RESPONSIBILITY REVIEW 22 BOARD OF DIRECTORS 24 CORPORATE GOVERNANCE REPORT 27 REMUNERATION REPORT 33 DIRECTORS’ REPORT 35 SUMMARY OF STATUTORY BASIS RESULTS 36 CONSOLIDATED PROFIT AND LOSS
42 BALANCE SHEET OF THE COMPANY 43 CONSOLIDATED CASH FLOW STATEMENT 44 NOTES ON THE FINANCIAL STATEMENTS 71 INDEPENDENT AUDITORS’ REPORT TO THE
75 STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES – ACHIEVED PROFITS BASIS
76 RECONCILIATION OF MOVEMENT IN SHAREHOLDERS’ CAPITAL AND RESERVES – ACHIEVED PROFITS BASIS
Prudential is a leading life and pensions provider in the UK.
• Prudential’s UK Insurance Operations provide a range of financial products and services including annuities, corporate and individual pensions, with-profits bonds and investment products to more than seven million customers.
Founded in 1931, M&G was acquired by Prudential in 1999 and is the Group’s UK and European fund manager with over £120 billion of funds under management, including £80 billion managed on behalf of the Prudential Assurance Company’s and Scottish Amicable’s long-term funds.
• PCA has operations in 12 countries: China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand and Vietnam.
These include joint ventures with some of the region’s leading players, including: – Bank of China International for Mandatory Provident Fund business in Hong Kong; – ICICI Ltd (India) for both life insurance and mutual funds; and
• PCA offers a comprehensive range of savings, protection and investment products.
JNL was acquired by Prudential in 1986. Today, it is one of the top 20 life insurance companies in the US in terms of total assets, and has more than 1.5 million policies and contracts in force.
• JNL is a leading provider of fixed, indexed and variable annuities, term and permanent life insurance, and stable value products.
Launched by Prudential in October 1998, Egg is the UK’s leading ecommerce financial services brand, and will be extending its reach into France and Germany in 2002.
• Prudential completed an Initial Public Offering of just over a 20 per cent share of Egg in June 2000.
Operating profit 1,186 1,029 Amortisation of goodwill (95) (84) Short-term fluctuations in investment returns (1,402) (440) Effect of change of economic assumptions (482) – Merger break fee (net of related expenses) 338 – Profit on business disposals – 223
Achieved Profits Basis – Total Operating Profit £1,528 million £376 million £613 million £1,029 million
None of the progress made during the year would have been possible without the hard work and dedication of our staff. In what has been an increasingly competitive environment for many parts of our business, I have been enormously impressed with their continued commitment, drive and professionalism and I would like to thank them for their considerable efforts.
There have been a number of changes to our Board during the year. Bridget Macaskill resigned from the Board in March. As Chairman and Chief Executive Officer of OppenheimerFunds Inc, a subsidiary of MassMutual Financial Services Group, Bridget concluded that she should resign to avoid any potential conflict of interest given that MassMutual and American General (with whom we were in merger discussions at the time) operate in the same market. I would like to take this opportunity to thank Bridget for the significant contribution she made to the Group.
Clark was previously Chief Operating Officer for JNL and he joined the Group Board on 2 January 2002. I know that both of them will make a valuable contribution to the future prosperity of the Group.
These results were particularly pleasing because they were achieved in difficult market conditions for many areas of our business. They also fully endorsed our strategy of growing internationally, broadening our distribution reach and diversifying our product range. The Board has decided to increase the total dividend by 3.7 per cent to 25.4 pence per share.
The year was, of course, overshadowed by the dreadful events of 11 September in the United States. Although the Group’s direct exposure following these events was extremely limited, we were without doubt all affected by this appalling tragedy.
All of the Group’s principal businesses – our UK and European insurance operations, M&G, Egg, Jackson National Life and Prudential Corporation Asia – are now represented on the main Board. As the Company develops both internationally and in complexity, its non-executive directors have had to take on an increasing workload and time commitment to ensure their duties are carried out effectively and this is likely to continue. The extensive knowledge and experience of the executive team, coupled with the breadth and complementary skills brought to the Group by the non-executive directors, ensures that Prudential enters 2002 in excellent hands.
We have continued to deliver our strategy of building an international retail financial services business by broadening our geographic presence, distribution channels and range of products to enable us to reach more customers and meet more of their needs. This clear and focused strategy is designed to exploit sustainable growth in key markets around the world where we have leading market positions and excellent customer access and reach. 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.
The success of this strategy has been demonstrated in our performance during the year. We have made real progress in restructuring and re-focusing our UK Insurance Operations and its strong performance in 2001 shows that we can build the business in competitive markets while driving through these changes. There has been continued strong investment performance at M&G and Egg broke even in the fourth quarter as planned. Jackson National Life had its second best year ever for total sales as well as record sales of fixed annuities, and Prudential Corporation Asia had another year of exceptionally strong growth across the region.
Group total insurance sales, on an annual premium equivalent (APE) basis, of £1.8 billion were up 16 per cent and sales of investment products of £1 billion increased from £376 million in 2000. Achieved basis operating profit (after restructuring costs) increased by 15 per cent to £1,186 million.
New business achieved profits were up 10 per cent, principally due to strong growth in Asia. Total in force achieved operating profits increased 24 per cent to £673 million, despite a £74 million charge relating to average realised bond losses in the United States.
As part of our ambition to build a business with long-term sustainable growth and to deliver top quartile performance, we have set a goal for the next four years of doubling the intrinsic value of the Group. We define intrinsic value as the discounted value of the cash generated by the business in the future. This can be approximated to the sum of the embedded value together with a multiple of new business profits for our long-term businesses, and the fair value of non-insurance operations such as Egg and M&G. In order to achieve this goal, we will need to broadly double new business achieved profits and the fair value of our non-insurance operations. This is a stretching target, the key to which
A STRONG RESULT ACROSS THE GROUP: TOTAL SALES OF £21.5 BILLION: GROWTH OF 54%
04 Prudential plc Annual Report 2001 are focusing on pension provision and medium to long-term savings products.
In what is becoming an increasingly competitive market, there are excellent opportunities for financially strong companies like Prudential – which has complementary businesses, market leading positions in key product areas, and some of the biggest financial services brands – to deliver sustained growth in the low margin environment in which we now operate.
UK and Europe The life insurance industry in the UK is well developed and the world’s third largest, behind only the United States and Japan, accounting for around 10 per cent of total worldwide premium income. The size of the market is influenced by the comparatively high penetration of life insurance, driven in part by the prominent role of the private sector in financial provision for retirement.
An ageing population, driven by increasing longevity and the baby-boomer generations of the 1940s and 1960s (which is forecast to increase the proportion of over 60s in the UK population to nearly 30 per cent by 2030 from around 20 per cent today), is increasingly focusing on accumulation of assets to provide retirement income to supplement their state benefits, while younger generations worldwide. In November, Egg achieved a break-even position and in doing so, 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. In January 2002, Egg announced that it would be developing its international business in France through the acquisition of Zebank, the first digital on-line bank in France, and associated distribution partnerships.
Prudential Europe recorded a number of notable achievements during the year including the opening of a Paris-based branch, the launch of Prudential Europe Vie, an equity-backed life insurance product that builds on the success of Prudence Bond in the UK, and the signing of an additional distribution agreement with Centre Francais du Patrimoine, one of the largest multiproduct broking services in France.
United States The United States is the largest financial services market in the world, accounting for approximately 70 per cent of retirement assets worldwide. Many of the factors that have affected the UK life insurance market in recent years, such as an ageing population and increasing risk of outliving savings in retirement, have also affected the US market.
When combined with its considerable operating efficiency, low cost base and modern IT systems, JNL’s diversified product portfolio and variety of distribution outlets enables it to continue writing profitable business in difficult economic conditions. Our ambition to grow the business remains and the focus going forward will be to continue to develop JNL’s product range and enhance its distribution channels to ensure that it is well placed to benefit from the anticipated growth in the US financial services market.
The prospects for the long-term savings markets will continue to be significant across Asia. A number of factors are fuelling this growth: a huge population base representing over 60 per cent of the world’s total population; increasing market reform and liberalisation; a relatively young and better educated population; rapid urbanisation; a growing middle class; an inherent propensity to save; increasing consumer sophistication; longer life spans and a limited social security net, all of which help to create a strong demand for longterm savings products.
PCA’s performance in 2001 (new business achieved profits were up 67 per cent) endorsed once again its successful strategy of entering new markets, strengthening and diversifying distribution channels, and launching innovative, customer-focused products. Although there has been evidence of a slowdown in some Asian economies, we are confident that there are substantial opportunities for us with our diversified business and a long-term commitment to the region, to continue to achieve profitable growth.
UK Insurance Operations 2001 was a significant year for our UK Insurance Operations as we began a major restructuring and re-focusing of our business to meet the opportunities and challenges presented by continued change in the UK’s life insurance market.
The UK insurance business recorded sales on an annual premium equivalent (APE) basis of £838 million, 10 per cent up on 2000. New business achieved profits (NBAP) were up six per cent to £243 million, reflecting increased volumes of new business written during the year, and our ability to build the UK business while driving through change. Total UK achieved operating profits fell 12 per cent to £620 million. However, these results reflect the adoption of the new active basis for setting economic assumptions. Underlying achieved operating profits, excluding the impact of the change to active-basis reporting, were £724 million (up two per cent on prior year), with NBAP contributing £269 million to this result, an improvement of 17 per cent on 2000.
Our core UK insurance businesses are currently being integrated into one organisational structure to significantly improve customer service and to lower costs. We announced our commitment to take a further £175 million out of our annual UK cost base by 2004 and aggressively drive expense levels across the business down to one per cent of funds under management. We believe this is an appropriate benchmark, and one which we are determined to surpass in the future.
During 2001, we continued to build our multichannel distribution capability, which will give us the flexibility to respond to changing market environments while maintaining our market-leading position. In the UK, we distribute our products direct to customers (telephone, internet and mail), through intermediaries including Independent Financial Advisers and consulting actuaries, and through the workplace to our corporate pensions customers. Going forward, we will also further develop partnerships with banks, retailers and other distributors.
UNITED KINGDOM & EUROPE THERE ARE EXCELLENT OPPORTUNITIES FOR FINANCIALLY STRONG PLAYERS LIKE PRUDENTIAL – WHICH HAS COMPLEMENTARY BUSINESSES, MARKET LEADING POSITIONS IN KEY PRODUCT AREAS, AND SOME OF THE BIGGEST FINANCIAL SERVICES BRANDS – TO DELIVER SUSTAINED GROWTH.
Looking ahead, our focus will be on larger corporate schemes, including Stakeholder, where we can offer quality service within the economics of a one per cent environment.
We see increasing scope for attracting more of these customers, given the ‘flight to quality’ we are witnessing in the market at present as people place increasing emphasis on financial strength when making their investment decisions. Consumers are seeking the reassurance of brands they can trust, and this puts Prudential in a very strong position.
There are 11 million employees in occupational pension schemes of which some 4.7 million are members of a defined benefit scheme. Changes to the tax treatment of dividends, lower equity returns and increased longevity, are leading trustees to consider alternatives to defined benefit schemes. In addition, over the next two years, FRS 17 will increase the transparency with which the impact on companies’ balance sheets of funding defined benefit schemes is reported. As a result, many companies are now looking to change their pension arrangements to defined contribution schemes, an area in which we have a strong customer offering.
We enjoyed a number of key successes in the Group pensions market during the year including being named joint provider for Additional Voluntary Contributions (AVCs) to the National Health Service
Pr op or tio n of p op ul at io n
Re la tiv e pr op en si ty to o w n bo nd p ro du ct (%
For the second consecutive year, M&G generated exceptional investment performance across the internal funds for which it was responsible, including the £80 billion managed on behalf of the Prudential Assurance Company’s and Scottish Amicable’s long-term funds. Against a backdrop of difficult market conditions, these funds beat their competitor and strategic benchmarks by more than two per cent in 2001.
During the year, M&G established its Berlinbased sales and marketing operation and has now opened for business in both Germany and Austria. A co-operative product strategy has also been agreed with Prudential Corporation Asia through which assets collected within PCA’s offshore fund range will flow into M&G’s UK OEIC funds.
Prudential Europe Prudential’s European operations encompass both the manufacture and distribution of Prudential branded products in continental Europe through strategic distribution agreements with strong local partners.
Egg 2001 was another year of outstanding growth for Egg, with operating income up 103 per cent to £189 million and strong customer growth, principally through its credit card business. Pre-tax losses decreased by 43 per cent to £88 million.
Egg will also be extending its partnership with Microsoft to offer further financial services products in France in addition to the proposed fund supermarket through MSN, a leading consumer web destination in Europe.
UNITED STATES OVER THE LAST FIVE YEARS, JACKSON NATIONAL LIFE HAS MADE SIGNIFICANT PROGRESS IN WIDENING ITS PRODUCT RANGE, ENABLING US TO SELL PROFITABLE PRODUCTS IN ALMOST ANY ECONOMIC ENVIRONMENT.
Looking ahead, significant opportunities exist in the US life insurance market as people seek to fund a longer retirement. In JNL, we have an outstanding business which is well positioned to capitalise on these favourable demographic trends through our diversified product offering, high quality distribution network and strong cost position.
The end of the bull market in 2001 created a challenging environment in the variable annuity (VA) market. After years of exceptional growth, VA assets were down in 2001, due to lower net inflows and a decrease in equity prices. Net variable annuity cash flow is a key measure of success in this market as it reflects overall variable annuity asset retention and therefore profit potential. JNL ranks eleventh in the industry on this basis with a net inflow of £345 million (US$497 million) as at 30 September 2001.
JNL maintained a top five market position in the sale of equity linked indexed (ELI) annuities with sales of £271 million in 2001. Fourth quarter sales of ELIs were the strongest single quarter sales in 2001 and were 28 per cent ahead of third quarter sales.
Prudential is Europe’s leading life insurer in Asia. Six years ago, we were only present in Singapore, Hong Kong and Malaysia. Today, we have a very strong regional presence with 21 operations in 12 countries, including top five market positions in eight of those operations (six in our life businesses and two in mutual funds).
Through our ‘think regional, act local’ management approach, we have been able to replicate our successful business model into the building of new operations.
Hong Kong Singapore Malaysia Thailand Indonesia Philippines Vietnam India Taiwan China Japan Korea
Products Life ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■
products was received in late November and these were successfully launched in January 2002.
In line with our strategy of expanding our successful unit trust operations across the region, we launched Prudential Unit Trusts in both Malaysia and Singapore during the year. These operations supplement our already successful and fast-growing mutual fund operations in India (ranked number two at the end of 2001), Taiwan (ranked number four at the end of 2001), and Japan.
equivalent (APE) basis were £434 million, up 69 per cent. As well as continuing strong growth in sales through agents, we achieved strong growth through other distribution channels. These included bancassurance (we have bank distribution agreements in place in nine countries) and direct distribution, which together generated just over 17 per cent of new APE life sales, up significantly compared to 2000. Net mutual fund sales of £1.4 billion were up 351 per cent.
During the year, PCA had a number of notable successes. We acquired Orico Life in Japan and YoungPoong Life in Korea. Both of these operations have been rebranded PCA Life and we are now building on these operationally and financially sound platforms. We intend, in time, to become material players in these two largest life insurance markets in Asia.
PCA extended its range of capital efficient unit-linked products with launches in China, where we became the first international life insurance company to launch a unit-linked life insurance product in Guangzhou (CITIC Prudential, our life insurance joint venture in Guangzhou, China, was established in late 2000). In Taiwan, our unit-linked single premium product is the first and only life insurance product that offers customers a significant investment choice. Regulatory approval for regular premium unit-linked
The implementation of the revised assumptions under the active basis applied primarily to the UK and the US operations, and those countries in Asia where there are well-developed government bond markets (Japan, Korea and US$ business in Hong Kong). Assumptions in other Asian territories continued to be based on an assessment of long-term economic conditions.
The overall impact on our Group achieved profit result for 2001 from using the active assumptions rather than the 2000 passive assumptions has been to reduce new business achieved profit by around £7 million and to reduce the in force operating result by around £90 million. Achieved profits shareholders’ funds are around £180 million lower than they would have been under the old assumptions.
Total insurance sales increased nine per cent to £11.4 billion, reflecting a 13 per cent growth in sales in the UK and the success of our Asian operations, where insurance sales increased 102 per cent to £1 billion.
Gross investment sales increased 188 per cent to £10 billion while net mutual fund sales in Asia were £1.4 billion, an increase of 351 per cent. Sales at Jackson National Life and Prudential Corporation Asia now represent 68 per cent of the Group total.
In the final quarter we regained the market leading position for IFA distributed with-profits bonds, with a 32 per cent share of the market. Annuities performed strongly in 2001 and we had a market leading position for the year with a 19 per cent market share. Annuities written in our shareholder backed entity, Prudential Retirement Income Limited (PRIL), generated new business achieved profit of around £30 million, being 12 per cent of total UK new business achieved profit.
The reported UK Insurance Operations’ margin has decreased one per cent to 30 per cent over the year. Excluding the impact of the change to the active basis, the margin would have increased to 33 per cent, two per cent above prior year. The underlying increase arises from Prudence Bond and annuities, offset in part by the impact of Stakeholder pension products.
Prudential Europe’s new business achieved profit of £8 million is broadly similar to 2000.
US broker dealer and fund management 16 7 Other income and expenditure (130) (117)
These bond losses occur at a time of record levels of credit defaults in the US, as highlighted in recent credit rating agency reports.
Non-insurance Operations M&G’s profit of £75 million compares 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 operating profit in 2000.
Compound annual growth in Asia’s new business achieved profit over the last three years has been 66 per cent as we have developed new businesses and grown distribution throughout the region. These results demonstrate the benefits of geographic and product diversification.
The US result was also affected by defaults and impairments on bonds resulting in realised losses of US$532 million in the year. As a proxy for determining the long-term rate of investment return and default experience over the credit cycle, realised gains and losses are included within now an established business with over two million customers today, and is still growing rapidly. Egg’s move to profit demonstrates that it has a profitable business model and a management team committed to, and capable of, delivering against their goals. Egg’s results are presented in its own annual report.
Development costs (excluding Asia head office costs) were up from £21 million to £48 million largely due to branding and re-launch costs of our operations in Japan, and higher development costs in Europe including costs of establishing our b2c business in Germany.
Other net expenditure increased by £13 million to £130 million. Lower core interest payable and Group corporate expenses were broadly offset by lower investment and other income and higher Asia head office costs reflecting the growth in scale of our Asian operations.
Achieved Profits – Result Before Tax The result before tax and minority interests was a loss of £455 million compared to a profit of £728 million in 2000. This principally reflects the adjustment for short-term fluctuations in investment returns of £1,402 million and includes £764 million in relation to the UK and £521 million in relation to JNL. The UK component reflects the difference between an actual investment return of negative 3.5 per cent and a long-term assumed return of 7.1 per cent. The US component reflects the full charge for bond write-downs and impairments to the extent that it is not included in operating profit, and the negative variance against long-term investment returns for equity-like investments, together with £85 million in relation to actual return on separate account business less return based on the longer-term rate.
Total AP shareholders’ funds (£bn) 8.1 *Includes return on JNL surplus assets (over target surplus).
Operating profit before amortisation of goodwill 1,186 1,029 Net break fee from American General Corporation 338 0 Profit on business disposals 0 223 Amortisation of goodwill (95) (84) Short-term fluctuations in investment return (1,402) (440) Loss arising from changes of economic assumptions (482) 0
Effective rate of tax on operating profit 31% 28% Operating earnings per share Achieved profits basis 41.9p 38.4p Statutory basis 23.3p 30.2p Total dividend per share 25.4p 24.5p
relation to average realised gains and losses on bonds. Fee income was lower due to lower sales and lower account values for variable annuities.
Prudential Asia’s operating profit before minority interests and development expenses was £44 million (£39 million). The Group’s more established operations in Singapore, Hong Kong and Malaysia reported further growth in statutory profits, up 40 per cent to £56 million. During 2002 and 2003 significant investment has been planned to build high quality customer focused distribution channels in Japan and Korea as we pursue a strategy of creating material scale in these businesses. We expect the effect of this investment to result in an MSB loss for Prudential Asia in 2002.
Modified Statutory Basis Results – Profit Before Tax MSB profit before tax and minority interests was £385 million in 2001, compared to £947 million in 2000. This decline principally reflects lower operating profit combined with a £480 million adjustment for shortterm fluctuations in investment returns. This was partially offset by £338 million profit net of expenses relating to the American General termination fee.
Earnings per Share Earnings per share, based on achieved basis operating profit after tax and related minority interests but before amortisation of goodwill, were up 3.5 pence to 41.9 pence. Earnings
This was partially offset by £338 million profit net of expenses relating to the American General termination fee. Amortisation of goodwill was £95 million against £84 million in 2000.
Achieved Profits – Result After Tax The result after tax and minority interests was a loss of £217 million after reflecting a tax credit of £213 million and minority interests of £25 million. The effective tax rate at an operating profit level was 31 per cent, up from 28 per cent in 2000, largely due to a more normalised tax rate at JNL following the impact on the 2000 result of the operational assumption changes. The effective tax relief rate at a total achieved profit level is 47 per cent on a loss of £455 million, due to tax payable on the American General break fee being relieved against capital losses available to the Group acquired during the year. The effective tax rate in 2000 was 33 per cent.
Modified Statutory Basis Results – Operating Profit Group operating profit before tax on the modified statutory basis (MSB) before re-engineering costs of £48 million, was £670 million, £170 million lower than 2000.
Dividend per Share The final dividend per share is 16.7 pence, resulting in a full year dividend growth of 3.7 per cent to 25.4 pence. Our intention remains to maintain a real rate of dividend growth, taking into account both the underlying earnings growth and the opportunities for further investment to create value for shareholders.
Post Balance Sheet Event – Disposal of General Insurance Operations In November 2001, we announced the formation of a long-term alliance with Winterthur Insurance and the Churchill Group, its UK subsidiary. This alliance was part of our UK insurance strategy to focus on our core medium and long-term saving businesses, and will see Churchill offering Prudential branded insurance products in the UK.
This transaction was completed in January 2002, and in addition to the payment on completion of £353 million, we expect the following additional benefits: some £200 million release of solvency capital; some £21 million release of net profit in the unearned premium reserve; and some £236 million in relation to the conservatively estimated net present value of future commissions and profits over the term of the agreement.
Acquisition of new businesses (162) (109) Reinvestment in existing businesses (537) (446) Timing differences and other items (132) 147
The issue closed with £435 million placed under 30 year notes priced at a 6.125 per cent fixed rate, and with ¤500 million (£306 million) placed under 20 year notes priced at 5.75 per cent fixed until December 2011, callable after 10 years. The issue was roughly two times oversubscribed and has enabled us to diversify our investor base with 60 institutions in Europe participating in the issue.
The debt issue enabled us to take advantage of current low interest rates in Europe to use the bond markets to refinance our longerterm debt and for other general corporate purposes and will be given equity credit by Standard & Poor’s for the purposes of determining financial strength ratings. It has been rated A1 by Moody’s and A+ by Standard & Poor’s.
Although each business unit is expected to meet their own liquidity needs, the Group has access to £1.2 billion committed bank facilities provided by 12 major international banks. These facilities have not been drawn on during the year.
In addition £537 million was reinvested in existing businesses including £222 million in relation to JNL funding, £108 million for Asia, £21million for Europe and £178 million of working capital for shareholder backed UK insurance businesses.
Shareholders’ Borrowings and Financial Flexibility Due to the holding company’s net funds outflow of £421 million, core borrowings at 31 December 2001 were £2.1 billion, compared to £1.7 billion at 31 December 2000. This increase is represented by the issue of hybrid debt in the year, offset by repayment of senior debt.
In the United Kingdom and Asia, Prudential uses derivatives to reduce equity risk, interest rate and currency exposures, and to facilitate efficient investment management. In the United States, JNL uses derivatives to reduce interest rate risk, to facilitate efficient portfolio management and to match liabilities under equity-indexed policies.
Funds Under Management Prudential’s funds under management support a range of businesses operating in many geographic areas. Each of the operations formulates a strategy, based on the nature of its underlying liabilities, its level of capital and local regulatory requirements. Where the nature of the underlying liabilities, its level of capital and
Shareholders’ Funds On the achieved profits basis, which recognises the shareholders’ interest in long-term businesses, shareholders’ funds at 31 December 2001 were £8,150 million, a decrease of £626 million from 31 December 2000. The decrease principally reflects short-term fluctuations in investment returns, combined with dividends declared and the impact of adopting active assumptions, offset by operating profits of £1,186 million.
To meet our obligations to existing policyholders, we expect to have to pay out over time assets equal to policyholders’ accumulated ‘asset shares’ plus any additional payments that may be required, by way of smoothing or to meet guarantees.
Our fixed income securities are principally invested in investment grade holdings. For the UK with-profits Life Fund 92 per cent of the fixed securities investments are investment grade with 43 per cent rated AA or above. For Prudential Annuities Limited 98 per cent of the fixed securities investments are investment grade with 36 per cent rated AA or above. For Prudential Retirement Income Limited 99 per cent of total assets are investment grade with an average credit rating of AA.
In the US 80 per cent of all invested assets are investment grade with a further nine per cent invested in commercial mortgages.
Asset and Liability Management Prudential manages its assets and liabilities locally, in accordance with local regulatory requirements and reflecting the differing types of liabilities Prudential has in each business. As a result of the diversity of products Prudential offers and the different regulatory environments in which it operates, Prudential employs different methods of asset/ liability management. Most of Prudential's methods fall into two major categories: cash flow analysis for interest-sensitive business and stochastic modelling/scenario testing for equity price risk sensitive business.
and able to meet its obligations to all policyholders. The inherited estate provides most of this solvency capital.
In addition, we can use the inherited estate to absorb the costs of significant events, such as fundamental strategic change in our long-term business and, as approved by the UK regulator, the cost of providing redress for past pension mis-selling, without affecting the level of distributions to policyholders and shareholders. The costs of fundamental strategic change may include investment in new technology, redundancy and restructuring costs, cost overruns on new business and the funding of other appropriate long-term insurance related activities including acquisitions.
The size of the inherited estate, by its nature as working capital, fluctuates from year to year depending on investment returns, and the extent to which the capital is required to meet smoothing costs, guarantees and any other unforeseen events. We estimate that at 31 December 2001, the inherited estate, after taking into account pension mis-selling costs and anticipated costs of fundamental strategic change, is in the range £6 billion to £8 billion.
Fixed Investments held to Equities income securities Property Other investments cover linked liabilities Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
resilience tests previously specified by the FSA (prior to September) in line with the tests we adopted in 2000. As at 31 December 2001, the overall liability was based on the following combined resilience scenario: • a fall in equity values of 25 per cent; • a fall in property values of 20 per cent; • a fall in bond values of 17 per cent (consistent with an increase in interest rates of three per cent).
The capital adequacy position of Jackson National Life remains strong with a risk based capital ratio of 296 per cent of the regulatory minimum. As a core business to the Group, JNL’s financial strength is also rated AAA by Standard & Poor’s. Adequate solvency levels have been maintained by our insurance operations in Asia.
Financial Strength of Insurance Operations A common measure of financial strength in the United Kingdom for long-term insurance business is the free asset ratio. The free asset ratio is the ratio of assets less liabilities to liabilities, and is expressed as a percentage of liabilities. The free asset ratio of the Prudential Assurance Company (PAC) longterm fund was approximately 12 per cent at the end of 2001, compared with 17 per cent at 31 December 2000. The reduction during the year principally reflects the significant fall in equity markets around the world.
On the statutory basis, profits after tax and minority interests for 2000 after restatement fell from £688 million to £657 million and shareholders’ capital and reserves at 1 January 2001 fell by £49 million to £3,971 million. The main impact has been on the fund for future appropriations where, on a restated basis, additional deferred tax principally on unrealised investment appreciation of £2,350 million was established at 31 December 2000. This has no impact on shareholders’ funds.
While FRS 17, ‘Retirement benefits’, only comes fully into effect for periods ending on or after 22 June 2003, certain disclosures are required for our 2001 financial statements. When fully implemented, the standard will require that companies include the whole of any pension surplus or deficit of defined benefit schemes in their balance sheet and has changed the way in which pension surpluses and deficits are valued. In particular, it requires assets of the scheme to be valued at their market value at the Company's year end, while pension liabilities are required to be discounted at a rate consistent with the current rate of return on a high quality corporate bond. Despite adverse market conditions our three main staff schemes (the Prudential Staff Pension scheme, the Scottish Amicable Staff Pension scheme, and the M&G Group Pension scheme) all remained in surplus for the year ended 31 December 2001 on the FRS 17 basis. The aggregate surplus before deferred tax provision, representing prepaid contributions, attributable to the Company at the year end was £585 million (£441 million attributable to the PAC with-profits fund, and £144 million attributable to shareholder financed operations). The disclosure required by the accounting standard is incorporated in note 19 on page 62 of the full financial statements.
As a large institutional investor and leading global insurance company, Prudential supports the work of the IASB and made contributions totalling US$50,000 in 2001.
During 2001, the various UK regulators whose functions had been absorbed into the FSA merged their supervisory teams dealing with our businesses into one team in the FSA’s Major Financial Groups Division. Matters being dealt with by the previous supervisors were taken over by the new team and an induction programme has been undertaken to help familiarise the new team with each of Prudential’s UK businesses.
The final shape of the standard is uncertain, but it is likely to be based on an ‘asset and liability’ model requiring insurance liabilities to be valued at a fair value, calculated using risk free rates, while not permitting the deferral of acquisition costs. The standard will differ considerably from the approach used since 1995 by the UK life industry for statutory reporting, and since 1997 for supplementary reporting as Achieved Profits. In particular, policies which are principally investment products are likely to be excluded from the definition of insurance contracts. The value of new business recognised on sale is likely to be limited. Once adopted, accounts prepared under the international accounting standard will replace accounts prepared under the Modified Statutory Basis (MSB).
Underwriting The Group operates controls over underwriting exposures covering both risks accepted and reinsured. Exposure limits are reviewed annually.
The Personal Finance Education Group’s ‘Excellence and Access’ Project. This will enable teachers to become skilled and confident in teaching personal finance in secondary schools and thereby give young people the confidence to make independent and informed decisions about their personal finances.
Our Employees We recognise that recruiting, retaining and developing the best talent is essential in order to maintain a competitive advantage. We are fully committed to investing for the long term in our people and our businesses offer a range of staff development and learning opportunities. Many courses are now delivered through on-line technology, which provide fast and efficient learning options. For example: • Prudential Corporation Asia has established a training programme, known internally as PRUuniversity, offering employees certified development and training programmes through a web-based knowledge portal and lessons at the University’s physical ‘campuses’ in each business location.
There are increasing references to corporate social responsibility (CSR) in both legislation and codes of conduct that are applicable to our business.
Having a sound reputation for behaving responsibly will contribute to our long-term financial success and to our primary objective of increasing shareholder value. As an investor, we believe that well managed and growing businesses will as a matter of course take account of their contribution to society in taking their business forward. In November, we announced a range of initiatives designed to add clarity to our approach to CSR. One of these, our first on-line CSR report, is available at www.prudential.co.uk and contains detailed information about our policies and programmes across the Group. These include: Group Code of Conduct Our Group Code of Conduct presents the minimum standards of ethical business practice that we expect from employees, agents and others working on behalf of the Group. It covers our dealings with a range of stakeholders with an interest in how our business is managed, from our shareholders, customers, staff and suppliers to the communities in which we are an employer.
Prudential Plan for Life Learning Plan for Life Learning is our new financial literacy programme that we are developing in association with established charities and educational bodies, currently in the UK. The programme aims to enable people from a diverse range of backgrounds to improve their skills and confidence in managing their finances. Programmes currently supported through Plan for Life Learning include: A financial literacy programme with the National Association of Citizens Advice Bureaux (NACAB). Our funding will enable NACAB to appoint a project manager who will help the CAB service to roll out new learning opportunities and guidance on financial literacy matters. Our support will also be used to establish a fund through which CAB can receive grants for new financial literacy initiatives.
• In the UK, our offices focus on funding educational initiatives. In Reading we funded the local branch of the Workers’ Education Association which provides learning opportunities for women from ethnic minorities. Staff also volunteer to mentor school pupils or help improve their skills in reading, IT, and numeracy.
Socially Responsible Investment in the UK We believe that well managed and growing businesses will as a matter of course take account of wider social and environmental issues in taking their businesses forward. In considering companies’ performance on these matters, M&G, our European fund manager, looks for a well reasoned and practical approach which may vary according to each company’s circumstances.
Non-executive Directors 7. Sir Roger Hurn (Age 63) A director since February 2000 and Chairman since May 2000. Deputy Chairman of GlaxoSmithKline plc and previously Deputy Chairman of Glaxo Wellcome plc. Non-executive director of Cazenove Group plc since May 2001. Previously a non-executive director of Imperial Chemical Industries PLC, Chairman of Smiths Industries plc and Marconi plc, and a non-executive director of SG Warburg Group. Chairman of the Court of Governors at the Henley Management College.
8. Sir David Barnes CBE (Age 66) A director since 1999. Non-executive Chairman of Imperial Cancer Research Technology Limited. Non-executive Deputy Chairman of Syngenta AG. Deputy Chairman of AstraZeneca plc to April 2001 and previously Chief Executive of Zeneca PLC. Previously Deputy Chairman of Business in the Community.
12. Sandy Stewart (Age 68) A director since 1997. Chairman of Murray Extra Return Investment Trust plc and of the Scottish Amicable (supervisory) Board. Previously a practising solicitor and Chairman of Scottish Amicable Life Assurance Society.
Executive Directors 1. Jonathan Bloomer FCA (Age 47) A director since 1995 and Group Chief Executive since March 2000. Previously Deputy Group Chief Executive and Group Finance Director. Non-executive director of Egg plc. Non-executive director of Railtrack Group plc. Member of the Practitioner Panel of the Financial Services Authority. Board Member of the Association of British Insurers.
3. Clark Manning (Age 43) A director since January 2002. President and Chief Executive Officer of Jackson National Life since November 2001. Previously Acting Chief Executive Officer and Chief Operating Officer of Jackson National Life which he joined in 1995. Previously Senior Vice President and Chief Actuary for SunAmerica Inc, and previous to that Consulting Actuary at Milliman & Robertson Inc. Fellow of the Society of Actuaries and a Member of the American Academy of Actuaries.
5. Mark Tucker (Age 44) A director since 1999. Chief Executive of Prudential Corporation Asia since 1994. Previously the General Manager of Prudential, Hong Kong from 1989 to 1992 and Senior Vice President of Operations of Jackson National Life from 1992 to 1994. Joined Prudential in 1986.
6. Mark Wood (Age 48) A director since June 2001 and Chief Executive of Prudential’s UK and European Insurance Business. Non-executive director of European e-commerce technology company Lost Wax since January 2002.
Previously Chief Executive of Axa UK plc (formerly Sun Life & Provincial Holdings plc) and Axa Equity and Law plc, and Managing Director of AA Insurance. Previously a director of Guardian Royal Exchange plc and deputy chairman of the Association of British Insurers.
The directors support the Combined Code on Corporate Governance annexed to the Listing Rules issued by the Financial Services Authority (the ‘Code’). The Company has complied throughout the accounting period ended 31 December 2001 with all the Code provisions set out in Section 1 of the Code, save for the appointment of a senior independent director. We have applied the principles in the manner described below and in the Remuneration Report.
Organisational Structure The organisational structure of the Group is clearly defined by reference to business units for which individual business unit chief executives are responsible. They report to the Group Chief Executive. The Board, the members of which are set out on pages 22 and 23, meets regularly, usually eight times a year with a separate strategy day and additional meetings as and when required. In 2001 the Board met 13 times and there were a further nine Board Committee meetings in addition to the regular Board Committees. The Board determines the objectives and strategy for the Group. It has set out the specific matters which are reserved to it for decision.
The Audit Committee normally meets six times a year and assists the Board in meeting its responsibilities under the Code in ensuring an effective system of financial reporting, internal control and risk management. It provides a direct channel of communication between the external and internal auditors and the Board and assists the Board in ensuring that the external audit is conducted in a thorough, objective and cost-effective manner. It also reviews the Internal Audit annual work plan. The terms of reference of the Audit Committee include reviewing annually with the management of the Company and the external auditors, the performance of the external auditors and the extent of their non-audit services; and the value for money obtained from auditors’ fees for both statutory audit work and non-audit work. The Audit Committee annually reviews the auditors’ independence. The external audit was last put out to competitive tender in 1999. The minutes of Audit Committee meetings are circulated to the Board after each meeting.
The Chairman, the Group Chief Executive, the Group Finance Director and other members of the senior management team, together with the external auditors usually attend meetings of the Committee except when the Committee wishes to meet alone. The Committee also meets privately with both external and internal auditors on a regular basis.
Relations with Shareholders As a major institutional investor, the Company is acutely aware of the importance of maintaining good relations with its shareholders. The Company regularly holds discussions with major shareholders and a programme of meetings took place during 2001. Information on the Company is also made available on our website at www.prudential.co.uk.
Internal Control The Board has responsibility for the Group’s system of internal control and for reviewing its effectiveness. The control procedures and systems the Group has established are designed to manage, rather than eliminate, the risk of failure to meet business objectives and can only provide reasonable and not absolute assurance against material mis-statement or loss. The system of internal controls includes financial, operational and compliance controls and risk management. In reviewing the risk management framework the Company has during the year commissioned independent reports on its risk management processes and procedures.
As a provider of financial services, including insurance, the Group’s business is the managed acceptance of risk. The system of internal control is an essential and integral part of the risk management process. As part of the annual preparation of its business plan, all of the Group’s businesses and functions are required to carry out a review of risks. This involves an assessment of the impact and likelihood of key risks and of the effectiveness of controls in place to manage them. The assessment is reviewed regularly through the year. In addition, business units review opportunities and risks to business objectives regularly with the Group Chief Executive and Group Finance Director.
The members of the Remuneration Committee during 2001 were: Sir David Barnes (Chairman) Ann Burdus Bridget Macaskill (who was a member until the date of her resignation from the Board on 16 March 2001) Roberto Mendoza Rob Rowley Sandy Stewart
Executive Directors’ Remuneration Remuneration policy The policy of the Company is to provide competitive remuneration packages in order to recruit and retain world class executives. In addition to salary and pensions, this is achieved through annual incentives and long-term incentive plans directly related to the Company’s longer-term performance.
Service contracts The normal notice of termination which the Company is required to give executive directors is 12 months, although for newly appointed directors there may be an initial contractual period of up to two years before the 12 months’ notice period applies. The contracts of employment for all executive directors contain a 12 months’ notice period, including Mark Wood who was appointed to the Board in 2001 without an initial longer notice period. When considering termination of service contracts, the Committee will have regard to the specific circumstances of each case, including mitigation.
Policy on external appointments Subject to the Board’s approval, executive directors are able to accept a limited number of external appointments as non-executive directors of other organisations.
Non-executive Directors’ Remuneration Non-executive directors do not have service contracts and are not eligible to participate in annual incentive plans, long-term incentive plans or pensions. Their fees are determined by the Board subject to the overall limit set by the shareholders, and reflect their individual responsibilities including membership of Board Committees.
Notes 1. The highest paid director for 2001 was Mark Tucker whose emoluments, including the value of rights granted to him under the long-term incentive plan, were £1,578,350. Additionally in 2001 the Company made a pension contribution of £47,480 on his behalf to the Prudential Staff Pension Scheme. The highest paid director for 2000 was Sir Peter Davis whose emoluments were £2,476,000 and on whose behalf the Company made pension contributions of £47,000.
2. The annual bonus figure comprises both the element paid in cash and the value of shares awarded under the scheme that are deferred for three years.
4. In 2000, Les Cullen also received compensation for the loss of office of £276,000.
5. Michael McLintock’s bonus includes a payment of £327,250 that was included in his contractual arrangements following the purchase of M&G in 1999.
7. Mark Wood’s bonus includes a payment of £275,000 in respect of his joining the Company.
In respect of the 1999 Restricted Share Plan, the Company’s TSR was ranked 43rd out of the 84 relevant comparator companies remaining in the FTSE 100 (i.e., 51st percentile) for the three-year performance period ended on 31 December 2001. As a result, rights will be granted over 22.5 per cent of the shares conditionally awarded to executive directors. The 2000 and 2001 Restricted Share Plans run to 31 December 2002 and 31 December 2003 respectively and any grants under these plans will be based on the TSR ranking determined at the end of each performance period. Performance under these plans was ranked respectively at percentile positions 67th and 62nd on the basis of TSR performance at 31 December 2001.
The table below shows the awards made under the Restricted Share Plan: Conditional Rights Market value Conditional share awards Conditionally (options) of rights share awards outstanding at awarded granted granted in 2001 outstanding at Release 1 Jan 2001 in 2001 in 2001 £000* 31 Dec 2001 year
The interests of directors in shares of the Company are shown below. These interests include shares awarded under the Share Participation Plan (the previous annual incentive plan) and the share awards made to Mark Wood on appointment. In addition, interests include rights granted under the 1997 and 1998 Restricted Share Plan where the executive has yet to exercise his right to receive shares. Awards that remain conditional under the Restricted Share Plan are excluded. All interests are beneficial except nonbeneficial interests in 6,300 shares in respect of Philip Broadley and in 9,875 shares in respect of Sandy Stewart.
Interests of directors in shares of the Company’s listed subsidiary, Egg plc, are shown below: Keith Bedell-Pearce 1,410 1,410 Jonathan Bloomer 470 470 Philip Broadley 470 470 Roberto Mendoza 200,000 200,000 Rob Rowley 940 940
Philip Broadley is connected to a not-for-profit organisation which disposed of 1,400 shares, 900 shares, 700 shares and 3,300 shares of the Company on 3 January, 18 January, 25 January and 28 February 2002 respectively. He had no beneficial interest in such shares. He acquired 1,038 shares of the Company, held beneficially, on 26 February 2002. With these exceptions, there were no changes in interests between 31 December 2001 and 6 March 2002.
Directors’ Share Options The Restricted Share Plan replaced the Executive Share Option Scheme (ESOS) in 1995 as the Group’s primary long-term incentive plan. Outstanding options under ESOS remain in force and are set out below together with options under the Savings-Related Share Option Scheme. The Savings-Related Share Option Scheme is open to all UK and certain overseas employees and options up to Inland Revenue limits are granted at a 20 per cent discount and cannot normally be exercised until a minimum of three years has elapsed.
Inland Revenue approved pension schemes Directors are eligible for one of two Inland Revenue approved pension schemes on the same basis as other employees.
The Prudential Staff Pension Scheme (PSPS) is a non-contributory defined benefit scheme, which provides a pension of 1/60 of Final Pensionable Earnings for each year of service on retirement at age 60 with an option to commute pension for a tax-free cash sum. The scheme also provides on death in service, a lump sum of four times Pensionable Salary, a spouse’s pension of the greater of 25 per cent of Pensionable Salary or 54 per cent of prospective pension at 60, and childrens’ pensions of the greater of 8.33 per cent of Pensionable Salary or 18 per cent of prospective pension at 60 in accordance with the scheme rules. On death in retirement, a spouse’s pension of 50 per cent of the pension available at retirement before commutation is payable and a lump sum is also payable if death occurs in the first five years of retirement. Some of the pension payable is guaranteed to increase in line with the Retail Prices Index capped at five per cent, but in recent years all pensions in payment have been increased fully in line with the Retail Prices Index.
The M&G Group Pension Scheme (MGGPS) is a contributory defined benefit scheme that provides a target pension of 2/3 of Final Pensionable Earnings on retirement at age 60 for an employee with 30 years or more potential service. The MGGPS also has an option to commute pension for a tax-free cash sum. The scheme provides on death in service, a lump sum of four times Pensionable Salary and a spouse’s pension of 50 per cent of prospective pension at 60 in accordance with the scheme rules. On death in retirement, a spouse’s pension of 50 per cent of the pension available at retirement before commutation is payable and a lump sum is also payable if death occurs in the first five years of retirement. Some of the pension payable is guaranteed to increase in line with the Retail Prices Index capped at five per cent, but in recent years all pensions have been increased fully in line with the Retail Prices Index. Members currently contribute 2.4 per cent of basic salary towards the cost of the benefits.
Michael McLintock is eligible for benefits under MGGPS on basic salary up to the earnings cap.
Service Contracts of Directors Proposed for Election or Re-election Clark Manning and Mark Wood, who are proposed for election, and Mark Tucker, who is proposed for re-election, have service contracts of 12 months. Ann Burdus and Rob Rowley, who are proposed for re-election, do not have service contracts.
Sir David Barnes Sir Roger Hurn Chairman of the Remuneration Committee Chairman
Principal Activity and Business Review Prudential plc is the Group holding company and the principal activity of its subsidiary undertakings is the provision of financial services in Europe, the US and Asia. Particulars of principal subsidiary undertakings are given in note 30 on page 65. The Group’s business and likely future developments are reviewed in the Chairman’s Statement on page 2, the Group Chief Executive’s Review on pages 3 to 5, the Business Review on pages 6 to 13 and the Financial Review on pages 14 to 20. Particulars of important events affecting the Group which have occurred since the end of the financial year are detailed in note 35 on page 70.
Financial Statements and Supplementary Information The consolidated balance sheet on pages 40 and 41 shows the state of affairs of the Group at 31 December 2001. The Company’s balance sheet appears on page 42 and the consolidated profit and loss account on pages 36 to 38. Information prepared on the achieved profits basis of financial reporting is provided on pages 74 to 85. A summary of the statutory basis results is shown on page 35. There is a five year review of the Group on pages 72 and 73.
Dividends The directors have declared a final dividend for 2001 of 16.7 pence per share payable on 29 May 2002 to shareholders on the register at the close of business on 22 March 2002. The dividend for the year, including the interim dividend of 8.7 pence per share paid in 2001, amounts to 25.4 pence per share compared with 24.5 pence per share for 2000. The total cost of dividends for 2001 was £504 million.
Payment Policy It is the policy of the Group to agree terms of payment when orders for goods and services are placed and to pay in accordance with those terms. Trade creditor days, based on the ratio of trade creditors at the year-end to the amounts invoiced by trade creditors during the year, were 22 days.
Employees The following information is given principally in respect of employees of the Group in the United Kingdom. The policy towards employees overseas is the same but the practical application of the policy varies according to local requirements.
Shareholders The number of accounts on the share register at 31 December 2001 was 84,936 (88,603). Further information about shareholdings in the Company is given on page 86. At 6 March 2002 the Company had received notification in accordance with Sections 198 to 202 of the Companies Act 1985 from Legal & General Investment Management Limited of a holding of 3.0049 per cent of the Company’s share capital.
Balance on the general business technical account (analysed on page 36) 72 33
US Operations 282 459 Prudential Asia (net of development expenses of £19m (£3m)) 25 36 Prudential Europe (net of development expenses of £29m (£18m)) (24) (10) UK re-engineering costs attributable to shareholders* (41) –
Statutory basis profit on ordinary activities before tax (analysed on page 38) 385 947
Net operating expenses (including re-engineering costs of £7m (£nil)) 8,14 (95) (79)
Following the sale of the Group’s UK home and motor general insurance operations (see note 35), gross premiums written and the balance on the general business technical account relate to discontinued operations.
Gross premiums written 6 15,196 14,173 Outwards reinsurance premiums (180) (109)
Change in the provision for claims: Gross amount 31 (128) Reinsurers’ share (1) 3
Change in provisions for linked liabilities, net of reinsurance 901 554
Net operating expenses (including re-engineering costs of £193m (£nil)) 8,14 (1,982) (1,729)
CONSOLIDATED PROFIT AND LOSS ACCOUNT CONTINUED YEAR ENDED 31 DECEMBER 2001
Balance on the long-term business technical account 442 670 Tax credit attributable to balance on the long-term business technical account 16 235 318
Balance on the long-term business technical account before tax 8 677 988
Dividends: Interim (at 8.7p (8.2p) per share) (172) (162) Final (at 16.7p (16.3p) per share) (332) (322)
Operating profit based on long-term investment returns 527 756 Short-term fluctuations in investment returns 8 (480) (48) Merger break fee (net of related expenses) 8 338 – Profit on business disposals 8 – 239
RECONCILIATION OF MOVEMENTS IN CONSOLIDATED SHAREHOLDERS’ CAPITAL AND RESERVES YEAR ENDED 31 DECEMBER 2001
Investments Land and buildings 22 10,487 10,303 Investments in participating interests 23 87 83 Other financial investments 24 109,328 108,125
Debtors Debtors arising out of direct insurance operations: Debtors arising out of reinsurance operations 21 14 Other debtors: Tax recoverable 174 50
Cash at bank and in hand 33 1,436 1,402 Own shares (ordinary shares of parent company) 27 52 31 Present value of acquired in force long-term business 18 138 133 Present value of future margins relating to advances from reinsurers 135 148
Prepayments and accrued income Accrued interest and rent 1,125 1,150 Deferred acquisition costs: Long-term business 3,175 2,935 General business 29 17
Technical provisions Provision for unearned premiums 202 175 Long-term business provision 98,511 91,006 Claims outstanding 980 1,022 Equalisation provision 40 38
Creditors Creditors arising out of direct insurance operations 420 213 Creditors arising out of reinsurance operations 341 21
Jackson National Life funding arrangements 31 2,816 1,920 Other creditors including taxation and social security: Banking business liabilities: US Operations 868 654
Less liabilities: amounts falling due within one year Bank loans and overdrafts – (20)
Net cash inflow from acquisitions, disposals and similar items 156 28
Financing Issue of debenture loans 31 649 – Redemption of loan notes 31 (9) (114) Movement on credit facility utilised by investment subsidiaries managed by US fund management operation 33 404 (31) Issues of ordinary share capital (net of expenses and related transfer to share ownership trust) 33 42 184
Net purchases (sales) of portfolio investments 33 1,777 (162) (Decrease) increase in cash and short-term deposits, net of overdrafts 33 (1,125) 185
Long-term business products written in the UK and Asia are principally with-profits deposit administration, other conventional and unitised with-profits policies and non-participating pension annuities in the course of payment. Long-term business also includes linked business written in the UK, Asia and Europe. The principal products written by Jackson National Life in the US are interest sensitive deferred annuities and whole-life policies, variable annuities, guaranteed investment contracts, equity linked indexed deferred annuities and term life insurance.
2. Basis of Presentation The consolidated financial statements are prepared in accordance with the provisions of Section 255A of, and Schedule 9A to, the Companies Act 1985 which cover the disclosures applicable to insurance companies and groups.
The consolidated financial statements are prepared in accordance with applicable accounting standards under UK Generally Accepted Accounting Practice (‘UK GAAP’), including Financial Reporting Standards (‘FRS’) and Statements of Standard Accounting Practice (‘SSAP’) and also in accordance with the Statement of Recommended Practice, ‘Accounting for Insurance Business’, issued in December 1998 by the Association of British Insurers (the ‘ABI SORP’).
FRS 18, ‘Accounting policies’ was issued in December 2000. This standard sets out the principles to be followed in selecting accounting policies and the disclosures needed to help users to understand the accounting policies adopted and how they have been applied. The standard is effective for accounting periods ended on or after 22 June 2001. Where appropriate, additional disclosures have been made in these financial statements to comply with the standard.
FRS 19, ‘Deferred tax’ was also issued in December 2000. This standard requires deferred tax to be recognised on most types of timing differences, in particular for gains and losses on assets that are continuously revalued to fair value where changes in fair value are recognised in the profit and loss account. The standard is effective for financial statements relating to accounting periods ended on or after 23 January 2002. However, early adoption is encouraged. The Company has adopted the standard in these financial statements with comparative figures for 2000 restated for consistency of approach. Details of the change and the effect on the financial statements are shown in note 4.
In accordance with FRS 1, ‘Cash flow statements’, long-term business cash flows are included in the statement of cash flows only to the extent of cash transferred to and available to meet the obligations of the Group. The statement of cash flows reflects only the cash flows of general business, the Group’s other non-insurance businesses included in the non-technical account, and amounts transferred to shareholders’ funds from the Group’s long-term businesses.
The balance sheet of the Company is prepared in accordance with Section 226 of, and Schedule 4 to, the Companies Act 1985, which apply to companies generally. The Company has taken advantage of the exemption under Section 230 of the Companies Act 1985 from presenting its own profit and loss account.
3. Significant Accounting Policies Long-term business The results are prepared in accordance with the modified statutory basis of reporting as set out in the Statement of Recommended Practice issued by the Association of British Insurers in December 1998.
Deferred acquisition costs Costs of acquiring new business, principally commissions, marketing and advertising costs and certain other costs associated with policy issuance and underwriting that are not reimbursed by policy charges are specifically identified and capitalised as deferred acquisition costs (‘DAC’). The DAC asset is amortised against margins in future revenues on the related insurance policies, to the extent that the amounts are recoverable out of the margins. Recoverability of the unamortised DAC asset is assessed at the time of policy issue, and reviewed if profit margins have declined.
Long-term business provision Prudential’s long-term business written in the UK comprises predominantly life insurance policies under which the policyholders are entitled to participate in the profits of the long-term business supporting these policies. This business is also written in parts of Asia. Such policies are called ‘with-profits’ policies. Prudential maintains with-profits funds within the Group’s long-term business funds which segregate the assets and liabilities and accumulate the profit and loss activity related to that with-profits business. The amounts accumulated in these with-profits funds are available to provide for future policyholder benefit provisions and for bonuses to be distributed to with-profits policyholders. The bonuses, both annual and terminal, reflect the right of the with-profits policyholders to participate in the financial performance of the with-profits funds. Shareholders’ profits with respect to bonuses declared on withprofits business correspond to the shareholders’ share of the cost of bonuses as declared by the Board of directors. The shareholders’ share currently represents one-ninth of the cost of bonuses declared for with-profits policies.
Annual bonuses are declared and credited each year to all with-profits policies. The annual bonuses increase policy benefits and, once credited, become guaranteed. Annual bonuses are charged to the profit and loss account as a change in the long-term business provision in the year declared. Terminal bonuses are declared each year and accrued for policies scheduled to mature and death benefits expected to be paid during the next financial year. Terminal bonuses are not guaranteed and are only paid on policies that result from claims through the death of the policyholder or maturity of the policy within the period of declaration or by concession on surrender. No policyholder benefit provisions are recorded for future annual or terminal bonus declarations.
The future policyholder benefit provisions on conventional with-profits and other protection-type policies are calculated using the net premium method. The net premium is calculated such that it would be sufficient at the outset of the policy to provide only for the discounted value of the original guaranteed death and maturity benefits. The provision is then calculated by subtracting the present value of future net premiums from the present value of future benefits (including vested bonuses) using a prudent discount rate. The assumptions to which the estimation of the long-term business provision is particularly sensitive are the interest rate used to discount the provision and the assumed future mortality experience of policyholders. The net premium reserves are calculated using assumptions for interest, mortality, morbidity and expense, but without assumptions for withdrawals. These assumptions are determined as prudent best estimates at the date of valuation. Interest rates used in establishing policyholder benefit provisions for conventional with-profits policies in the consolidated financial statements range from 3.0% to 5.35%. The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year and range from 5.0% to 6.0%. Mortality rates used in establishing policyholder benefit provisions are based on published mortality tables adjusted to reflect actual experience. For accumulating with-profits business of Prudential Assurance Company, the provision has been taken as the lower of: • the accumulated fund or the value at the bid price of the notional number of units allocated to policyholders, in both cases excluding terminal bonus, and • the surrender or transfer value which, having regard to policyholders’ reasonable expectations, would be payable at the valuation date, or, if greater, the value of the guaranteed liabilities excluding terminal bonus calculated on a gross premium bonus reserve method.
For the purpose of calculating the liability using the bonus reserve method, the assumed interest rates range from 1.6% to 5.0%, while future reversionary bonuses are assumed to fall from current levels to zero at 1.5% per year. Additional details for PAC are given in the statutory accounts of that company.
The future policyholder benefit provisions for Jackson National Life’s conventional protection-type policies are determined using the net level premium method, with an allowance for surrenders and claims expenses. Rates of interest used in establishing the policyholder benefit provisions range from 6.0% to 9.5%. Mortality assumptions range from 50% to 90% of the 1975-1980 Basic Select and Ultimate tables, depending on underwriting classification and policy duration. For investment-type products sold by Jackson National Life, the policyholder benefit provision included within technical provisions in the consolidated balance sheet is the policyholder account balance.
Overseas subsidiaries Results of overseas subsidiaries are determined initially using local GAAP bases of accounting with subsequent adjustments where necessary to comply with the Group’s accounting policies.
In the case of Jackson National Life, US GAAP results are adjusted to comply with UK GAAP in respect of the valuation basis for fixed income securities and certain financial derivative instruments. Further details are shown in note 11.
Deferred acquisition costs Direct and indirect costs associated with the writing of new general insurance policies are deferred and amortised in a manner consistent with the method used for premium recognition described above.
Investment returns Investment returns comprise investment income, realised gains and losses and changes in unrealised gains and losses, except for changes in unrealised gains and losses on debt securities held by Jackson National Life which are carried at amortised cost. For debt and other fixed income securities held by Jackson National Life, purchase premiums and discounts are amortised based on the underlying investments’ call or maturity dates and this amortisation is included in investment returns. Realised gains and losses, including writedowns on permanent diminutions, are recognised in income on the date of sale as determined on a specific identification basis for Jackson National Life and on an average cost basis elsewhere.
Tax The Group’s UK subsidiaries each file separate tax returns. Jackson National Life and other foreign subsidiaries, where permitted, file consolidated income tax returns. In accordance with UK tax legislation, where one domestic UK company is a 75% owned subsidiary of another UK company or both are 75% owned subsidiaries of a common parent, the companies are considered to be within the same UK tax group. For companies within the same tax group, trading profits and losses arising in the same accounting period may be offset for purposes of determining current and deferred taxes.
Land and buildings Investments in tenant and Group occupied leasehold and freehold (directly owned) properties are carried at estimated fair value, with changes in estimated fair value included in investment returns. Properties are valued annually either by the Group’s qualified surveyors or professional external valuers using The Royal Institution of Chartered Surveyors (‘RICS’) guidelines. The RICS guidelines apply separate assumptions to the value of the land, buildings, and tenancy associated with each property. Each property is externally valued at least once every three years. The cost of additions and renovations is capitalised and considered when estimating fair value.
Other financial investments Other financial investments include equity securities; debt and other fixed income securities; mortgage and other loans; loans to policyholders and deposits with credit institutions.
Mortgage and other loans Loans collateralised by mortgages and other unsecured loans are carried at unpaid principal balances, net of unamortised discounts and premiums and an allowance for loan losses, except for loans held by UK insurance operations which are carried at fair value. The allowance for loan losses is maintained at a level considered adequate to absorb losses inherent in the mortgage loan portfolio.
Derivatives Derivative financial instruments are used to reduce or manage investment, interest rate and currency exposures, to facilitate efficient portfolio management and for investment purposes. The Group’s policy is that amounts at risk through derivative transactions are covered by cash or by corresponding assets. Derivative financial instruments used to facilitate efficient portfolio management and for investment purposes are carried at fair value with changes in fair value included in investment returns. For Jackson National Life, the accounting for derivative financial instruments is explained in note 11.
Linked business funds Certain long-term business policies are linked to specific portfolios of assets or to an investment-related index. Such policies provide benefits to policyholders which are wholly or partly determined by reference to the value of or income from specific investments or by reference to fluctuations in the value of an index of investments. The assets supporting the linked policies are maintained in segregated accounts in conformity with applicable laws and regulations. The segregated assets are reported at fair value within assets held to cover linked liabilities on the consolidated balance sheet. The technical provisions for linked liabilities on the consolidated balance sheet are determined based on the fair value of the underlying assets supporting the policies.
Banking business assets and liabilities Banking business assets consist primarily of certificates of deposit and short-term deposits with credit institutions carried at fair value and mortgage loans carried at outstanding principal balances, net of allowances for loan losses, which approximates fair value. Loan provisions are recorded for the overall loan portfolio to cover bad debts which have not been separately identified but which are known from experience to be present in the portfolio. For loans in default specific loan provisions are recorded. General provisions are raised in respect of losses, which although not specifically identified, are known from experience to be present in any such portfolios. The level of general provision is determined by the application of a number of basis points to the aspects of the portfolio which are not currently identified as delinquent but which experience suggests contains lending which will ultimately lead to losses. The number of basis points applied to the portfolios are regularly assessed against recent experience and adjusted if appropriate. Changes in loan provisions during the year are included in the consolidated profit and loss account.
Effective 1 January 1998, goodwill arising from acquisitions is reflected as an asset on the consolidated balance sheet and is amortised through the consolidated profit and loss account on a straight-line basis over its estimated useful life, not exceeding 20 years. Prior to 1 January 1998, goodwill relating to acquisitions was charged directly to shareholders’ funds. As permitted under the transitional arrangements of FRS 10, ‘Goodwill and intangible assets’, amounts previously charged to shareholders’ funds have not been reinstated as assets. Upon disposal of a business acquired prior to 1 January 1998 to which goodwill relates, the original goodwill balance is charged to the consolidated profit and loss account in determining the gain or loss on the sale.
For life insurance company acquisitions, the adjusted net assets include an identifiable intangible asset recorded for the present value of in force business which represents the profits that are expected to emerge from the acquired insurance business. The present value of in force business is calculated using best estimate actuarial assumptions for interest, mortality, persistency and expenses and is amortised over the anticipated lives of the related contracts in the portfolio.
Shareholders’ dividends Shareholders’ dividends are accrued in the period to which they relate regardless of when they are declared. Where scrip dividends are issued, the value of such shares, measured as the amount of the cash dividend alternative, is credited to reserves and is transferred from the share premium account.
4. Implementation of FRS 19 on Deferred Taxation The Company has implemented FRS 19 in these financial statements. There are two primary effects of the implementation of the standard. These are to alter the basis of recognition for deferred tax assets in respect of Jackson National Life and deferred tax provisions on unrealised appreciation on investments.
On implementation of the standard the Company has chosen not to discount deferred tax assets and liabilities to allow for the time value of money.
Summarised profit and loss account and earnings per share £m £m
Shareholders' funds 3,897 4,020 Fund for future appropriations 14,981 23,267 Deferred tax provision 279 332 Technical provisions and other liabilities 137,612 127,331
5. Supplemental Earnings Information The Group uses operating profit based on long-term investment returns before amortisation of goodwill and before tax as a supplemental measure of its results. For the purposes of measuring operating profit, investment returns on general business and other shareholder business are based on the expected long-term rates of return. The expected long-term rates of return are based on historical real rates of return and current inflation expectations adjusted for consensus economic and investment forecasts. The only general business and shareholder investments that require calculation of an expected long-term rate of return are UK equity securities. For these investments the long-term rate of return is estimated at 7.5% (8.0%). The long-term dividend yield has been assumed to be 2.60% (2.75%).
For the purposes of determining the long-term investment returns of Jackson National Life for 2001, realised gains and losses arising on debt securities (including the losses arising on the recognition of permanent diminutions in value) have been averaged over five years for inclusion in operating profit. For equity-related investments of Jackson National Life for 2001, a long-term rate of return of 7.75% has been assumed and this rate 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 debt securities and other types of security. Comparatives for 2000 have not been restated for the refinement in policy, as the effect is immaterial to the results.
For the Group’s continuing operations with investment portfolios that are both attributable to shareholders and subject to short-term volatility, and the personal lines general business that was sold in January 2002, a comparison of actual and longer-term gains is as follows: 1993 to 1993 to 1993 to £m £m £m £m £m
In accordance with FRS 3, the presentation of additional supplementary earnings per share information is permitted provided the earnings basis used is applied consistently over time and is reconciled to consolidated profit for the financial year. In determining operating profit, the Group has used the expected long-term investment return excluding exceptional items as management believe that such presentation better reflects the Group’s underlying financial performance.
5. Supplemental Earnings Information continued The Group’s supplemental measure of its results and reconciliation of operating profit based on long-term investment returns before amortisation of goodwill to profit on ordinary activities, including the related basic earnings per share amounts, are as follows: Before Basic tax Tax Minority earnings
Amortisation of goodwill (84) – – (84) (4.3)p Short-term fluctuations in investment returns:*
M&G Individual life and pensions – 29 – 2 – 5
Annual equivalents are calculated as the aggregate of regular new business contributions and one tenth of single new business contributions.
Prudential Europe (net of development expenses of £29m (£18m)) (24) (10) (24) (10)
Investment return and other income** 51 64 51 64 Interest payable on core structural borrowings
Short-term fluctuations in investment returns (note 5) (480) (48) (480) (48) Merger break fee net of related expenses**** 338 – 338 – Profit on Egg flotation and business disposals – 239 – 239
**** In March 2001 the Company entered into a merger agreement with American General Corporation, a US investment, life insurance and consumer finance group. On 11 May, following the termination of the merger and in accordance with the terms of the agreement, a fee of US$600m (£423m) was paid to the Company by American General. After deducting employment costs incurred as a consequence of the proposed merger for the Company’s US operations, adviser costs, and other directly related expenses, of £85m, an exceptional item of £338m before tax has been accounted for within the Group’s results.
9. Segmental Information – Net Assets and Shareholders’ Funds (a) Net assets A segmental analysis of the fund for future appropriations and the technical provisions net of reinsurance is set out below which, although liabilities, provides a more useful indication of the assets supporting the business: Restated†
(closed to new business and wholly attributable but not allocated to policyholders)* 1,814 3,082 Other Group companies (principally the with-profits fund of PAC) 11,388 17,835
Net assets shareholder Net assets shareholder before core financed before core financed Restated†
shareholder operations Shareholders’ shareholder operations Shareholders’ borrowings (note 31) funds borrowings (note 31) funds £m £m £m £m £m £m
Analysis of shareholders’ capital and reserves UK Operations: Long-term business operations 494 494 345 345 General business solvency capital* – – 135 135
Other operations: † Net assets for 2000 have been restated for the implementation of FRS 19 on deferred tax. * The 2001 figure for general business solvency capital is zero due to the sale of the business. The capital required to support the run-off of the remaining business is included within other assets of other operations.
Gross (based on long-term premiums written Underwriting result Investment return investment returns)
(a) General business £m £m £m £m £m £m £m £m
Administrative expenses (185) (193) Provision for bad and doubtful debts (68) (37)
11. Jackson National Life – Additional Detail on Basis of Presentation of Results The results of US operations, mainly Jackson National Life, are consolidated into the Group accounts based on US Generally Accepted Accounting Principles (‘US GAAP’). However, certain adjustments are made in the Group’s consolidated financial statements to the US GAAP results as reported in Jackson National Life’s own financial statements to comply with UK GAAP, with the Group’s accounting policies, and to reflect appropriately the Jackson National Life segmental result, as set out below.
(i) The valuation basis for debt securities Under US GAAP debt securities classified as ‘available for sale’ under Financial Accounting Standard (‘FAS’) 115 are carried in the balance sheet at fair value with movements on unrealised appreciation accounted for directly within shareholders’ reserves as ‘Other Comprehensive Income’. By contrast, consistent with the ABI SORP, for Group reporting purposes, all fixed income securities are carried at amortised cost subject to provision for permanent diminution in value. This accounting treatment is appropriate as the securities are held as part of a portfolio of such securities intended to be held to maturity. Movements in unrealised appreciation arising from changes in the fair value of these securities do not feature as a part of the Group’s UK GAAP accounting.
(iii) Presentation of investment returns within the UK basis performance statements Profit (loss) on ordinary activities before tax With the exception of the elimination of FAS 133 effects, as explained in (ii) above, the total profit (loss) under UK GAAP is the same as under US GAAP.
Financed by with-profits funds: With-profits business 44% 43% Non-participating business** 8% 8%
Financed by with-profits funds: With-profits business 35% 32% Non-participating business** 3% 4% Linked business 0% 1%
Shareholder financed business: Non-participating business 49% 45% Linked business 11% 14%
* The Scottish Amicable Insurance Fund is closed to new business. The assets and liabilities of the fund are wholly attributable to the policyholders of the fund.
(c) Policyholders’ bonuses Bonuses declared for the year in respect of the Group’s with-profits business are included in the change in long-term business provision or, where the policy is no longer in force, in claims incurred. The total cost of policyholders’ bonuses was £3,536m (£3,454m).
14. Net Operating Expenses Long-term business General business technical account technical account £m £m £m £m
Administrative expenses for 2001 include £193m (long-term business) and £7m (general business) of UK re-engineering costs. £48m of the total costs are borne by shareholder financed operations.
Net operating expenses in the consolidated profit and loss account also include corporate expenditure of £63m (£56m) in the non-technical account.
Long-term business interest payable includes £128m (£102m) in respect of funding arrangements entered into by Jackson National Life.
16. Tax (i) Profit and loss account tax (credit) charge The tax expense for certain long-term business operations is attributable to shareholders and policyholders. The shareholders’ portion of tax is determined using the long-term effective tax rate of the underlying business applied to the profits transferred to the nontechnical account. A summary of the tax expense attributable to the long-term business technical account and shareholders’ profits in the non-technical account is shown below: Long-term business Non-technical account technical account (attributable to (attributable to shareholders’
(a) Between current and deferred tax expense (benefit) Current: Deferred: (b) By category of tax expense (benefit) UK corporation tax 286 802 (1) 2
Shareholder tax attributable to balance on the long-term business technical account – – 235 318 59 Prudential plc Annual Report 2001
16. Tax continued (c) By source of profit Tax on operating profit (based on long-term investment returns)
Long-term business: UK Operations 120 125 Jackson National Life 99 161 Prudential Asia 17 8 Prudential Europe (1) (2)
Total long-term business* 235 292 General business and shareholders (61) (32)
Total tax on operating profit 174 260 Tax on short-term fluctuations in investment returns (159) (3) Tax on profit on business disposals – 57 Tax on merger break fee (after utilisation of available capital losses) 6 –
(c) Reconciliation of movements in deferred tax Restated deferred tax liability at beginning of year 2,777 3,541 Deferred tax credited in profit and loss account for the year (772) (764)
Charges to profit and loss account: In respect of the disposal of M&G institutional fund management business – (22)
The balance at beginning of 2001 comprises cost of £1,748m less accumulated amortisation of £137m.
Amortisation includes a £20m credit (£47m charge) in respect of in force business of M&G acquired in 1999.
19. Information on Staff and Pension Costs The average numbers of staff employed by the Group during the year were: UK Operations 15,266 16,652 US Operations 2,580 2,250 Prudential Asia 4,651 2,635 Prudential Europe 550 405
Pension costs The Group has chosen not to fully implement FRS 17 ‘Retirement benefits’ for the 2001 financial statements. Pension costs shown above have been determined applying the principles of SSAP 24 ‘Pension costs’. £9m (£7m) of the Group’s pension costs related to overseas schemes.
19. Information on Staff and Pensions Costs continued The Group operates a number of pension schemes around the world. The largest scheme is the Prudential Staff Pension Scheme (PSPS). On the FRS 17 basis of valuation described below, 92% of the liabilities of Group defined benefit schemes are accounted for within PSPS.
The market value of Scheme assets as at that date was £4,504m and the actuarial value of the assets was sufficient to cover 116% of the benefits that had accrued to members, allowing for expected future increases in earnings. As a result of the actuarial valuation, the employers’ contribution rate has continued at the minimum prescribed under the Scheme rules which is 12.5% of salaries.
Using external actuarial advice provided by Watson Wyatt Partners for the valuation of PSPS, and by Aon Limited for the M&G scheme, and internal advice for the Scottish Amicable scheme, the most recent full valuations have been updated to 31 December 2001 applying the principles prescribed by FRS 17. The key assumptions adopted for these updated valuations were inflation 2.5%, rate of increase in salaries 4.5%, rate of increase of present and future pensions 2.5%, and rate used to discount scheme liabilities 5.75%.
Assets: Equities 3,321 Fixed income securities 402 Property 536 Cash 103
Total market value of assets 4,362 Present value of liabilities (3,777)
Net of deferred tax of £49m and £43m attaching respectively to these amounts, the post-tax surpluses attributable to the PAC withprofits fund and shareholder financed operations are £392m and £101m respectively. If the surplus attributable to the PAC with-profits fund had been recognised in the 2001 financial statements, the reported Group fund for future appropriations of £13,202m at 31 December 2001 would have been augmented by £392m. Similarly, the Group shareholders’ funds of £3,950m at 31 December 2001 would have been augmented by £101m.
Statutory audit fees include £0.1m (£0.1m) in respect of the Company. Audit related and consultancy fees payable to KPMG Audit Plc and its associates include £16.6m (£18.8m) for work performed in the UK.
A summary of the movement in interest in associate undertaking is set out below: Total
Interests in joint ventures are valued on a net equity basis and mainly reflect ventures with the Bank of China in Hong Kong, ICICI in India and CITIC in China. The differences between the investments on a gross and net equity basis are not material. The other participating interest relates to the Group’s 15% interest in Life Assurance Holding Corporation Limited, a holding company for UK life assurance companies.
24. Other Financial Investments Cost Current value £m £m £m £m
Consistent with the Group’s accounting policy set out on page 48, amortised cost has been applied as current value for certain fixed income securities. Where appropriate, to reflect requirements the current value of such investments has been reduced to impaired value.
The market value of debt securities and other fixed income securities valued at amortised cost was £21,323m (£17,849m). All debt securities carried at amortised cost are held by long-term business operations.
For those debt securities and other fixed income securities valued at amortised cost where the maturity value exceeded purchase price, the unamortised difference at the year end was £344m (£186m). For securities valued at amortised cost where the purchase price exceeded maturity value, the unamortised difference at the year end was £148m (£nil).
25. Assets Held to Cover Linked Liabilities Cost Current value £m £m £m £m
Number of 2001 2001 Issued shares of 5 pence each fully paid shares £m £m
The Company has established trusts to facilitate the delivery of shares under employee incentive plans and savings-related share option schemes. At 31 December 2001, 10.1m Prudential plc shares with a market value of £81m were held in such trusts.
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation.
Prudential Banking plc is a subsidiary of Egg plc, a listed subsidiary of the Company. The ordinary shares of Egg plc, of which there is only one class, are 79% owned by the Company and 21% owned by shareholders external to the Prudential Group.
Other borrowings of general insurance and shareholders’ funds: Bank loans and overdrafts repayable on demand 21 20 21 20
General insurance and shareholders’ funds 1,972 1,318 470 166 1,543 230 3,985 1,714 Long-term business operations 272 267 272 267 * Debenture loans issued by the holding company. The interests of the holders of the Subordinated Notes are subordinate to the entitlements of other creditors of the holding company.
(ii) These commercial paper borrowings support a short-term fixed income securities reinvestment programme.
(iv) The interests of the holders of the Notes issued by the UK Banking operation are subordinate to the entitlements of other creditors of that operation. At 31 December 2001 the UK Banking operation had also issued debt securities totalling £915m and sold securities under agreements to repurchase totalling £384m.
(vi) Jackson National Life, through its subsidiary Jackson Federal Savings Bank, has bank borrowings of £244m (£157m). The advances are secured by mortgage loans and mortgage backed securities.
32. Contingencies and Related Obligations Consistent with FRS 12, appropriate provision has been made in the financial statements where the Group has an obligation arising from the events or activities described below but not for contingent liabilities.
Mortgage Endowment Products Review The Group’s main exposure to mortgage endowment products is through Scottish Amicable. The FSA issued a report in March 2001 raising concerns regarding Scottish Amicable’s conduct of sales of these products by its tied agents since 1999. We have agreed to review business written up to February 2001 to identify cases where customers may not have received a full explanation of the risks in the product and to offer rectification. Some cases from before 1999 may also need to be reviewed if an analysis shows that particular groups of clients are in this position. In addition, the FSA is considering whether disciplinary action should be taken against Scottish Amicable. Scottish Amicable withdrew from the mortgage endowment product market in April 2001 and disbanded its network of tied agents in September 2001. The directors are satisfied that adequate provision has been made within the long-term business provision.
Guaranteed Annuities Prudential Assurance did not sell significant volumes of guaranteed annuity products and holds a provision of £34m at 31 December 2001 within the main with-profits fund to honour guarantees on these products. The Group’s main exposure to guaranteed annuities is through the Scottish Amicable Insurance Fund (SAIF) and a provision of £756m is held in SAIF at 31 December 2001 to honour the guarantees. SAIF is a separate sub-fund of the Prudential Assurance long-term fund. Accordingly, this provision has no impact on shareholders.
Guarantees and Commitments Guarantee funds in both the UK and US provide for payments to be made to policyholders on behalf of insolvent life insurance companies. These guarantee funds are financed by payments assessed on solvent insurance companies based on location, volume and types of business. Jackson National Life has established a provision of £31m at 31 December 2001 for future guarantee fund assessments. Similar assessments for the UK businesses were not significant.
32. Contingencies and Related Obligations continued Prudential Assurance’s Inherited Estate The inherited estate is the assets of the main with-profits fund within the long-term fund of Prudential Assurance less non-participating liabilities, the policyholder asset shares aggregated across with-profits policies and any additional amounts expected at the valuation date to be paid to in force policyholders in the future in respect of smoothing costs and guarantees. The inherited estate is thus the assets in the main with-profits fund in excess of what we expect to pay to policyholders. We are currently discussing the attribution of the inherited estate with the FSA, which may or may not result in a portion of the inherited estate in the main with-profits fund being attributed solely to shareholders. The amount and timing of any attribution to shareholders is sufficiently uncertain that it is not possible to accurately estimate any potential attribution. In addition, it is likely that if any part of the inherited estate is attributed to shareholders, it will remain in Prudential Assurance’s long-term fund to support the long-term business and accordingly is unlikely to be distributed to shareholders for some considerable period of time, if at all.
Operating profit before tax before amortisation of goodwill 622 840 Add back interest charged to operating profit 162 143 Adjustments for non-cash items: Tax on long-term business profits (235) (318) General business and shareholder longer-term investment gains (24) (28) Increase in gross general business technical provisions 4 71 Amounts retained and invested in long-term business operations (534) (449) Increase in net banking assets 36 76 General business reinsurance and other 20 63
(Decrease) increase in cash and short-term deposits, net of overdrafts (1,125) 185 Net purchases (sales) of portfolio investments 1,777 (162) (Increase) decrease in loans (640) 114 Movement on credit facility utilised by investment subsidiaries managed by PPM America (404) 31 Share capital issued (42) (184)
Total cash at bank and in hand (per balance sheet) 1,436 1,402
Net assets acquired: Goodwill on acquisitions 171 108 Cash and short-term deposits – 16 Banking business assets – 714 Banking business liabilities – (535) Interest in associate undertaking – (79) Net assets held in long-term business operations 2 184 Minority interests in Egg – (120) Other net assets 9 (24)
Net assets acquired 182 264 Cash consideration (paid) received after expenses (182) 12
Fair value of consideration (including expenses) 139 23 20 182 Net assets acquired: Book and fair value of assets at acquisition 0 6 5 11
The amounts included in the profit and loss account for 2001 in respect of these operations are not material. The goodwill is being amortised from the date of acquisition over a period of 20 years.
We have audited the financial statements on pages 36 to 70.
Respective Responsibilities of Directors and Auditors The directors are responsible for preparing the Annual Report. As described on page 25 this includes responsibility for preparing the financial statements in accordance with applicable United Kingdom law and accounting standards. Our responsibilities, as independent auditors, are established in the United Kingdom by statute, the Auditing Practices Board, the Listing Rules of the Financial Services Authority, and by our profession’s ethical guidance.
We review whether the statement on pages 24 to 26 reflects the Company’s compliance with the seven provisions of the Combined Code specified for our review by the Listing Rules, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material mis-statement, whether caused by fraud or other irregularity or error.
Opinion In our opinion the financial statements give a true and fair view of the state of affairs of the Company and the Group as at 31 December 2001 and of the profit of the Group for the year then ended and have been properly prepared in accordance with the Companies Act 1985.
Shareholders’ investment return and other income* 51 64 84 181 137 Interest payable on core structural borrowings* (118) (131) (122) (97) (71)
Amortisation of goodwill (95) (84) (54) – – Short-term fluctuations in investment returns (480) (48) 28 24 83 Merger break fee, net of related expenses 338 – – – – Profit on business disposals – 239 – 249 18 Reclassification of shareholder reserves of discontinued Australian operation – – – – 204
Profit after tax and minority interests: Operating profit (including post-tax long-term investment returns)* 460 591 507 620 580 Profit for the year (including post-tax actual investment returns)* 389 657 472 853 811
Total statutory basis capital and reserves 3,950 3,971 3,404 3,298 2,861 Additional achieved profits basis retained profit* 4,200 4,805 4,884 4,165 4,007
Based on profit for the year after tax and minority interests 19.7p 33.5p 24.2p 43.9p 42.0p
Market price at 31 December 796p 1,077p 1,220p 908p 734p * Comparative results have been restated for the reallocation of Asia Regional Head Office costs from Asia development expenses to Corporate expenditure, the reallocation of interest payable on non-core borrowings to shareholders’ investment return and other income, and for the implementation of FRS 19 on deferred tax.
Achieved profits basis capital and reserves* 4,365 5,129 5,113 3,919 3,725
Prudential Asia Long-term business including investment products: New business: Operating profit before development expenses 44 39 27 23 20 Development expenses* (19) (3) – – –
Statutory basis capital and reserves 402 315 217 123 46 Additional achieved profits basis retained profit 687 478 376 255 214
Achieved profits basis capital and reserves 1,089 793 593 378 260
Statutory basis capital and reserves 58 60 53 37 29 Additional achieved profits basis retained profit 32 22 15 9 2
Achieved profits basis capital and reserves 90 82 68 46 31
Insurance and investment funds under management (£bn) 0.6 0.6 0.5 0.4 0.3
Long-term business 303 219 Broker dealer and fund management 16 7
UK Operations 686 711 US Operations 319 226 Prudential Asia 415 213 Prudential Europe 8 17 Other income and expenditure (including development expenses) (178) (138)
(Loss) profit on ordinary activities before tax (including actual investment returns) (455) 728
(Loss) profit for the financial year after minority interests (217) 511
SUMMARISED CONSOLIDATED PROFIT AND LOSS ACCOUNT – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2001
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2001
Total gains and losses recognised since last Annual Report (221) † Comparative figures for 2000 have been restated for the implementation of FRS 19 on deferred tax.
Based on operating profit after tax and related minority interests before amortisation of goodwill
EARNINGS PER SHARE – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2001
Total recognised (losses) gains relating to the financial year (164) 698 New share capital subscribed 42 184 Goodwill on sale of holding in associate company – 90
Net (decrease) increase in shareholders’ capital and reserves 14 (626) 488
Shareholders’ capital and reserves, at beginning of year, as restated 8,776 8,288
† Comparative figures for deferred tax within other liabilities, the fund for future appropriations and shareholders’ funds for 2000 have been restated for the implementation of FRS 19 on deferred tax.
The proportion of surplus allocated to shareholders from the UK with-profits business has been based on the present level of 10%. Future bonus rates have been set at levels which would fully utilise the assets of the with-profits fund over the lifetime of the business in force. In the UK, Department of Social Security rebate business has been treated as single premium business.
Under the December 2001 guidance, for most countries, these rates are set by reference to period end rates of return on fixed interest securities. This ‘active’ basis of assumption setting has been applied in preparing the results of all the Group's UK, US and European long-term business operations. For the Group's Asian operations the active basis is appropriate for business written in Japan and Korea and US dollar denominated business written in Hong Kong.
For 2000 and earlier years, the achieved profits basis results for all of the Group's operations were calculated by using expected longerterm equilibrium rates of return and discount rates.
Post-tax expected long-term nominal rate of return: Pension business (where no tax applies) 7.1% 8.0% Life business 6.3% 7.4%
78 Prudential plc Annual Report 2001 4. Investment Return (i) Profit before tax With the exception of fixed interest investments held by Jackson National Life, investment gains during the period (to the extent that changes in capital values do not directly match changes in liabilities) are included in the profit for the year and shareholders’ funds as they arise.
Based on operating profit after tax and minority interests before amortisation of goodwill and merger break fee 1,186 (370) 816 12 828 41.9p Adjustment for amortisation of goodwill (95) – (95) – (95) (4.8)p Adjustment from post-tax longer-term investment returns to post-tax actual investment returns (after related
Effect of change of economic assumptions (482) 167 (315) – (315) (16.0)p Adjustment for merger break fee, net of related expenses 338 (6) 332 – 332 16.8p
Adjustment for amortisation of goodwill (84) – (84) – (84) (4.3)p Adjustment from post-tax longer-term investment returns to post-tax actual investment returns (after related
Based on profit for the financial year after minority interests 728 (241) 487 24 511 26.1p
* The adjustment from post-tax longer-term returns to post-tax actual investment returns includes investment return that is attributable to external equity investors in two investment funds managed by PPM America. These two funds are consolidated as quasi-subsidiaries but have no net impact on pre-tax or post-tax operating profit. Total profit, before and after tax, incorporating the adjustment from longerterm returns to actual investment returns includes losses of £13m (£13m) attributable to these minority interests.
In determining the cost of capital of Jackson National Life, it has been assumed that an amount equal to 200% of the risk based capital required by the US supervisory authorities must be retained. The impact of the related capital charge is to reduce Jackson National Life’s shareholders’ funds by £222m (£222m).
Pre-tax Tax Post-tax Pre-tax Tax Post-tax £m £m £m £m £m £m *Jackson National Life net of tax profit: Before capital charge 108 155 Capital charge (note 6) (35) (35)
After capital charge 73 120 9. Operating Profit from Business in Force £m £m
UK Operations* Unwind of discount 384 429 Change of renewal expense assumption resulting from closure of direct sales force
(2000 change of persistency assumption) 15 30 Cost of strengthened assumption for required capital for shareholder backed business (16) – Experience variances and other items (6) 19
Prudential Asia Unwind of discount 78 58 Change in operating assumptions 66 – Other items and experience variances 16 2
Long-term business: UK Operations* (764) (218) Jackson National Life** (521) (171) Prudential Asia (9) (46) Prudential Europe – (3)
Share of investment return of US managed investment funds consolidated into Group results that is attributable to external investors (13) (13)
General insurance and shareholders: Relating to investment in St James's Place Capital plc – 17 * UK Operations
Short-term fluctuations in investment returns represent the difference between actual investment returns attributable to shareholders on the achieved profits basis and the expected returns as described in note 3.
Actual investment return on investments less longer-term returns included within operating profit*** (413) (109)
*** Jackson National Life – Actual investment return on investments less longer-term returns for the year ended 31 December 2001
Actual less averaged realised gains and losses (including impairments) for fixed income securities**** (295) Actual less longer-term return on equity based investments (124) Gains on preference shares 6
10. Short-term Fluctuations in Investment Returns continued **** Jackson National Life – Actual less averaged realised gains and losses (including impairments for fixed income securities)
Averaged realised gains differ from those reported on the statutory basis for the impact of amortisation of policy acquisition costs attributable to realised gains and losses. These have been included in the statutory basis gains averaging calculation for the years 1998 to 2001. On the achieved profits basis deferred acquisition costs do not feature as part of the methodology. Accordingly the realised gains and losses included in the averaging process are exclusive of the amortisation of policy acquisition costs attributable to realised gains and losses.
Tax on items not included in operating profit Tax credit on short-term fluctuations in investment returns (422) (104) Tax effect of change of economic assumptions (167) – Tax charge on merger break fee, net of expenses (after utilisation of available capital losses) 6 – Tax on profit on Egg flotation and business disposals – 57
Total tax on items not included in operating profit (583) (47)
Tax (credit) charge on (loss) profit on ordinary activities (including tax on actual investment returns) (213) 241 † Comparative figures for 2000 have been restated for the implementation of FRS 19 on deferred tax, see note 15.
† Comparative figures for 2000 have been restated for the implementation of FRS 19 on deferred tax, see note 15.
* UK long-term business smoothed assets represent asset values adjusted to remove the effects of short-term volatility.
** In determining the cost of capital of Jackson National Life it has been assumed that an amount equal to 200% of the risk based capital required by the US supervisory authorities must be retained. The impact of the related capital charge is to reduce Jackson National Life's shareholders' funds by £222m (£222m).
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 82 Prudential plc Annual Report 2001
Operating profit (including investment return based on long-term rates of returns)
US broker dealer and fund management 16 16 Other income and expenditure (130) (130)
Operating profit (loss) before amortisation of goodwill 575 303 396 (21) 1,253 (67) 1,186
Tax: Tax on operating profit (loss) (173) (127) (133) 2 (431) 61 (370) Tax on short-term fluctuations in investment returns 229 158 6 393 29 422 Tax on effect of change of economic assumptions 128 12 27 167 167 Tax on merger break fee, net of expenses (6) (6)
(Loss) profit for the financial year (431) (177) 230 (19) (397) 180 (217)
Net increase in shareholders’ capital and reserves (571) 12 296 8 (255) (371) (626)
Shareholders’ capital and reserves at 1 January 2001: Restatement effects for implementation of FRS 19 on deferred tax (57) (57)
Achieved Profits basis shareholders' funds 3,656 2,683 1,089 90 7,518 632 8,150 83 Prudential plc Annual Report 2001
15. Implementation of FRS 19 on Deferred Taxation The Company has adopted FRS 19 on deferred taxation in its 2001 financial statements with restated comparative results for 2000. The principal impact of the change from the accounting policy applied under SSAP 15 is to provide additional deferred tax on unrealised appreciation on investments. The additional deferred tax provision is reflected in the fund for future appropriations for with-profits long-term business and in the profit and loss reserve for shareholder backed long-term business. Consistent with previous practice and the achieved profits methodology, expected future tax cash flows related to in force and new long-term business effectively continue to be discounted.
The Company has chosen not to adopt the discounting option available under FRS 19 in respect of the deferred tax provisions of non long-term business operations.
Estimated Estimated profit from new business pre-tax unwind of Pre-tax Tax Post-tax discount £m £m £m £m *Jackson National Life: Before capital charge 132 Capital charge (39)
(b) Shareholders' funds If the economic assumptions applied for 2001 had been in place at 31 December 2000 the achieved profits basis shareholders' funds at that date would have been lower by £315m. This represents a pre-tax loss of £482m less related tax credit of £167m. These figures are analysed by business operation in note 14.
(ii) Estimated impact on 2001 results based on alternative assumptions The key assumptions that affect the Group’s results are economic, in particular expected rates of investment return and risk discount rates. The sensitivity of the 2001 results to changes in these assumptions is set out below: Group Total £m
(a) 2001 Pre-tax operating profit from new business Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 105 Decrease in rates of 1% (99)
Risk discount rates: Increase in rates of 1% (72) Decrease in rates of 1% 83
(b) 31 December 2001 shareholders' funds Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 824 Decrease in rates of 1% (779)
Risk discount rates: Increase in rates of 1% (494) Decrease in rates of 1% 592 17. UK Re-engineering Costs Details of the re-engineering costs charged in the year are explained in note 8 on page 54. After including amounts borne by the main with-profits fund but attributed to shareholders, the costs recognised on the achieved profits basis were £64m.
The achieved profits basis can be illustrated by considering an individual contract. Using prudent best estimate assumptions of the main elements of future income and expenditure – investment return, claims, lapses, surrenders and administration expenses – the total profit expected to be earned from the contract can be estimated at the time of its sale. The total profit expected to be earned is then allocated to individual financial years by application of a discount rate, which allows for both the time value of money and the risk associated with the future shareholder cash flows.
The additional profit recognised using the achieved profits basis is represented by the shareholders’ accrued interest in the long-term business and, when combined with shareholders’ funds reported on the statutory basis, provides an improved measure of total shareholders’ funds of the Group.
We have reviewed the supplementary information on pages 75 to 84 which have been prepared on the basis set out in note 1 on page 77.
INDEPENDENT AUDITORS’ REPORT ON THE ACHIEVED PROFITS BASIS SUPPLEMENTARY INFORMATION TO THE MEMBERS OF PRUDENTIAL PLC
Registered office: Laurence Pountney Hill, London EC4R 0HH. Registered number 1397169.
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