. In 2001, our sales of bulk annuities totalled £575 million, and we will continue to be a leading player in this market.
UK population 16-75 years Prudential customer base Relative propensity to own bond product
M&G’s market leadership in liability and cash flow matching being a particular factor behind these wins. During 2001, M&G continued to develop its pooled fund business and increased the number of defined contribution clients.
2001 proved a challenging year for the retail fund management industry with gross industry retail sales falling 22 per cent, net retail sales falling 48 per cent and net Individual Savings Account (ISA) sales falling 39 per cent (Association of Unit Trusts and Investment Funds figures to December 2001). Excluding an exceptional loan note rollover in 2000, relating to the original acquisition of M&G by Prudential, M&G saw a decrease in gross sales of only five per cent and achieved a significant increase in net retail sales over the year. M&G was able to leverage its leading fixed income position and reduce redemptions, in addition to benefiting from an increasing recognition among Independent Financial Advisers (IFA) of the good performance of a number of its equity funds. M&G also significantly increased its market share in the IFA channel, winning more than a six per cent share of all ISA and Personal Equity Plan transfer business sold via intermediaries during 2001.
M&G’s property and private equity arms, which primarily invest on behalf of the Prudential Assurance Company, also enjoyed a successful year. The managed property portfolio delivered another impressive performance, beating its market benchmark by a considerable margin, its tenth consecutive year of outperformance. While market conditions for private equity remain challenging, we continued to diversify the portfolio with new investments across Europe and Asia.
M&G has also taken significant steps to build its distribution capability in other parts of the world. In 2001, M&G won unitholder approval to convert 38 of its unit trust funds to an OEIC (Open Ended Investment Company) structure. This conversion is part of M&G’s plans to distribute its product range into European markets.
M&G M&G is Prudential’s UK and European fund management business and has over £120 billion of funds under management.
These funds are invested in a wide range of assets, including UK and international equities, fixed interest, property and private equity. M&G is the UK’s second largest retail fund manager in terms of funds under management.
Underlying profit from the core retail and wholesale businesses was £56 million, an increase of £4 million from 2000. In addition, M&G earned a performance fee of £19 million (£14 million in 2000) reflecting its outperformance in managing the Prudential life fund. M&G’s profits of £75 million compare to £125 million in 2000. This decline was primarily due to the transfer of the life and pensions business to Scottish Amicable in 2000, which contributed £35 million of operating profit in 2000.
M&G’s strategy of refocusing its institutional business on core areas of strength in fixed interest, defined contribution and pooled pensions is increasingly bearing fruit as the move away from defined benefit schemes gathers momentum. A further £700 million of institutional specialist fixed income mandates were won during the year, with
In Germany, our focus has been on unitlinked pension and protection products, distributed through local agent sales forces. During 2001, Prudential Europe re-launched its Vorsorge critical illness product, and launched two new mutual funds which were developed jointly with the Deutsche Bank Group. These are fund of funds (Dachfonds) and are the first Prudential branded products to be available in the German market.
During 2001, new business achieved profits of £8 million remained broadly in line with 2000. Total sales in 2001 were £78 million, more than double the levels achieved in the previous year, principally due to strong sales of Prudential Europe Vie, an equity-backed life insurance product that was launched in France in January 2001.
Egg’s management accounts for November showed that the business made a profit for the month. In doing so, Egg met the commitment made at the time of its flotation in June 2000 that it would break even during the fourth quarter of 2001. Egg’s management team is confident that its UK business is sustainably profitable.
During the year, Egg acquired 600,000 net new customers, giving a year-end total of 1.95 million. Today, Egg has over two million customers. The credit card business performed strongly, particularly Egg Card, and now has 1.37 million customers. Credit card balances nearly doubled to £1.8 billion and credit quality remains strong. Egg Mortgages increased its book by 18 per cent to £1 billion.
In January 2002, Egg announced its intention to launch in France during the year. As part of this strategy, Egg will acquire Zebank (subject to regulatory approval), the leading French on-line banking business, which will provide Egg with a platform to distribute Egg-branded products. In addition to this deal, Egg has signed distribution partnerships with French retailers Sephora and La Samaritaine.
The markets in the United States witnessed a year of unprecedented uncertainty in 2001, with equity markets suffering significant declines and bond defaults reaching record levels. No one in the US was immune from these difficult market conditions and Jackson National Life (JNL) was no exception.
However, long-term demographic trends in the US are favourable and we have continued to develop and enhance our product range and distribution channels to ensure that we are well placed to benefit from the anticipated growth in the US financial services market.
This reflects our key strengths in distribution, product design and cost. In addition, initiatives to expand product lines and distribution channels have resulted in more diversified, higher quality earnings.
Against this background, JNL recorded total sales of £4.6 billion during the year, down only marginally on the record figure set in 2000. Sales of fixed annuities reached record levels, up 80 per cent to £1.9 billion. Despite declining interest rates in 2001, investors sought the safety of fixed annuities resulting in record industry sales.
New business achieved profits fell to £167 million from £221 million in 2000, principally due to the adoption of revised achieved profits assumptions and a five per cent reduction in total sales. In force profits were affected by £369 million (US$532 million) of net losses relating to JNL’s bond holdings, resulting in a £74 million charge against current year profits on a five-year averaging basis. These losses equated to 1.4 per cent of JNL’s total invested assets and default experience appears to be broadly in line with that of our major competitors.
po pu la tio n by a ge g ro up O
Over the last five years, JNL has made significant progress in widening its product range, enabling us to sell profitable products in almost any economic environment. In addition, our costs remain among the lowest in the industry and our highly rated service and technology capability makes us well positioned for continued growth and diversification.
Our Institutional Marketing Group (IMG), which distributes through banks in the US, announced another record year with sales up nearly 58 per cent on 2000. IMG now offers annuities direct to customers through more than 320 banks and credit unions in the US, as well as to around 1,930 financial institutions through third-party marketing organisations and bank broker/dealers.
In 2001, JNL issued £1.7 billion of institutional products and maintained a top 10 position in the overall institutional product market and a top four position in the Medium Term Note funding agreement market. The notes, which may be in any currency, are issued to institutional investors and are backed by funding agreements issued by JNL.
Source: Townsend & Schupp. Companies with more than $100m Fixed annuity sales, and more than $1bn Variable annuity sales LIMRA 2000.
Our success in Asia derives from a unique combination of competitive advantages including our ability to invest for the longterm, an extensive understanding of local markets and their people, considerable experience of overcoming barriers to entry into new markets, and our ability to leverage the power and financial strength of Prudential’s brand.
This helps us to capitalise on synergies in brand, systems, product and distribution development while taking into account the great diversity in culture, regulation and levels of economic development across the region. Very importantly, we have also benefited from our ability to attract, motivate and retain the best people in the industry.
The prospects for the long-term savings markets in Asia are significant, driven by a combination of favourable demographic trends and increasing market liberalisation. Through its extensive network of life insurance and mutual funds operations, Prudential Corporation Asia (PCA) is strongly positioned to capture a major part of the region’s fast-growing financial services market.
2001 was another year of strong growth for PCA. This was despite the anticipated slowdown in life insurance new business growth rates during the fourth quarter as the global economic slowdown started to have an effect on the region. Sales of insurance products on an annual premium 12 Prudential plc Annual Report 2001
PCA’S DEVELOPMENT IN TERMS OF GEOGRAPHY, PRODUCT AND DISTRIBUTION SINCE 1994
Distribution Agency ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■
Prudential is now the largest private sector mutual funds company in India, having re-entered the Indian market in 1998 by teaming up with one of the country’s leading banking groups, ICICI, and launching award-winning funds. In December 2000, we entered the Indian life market with the launch of ICICI Prudential, one of the few international joint ventures to be fully licensed and selling policies. The partnership with ICICI has gone from strength to strength and has grown still further in 2001 to include a bancassurance relationship with ICICI Bank.
Hong Kong’s Mandatory Provident Fund had its first full year of operation in 2001 and our joint venture with Bank of China International (BOCI) is now one of the leaders in this market with an estimated 15 per cent market share. In December 2001, BOCI-Prudential also launched its first unit trust in Hong Kong.
Looking ahead, the global economic slowdown is likely to depress shortterm growth rates in the region. However, the long-term potential in Asia remains exceptional. PCA, with its significant portfolio of businesses in the region, multichannel distribution capabilities, excellent strategic partners, and customer-focused product expertise is in a very strong position to continue to benefit from the excellent growth potential throughout Asia.
Achieved operating profit, before development costs and minority interest, increased from £213 million to £415 million in 2001. Achieved profit from life operations increased from £205 million to £405 million. New business achieved profits were up 67 per cent to £255 million, reflecting strong sales growth across all operations, and in force achieved profit growth was also strong. This strong growth reflects PCA’s successful strategy of entering new markets, strengthening and diversifying distribution channels and meeting customers’ needs with innovative products.
South Asia Greater China North Asia Proportion from alternative distribution, such as bancassurance
Pr op or tio n fr om a lte rn at iv e di st rib ut io n (%
This has resulted in our reducing the risk discount rate applied to our UK and US operations from 8.5 per cent to 7.7 per cent, and reducing the UK investment return assumption from 8.0 per cent to 7.1 per cent.
New Business Achieved Profit Group new business achieved profit from insurance business of £673 million was 10 per cent ahead of prior year, reflecting strong growth in Asia partially offset by a fall in profit at JNL. The growth in new business achieved profit reflects a 16 per cent increase in insurance sales on an annual premium equivalent (APE) basis.
Offsetting this the Group new business achieved profit margin decreased from 40 per cent to 38 per cent, primarily reflecting the adoption of active basis reporting combined with the impact of lower US spreads (ie the difference between the investment rate we earn and the rate we 2001 was an exceptional year for sales with total insurance and investment sales reaching a record £21.5 billion, up 54 per cent on last year. Total new business inflows including renewal premiums reached £25.7 billion, 42 per cent ahead of last year.
Total Achieved Operating Profit Total achieved operating profit before re-engineering costs was £1,250 million, up 21 per cent from £1,029 million in 2000. This result reflects a 10 per cent improvement in new business achieved profit to £673 million combined with a 24 per cent improvement in the in force result to £673 million.
Results from other operations including development costs and other shareholders’ income improved from a loss of £128 million in 2000 to a loss of £96 million, principally due to a much reduced initial operating loss at Egg.
Our results are reported on the basis of the new ABI guidance for Achieved Profits reporting, issued in December 2001. The revised guidance requires the economic assumptions used for the projection of cash flows to be on an ‘active’ basis, that is primarily based on appropriate government bond returns at each period end. These assumptions are reflected in the profit reported for the year to 31 December 2001. Previously, the results have been prepared on a ‘passive’ basis, which uses stable assumptions based on a long-term economic credit to our customers’ accounts) brought about by the challenging US operating environment.
UK Insurance Operations’ new business achieved profit of £243 million is six per cent higher than 2000. This is mainly due to increased volumes of new business written during the year, offset by the impact of the move to active basis economic assumptions.
The 24 per cent fall in Jackson’s new business achieved profit to £167 million was driven by a five per cent decline in new insurance sales and a decline in new business margin from 44 per cent to 35 per cent, primarily reflecting a reduction in the spread assumption in the current challenging operating environment and revisions to variable annuity lapse rates.
Prudential Asia’s new business achieved profit of £255 million is up 67 per cent on 2000 reflecting strong sales growth across all operations (APE insurance sales up 14 Prudential plc Annual Report 2001
Total long-term business 1,346 1,157 16% Development costs for long-term business (48) (21) General business 79 33
operating results on a five year average basis. Accordingly, this resulted in a £74 million charge to the current year operating result. The US$532 million loss represents 1.4 per cent of JNL’s total invested assets and includes approximately US$200 million charged to this year’s result following impairment in the portfolio identified in 2002.
Asia in force profit (before development costs) has increased significantly from £60 million in 2000 to £160 million in 2001. The result includes a £66 million profit reflecting improvements in operating assumptions across all long-term businesses in the region and £16 million of favourable experience variances in Singapore, Hong Kong and Malaysia.
M&G’s profit has also been affected by reducing fee income due to lower equity markets, and investment in new operations, including Cofunds and Europe. We have now established an office in Berlin and will start to sell our global theme range via intermediaries in Germany in 2002. A performance fee of £19 million was recognised in the 2001 result (£14 million) due to the life fund beating its strategic benchmark by 2.3 percentage points (the investment return for the life fund was minus 3.5 per cent against a strategic benchmark of minus 5.8 per cent).
Egg moved into profit in the fourth quarter of 2001 and the reported loss of £88 million is in line with the market expectation. Egg is 69 per cent). The new business margin in Asia remained broadly stable at 59 per cent despite a significant change in geographic and product mix.
In Force Achieved Profit The UK in force profit of £377 million was down 21 per cent on 2000. The decline is mainly due to lower than expected returns in the UK arising from the lower discount rate, and strengthening of the assumption for the amount of required capital for our shareholder backed businesses, offset by lower renewal expense assumptions resulting from the closure of the direct sales force.
The US in force profit has increased significantly from a loss of £2 million in 2000 to a profit of £136 million in 2001. However, the 2000 result was affected by a change to the persistency and expense assumptions which led to a charge of £258 million. Excluding this charge in 2000, 2001 profit was 47 per cent down, primarily reflecting lower investment income and the fact that we did not, in the increasingly competitive market, fully reset policyholder crediting rates to compensate.
Amortisation of goodwill was £95 million against £84 million in 2000.
UK Insurance Operations’ operating profit (excluding discontinued operations) in 2001 was £435 million, £33 million below 2000. This reflected the effect of lower with-profits bonuses together with the one-off £30 million profit in 2000 relating to transfer of the M&G life and pensions business to Scottish Amicable.
The US operations result of £298 million was £168 million worse than prior year, principally reflecting reduced spread income combined with a £67 million charge in per share on an MSB basis were down 6.9 pence to 23.3 pence.
Funds Flow The table below provides details of the holding company funds flow. We believe that for an insurance group this presentation provides a clearer demonstration of the use of resources than the format prescribed under FRS 1 shown on page 43 of the full financial statements.
The holding company’s net funds outflow of £421 million compares to a funds inflow of £179 million in 2000 and is after taking into account a £699 million investment in businesses, and £132 million of timing 16 Prudential plc Annual Report 2001
Group operating profit after tax and minority interests 460 591 American General Corporation merger break fee* 332 0 Capital repatriated from businesses 80 123 Proceeds from disposals 0 173 New share capital subscribed 42 45 Listing of shares on New York Stock Exchange 0 139
Proceeds of 2001 initiatives due in 2002 c. 450 * Net of expenses and applicable taxes.
Euro denominated offering of subordinated hybrid capital securities as the first issue under a new European Medium Term Note (EMTN) programme. This was marketed throughout Europe and the UK.
The Group’s capacity to meet its financial commitments remains very strong. On the achieved profits basis, interest cover improved to 11.6 times in 2001 from 8.9 times in 2000, driven by strong earnings from a diversified income stream to service debt. The current level of interest cover is broadly in line with the level recorded four years ago. Group gearing was 21 per cent at 31 December 2001 (including the December hybrid issue) compared to 16 per cent at
Prudential plc enjoys strong debt ratings from both Moody’s and Standard & Poor’s. Its rated long-term debt is Aa3 and AA
differences and other items. The investment in businesses includes £162 million in relation to acquisitions comprising £139 million in relation to Orico Life in Japan and £23 million in relation to Korea.
This funds flow statement does not reflect the benefits to the Group of a number of initiatives that were undertaken in 2001. The Group will receive the benefit of about £450 million in 2002 including proceeds of the sale of the General Insurance business and the capital release from the Part 7 transfer (previously 2C transfer) of the life fund of Scottish Amicable Life into the Prudential Assurance Company (PAC) Life Fund.
Core structural borrowings of shareholder financed operations at the end of 2001 totalled £2,152 million, including £2,020 million at fixed rates of interest with maturity dates ranging from 2005 to 2031, as set out in note 31 on page 66 of the full financial statements. Of these borrowings £344 million were denominated in US dollars, partially to hedge the currency exposure arising from our investment in Jackson National Life. Core borrowings also included £87 million shortterm commercial paper, and £45 million floating rate loan notes, all sterling denominated.
In December 2001, we placed a Sterling and respectively, while short-term ratings are P-1 and A-1+.
The aim of our capital funding programme, which includes the EMTN programme and an unlimited commercial paper programme, is to maintain a strong and flexible funding capacity.
Interest cover ratio = (achieved operating profit before goodwill amortisation and re-engineering costs – interest payable on core borrowings)/interest payable on core borrowings.
Statutory basis shareholders’ funds, which are not affected by fluctuations in the value of investments in the Prudential Assurance Company (PAC) long-term fund, were almost unchanged at £3,950 million against £3,971 million in 2000.
Prudential Assurance Company’s Inherited Estate In order to support our with-profits business, we hold a substantial amount of working capital in PAC's long-term fund. Without such working capital, we could not provide the benefits associated with smoothing and guarantees, or invest such a high proportion of the main with-profits fund’s assets in equities and property, for the benefit of both policyholders and shareholders.
The balance at any time of the main with-profits fund, which is not expected to be paid out to the current generation of with-profits policyholders as claim values, represents the major part of Prudential Assurance’s working capital and is called the ‘inherited estate’.
To ensure that policyholders’ benefits are secure, we are required by regulations to hold a substantial amount of capital in our long-term fund, so that we can demonstrate at all times that the Company is solvent its local regulatory requirements permit, Prudential seeks to invest its assets predominantly in equities and property that have, over longer periods, provided superior returns to fixed interest assets.
Insurance and investment funds under management at 31 December 2001 totalled £163 billion, compared to £165 billion at the end of 2000. This reduction is mainly due to a fall in the market value of investments which more than offset the net sales achieved during the year. The total includes £137.2 billion of Group investments under management and £25.6 billion of external funds under management. Internal funds are analysed in the table below.
The long-term funds remain well capitalised and the PAC long-term fund is rated AAA by Standard & Poor's and Aaa by Moody's.
At 31 December 2001, 69 per cent of the assets of the fund were held in equities and property, including 15 per cent in international equities, 15 per cent in property and 39 per cent in UK equities. This reflects our strategic asset allocation of the fund between equities and other classes of assets and represents a switch over the last couple of years away from equities into investment grade bonds. The fund had an investment return of negative 3.5 per cent in 2001. This compares to a fall in the FTSE all-share index of 15 per cent over the same period and represents a strong investment performance from M&G and from our fund managers in America and in Asia.
Recent Accounting Pronouncements In December 2000, the Accounting Standards Board published a new accounting standard, FRS 19, ‘Deferred tax’, which replaced SSAP 15. We adopted the new standard early and have restated our 2000 comparatives accordingly. The
The statutory valuation has been prepared on a conservative basis in accordance with the valuation rules, and without use of implicit items. No allowance has been taken for the present value of future profits and the PAC long-term fund has not entered into any financial reinsurance contracts.
Solvency requirements in the UK include the establishment of a resilience reserve which makes prudent allowance for potential future movements in investment values. The Financial Services Authority (FSA) relaxed the recommended resilience tests in September 2001 in response to the changing economic conditions and extreme market movements at that time. Pending the outcome of FSA consultation on the resilience tests that should be applied in the future, we have applied the rigorous adoption of the new standard has had a limited impact on our shareholder results.
UK Equities 38.5% Alternative Assets 1.6% International Equities 14.8% M&G Fixed Interest 19.4%
20 Prudential plc Annual Report 2001 to sale. Prudential expects to continue publishing this information in the future following the implementation of the international standard as the statutory reporting basis.
Supervision From 1 December 2001, the Financial Services Authority (FSA) took formal responsibility for the regulation and supervision of all our authorised UK insurance, investment and banking businesses under the Financial Services and Markets Act 2000.
In addition, the FSA considers a view of the Group’s management of its non-UK businesses, in order to understand how pan-Group risks are managed. This helps the FSA meet its statutory objectives.
International Accounting Standard for Insurance The International Accounting Standards Board (IASB) has undertaken a project to develop and implement an accounting standard for insurance. The IASB is currently reviewing the draft statement of principles prepared by its predecessor body, the International Accounting Standards Committee. The IASB’s timetable is to implement a standard by 2005. In addition, the European Union will require all European insurers to implement IASB standards in 2005.
The implementation of the proposed standard will present considerable challenges for the industry worldwide, requiring development of accounting and actuarial systems. In order for European companies to meet the EU timetable, the standard needs to be published in final form in 2003.
In the UK, the information provided to investors by the supplementary financial information on the Achieved Profits basis allows investors and other users of the accounts to assess the profitability and value created from new business written and the management of in force business subsequent
Financial control procedures Detailed controls, applicable across the Group, are laid down in financial and actuarial procedures manuals.
Performance planning and monitoring There is a comprehensive planning and performance monitoring system based on key performance indicators for each business area. The Group Board receives regular reports on the performance of the Group against plan, together with frequent financial forecasts and projections.
PRUDENTIAL IS ONE OF ONLY 10 INSURANCE COMPANIES WORLDWIDE WITH AAA FINANCIAL STRENGTH RATINGS FROM BOTH STANDARD & POOR’S AND MOODY’S.
We will continue to build Plan For Life Learning during 2002, extending access to financial education and improving financial literacy for people from a diverse range of backgrounds.
Environment During 2001, we announced our intention to produce our first detailed environment report, documenting our environmental policy and the progress on environmental management made within our UK business since July 1999, when our environment programme began. This is available at www.prudential.co.uk. We recognise that, through our day to day business activities and the investments made on behalf of customers we have an impact on the environment. We are committed to minimising that impact and preventing pollution and unnecessary damage to the environment from our operations.
• In the UK, Prudential offers development opportunities through ‘Einstein’, a desktop portal which provides access to a range of learning opportunities, with an emphasis on interpersonal skills. M&G employees can also access development courses through an e-learning website known as ‘The I’.
During 2001 we conducted a review of our approach to CSR to ensure that our existing focus was appropriate for our business in the future.
Community We are committed to supporting the communities where we are an employer. We aim to build strong, relevant and longterm associations that meet our business objectives and are of real value to the organisations with whom we work. Our support consists of cash donations as well as support in kind, such as the expertise of our staff, office space, computer equipment and other gifts in kind. In 2001, these contributions amounted to £2.8 million, of which £1.3 million was spent on charitable donations. Our community investment is international, reflecting our business structure and local priorities. Initiatives in 2001 included: • Our office in Vietnam worked in partnership with the British government to establish a vocational school for underprivileged children in Ho Chi Minh City.
The Prudential plc Board is fully committed to ensuring that CSR issues are properly integrated into our wider Group strategy. Philip Broadley, Group Finance Director, has taken on executive responsibility for this going forward.
9. Ann Burdus (Age 68) A director since 1996. Non-executive director of Next plc. Council member of the Institute of Directors. Previously a non-executive director of Safeway Group plc and previously a committee member of the Automobile Association.
10. Roberto Mendoza (Age 56) A director since May 2000. Non-executive Chairman of Egg plc. Non-executive director of ACE Limited, Reuters Group PLC and Vitro SA. Co-CEO of Hancock, Mendoza, Dachille & Merton, Limited. Previously Vice Chairman and director and a member of the Corporate Office of JP Morgan & Co, Inc., and a managing director of Goldman Sachs.
4. Michael McLintock (Age 40) A director since September 2000. Chief Executive of M&G since February 1997, a position he held at the time of M&G’s acquisition by Prudential in March 1999. Joined M&G in October 1992. Nonexecutive director of Close Brothers Group plc since May 2001.
The head of each business unit, who in respect of their business unit responsibilities report to the Group Chief Executive, has authority for management of that business unit and has established a management board comprising the most senior executives in that business unit.
Remuneration Committee Sir David Barnes (Chairman) Ann Burdus Roberto Mendoza Rob Rowley Sandy Stewart
The Remuneration Committee normally meets at least twice a year to review remuneration policy and determines the remuneration packages of the executive directors and certain other senior executives. Additional meetings of the Remuneration Committee are held as necessary during the year. In framing its remuneration policy, the Committee has given full consideration to the provisions of Section 1B of and Schedule A to the Code. The Remuneration Report prepared by the Board is set out on pages 27 to 32. In preparing the Report, the Board has followed the provisions of Schedule B to the Code.
Except in relation to the remuneration of the Group Chief Executive, when only the Chairman is consulted, the Remuneration Committee consults the Chairman and the Group Chief Executive about the Committee’s proposals relating to the remuneration of all executive directors and certain other senior executives. The Committee has access to professional advice inside and outside the Company.
Nomination Committee Sir Roger Hurn (Chairman) Sir David Barnes Ann Burdus Sandy Stewart
The Nomination Committee meets as required to consider candidates for appointment to the Board and to make recommendations to the Board in respect of those candidates.
Copies of any instructions and advice given by an independent professional adviser to a director is supplied by the director to the Company Secretary who will, unless otherwise instructed by the director concerned, circulate to other directors any necessary information to ensure that other members of the Board are kept informed on issues arising affecting the Company or any of its subsidiaries.
Directors’ Independence, Training and Re-election The non-executive directors were throughout the year and continue to be considered to be independent. Given the calibre and experience of our non-executive directors and given that the roles of the Chairman of the Board, Audit Committee and Remuneration Committee are split, the Board does not believe that it is appropriate at this time to recognise a senior independent director, other than these Chairmen, to whom concerns can be conveyed in respect of relevant issues. The Company is one of the UK’s largest institutional investors and the Board does not believe that this situation compromises the independence of those non-executive directors who are also on the boards of companies in which the Company has a shareholding. The Board also believes that such shareholdings should not preclude the Company from having the most appropriate and highest calibre non-executive directors.
Non-executive directors are appointed initially for a three-year term. The appointment is reviewed towards the end of this period. Upon appointment, all non-executive directors embark upon an induction programme that will usually take the form of visits to different business areas in the Group where the opportunity is taken for the newly appointed director to meet members of staff. Training is available for executive directors where appropriate.
All directors are required to submit themselves for re-election at regular intervals and at least every three years, and at the AGM following their reaching the age of 70.
The Annual General Meeting will be held at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on Thursday, 9 May 2002 at 11.00am. The Company believes the Annual General Meeting is an important forum for both institutional and private shareholders and encourages attendance by all its shareholders. At its Annual General Meeting in 2001, the Company indicated the balance of proxies lodged for each resolution after it had been dealt with on a show of hands and the total percentage of share capital voted on all resolutions. This practice provides shareholders present with sufficient information regarding the level of support and opposition to each resolution. The Company discloses the number of the proxy votes received to any shareholder upon request after the Annual General Meeting. The notice of the Annual General Meeting and related papers are sent to shareholders at the same time as the Annual Report and Annual Review and Summary Financial Statement more than 20 working days before the meeting. At the 2002 Annual General Meeting, as with last year’s meeting, questions will be sought from shareholders.
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 36 to 70 and the supplementary information on pages 75 to 84. It is the responsibility of the auditors to form an independent opinion, based on their audit of the financial statements and their review of the supplementary financial statements; and to report their opinions to the Company’s shareholders. Their opinions are given on pages 71 and 85.
The Group Risk Framework, adopted in 1999, requires that all of the Group’s businesses and functions establish processes for identifying, evaluating and managing the key risks faced by the Group.
Businesses are required to confirm annually that they have undertaken risk management during the year as required by the Group Risk Framework and that they have reviewed the effectiveness of the system of internal control. The results of this review were reported to and reviewed by the Audit Committee and confirmed that the processes described above and required by the Group Risk Framework were in place throughout 2001 and complied with Internal Control: Guidance for Directors on the Combined Code (the Turnbull guidance). Internal Audit undertakes a review for the Audit Committee of the operation of the risk management process throughout the Group.
The Group’s internal control framework includes detailed procedures laid down in financial and actuarial procedure manuals. The Group prepares an annual business plan with three year projections. Executive management and the Board receive monthly reports on the Group’s actual performance against plan, together with regularly updated forecasts. The Group’s risk management procedures are further described in the Financial Review.
As a result of a review of the Group’s remuneration policy and the current arrangements for executive directors, new incentive plans are being introduced from 2002 subject to shareholders’ approval. In addition an executive shareholding policy is also being introduced from 2002. The new arrangements are detailed in a shareholders’ circular dated 4 April 2002.
Salary The Remuneration Committee normally reviews executive directors’ salaries annually, having regard to business results, individual accountabilities and performance, and market conditions. Independent surveys are obtained on salary levels in major international companies in both the financial and non-financial sectors in relevant locations.
For 2001, with the exception of Michael McLintock who has an annual bonus award in line with remuneration levels in the investment management industry, executive directors were eligible for awards of up to 110 per cent of basic salary at the end of the performance period, ie at the end of 2001. The award for on target performance is 50 per cent of basic salary at the end of 2001, paid in cash. For performance above target, part of the award is made in Prudential plc shares deferred for three years during which time dividends accumulate for the benefit of the award holders.
Benefits and protections Executive directors receive certain benefits, principally the provision of company cars or allowances, participation in medical insurance schemes and in some cases security arrangements. These benefits are not pensionable.
In addition, the Company provides certain protections for directors and senior managers against personal financial exposure which they may incur in their capacity as such.
The basic fees payable to each non-executive director is £32,500 per annum. It is intended that the non-executive directors will continue to use a portion of their fees to purchase shares in the Company which they will hold at least until their retirement from the Board.
With effect from 1 June 2001, the respective Chairmen of the Audit and Remuneration Committees were paid an additional fee of £5,000 per annum in respect of their respective roles and the other directors on each Committee were paid an additional fee of £2,500 per annum. It is intended that each year the net amount of these fees will be used by the non-executive directors to purchase shares in the Company, which will be held at least until their retirement from the Board. In 2001 the fee received by Sir Roger Hurn as Chairman was £300,000. In addition, Sandy Stewart, as Chairman of the supervisory board of the Scottish Amicable Insurance Fund received a fee of £30,000 and Roberto Mendoza as Chairman of Egg received a fee of £75,000.
Executive directors Keith Bedell-Pearce (retired 31/12/01, note 3) 340 165 46 551 458
Les Cullen (resigned 29/2/00, note 4) – – – – 122 Sir Peter Davis (resigned 29/2/00) – – – – 105 Derek Higgs (retired 30/11/00) – – – – 511
Non-executive directors Michael Abrahams (retired 5/5/00) – – – – 23 Sir David Barnes 35 – – 35 29
Sir Roger Hurn (appointed 17/2/00, Chairman 5/5/00) 300 – 9 309 200 Sir Martin Jacomb (retired 5/5/00) – – – – 65 Bridget Macaskill (resigned 16/3/01) 8 – – 8 29 Roberto Mendoza (appointed 25/5/00) 109 – – 109 68
3. Keith Bedell-Pearce’s bonus includes a payment of £45,000 recognising his contribution to the Company’s long-term objectives.
6. Mark Tucker’s bonus includes a payment of £495,350 from his 1999 Asian long-term incentive plan. His benefits include an allowance of £124,000 for housing paid to reflect his expatriate circumstances.
Directors’ Long-term Incentive Plans Since 1996 up to and including 2001, the Group’s primary long-term incentive plan was the Restricted Share Plan which was designed to provide rewards contingent upon the achievement of pre-determined returns to shareholders.
Under the Restricted Share Plan executive directors have received annual grants of conditional awards of shares in the Company which are held in trust for three years.
In 2001, it became apparent that long-term incentive awards made in the market had moved significantly. Therefore for 2001, for the Group Chief Executive, the conditional Restricted Share Plan award was equivalent to 200 per cent of basic salary at the time of the award and for Michael McLintock the award was equivalent to 80 per cent of basic salary. For Philip Broadley and Mark Tucker, the award was equivalent to 160 per cent of basic salary. The shares were valued at their average share price during the preceding calendar year, and the award price used for the 2001 award was 975.6 pence (2000 – 921.7 pence).
At the end of the three-year performance period, a right to receive shares at no cost to the individual may be granted dependent on the Company’s Total Shareholder Return (TSR) relative to other companies in the FTSE 100 share index over the performance period. In addition, the Remuneration Committee must be satisfied with the Company’s underlying financial performance during this period. No rights will be granted if the Company’s TSR percentile ranking is 60th or below and the maximum grant will be made only if the TSR percentile ranking is 20th or above. Between these points, the size of the grant made is calculated on a straight line basis. In normal circumstances, directors may take up their right to receive shares at any time during the following seven years.
Details of conditional awards made under the Plan are shown below. These shares are held in trust and represent the conditional awards out of which rights may be granted, as stated above, at the end of the relevant performance period.
Keith Bedell-Pearce 36,024 30,620 234 * The market value of rights granted in 2001 is based on the market value of the shares over which rights are granted on the day of the grant.
** Following his retirement, no release will be made in respect of the 2000 RSP award to Keith Bedell-Pearce.
Directors’ Long-term Incentive Plans continued Details of awards under other long-term incentive schemes are set out below: Michael McLintock – long-term awards To reflect his role as Chief Executive of M&G, Michael McLintock also participates in a long-term incentive plan designed to provide a cash reward based on the economic and investment performance of M&G over a three-year period. Awards under the plan are made in the form of phantom share options and phantom restricted shares, vesting at the end of the performance period.
He held awards for the year 2001 with face values of £225,000 in phantom restricted shares and £367,800 in phantom share options.
Mark Tucker – long-term awards To reflect his role as Chief Executive, Prudential Asia, Mark Tucker also participates in a cash-based long-term incentive plan that provides rewards in respect of the Group’s Asian operations. This plan is designed to provide reward contingent upon the rate of growth in value of those operations over a three-year period. The threshold performance criteria under the plan is that the growth in value must be greater than 15 per cent per annum over the period. Any payment for performance above threshold is made following the end of the performance period. The on-target payout is 100 per cent of basic salary at the beginning of the period, for which an annual growth rate of 35 per cent is required. The payment for the 1999 award is included in the Directors’ Remuneration table.
Mark Wood – share awards and long-term awards In order to secure the appointment of Mark Wood, on joining Prudential he was granted Prudential plc share awards expected to be released as follows: 71,569 shares (31 July 2002), 15,080 shares (31 July 2003) and 31,672 shares (31 December 2003).
Directors’ Shareholdings As a condition of serving, all executive and non-executive directors have been required to hold 2,500 shares in the Company. These shares must be acquired within two months of appointment to the Board if the director does not own that number upon appointment. As stated above, non-executive directors also use a proportion of their fees to purchase additional shares in the Company on a quarterly basis.
Sir David Barnes 3,971 4,778 Keith Bedell-Pearce 144,654 178,289 Jonathan Bloomer 112,947 152,623 Philip Broadley 10,722 10,381 Ann Burdus 2,938 3,844 Sir Roger Hurn 10,000 10,000 Michael McLintock 2,820 3,884 Roberto Mendoza 2,765 3,444 Rob Rowley 2,799 3,680 Sandy Stewart 9,025 13,533 Mark Tucker 134,713 174,150 Mark Wood 2,550 120,900 * Or date of appointment if later.
Options Options Exercise Earliest Latest outstanding at Granted Exercised outstanding at price exercise exercise 1 Jan 2001 in year in year 31 Dec 2001 (pence) date date * Savings-Related Share Option Scheme.
Notes 1. The market price of shares at 31 December 2001 was 796 pence. The highest and lowest share price during 2001 were 1,095 pence and 568 pence respectively.
2. The market price of shares was 778 pence when Mark Tucker exercised options of 4,074 shares, resulting in a gain on exercise of £21,348.
3. Keith Bedell-Pearce will be entitled to exercise his Savings-Related share options as a result of his retirement.
Directors’ Pensions It is the Company’s policy to offer executive directors the facility to save for retirement through efficient pension vehicles. Changes were introduced by the UK Government in 1989 which restrict the pension provision which can be made under Inland Revenue approved pension schemes for new entrants after 31 May 1989 to benefits on annual basic salary up to a threshold known as the earnings cap. The earnings cap for the 2001/2002 tax year is £95,400 per annum. For this reason executive directors employed since 1989 are offered a combination of Inland Revenue approved pension schemes and supplementary provision.
Directors’ Pensions continued Inland Revenue approved pension schemes continued Mark Tucker and Keith Bedell-Pearce, having commenced employment before 1989, are eligible for benefits from PSPS on all basic salary. Keith Bedell-Pearce also has a special arrangement whereby his pension accrued since the age of 50 has been enhanced to 1/30 for each year of service. Philip Broadley and Mark Wood are eligible for benefits from PSPS on basic salary up to the earnings cap. Jonathan Bloomer only receives a lump sum death benefit of four times basic salary up to the earnings cap from PSPS.
Supplementary arrangements Directors are entitled to taxable salary supplements calculated on a formula based on their basic salary not covered for pension benefits under an Inland Revenue approved scheme.
Directors may elect to have this salary supplement paid directly to them or to a Funded Unapproved Retirement Benefit Scheme (FURBS) established in their name. In either case it is a taxable emolument.
In addition directors are eligible for death benefits broadly equivalent to the PSPS death benefits (both the lump sum and the capitalised value of spouse’s and children’s pensions) on that part of their basic salary not covered by the Inland Revenue approved scheme under the Prudential Supplementary Life Assurance Scheme (PSLAS). The premiums paid by the Company to this scheme are a taxable benefit.
Details of directors’ pension entitlements under Inland Revenue approved defined benefit schemes and the pre-tax contribution to salary supplements and/or FURBS are set out below: Additional pension earned Accrued entitlement based Pre-tax contribution to salaryYears of (excluding on normal retirement age supplement and/or FURBSpensionable inflation)
Age at service at in year 31 Dec 2001 31 Dec 2000* 2001 2000 *Or date of appointment to Board if later.
Total contributions to directors’ pension schemes including payments by the Company to PSPS, MGGPS and PSLAS were £575,000
In 2001 employees were again invited to participate in the Prudential Savings-Related Share Option Scheme. The Scheme has now been operating for over 18 years and a majority of UK staff currently participate. The Prudential International Savings-Related Share Option Scheme (‘ISOS’) for employees in Hong Kong, Malaysia and Singapore has been operating for two years. In 2001 employees in Taiwan and India joined the Scheme. On average just over 30 per cent of employees in those countries covered by the ISOS currently participate.
Donations We are committed to supporting the communities where we are an employer. In 2001 we spent £2.8 million in support of the community. Within this, direct donations to charitable organisations amounted to £1.3 million. Charitable giving benefits a wide range of organisations including those involved with financial literacy, education, regeneration and family welfare. The Group’s policy not to make donations to political parties, within the normal meaning of that expression, has not changed and the Group did not make any such donations in 2001.
The following table shows the statutory basis results reported in the profit and loss account on pages 36 to 38.
General business: UK Insurance Operations 79 33 Re-engineering costs* (7) –
Long-term business: UK Operations: UK Insurance Operations 435 468 M&G – 35
Balance on the long-term business technical account before tax (analysed on pages 37 and 38) 677 988
Statutory basis profit for the financial year after minority interests: Operating profit after tax and related minority interests before amortisation of goodwill 460 591 Items excluded from operating profit after tax before amortisation of goodwill (71) 66
Total statutory basis profit for the financial year after minority interests 389 657
Earnings per share Based on operating profit after tax and related minority interests before amortisation of goodwill 23.3p 30.2p Based on total statutory profit for the financial year after minority interests – basic 19.7p 33.5p
Dividend per share 25.4p 24.5p † The tax charge, minority interests and earnings per share for 2000 have been restated for the implementation of FRS 19 on deferred tax (see note 4).
* Part of re-engineering costs of UK Insurance Operations of £48m borne by shareholders’ funds.
Premiums written, net of reinsurance 57 321 Change in the gross provision for unearned premiums (25) (10) Change in the provision for unearned premiums, reinsurers’ share 35 158 1
Change in long-term business provision: Gross amount (7,233) (6,239) Reinsurers’ share 221 123
Balance on the long-term business technical account 442 670 † The tax charge and the transfer from the fund for future appropriations for 2000 have been restated for the implementation of FRS 19 on deferred tax (see note 4).
Gross premiums written and the balance on the long-term business technical account relate to continuing operations.
Allocated investment return transferred to the long-term business technical account (385) (57) Investment expenses and charges 15 (162) (144) Unrealised losses on investments (162) (7) Allocated investment return transferred to the general business technical account (37) (47) Other income: UK investment management and products result 75 90 US broker dealer and fund management 16 7 Merger break fee (net of related expenses) 8 338 – Profit on business disposals – 239
Profit on ordinary activities before tax 8 385 947 Tax on profit on ordinary activities 16 (21) (314)
Profit for the financial year before minority interests 364 633 Minority interests 25 24
Reconciliation of operating profit before amortisation of goodwill to profit on ordinary activities* Continuing operations 550 807 Discontinued general business operations 72 33
Operating profit before amortisation of goodwill based on long-term investment returns 8 622 840 Amortisation of goodwill 17 (95) (84)
Based on profit for the financial year after minority interests of £389m (£657m) and 1,978m (1,959m) shares 5 19.7p 33.5p
* For the purposes of this analysis, operating profit is determined on a long-term investment return basis and before amortisation of goodwill. Management consider this to be the most meaningful definition of operating profit.
CONSOLIDATED STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES YEAR ENDED 31 DECEMBER 2001
Total gains and losses recognised since previous Annual Report 392 39 Prudential plc Annual Report 2001
Ordinary Retained share Share profit capital premium and loss (note 27) (note 27) reserve Total £m £m £m £m
† Total recognised gains relating to 2000 and the movement in capital and reserves for 2000 have been restated for the implementation of FRS 19 on deferred tax (see note 4).
Reinsurers’ share of technical provisions Provision for unearned premiums 35 163 5 Long-term business provision 589 353
Total liabilities 156,769 154,950 † As a result of restating comparatives for 2000 to reflect the implementation of FRS 19 on deferred tax, the provision for deferred tax at 31 December 2000 was increased by £2,445m. This increase in provision is matched by reductions of £2,350m in the fund for future appropriations, £49m in shareholders’ capital and reserves and £46m in technical provisions.
Fixed assets Investments: Shares in subsidiary undertakings 28 5,179 4,972 Loans to subsidiary undertakings 28 2,920 1,673
Current assets Debtors: Amounts owed by subsidiary undertakings 185 307 Tax recoverable 9 – Other debtors 24 6
The financial statements on pages 36 to 70 and the supplementary information on pages 75 to 84 were approved by the Board of directors on 14 March 2002.
Philip Broadley Group Finance Director 42 Prudential plc Annual Report 2001
Acquisitions, disposals and similar items Net cash (outflow) inflow from: Acquisition of subsidiary undertakings 33 (182) (167) Merger break fee received 8 338 – Flotation of Egg and business disposals – 195
The net cash inflow was invested as follows: Portfolio investments Purchases: Ordinary shares 20 9 Fixed income securities 2,416 146
FRS 17, ‘Retirement benefits’ was issued in November 2000. This standard specifies how costs of providing retirement benefits, in particular for defined benefit schemes, should be recognised and disclosed in the financial statements. Disclosures relating to the closing balance sheet position became effective for accounting periods ended on or after 22 June 2001. The Company has adopted the standard in this respect and details are disclosed in note 19. The additional requirements of FRS 17 in respect of performance statements are not mandatory for the 2001 financial statements and have not been adopted by the Company.
The consolidated financial statements of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Prudential has a controlling interest, using accounts drawn up to 31 December 2001. The results of subsidiaries are included in the financial statements from the date acquired to the effective date of disposal. All intercompany transactions are eliminated on consolidation except for investment management fees charged by M&G and the Group’s US and Asia fund management operations to long-term business funds.
Premiums and Claims Premium and annuity considerations for conventional with-profits policies and other protection-type life insurance policies are recognised when due. Premium and annuity considerations for linked policies, unitised with-profits policies and other investment-type policies are recognised when received or, in the case of unitised or unit linked policies, when units are issued. Premiums exclude any taxes or duties assessed based on premiums.
For single premium deferred annuity business of Jackson National Life, the determination of the expected emergence of margins, against which the amortisation profile of the DAC asset is established, is dependent on the key assumption of the expected long-term spread between the earned rate and the rate credited to policyholders. For 2001 the assumed rate was 1.75%.
Segregated accounts are established for policyholder business for which policyholder benefits are wholly or partly determined by reference to specific investments or to an investment-related index. The assets and liabilities of this linked business are reported as summary totals in the consolidated balance sheet.
Fund for future appropriations The fund for future appropriations (‘FFA’) represents the excess of assets over policyholder liabilities for the Group’s with-profits funds. The annual excess (shortfall) of income over expenditure of the with-profits funds, after declaration and attribution of the cost of bonuses to policyholders and shareholders, is transferred to (from) the FFA each year through a charge (credit) to the profit and loss account. The balance retained in the FFA represents cumulative retained earnings arising on the with-profits business that has not been allocated to policyholders or shareholders. The balance retained in the FFA is determined after full provision for deferred tax on unrealised appreciation on investments.
An unexpired risks provision is established for any excess of expected claims and deferred acquisition costs over unearned premiums and investment returns. The assessment of expected claims involves consideration of claims experience up to the end of the accounting period. No specific provision is made for major events occurring after this date. In addition to the liability for outstanding claims, an equalisation provision has been established in accordance with the requirements of the UK Insurance Companies (Reserves) Act 1995 to reduce the impact of claims volatility. Increases in the equalisation provision are limited to certain percentages of premiums written for different lines of business as specified by statute.
Investment returns are allocated from the non-technical account to the general business technical account using the longer-term rate of return on assets supporting the general business technical account, liabilities and solvency capital. Investment returns are also allocated between the long-term business technical account and the non-technical account for the difference between the actual investment rate of return of the long-term business technical account and the longer-term rate of return on the assets backing shareholder financed long-term business (primarily Jackson National Life). Further details are provided in note 5.
The balance of the long-term business technical account is net of the total tax attributable to the long-term business. In order to present the profit on long-term insurance activities in the non-technical account on a pre-tax basis, a tax credit attributable to the shareholders’ portion of the tax provision for long-term business, calculated at the effective tax rate (where appropriate on a long-term basis) of the underlying business, is added. This shareholder tax add-back is then included in the tax expense on the profit on ordinary activities within the non-technical account. Further details are provided in note 16.
Stock-based compensation The Group offers share award and option plans for certain key employees and a Save As You Earn plan (‘SAYE plan’) for all UK and certain overseas employees. Compensation costs for non-SAYE plans are recorded over the periods during which share awards or options are earned. Compensation costs are based on the quoted market prices of the shares at the grant date less any amounts paid or payable by employees in respect of the awards. In addition shares are issued to a qualifying share ownership trust with the excess of the market price subscribed at the date of transfer by the trust over nominal value recorded by the Company in its share premium account. This amount includes the difference between the market price at the date of transfer to the trust and amounts payable by employees. A cost equal to this amount is charged directly to the profit and loss account reserve within shareholders’ funds.
In accordance with SSAP 19, ‘Investment properties’, no depreciation is provided on investment properties (other than Group occupied) as management consider that these properties are held for investment purposes, and to depreciate them would not give a true and fair view of the Group’s financial position or profit for the financial year.
The Group’s investments in joint ventures are also recorded at the Group’s share of net assets. Other participating interests, where significant influence is not exercised, due to ownership being less than 20%, are carried as investments on the consolidated balance sheet at fair value.
Equity securities and debt and other fixed income securities Equity securities are carried at fair value. Debt and other fixed income securities are carried at fair value, except for those held by Jackson National Life, which are carried at amortised cost. Fair value is based on quoted market prices for listed securities, and on quotations provided by external fund managers, brokers, independent pricing services or values as determined by management for unlisted securities. Changes in fair value are recognised in investment returns during the year of the change. Debt and other fixed income securities held by Jackson National Life are carried at amortised cost as permitted by paragraph 24 of Schedule 9A to the Companies Act 1985. The amortised cost basis of valuation is appropriate under the provisions of the ABI SORP for Jackson National Life’s redeemable fixed income securities as they are held as part of a portfolio of such securities intended to be held to maturity. Further details of the valuation basis for fixed income securities of Jackson National Life are explained in note 11.
Loans to policyholders Loans to policyholders are carried at unpaid principal balances and are fully collateralised by the cash value of policies.
Securities lending The Group is party to various securities lending agreements under which securities are loaned to third parties on a short-term basis. The loaned securities are not removed from the Group’s consolidated balance sheet, rather, they are retained within the appropriate investment classification. Management’s policy is that collateral in excess of 100% of the fair value of securities loaned is required from all securities borrowers and typically consists of cash, debt securities, equity securities or letters of credit.
Tangible assets Tangible assets, principally computer equipment, software development expenditure, and furniture and fixtures, are capitalised and depreciated on a straight-line basis over their estimated useful lives, generally three to ten years. Leasehold improvements are depreciated over the life of the lease. Assets held under finance leases are capitalised at their fair value.
Further details of UK banking business assets and liabilities are contained in note 10(b).
Share premium Share premium represents the difference between the proceeds received on issue of shares, net of issue costs, and the nominal value of the shares issued.
Foreign currency translation The profit and loss accounts of foreign subsidiaries are translated at average exchange rates for the year. Assets and liabilities of foreign subsidiaries are translated at year-end exchange rates. Foreign currency borrowings that have been used to finance or provide a hedge against Group equity investments in overseas subsidiaries, are translated at year-end exchange rates. The impact of these currency translations is recorded as a component of shareholders’ funds within the Statement of Total Recognised Gains and Losses.
The summary effect of the changes on the Group’s earnings, fund for future appropriations, and shareholders’ funds are shown below: Revised basis of deferred tax provision, reflecting the implementation of FRS 19, as reported in these financial statements
Profit on ordinary activities before tax 385 947 Tax* (21) (314)
Profit for the year before minority interests 364 633 Minority interests 25 24
Previous basis of deferred tax provision, reflecting the application of SSAP 15 Memorandum As only previously (estimated) published
Profit on ordinary activities before tax 385 947 Tax* (123) (284)
Profit for the year before minority interests 262 663 Minority interests 25 25
Total liabilities 156,769 154,950 * The shareholder tax charge of £123m for 2001 on a SSAP 15 basis compares with a charge of £21m on the FRS 19 basis. Two factors explain the difference of £102m. For Jackson National Life, on a FRS 19 basis the recognised deferred tax asset increased by £27m over the year, whereas on a SSAP 15 basis no deferred tax asset is recognised. The remaining difference of £75m reflects the accounting treatment of deferred tax on unrealised appreciation on certain equity securities held to cover general business technical provisions and solvency capital. Previously the unrealised appreciation on these securities was regarded as a timing difference that did not require a deferred tax provision on the basis that it was not intended to sell the securities in the foreseeable future. As a result of changes to Inland Revenue rules for the taxation of unrealised appreciation on equities backing general insurance business, this treatment would no longer have been appropriate and a deferred tax provision would be necessary on a SSAP 15 basis as well as a FRS 19 basis. The £75m represents the deferred tax attaching to the unrealised appreciation as at 1 January 2001, which would already have been provided on the FRS 19 basis. The deferred tax provision at 31 December 2001 on these investments on both a FRS 19 and a SSAP 15 basis is £57m.
Actual gains attributable to shareholders: Longer-term gains credited to operating results: Excess of actual gains over longer-term gains (278) (467) 189 (59) 248
The table shown above compares actual and long-term investment gains from 1993 to 2001. 1993 is the earliest practicable year for preparing this information on the current basis of accounting which was implemented in 1998 on the publication of the ABI SORP.
In addition, operating profit excludes gains on business disposals and similar items.
Amortisation of goodwill (95) – – (95) (4.8)p Short-term fluctuations in investment returns:*
Merger break fee, net of related expenses 338 (6) – 332 16.8p 2000 (restated†) Operating profit based on long-term investment returns
Profit on business disposals 239 (57) – 182 9.3p * The adjustment from post-tax long-term investment returns to post-tax actual investment returns includes investment return that is attributable to external equity investors in two investment funds managed by PPM America. These two funds are consolidated as quasi-subsidiaries but have no net impact on pre-tax or post-tax operating profit. Total profit, before and after tax, incorporating the adjustment from long-term investment returns to actual investment returns, includes losses of £13m attributable to these minority interests.
† Earnings per share for 2000 have been restated for the implementation of FRS 19 on deferred tax.
Weighted average shares for basic earnings per share 1,978 1,959 Shares under option at end of year (note 27) 16 20 Number of shares that would have been issued at fair value on assumed option exercise (12) (11)
Long-term business Investment products General business Total £m £m £m £m £m £m £m £m
The geographical analysis of premiums and investment product contributions is based on the territory of the operating unit assuming the risk. A similar analysis by territory of risk would not be materially different.
Department of Social Security rebate business 64 59 – – 6 6
Department of Social Security rebate business 185 175 – – 19 18
GIC – European Medium Term Notes 1,504 1,291 – – 150 129
Single new business insurance premiums include increments under existing group pension schemes and pensions vested into annuity contracts (at the annuity purchase price). Regular new business contributions are determined on an annualised basis.
India Taiwan Other Total Asia mutual funds under management £m £m £m £m 53 Prudential plc Annual Report 2001
US Operations: Broker dealer and fund management 16 7 16 7
Prudential Asia (net of development expenses of £19m (£3m))* 25 36 25 36
Unrealised losses on investments (162) (7) (162) (7) Allocations to technical accounts (422) (104) (422) (104)
Re-engineering costs attributable to shareholders*** (7) – (41) – (48) –
Group operating profit before amortisation of goodwill 72 33 677 988 (127) (181) 622 840
Statutory basis profit on ordinary activities before tax 72 33 677 988 (364) (74) 385 947 * Asia Regional Head Office expenses of £14m incurred in 2000 and previously charged to the long-term business technical account, have been reclassified as corporate expenditure.
** Investment return and other income is shown after deducting interest payable on non-core borrowings, as described in note 15.
*** In February 2001 the Company announced the restructuring of the direct sales force and customer service channels of its UK Insurance Operations. In November 2001 the Company announced further details of changes to the future structure of those operations, in particular the intention to pursue a single brand strategy for life and pensions business including the integration of the Scottish Amicable operation under the Prudential brand. The changes also included a simplification of the organisational structure and plans for a significant reduction in operating costs. The total cost in 2001 of this restructuring, including amounts borne by the main with-profits fund, is £200m. £48m of this cost is attributable to shareholders on the modified statutory basis of reporting.
Comprising: UK Operations 98,832 103,543 Jackson National Life 25,055 23,585 Prudential Asia 4,894 3,340 Prudential Europe 634 593
† The restated fund for future appropriations for 2000 is £2,350m lower than previously reported following the implementation of FRS 19 on deferred tax.
* The Scottish Amicable Insurance Fund (‘SAIF’) is a separate sub-fund within the PAC long-term business fund. This sub-fund contains all the with-profits business and all other pension business that was transferred from the Scottish Amicable Life Assurance Society to PAC in 1997. No new business will be written in the sub-fund. The SAIF sub-fund will be managed to ensure that all the invested assets of SAIF are distributed to SAIF policyholders over the lifetime of the SAIF policies. With the exception of certain amounts in respect of unitised with-profits life business, all future earnings arising in SAIF are retained for existing SAIF with-profits policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period will be offset by a transfer to (from) the SAIF fund for future appropriations. Shareholders have no interest in the profits of SAIF, although they are entitled to the investment management fees paid on this business. Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency. With the exception of certain guaranteed annuity products (as described in note 32), SAIF with-profits policies do not guarantee minimum rates of return to policyholders.
Held within US operations relating to purchase of broker dealer and banking businesses 63 Other operations relating to M&G and acquired Asian businesses 1,624 *** Other US operations relate to broker dealer, fund management, intragroup funding arrangements and certain tax balances.
Discontinued home and motor business 390 333 51 (3) 28 36 79 33 Re-engineering costs – – (7) – – – (7) –
Interest receivable from: Loans and advances to banks 3 79 Loans and advances to customers 312 211 Debt securities 188 249
Assets Loans and advances to banks 67 238 Loans and advances to customers 4,712 3,736 Debt securities 3,061 3,686 Other banking assets 197 235
Total banking assets 8,037 7,895 Intragroup balances 4 – Deferred tax asset 15 11 Other assets including tax 28 39
Liabilities Customer accounts 5,945 7,128 Debt securities issued (note 31) 915 – Securities sold under agreements to repurchase (note 31) 384 – Other banking liabilities 221 258
† As a result of restating balance sheet comparatives for 2000 to reflect the implementation of FRS 19 on deferred tax, a deferred tax asset of £11m has been recognised.
In future years net earnings for Jackson National Life on a US GAAP basis are likely to reflect increased volatility owing to fair value fluctuations on its derivative instruments, particularly for interest rate swaps that are regularly used to manage risks associated with movements in interest rates. As noted above, changes in the fair value of derivative instruments, on a US GAAP basis, are now reflected in income. However, the largely offsetting change in the fair value of Jackson National Life’s hedged investments will remain as an adjustment taken directly to shareholders’ funds under US GAAP, as described in note (i). This position can be contrasted with the position under UK GAAP where hedge accounting for relevant derivative instruments is still appropriate. Accordingly, gains and losses recognised under FAS 133 are eliminated as part of the reconciliation to UK GAAP. By such elimination broad symmetry with the UK basis of valuation of debt securities is also attained.
12. Investment Income Long-term business Non-technical technical account account £m £m £m £m
Gains on the realisation of investments 2,719 7,579 106 32 57 Prudential plc Annual Report 2001
13. Long-term Business Provisions, Premiums and Policyholders’ Bonuses (a) Technical provisions and technical provisions for linked liabilities The following table provides an analysis of technical provisions between with-profits and non-participating business: Scottish Amicable Insurance Fund* 11% 11%
Shareholder financed business: Non-participating business 22% 21% Linked business 15% 17%
(b) Gross premiums The following table provides an analysis of gross premiums between with-profits and non-participating business: Scottish Amicable Insurance Fund* 2% 4%
** Annuity business written by Prudential Annuities Limited, a subsidiary of the with-profits fund of the Prudential Assurance Company Limited (PAC), and by a separate fund of the PAC with-profits fund, which comprises non-participating and linked business purchased from the Scottish Amicable Life Assurance Society.
Interest payable on core structural borrowings – – 118 131 Interest on bank loans and overdrafts 45 33 0 0 Interest on other borrowings 137 116 44 12
Interest on other borrowings in the non-technical account includes £12m (£12m) in respect of non-recourse borrowings of investment funds managed by PPM America, £4m (£nil) in respect of the UK Banking debenture loan and £28m (£nil) in respect of commercial paper borrowings that support a short-term fixed income securities reinvestment programme. Further details on borrowings are included in note 31.
Long-term business investment management expenses include management fees charged by M&G and the Group’s US and Asia fund management operations and fees paid to external property managers.
Tax on profit on ordinary activities (including tax on actual investment returns)** 21 314 * The tax charge on long-term business for 2000 excludes the tax related to M&G long-term business that has now been transferred to Scottish Amicable.
** The effective tax rate on total profit was 5% compared to 33% in 2000 due to tax payable on the American General merger break fee being relieved against capital losses available to the Group and acquired during the year.
(a) By category of timing difference Unrealised gains on investments 1,857 2,679 Deferred acquisition costs 465 391 Short-term timing differences (471) (359) Long-term business technical provisions and other insurance items 186 107 Capital allowances (32) (41)
(b) By fund Scottish Amicable Insurance Fund 145 247 PAC with-profits fund* 1,795 2,366 Jackson National Life (45) (7) Other long-term business operations 68 87 Other operations 42 84 * Includes deferred tax charges in respect of non-participating annuity business written by a subsidiary, Prudential Annuities Limited, financed by the PAC withprofits fund.
A potential deferred tax asset of £17m relating to realised losses has not been recognised.
Balance at beginning of year 1,611 1,582 Adjustment in respect of 1999 acquisitions – 5 Additions in respect of acquisitions (note 34): Orico Life Insurance Company, Japan 139 – YoungPoong Life, Korea 17 – Prudential SITE, Taiwan – 63 US banking and broker dealer operations 3 63 Other operations 12 4
18. Present Value of Acquired In Force Long-term Business £m £m
Balance at beginning of year 133 170 Exchange adjustment 4 9 Amortisation: Pre-tax 2 (65)
The balance at beginning of 2001 comprises cost of £254m less accumulated amortisation of £64m and tax of £57m.
Wages and salaries 734 656 Social security costs 61 55 Other pension costs (see below) 48 46
This Scheme has assets held in separate trustee administered funds and was last subject to full actuarial valuation as at 5 April 1999 by P N Thornton, a qualified actuary and a partner in the firm of Watson Wyatt Partners. The principal actuarial assumptions adopted were investment return 7.1% per annum, pensionable earnings growth 5% per annum, increases to pensions in payment 3% per annum and dividend growth 3.5% per annum.
The aggregate surplus before deferred tax provision, representing prepaid contributions, attributable to the Company at this date is £585m of which £441m is estimated to be attributable to prepaid contributions by the PAC with-profits fund and £144m is attributable to shareholder operations. At current levels, this surplus is anticipated to be recoverable only after many years of payment of the minimum contribution to PSPS but, on full implementation of FRS 17, is required to be recognised in the Group’s financial statements.
20. Directors’ Remuneration Information on directors’ remuneration is given in the Remuneration Report on pages 27 to 32. Apart from the transactions with directors shown in note 36, no director had an interest in shares, transactions or arrangements which requires disclosure, other than those given in the above Report.
Statutory audit fees 2.3 1.9 Audit related services: Regulatory returns and achieved profits basis audits 0.6 0.4 Tax and accounting advice 0.3 0.3 US GAAP work 0.2 0.7
The cost of land and buildings was £7,368m (£6,970m). The value of land and buildings occupied by the Group was £233m (£230m).
23. Investments in Participating Interests Cost Carrying value £m £m £m £m
Interest in associate undertaking 16 15 10 13 Interests in joint ventures 34 34 29 34
Share of Share of Convertible carrying capital reserves loan Goodwill value £m £m £m £m £m
The associate undertaking at the end of the year is IFonline plc, a company whose principal activity is mortgage intermediation. Egg plc has a 37% share in the total issued share capital of IFonline plc.
Amounts included in the above relating to listed investments were: Shares and other variable yield securities and units in unit trusts 40,077 50,785 Debt securities and other fixed income securities – carried at market value 31,816 26,516 Debt securities and other fixed income securities – carried at amortised cost 18,308 15,090
Depreciation: Balance at beginning of year (266) (231) Provided during year (108) (62) Arising on acquisition of subsidiaries (6) (5)
Net book value at beginning of year 288 239 64 Prudential plc Annual Report 2001
27. Share Capital and Share Premium The authorised share capital of the Company is £120m comprising 2,400,000,000 shares of 5 pence each.
At beginning of year 1,981,406,182 99.1 458.0 Shares issued under share option schemes and to qualifying share ownership trust 9,883,793 0.5 74.5 Shares issued in lieu of cash dividends 2,529,795 0.1 19.9 Transfer to retained profit in respect of shares issued in lieu of cash dividends – – (19.9)
At 31 December 2001 there were options subsisting under share option schemes to subscribe for 15,558,387 (19,816,460) shares at prices ranging from 201 pence to 759 pence (201 pence to 759 pence) and exercisable by the year 2008 (2007).
In addition to the 4.1m shares in respect of incentive plans, 6.0m shares were held by a qualifying employee share ownership trust. These shares are expected to be fully distributed after 1 June 2002 on maturity of savings-related share option schemes. The weighted average exercise price under these schemes is 558 pence and the expected proceeds of £33m relating to these shares have also been included in the consolidated balance sheet.
At beginning of year 4,972 1,673 Investments in subsidiary undertakings 208 – Disposals (1) – Exchange rate movements – 5 Advances of new loans – 1,350 Repayments of loans – (108)
30. Subsidiary Undertakings The principal subsidiary undertakings of the Company at 31 December 2001 were: Main activity Country of incorporation
(a) By fund Core structural borrowings of shareholder financed operations: Holding company and finance subsidiaries: Bank loans and overdrafts repayable on demand – 20 – 20
Total borrowings of shareholder financed operations 2,020 1,485 21 40 1,462 230 3,503 1,755
Borrowings of UK Banking operation (note (iv)): Borrowings of operations financed by with-profits operations: Scottish Amicable Finance plc (a subsidiary of the Scottish Amicable Insurance Fund of The Prudential Assurance Company Limited): (b) By maturity Borrowings are repayable as follows: Within one year or on demand 1,524 417 Between one and two years 0 0 Between two and five years 218 347 After five years 2,515 1,217
Borrowings (per table) 470 166 Obligations of Jackson National Life under sale and repurchase agreements 577 733 Obligations under finance leases 5 10
(v) The interests of the holders of the Bonds issued by Scottish Amicable Finance plc are subordinate to the entitlements of the policyholders of the Scottish Amicable Insurance Fund.
(vii) Jackson National Life has entered into a programme of funding arrangements (European Medium Term Notes – EMTNs) under contracts which, in substance, are almost identical to Guaranteed Investment Contracts. The liabilities of £2,816m (£1,920m) under these funding arrangements are shown on the consolidated balance sheet within creditors.
(viii) Under the terms of the Group’s arrangements with its main United Kingdom banker, the bank has a right of set off between credit balances (other than those of long-term funds) and all overdrawn balances of those Group undertakings with similar arrangements.
Jackson National Life has been named in civil litigation proceedings, which appear to be substantially similar to other class action litigation brought against many life insurers alleging misconduct in the sale of insurance products. At this time, it is not possible to make a meaningful estimate of the amount or range of loss, if any, that could result from an unfavourable outcome in such actions. In addition, Jackson National Life has been a defendant in several individual actions that involve similar issues. Most of the individual cases, including one which was on appeal to the Supreme Court in the State of Mississippi, were settled in January 2002 for a sum of £7m.
Pension Mis-selling Review We have received confirmation of our approach to complete Prudential Assurance’s outstanding Phase 1 (priority) cases from the Financial Services Authority (FSA), the UK insurance industry regulator, and we met the interim target of 82% Phase 2 (non-priority) cases offered by 31 December 2001. We are now taking steps to ensure that we finish the data gathering and loss calculation processes for all outstanding cases to enable us to achieve the 100% completion target for June 2002.
During the year a fine of £650,000 was levied by the Personal Investment Authority, following an inspection in 1999 of Prudential Assurance’s Phase 1 procedures, which revealed instances of delay in making payments of redress and of deficiencies in its record keeping.
32. Contingencies and Related Obligations continued The calculation of the pension mis-selling provision is dependent upon a number of assumptions and requirements provided by the FSA. The costs associated with the pension mis-selling review have been met from Prudential Assurance’s inherited estate. Given the strength of Prudential Assurance, the directors are of the opinion that charging the costs to the inherited estate will not have an adverse effect on the level of bonuses paid to policyholders or on their reasonable expectations. In the unlikely event of this proving not to be the case, the directors’ intention would be that appropriate support would be provided to the long-term fund from shareholders. In view of the uncertainty, it is not practicable to estimate the level of any potential support.
Provisions in respect of the costs associated with the review have been included in the change in the long-term business provision in the Group’s profit and loss account. The transfer from the fund for future appropriations has been determined accordingly. A summary of the changes in the pension mis-selling liability is set out below: £m £m
At beginning of year 1,475 1,700 Changes to actuarial assumptions and method of calculation (89) (117) Increase in provision for administrative expenses – 50 Discount unwind 89 102 Redress to policyholders (273) (134) Payments of administrative expenses (137) (126)
The pension mis-selling liability represents the discounted value of future expected payments, including benefit payments and all internal and external legal and administrative costs of adjudicating, processing and settling those claims. As a consequence, to the extent that amounts have not been paid, the provision increases each year reflecting the unwind of the discount.
Free Standing Additional Voluntary Contribution (FSAVC) Business Review We are taking steps to ensure that we meet the deadline of 31 December 2002 for completing outstanding cases (and the interim deadline of 90% of cases by 30 June 2002) including raising with the FSA the problem of delays by pension schemes in responding to requests for information. As a result of the work completed to date, Prudential Assurance holds a provision of £42m at 31 December 2001.
Jackson National Life offers synthetic guaranteed investment contracts to group customers including pension funds and other institutional organisations. These contracts represent an off-balance sheet fee-based product where the customer retains ownership of the assets related to these contracts and Jackson National Life guarantees each contractholder’s obligations to its own members in respect of these assets. The values of these guarantees were £22m at 31 December 2001.
Jackson National Life has unfunded commitments related to its investments in limited partnerships totalling £380m at 31 December 2001.
Reconciliation of operating profit to net cash inflow from operations £m £m
Movements arising from cash flow (434) (16) Investment (depreciation) appreciation (71) 22 Investments and cash acquired with purchase of businesses – 16 Exchange translation and other (2) 9 Transfer to retained profit in respect of shares issued in lieu of cash dividends 20 20 Portfolio investments net of financing at beginning of year (974) (1,025)
Portfolio investments net of financing at end of year (1,461) (974)
Represented by: Investments (including short-term deposits) 2,805 983 Cash at bank and in hand 193 209 Borrowings (per note 31) (3,985) (1,714) Share capital and share premium (633) (557) Cumulative charge to Group profit and loss account reserve in respect of shares issued to qualifying employee share ownership trust 159 105
General business and shareholder portfolio investments (as above) 2,805 983 Long-term business portfolio investments 117,010 117,445 Investments in participating interests 87 83
General business and shareholders (as above) 3,985 1,714 Long-term business 272 267
Total borrowings (per note 31) 4,257 1,981 69 Prudential plc Annual Report 2001
Comprising: Short-term fluctuations in investment returns after tax – 19 Profit on business disposals after tax – 167 Goodwill credited to reserves – 90 34. Acquisitions Acquisitions in 2001 principally relate to the purchase of Orico Life Insurance Company of Japan and YoungPoong Life in Korea.
The effect of these transactions, which have been accounted for as acquisitions, was: Japan Korea Other Total £m £m £m £m
35. Post Balance Sheet Events Sale of UK General Insurance Business In November 2001, the Company agreed to transfer its UK home and motor general business operations to Winterthur Insurance and the Churchill Group, its UK subsidiary. On 31 December 2001 the insurance liabilities of the business were almost wholly reassured, to Winterthur. The related cash transfer for this reinsurance was offset in January 2002 against the sale proceeds of the business. The sale was completed on 4 January 2002 for a consideration of £353m. After allowing for the costs of the sale and other related items, it is anticipated that the profit on sale recorded in the 2002 results will be approximately £360m before tax.
We read the other information contained in the Annual Report, including the corporate governance statement, and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent mis-statements or material inconsistencies with the financial statements.
In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements.
Results for the year Long-term business including investment products: New business of continuing operations: Premium income: Discontinued operations – – – 456 788
General business premiums written: Operating profit before amortisation of goodwill: US broker dealer and fund management 16 7 (6) – –
Profit on ordinary activities before tax (including actual investment returns) 385 947 750 1,141 1,169
Achieved profits basis capital and reserves* 8,150 8,776 8,288 7,463 6,868
Insurance and investment funds under management (£bn) 163 165 170 128 119
Insurance and investment funds under management (£bn) 120 129 142 105 93
US Operations Long-term business: New business: Operating profit (including long-term investment returns): US broker dealer and fund management 16 7 (6) – –
Achieved profits basis capital and reserves* 2,817 2,756 2,533 2,166 1,846
Insurance and investment funds under management (£bn) 34 30 25 21 19
Insurance and investment funds under management (£bn) 8.3 5.6 2.7 1.7 1.5
UK Insurance Operations: Long-term business 620 708 General business 79 33
Amortisation of goodwill (95) (84) Short-term fluctuations in investment returns 10 (1,402) (440) Effect of change in economic assumptions 11 (482) – Merger break fee (net of related expenses) 338 – Profit on business disposals – 223
(Loss) profit for the financial year after minority interests (217) 511 Exchange movements 53 187
Total recognised (losses) gains relating to the financial year (164) 698
Based on (loss) profit for the financial year after minority interests of £(217m) (£511m) 5 (11.0)p 26.1p
Assets held to cover linked liabilities 17,453 18,323 Banking business assets 8,972 8,603 Other assets 10,442 9,513
Total assets 156,769 154,950 Less banking business liabilities (8,333) (8,040) Less other liabilities (13,768) (11,062)
Less insurance funds Technical provisions 117,516 110,960 Fund for future appropriations 13,202 20,917 Less shareholders’ accrued interest in the long-term business (4,200) (4,805)
Shareholders’ capital and reserves Share capital and share premium 633 557 Statutory basis retained profit 3,317 3,414 Additional achieved profits basis retained profit 4,200 4,805
RECONCILIATION OF MOVEMENT IN SHAREHOLDERS’ CAPITAL AND RESERVES – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2001
Shareholders’ capital and reserves at beginning of year, as originally reported 8,833 8,342 Prior year adjustment on implementation of FRS 19 15 (57) (54)
Shareholders’ capital and reserves at end of year 13,14 8,150 8,776
1. Basis of Preparation of Results The achieved profits basis results include the results of the Group’s long-term insurance operations on the achieved profits basis. These results are combined with the statutory basis results of the Group’s other operations including unit trusts, mutual funds and other non-insurance investment management business. The achieved profits basis results for long-term business for 2001 have been prepared in accordance with the guidance issued by the Association of British Insurers in December 2001 ‘Supplementary Reporting for long-term insurance business (the achieved profits method)’. Previously the achieved profits basis results for long-term business were prepared in accordance with the guidance issued in July 1995. Comparative results for the year 2000 have not been restated for the change of guidance. Restatements of prior year figures relate solely to the implementation of FRS 19 on deferred tax. The information is supplementary to the financial statements on pages 36 to 70.
3. Economic Assumptions One of the key differences between the December 2001 guidance and the predecessor 1995 guidance (see note 1) relates to the basis for setting long-term expected rates of return on investments and risk discount rates.
An exception to this general rule is that for countries where longer-term fixed interest markets are underdeveloped, investment return assumptions and risk discount rates should be based on an assessment of longer-term economic conditions. Except for the countries listed above, this basis is appropriate for the Group's Asian operations.
The key economic assumptions and sensitivity of the results to changes to those assumptions are described below: UK Operations Pre-tax expected long-term nominal rates of investment return: UK equities 7.5% 8.0% Overseas equities 7.5 to 7.8% 8.0%
Corporate bonds 6.0% 7.0% Main with-profits fund assets aggregate earned rate
(applying the rates listed above to the investments held by the fund) 7.1% 8.0% Expected long-term rate of inflation 2.6% 2.5%
US Operations (Jackson National Life) Expected long-term spread between earned rate and rate credited to policyholders for single premium deferred annuity business 1.75% 1.9% Risk discount rate* 7.7% 8.5%
* For all operations, a discount rate is applied to post-tax cash flows to determine post-tax results. For most operations, these results are then grossed up for the effective rate of tax to derive the pre-tax results. For Jackson National Life, pre-tax results are determined by applying the risk discount rate to pre-tax cash flows adjusted for the impact of capital charges.
For the purposes of determining the longer-term returns for 2001, realised gains and losses arising (including impairment losses) on debt securities of Jackson National Life have been averaged over five years and combined with actual interests and dividends. For equity related investments of Jackson National Life a longer-term rate of return of 7.75% has been assumed. This has been applied to the monthly average carrying value of such investments after excluding the estimated effect of short-term market movements. In prior periods longer-term investment returns included within UK basis operating profit were estimated as the aggregate of investment income and averaged realised gains and losses for both fixed maturities and other types of security. Comparative results have not been restated for the refinement of policy as the effect is immaterial to the results for those periods.
5. Supplemental Earnings Information The Group's supplemental measure of its results and reconciliation of Achieved Profits basis operating profit based on longer-term investment returns before amortisation of goodwill to Achieved Profits basis profit on ordinary activities, including the related basic earnings per share amounts, are as follows: Before Minority Basic tax Tax** Post-tax interests** Net Earnings £m £m £m £m £m per share**
Based on loss for the financial year after minority interests (455) 213 (242) 25 (217) (11.0)p 2000** Based on operating profit after tax and minority interests
Adjustment for profit on flotation of Egg and business disposals 223 (57) 166 – 166 8.5p
** The tax charge, minority interests and earnings per share for 2000 have been restated for minor changes to reflect the implementation of FRS 19 on deferred taxation (see note 15).
6. Cost of Capital On the achieved profits basis, a charge is deducted from the annual result and the balance sheet value for the cost of capital supporting solvency requirements for the Group’s long-term business. This cost is the difference between the nominal value of solvency capital and the present value, at risk discount rates, of the projected release of this capital and investment earnings on the capital.
7. Foreign Currency Translation Foreign currency revenue has been translated at average exchange rates for the year. Foreign currency assets and liabilities have been translated at year-end rates of exchange.
Jackson National Life Unwind of discount 200 218 Return on surplus assets (over target surplus) 44 34 Averaged realised investment (losses) gains (note 10) (74) 19 Experience variances against current assumptions: Mortality and morbidity (2) (10)
Loss from strengthening operating assumptions (2000 – persistency and expense assumptions) (13) (258)
Prudential Europe Unwind of discount 9 8 Experience variances against current assumptions (9) 0 * The unwind of discount for UK long-term business operations represents the unwind of discount on the value of in force business at the beginning of the year (adjusted for the effect of current year assumption changes), the expected return on smoothed surplus assets retained within the main with-profits fund (see note 13), and the expected return on shareholders' assets held in other UK long-term business operations.
Surplus assets retained within the main with-profits fund are smoothed for this purpose to remove the effects of short-term investment volatility.
Actual return on Separate Account business less return based on longer-term rate (85) (62) Transition writedown on implementation of EITF 99-20 for interests in securitised financial assets (23) –
Five year total (535) Five year average included in operating result (see note 9) (107) (74)
Tax charge on operating profit Long-term business: UK Operations* 173 212 Jackson National Life 127 44 Prudential Asia** 133 61 Prudential Europe** (2) 0
* Including tax relief on shareholders' portion of UK re-engineering costs borne by the main with-profits fund.
UK Operations Long-term business operations: Smoothed assets* 3,775 3,887 Actual assets less smoothed assets (119) 340
US Operations Jackson National Life (net of surplus note borrowings of £172m (£167m)) Before capital charge: Excluding assets in excess of target surplus 2,442 2,298 Assets in excess of target surplus 463 595
National Prudential Prudential business Other Group UK Life Asia Europe operations operations total £m £m £m £m £m £m £m
Shareholders’ capital and reserves at 31 December 2001 3,656 2,683 1,089 90 7,518 632 8,150
Analysed as: Additional shareholders’ interest on Achieved Profits basis 3,162 319 687 32 4,200 4,200
18. Development Expenses Development expenses (excluding Asia regional head office costs) were up from £21m to £48m largely due to branding and re-launch costs of our operations in Japan, and higher development expenses in Europe including costs of establishing our business in Germany.
The achieved profits basis is designed to report profit which reflects business performance during the year under review, particularly new business sales and fluctuations between actual and assumed experience.
The use of the achieved profits basis does not affect either the cash surpluses which are released to shareholders’ funds from the longterm funds, which continue to be determined by the directors following statutory actuarial valuations of the funds, or amounts available for dividend payments to shareholders.
Respective Responsibilities of Directors and Auditors The directors are responsible for the preparation of the Annual Report, including as described on page 25, the financial statements and supplementary information. Our responsibilities are outlined on page 71.
Opinion In our opinion, the achieved profits basis Group profit for the year ended 31 December 2001 and shareholders’ interest in the longterm business at that date have been properly prepared on the basis of the assumptions set out on page 77 and in accordance with the methodology and disclosure requirements contained in the guidance on ‘Supplementary Reporting for long-term insurance business (the achieved profits method)’, issued by the Association of British Insurers in December 2001.
Prudential public limited company. Incorporated and registered in England and Wales.
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