Contents 1 Group Financial Highlights 2 Chairman’s Statement 3 Group Chief Executive’s Review 5 Business Review 12 Financial Review 30 Corporate Responsibility Review 32 Board of Directors 34 Corporate Governance Report 42 Remuneration Report 53 Directors’ Report 55 Summary of Statutory Basis Results 56 Consolidated Profit and Loss Account 59 Consolidated Statement of Total Recognised Gains and Losses 59 Reconciliation of Movement in Consolidated Shareholders’ Capital and Reserves 60 Consolidated Balance Sheet 62 Balance Sheet of the Company 63 Consolidated Cash Flow Statement 64 Notes on the Financial Statements 96 Statement of Directors’ Responsibilities 97 Independent Auditor’s Report to the Members of Prudential plc 98 Five Year Review 100 Financial Review: FRS 27 Disclosure Requirements 110 Risk Factors 113 Achieved Profits Basis Supplementary Information 114 Summarised Consolidated Profit and Loss Account – Achieved Profits Basis 114 Earnings per Share – Achieved Profits Basis 114 Statement of Total Recognised Gains and Losses – Achieved Profits Basis 115 Reconciliation of Movement in Shareholders’ Capital and Reserves – Achieved Profits Basis 115 Summarised Consolidated Balance Sheet – Achieved Profits Basis 116 Notes on the Achieved Profits Basis Supplementary Information 125 Statement of Directors’ Responsibilities in Relation to the Achieved Profits Basis Supplementary Information 125 Independent Auditor’s Report to Prudential plc on the Achieved Profits Basis Supplementary Information 126 Shareholder Information IBC How to Contact Us
We have strong positions in three of the largest and most attractive markets in the world, where rising global wealth and changing demographics are fuelling demand for long-term savings.
Our strategy is to build sustainable, profitable businesses in each of these markets, and thereby maximise returns to our shareholders over time.
M&G is Prudential’s UK and European fund manager, with £126 billion of funds under management, as at 31 December 2004.
Product Distribution Channels ■ Independent Financial Advisers ■ Business to Business (consulting actuaries and benefit advisers) ■ Partnerships (affinities and banks) ■ Multi-tie Panels ■ Direct to customers (telephone, internet and mail)
M&G offers a range of over 40 funds and invests in a wide range of assets including UK and international equities, fixed interest, property and private equity.
Also part of M&G Prudential Property Investment Managers Ltd (PruPIM) PPM Ventures Ltd PPM South Africa
Secured places on two of the new multi-tie panels – Sesame and Millfield.
JNL’s investment portfolio manager, PPM America Inc., manages around US$71 billion of assets.
Prudential Corporation Asia provides a comprehensive range of savings, protection and investment products tailored to the needs of each local market.
Group operating income up 19 per cent to £505 million (2003: £424 million).
Announced the purchase of Life Insurance Company of Georgia (subject to regulatory approval).
For the year to 31 December 2004, total insurance sales rose 26 per cent to £1,846 million*; operating profit on an achieved profits basis increased 39 per cent to £1,124 million; operating profit under the modified statutory basis increased 49 per cent to £603 million; and the full year dividend per share has been increased by three per cent to 15.84 pence per share**.
In the UK we have transformed our insurance business over the last three years, and now have a robust, multi-channel operation, which is increasingly writing shareholder-backed business. Growth in this business over the medium term will be funded from the proceeds of the Rights Issue. Jackson National Life and M&G are already delivering strong profits and funding their own growth from internal revenues. Our Asian business continues to grow and is on track to become cash positive from 2006.
Looking to the future, we see many opportunities for growth in each of our core markets. As governments and individuals seek to address the combined challenge of rising life expectancy and inadequate retirement funding, we believe they will look increasingly to the private sector to fulfil their needs. By sharing knowledge between Prudential’s businesses we can adapt and export products across borders, meeting emerging needs often more quickly and efficiently than competitors. Our operational plans, in areas such as product design and IT product processing, are increasingly developed on an international, rather than a local, basis.
A sustainable business also requires commitment to the communities in which it operates; and Prudential believes that financial education must be a fundamental part of any forwardlooking financial services company’s approach. This is the thinking behind the financial education programme that we have developed over the past four years, more details of which are given in the Corporate Responsibility section of this Report. This programme is an integral part of our strategy to build trusting, long-term relationships with consumers.
Two directors left the Board in 2004: Sandy Stewart in May and Bart Becht in August; and I would like to thank them both for their contribution.
Mark Tucker previously worked for Prudential from 1986 to 2003. He was an Executive Director of Prudential from 1999 to 2003 and Chief Executive of Prudential Corporation Asia from 1993 to 2003. His background and experience mean that he is well suited to lead Prudential to the next stage in the Group’s development.
While the prospects for the future are encouraging, we will continue to rely on our experienced and talented people around the world to capitalise on them; and I would like to thank our staff for their hard work and commitment to the Group over the past year.
UNITED STATES The US is the largest long-term savings market in the world, with considerable opportunities for growth.
The business continues to fund its own growth, including small acquisitions, such as that of Life Insurance Company of Georgia, announced in November. It also contributed US$120 million to the Group in 2004, and this is expected to increase to US$150 million in 2005.
In 2005, we expect the US market to grow at about four per cent and Jackson National Life to grow sales at around twice this rate, while keeping its costs down and delivering above market returns.
ASIA The Asian economies’ consistently high growth rates and favourable demographics, together with the trend towards allowing greater access and ownership to foreign financial services players, make these markets very attractive for Prudential, and we have a strong record of success in the region.
*All year-on-year comparisons of financial performance are at constant exchange rates (CER), unless otherwise stated.
EGG Egg has closed its loss-making French operation and has recently put its Funds Direct business on the market. It is now firmly focused on its profitable core UK business, where it achieved underlying profit of £74 million in 2004. This was a good performance from Egg’s UK business, especially given the increased competition and rising interest rates that have affected the credit card and personal loan markets. Egg’s effective cost management and good credit quality also contributed to the solid results from its UK operation.
We expect Egg to finance its own growth without requiring capital support from the Group.
OUTLOOK Prudential has built strong positions in three of the most attractive savings markets in the world. Each of the businesses is performing well, and is positioned to take advantage of the opportunities in its respective market. We are on track to deliver sustainable, profitable growth and to achieve our target returns on capital in 2005 and beyond.
We are confident of our ability to grow strongly and profitably in the region, and our Asian business remains on track to become cash positive from 2006.
In recent years, M&G has developed profitable new income streams while keeping a tight control over costs. This powerful combination has resulted in underlying profit of £110 million, up 57 per cent on 2003.
eliminates the impact from conversion, the effects of which do not alter the long-term value of shareholders’ interests in our non UK businesses.
This increase in new business sales and a new business margin of 27 per cent led to an increase in new business achieved profit (NBAP) of 40 per cent to £220 million. Total achieved profits basis operating profit increased 25 per cent to £450 million. The increase in profit from the in-force book was partially offset by experience and assumption changes. MSB operating profit was £305 million in 2004, an increase of 19 per cent on 2003. This was driven principally by increased annuity sales now being written through the shareholder-backed subsidiary, Prudential Retirement Income Limited (PRIL).
Basic earnings per share on an achieved profits basis for the year after minority interests were 37.2 pence, compared with a restated figure of 25.4 pence in 2003. Following the Rights Issue in October 2004, a restatement of earnings per share is derived and reported in accordance with the requirement of Financial Reporting Standard (FRS) 14.
Impact of Currency Movements Prudential has a diverse international mix of businesses with a significant proportion of its profit generated outside the UK. In preparing the Group’s consolidated accounts, results of overseas operations are converted at rates of exchange based on the year average, while shareholders’ funds are converted at year end rates of exchange.
Consequently, the Board has for a number of years reviewed the Group’s international performance at CER. This basis
£m unless otherwise stated (as reported) exchange rate) change (as reported) (as reported) change
Total achieved profits basis operating profit* 1,124 807 39% 1,124 861 31% Total modified statutory basis (MSB) operating profit* 603 405 49% 603 424 42% Achieved profits basis shareholders’ funds 8,596 6,762 27% 8,596 7,005 23%
Prudential UK operates through four diversified distribution channels. The Intermediaries (IFA) channel, which accounted for 34 per cent of APE sales in 2004, distributes a range of medium to long-term savings products primarily through independent financial advisers and will include sales generated through multi-ties. The B2B channel, which accounted for 28 per cent of 2004 APE sales, distributes corporate pensions through worksite marketing in partnership with consulting actuaries and benefit consultants. The Partnerships channel has responsibility for developing relationships with banks and other distributors and accounted for 26 per cent of APE sales in 2004, an increase from six per cent in 2003. The remaining 12 per cent of APE sales was generated by the Direct to Customer channel which focuses primarily on the sale of annuities to individual pension customers, although an increasing proportion of this is now being transacted through IFAs.
Independent financial advisers continue to be the principal channel for the distribution of life and pension products for insurers in the UK. This channel is undergoing significant change with the introduction by the Financial Services Authority (FSA) of new depolarisation rules leading to the establishment of multi-tie panels. Over the next few years, Prudential UK expects that a significant proportion of IFAs, which previously operated as wholeof -market providers, will move to a panel approach whereby they distribute the product range of a select number of life companies.
Prudential UK has already been appointed to work with Sesame, Millfield, Tenet and Burns-Anderson on the design of their respective multi-tie propositions. It has been appointed to the regulated multi-tie panels for Sesame, Millfield, Burns-Anderson and THINC Destini and has also been appointed as THINC Destini’s single-tie annuity provider.
Prudential UK is a market leader in corporate pensions: in 2004, it was the provider to 20 per cent of FTSE 350 companies, managing more than 4,000 pension schemes, and it is the market leader in the provision of pension schemes to the UK public sector. It has enhanced its sales process to include automatic enrolment and greater use of worksite marketing to support its position.
The Prudential Assurance Company’s (PAC) long-term fund remains well capitalised with a free asset ratio of 14.8 per cent on the former regulatory Form 9 basis, without taking account of future profits or implicit items. The with-profits fund delivered a pre-tax return of 13.4 per cent in 2004, compared with a FTSE All Share (Total Return) of 12.8 per cent. Consequently, Prudential
Prudential UK has also made a significant investment in its unitlinked offering and this is reflected in the increase in year-on-year sales and market share. The Flexible Investment Bond, launched late in 2003, and the recently-launched range of protected bonds continue to build share in the growing IFA unit-linked bond market.
Prudential UK is achieving strong growth, through both new and existing products, and by developing new distribution opportunities. Having completed the £200 million cost saving programme, it has maintained a focus on capital management and has achieved further cost efficiencies. This is reflected in Prudential UK’s ability to maintain overall new business margins in 2004.
United States In 2004, Jackson National Life (JNL) delivered record sales despite the challenges of low crediting rates offered in the fixed annuity market, relatively flat equity markets during the first nine months of the year and an evolving regulatory environment.
Total MSB operating profit on continuing operations of £182 million was up 46 per cent on 2003. The 53 per cent growth in long-term business operating profit reflects £169 million higher spread income and record variable annuity fee income due to significant growth in separate account assets. In addition, there were two one-off items, a £28 million favourable legal settlement and a positive £8 million adjustment arising from the adoption of SOP 03-01 ‘Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and for Separate Accounts’. This adjustment relates to a change in the method of valuing certain liabilities.
In 2004, JNL continued its focus on giving its customers greater freedom of choice by enhancing its product portfolio, distribution network and customer service.
Total achieved profits basis operating profit* 303 173 75% 303 194 56%
JNL’s APE fixed annuity sales of £113 million in 2004 were down eight per cent on 2003. It was ranked the seventh largest provider of fixed annuities in the US (Source: LIMRA).
JNL anticipates achieving a minimum internal rate of return after tax on this transaction of 13 per cent and the capital provided from its retained earnings will be returned over a payback period of about five years. The planning for the integration of the business is on track and full integration is anticipated within 12 months of closing the transaction. The regulatory approval process is under way.
The US is the world’s largest medium and long-term savings market. Although a fragmented market, it contains many profitable segments. JNL is a scale player in its chosen segments and its position as a low cost provider gives it an expense advantage over competitors. JNL’s distribution proposition is strong; it provides market leading sales support through value-added wholesaling and marketing support.
The ageing demographics of the US, combined with customers’ increasing demand for professional advice, increase the potential for profitable growth. JNL is well positioned to capitalise on this given its strength among independent broker-dealers through National Planning Holdings (NPH), its independent broker-dealer network. In 2004, NPH increased gross sales by 23 per cent and increased agent productivity.
Following President Bush’s State of the Union address and the items contained in the President’s proposed 2006 budget, JNL anticipates a variety of initiatives to promote further individual choice, greater flexibility and a stronger orientation toward marketbased solutions to savings and retirement. These proposals will include personal security accounts, as well as tax-free accounts for savings and simplified retirement accounts.
We expect the US market to grow at about four per cent in 2005 and JNL to grow sales at around twice this rate as current conditions continue to favour companies which have a range of variable and fixed annuity product offerings, a relationship-based distribution model and award-winning service. We expect to be able to maintain margins at current levels depending on the mix of business written.
Chartered Bank (SCB) in Hong Kong, has proven to be very effective in enabling Prudential to leverage its top five position in a very competitive market while still retaining a strong core agency channel which produces a higher proportion of regular premium business.
■ in Singapore the market is competitive and Prudential remains focused on profitability rather than pure volume; although new business APE declined by four per cent in 2004, new business achieved profit margins increased by five percentage points. Prudential’s other long-established market, Malaysia, which celebrated its 80th anniversary in 2004 recorded APE sales up 15 per cent on 2003.
With over five million life insurance customers, Prudential Corporation Asia now has the scale to benefit from more standardisation and integration of processes and the introduction of common systems platforms. In 2004, the first step towards a more integrated back office was made with the launch of a regional processing centre, Prudential Services Asia, based in Malaysia’s high tech business park Cyberjaya.
In China, Prudential’s joint venture with China International Trust and Investment Corporation (CITIC) is one of the country’s leading foreign players and APE growth was 70 per cent last year. CITIC Prudential already operates in three cities, has a new Shanghai operation launching in the second quarter of 2005 and in February 2005 received additional licences for cities in Guangdong province (Dongguan and Foshan), and has approval to provide group policies alongside the core individual life products.
The impact of Prudential Corporation Asia’s focus on capital efficiency and its increasing scale can be seen as it is expected to become a net contributor of cash to the Group in 2006, whilst continuing to fund high growth rates.
We are confident of our ability to grow strongly and profitably in Asia: the opportunities in our newer markets, coupled with the strength of our larger operations, should enable us to accelerate our level of sales growth in 2005. We expect to be able to maintain margin while delivering this growth.
M&G’s property division, Prudential Property Investment Managers (PruPIM), which invests primarily on behalf of the Prudential Assurance Company, significantly increased its funds under management during 2004 and expanded its product offering into the retail marketplace with the launch of the M&G Property Fund alongside the successful expansion of its unit-linked funds. PruPIM is one of the largest institutional property fund managers in the UK with over £14.8 billion invested in the property market.
Investment flows are from our mutual fund operations in seven Asian markets and include our 36 per cent share of our joint venture with Bank of China International (BOCI) in Hong Kong for Mandatory Provident Fund (MPF) products and unit trusts.
During 2004 our Japanese mutual fund operation has seen considerable success with net inflows of £1.4 billion, primarily driven by marketing US bond funds that leverage the expertise of PPM America.
Looking ahead, while our Asian funds division will continue to add value to its core internal clients, there are also good opportunities for it to continue to expand its retail customer base.
Operating profit from the core UK business was £74 million, compared with £73 million in 2003. This represents a solid result considering the increased competition and rising interest rates that have impacted the credit card and personal loan markets.
Egg’s effective cost management and good credit quality also contributed to the solid results from its UK operation. It has increased its provision levels to reflect the change in its product mix following growth in its unsecured lending portfolio, the stage in the life cycle of its card and loan books and the increasing proportion of personal loans business.
Egg has 3.1 million customers who are defined as ‘marketable’ based on their activity levels. Moving forward, Egg will focus on growing lending balances and fee income through a mix of both acquisition and cross-sales rather than by customer acquisition as the key growth metric.
The operating loss for the discontinued French operation was £37 million reflecting the results up to the date of the announcement of Egg’s intention to withdraw from the market in July 2004. In 2004, Egg sold its French unsecured lending, savings and brokerage portfolios and in early 2005 closed the current account business. The expected total exit costs remain unchanged from the £113 million provision established in July 2004.
Consistent with the intention to focus on its successful UK business, Egg has sold its investment business to Fidelity at a small loss, which will release approximately £20 million of capital back to its core banking business in 2005. It has also put Funds Direct, its investment wrap platform business, up for sale and provided for a £17 million impairment charge against the full carrying value of the underlying assets in Funds Direct.
Looking forward, Egg’s highly attractive unsecured lending portfolio represents an opportunity to grow further and deliver healthy returns. In addition, it will continue to build on its strong relationship with customers and their levels of consideration to buy other products from Egg, as evidenced by general insurance cross-sales in the fourth quarter. To this end, Egg will look to offer a broader range of products and services in 2005 and beyond.
In 2004, gross written premiums, including insurance renewal premiums, increased 19 per cent to £16.4 billion, reflecting the growth of new insurance sales in 2004 and the significant contribution from regular premium business written in previous years.
Total gross investment sales for 2004 were £25.1 billion, up 21 per cent on 2003 at CER. Net investment sales of £3.6 billion were up 23 per cent on last year at CER. The strong growth across a number of markets offset the high level of redemptions in Taiwan, which was the result of market concern about the liquidity of bond funds across the Taiwanese mutual fund market.
ACHIEVED PROFITS BASIS RESULTS The achieved profits basis results for long-term business are prepared in accordance with the Association of British Insurers’ (ABI) guidance for achieved profits reporting issued in December 2001. This guidance requires that for countries where capital markets are well developed, the economic assumptions used for the projection of cash flows are to be on an active basis, which is primarily based on appropriate government bond returns at each period end. The effects of changed economic assumptions on the adjusted opening balance sheet value are reflected in the profit reported for the year and excluded from operating profit.
In the US, the risk discount rate has remained at 7.4 per cent. The level of capital required to support the business (the ‘target surplus’) has been taken, as in 2003, to be 200 per cent of the Company Action Level Risk Based Capital, calculated in accordance with the National Association of Insurance Commissioners’ risk-based capital standards for life insurance companies.
Prudential’s insurance business achieved significant growth, both in terms of new business achieved profit (NBAP) and in-force profit, resulting in a 35 per cent increase in operating profit over 2003 at CER. NBAP of £688 million was up 23 per cent on the prior year at CER and up 14 per cent at reported exchange rates. In-force profit increased 51 per cent on 2003 at CER to £460 million. At reported exchange rates, in-force profit was up 46 per cent.
Other income and expenditure was negative £193 million compared with negative £178 million at CER in 2003. This reflected an increase in investment return on centrally held assets and other income offset by higher interest payable and head office costs.
Banking: Operating profit from continuing operations 1,124 807 39% 1,124 861 31%
As the unit-linked business has gained scale, with sales growing by 219 per cent in 2004, margins have approached a break-even position.
In the US, Jackson National Life’s (JNL) NBAP of £156 million was up 18 per cent on 2003 at CER and up five per cent at reported rates. This increase was principally volume driven as a result of high sales levels recorded during the year. The NBAP margin was 34 per cent in 2004, a slight reduction from 35 per cent in 2003 due to a shift in product mix and a small impact from economic assumption changes.
In-Force Achieved Profit Total in-force profit in 2004 was £460 million, an increase of 51 per cent on 2003 at CER. This was driven by the significant increase in the in-force profit in the US.
UK and European in-force profit of £230 million was up 19 per cent on 2003. The profit arising from the unwind of discount from the in-force book was partially offset by adverse operating assumption changes and other experience charges.
Measures to manage and improve the conservation of in-force business have had a beneficial effect on persistency that Prudential UK expects to maintain or improve. Consequently, Prudential UK has not changed persistency assumptions for all other products.
In the US, the in-force profit of £161 million was more than three times higher than in 2003. This growth reflects improvements from 2003 in net experience variances to positive £33 million (an increase of £46 million at CER), changes in operating assumptions to negative £3 million (an increase of £16 million at CER) and changes in other items to positive £12 million (an increase of £37 million at CER). Included in other items is a £28 million favourable legal settlement.
M&G’s revenue growth continues to be combined with careful cost control. In 2004, M&G enjoyed the first full year of savings from the outsourcing of retail administration at the end of 2003. This, together with the tight management of overhead across the entire business, has resulted in costs remaining flat for the last four years.
Egg’s UK business delivered a good set of results with a particularly encouraging performance in the second half of 2004. For the full year, a profit of £74 million was recorded, compared with £73 million in 2003. This represents a solid result considering the increased competition and rising interest rates that have impacted the credit card and personal loan markets.
Included in the continuing operating results was a charge of £3 million, which related to the migration and other exit costs associated with the transfer of the funds supermarket business to Fidelity FundsNetwork. The transfer will result in annual savings of around £3 million.
Others Asia’s development expenses (excluding the regional head office expenses) reduced by 38 per cent at CER to £15 million, compared with £24 million in 2003. These development expenses primarily related to repositioning the insurance operation in Japan.
Other net expenditure increased by £15 million to £193 million. This reflected an increase in investment return and other income offset by higher interest payable and head office costs. Head office costs (including Asia regional head office costs of £29 million) were £83 million, up £16 million on 2003. The increase mainly reflects the substantial work being undertaken for the implementation of International Financial Reporting Standards, Sarbanes-Oxley and other regulatory costs.
The result before tax and minority interests was a profit of £1,521 million, up 82 per cent on 2003. This primarily reflects the strong operating profit from continuing operations of £1,124 million and the lower negative effect of changes in economic assumption of £100 million, compared with negative £540 million in 2003. The result also benefited from strong investment performance which was ahead of the long-term investment assumptions.
In the UK, economic assumption changes of negative £19 million reflect the impact of the decrease in the future investment return assumption offset by the decrease in the risk discount rate.
Amortisation of goodwill was £97 million in 2004 compared to £98 million in 2003.
The effective tax rate at an operating profit level was 29 per cent, reflecting the lower effective tax rates in the UK and certain Asian territories.
The effective tax rate at a total achieved profit level was 32 per cent on a profit of £1,521 million. The higher effective rate of tax compared with that at an operating profit level is primarily due to amortisation of goodwill not being deductible for tax purposes.
J Tax, minority interests and others (-£479m) K Foreign exchange movement (-£229m) L Dividends paid to shareholders (net of Scrip) (-£243m) M Rights Issue proceeds (+£1,021m) N Closing 2004 achieved profits basis shareholders' funds (+£8,596m)
Group operating profit from continuing operations on the modified statutory basis (MSB) was £603 million, an increase of 49 per cent from 2003 at CER. At reported exchange rates, operating profit was up 42 per cent on last year. This reflects strong growth in insurance and fund management businesses.
In the US, Jackson National Life’s (JNL) operating profit from continuing operations of £182 million was up 46 per cent on 2003. Total MSB operating profit for long-term business from continuing operations was £196 million, up 53 per cent from £128 million in 2003.
Growth in the long-term business operating profit reflects JNL’s clear focus on profitability and its ability to deliver improved investment returns. In 2004, spread income was £169 million higher than in 2003 and variable annuity fee income was at a record level due to the significant growth (47 per cent) in separate account assets. In addition, there were two one-off items, a favourable legal settlement of £28 million and a positive £8 million adjustment arising from the adoption of SOP 03-01 ‘Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and for Separate Accounts’. This adjustment relates to a change in the method of valuing certain liabilities.
Prudential Corporation Asia’s operating profit for long-term business before development expenses of £15 million was £126 million, an increase of 64 per cent on 2003 at CER. At reported rates, operating profit was 48 per cent up on last year. The majority of this profit currently still comes from the larger and more established operations of Singapore, Hong Kong and Malaysia, which represented £110 million of the total in 2004, compared to £86 million last year. Five life operations made MSB losses; China, India and Korea reflecting their rapid building of scale while Thailand is marginally loss making and Japan’s loss reduced significantly over 2003 due to lower new business strain, reduced management expenses and mark to market gains on investments.
Amortisation of goodwill was £97 million in 2004 compared with £98 million in 2003.
Profit on the disposals of Jackson Federal Bank and the Group’s 15 per cent interest in Life Assurance Holding Corporation Limited was £41 million and £7 million respectively.
Banking: Operating profit from continuing operations 603 405 49% 603 424 42%
Total MSB Profit – Result After Tax MSB profit after tax and minority interests was £428 million, after a tax charge of £232 million.
The effective tax rate at an operating profit level was 30 per cent, a blend of the effective tax rates of 35 per cent in the US, 33 per cent in Asia and 28 per cent in the UK. The effective tax rate of 28 per cent on the UK results reflects the basis of taxation on profit arising from the life fund.
The effective tax rate at a total MSB profit level was 36 per cent on a profit of £650 million. The higher effective rate of tax compared with that at an operating profit level is primarily due to amortisation of goodwill not being deductible for tax purposes.
Basic earnings per share, based on total achieved profits basis profit for the year after minority interests, were 49.1 pence, compared with a restated figure of 23.4 pence in 2003. Basic earnings per share, based on MSB profit for the year after minority interests, were 20.1 pence, 10.1 pence up from a restated 2003 figure of 10.0 pence.
DIVIDEND PER SHARE As outlined in the Rights Issue prospectus, Prudential has maintained its current dividend policy, with the proposed 2004 final dividend payment per share taking account of the bonus element of the Rights Issue.
The shares issued as part of the Rights Issue were issued at a discount to market price (308 pence per share versus a closing share price of 458 pence per share on the day immediately preceding the announcement of the Rights Issue). It is therefore necessary to restate the Company’s previously reported earnings and previously declared dividends per share for this bonus element.
The bonus adjustment is equal to the closing share price on the final day Prudential’s shares traded cum-rights (19 October 2004) divided by the theoretical ex-rights price (TERP) as outlined in the table below.
The final dividend per share for 2003 was 10.29 pence after adjusting for the bonus element of the Rights Issue (10.70 pence before the adjustment). The interim dividend for 2004 was 5.40 pence (5.19 pence after adjustment for the Rights Issue).
The 2004 dividend is covered 1.2 times by post-tax modified statutory basis profit for the financial year after minority interests.
The FSA has established a structure for determining how much hybrid debt can count as capital which is similar to that used for banks. It categorises capital as Tier 1 (equity and preference shares), Upper Tier 2 debt and Lower Tier 2 debt. Up to 15 per cent of Tier 1 can be in the form of hybrid debt and called ‘Innovative Tier 1’. At 31 December 2004, the Group held £638 million of Innovative Tier 1 capital, in the form of perpetual securities, nil Upper Tier 2 and £921 million of Lower Tier 2 capital.
The FFA represents assets in the life fund which have not yet been allocated either to policyholders or shareholders and which are not available to the Group as a whole other than as they emerge through the statutory transfer of the shareholders’ share of the surplus as it emerges from the fund over time.
Weighted Average Cost of Capital Our commitment to our shareholders is to maximise the value of Prudential over time by delivering superior financial returns. Prudential’s weighted average cost of capital (WACC) is 8.7 per cent, which is based on the net core debt and shares outstanding at the end of 2004, an equity market premium of three per cent and a market Beta of 1.6. Prudential’s core debt at the end of 2004 is net of the Rights Issue proceeds which have increased the proportion of the Group’s capital funded by equity and therefore increased the Group’s WACC.
In response to these developments the Board took the decision in October 2004 to launch a 1 for 6 Rights Issue.
The majority of the net proceeds of the Rights Issue (£1,021 million) will be used to provide capital to support Prudential’s growth plans for the UK and to fund a potential opportunity to increase its ownership from 26 per cent to 49 per cent of its joint venture life insurance business with ICICI in India. The remainder of the proceeds will be used to ensure that Prudential meets the parent company solvency test under the EU Financial Groups Directive (FGD) that became effective from 1 January 2005. The proceeds of the Rights Issue have initially been invested centrally within the Group in fixed interest securities.
Modified statutory basis (MSB) shareholders’ funds, which are not affected by fluctuations in the value of investments in the Group’s with-profits funds were £4.3 billion, an increase of £1.1 billion from
INTERNAL RATE OF RETURN OF INSURANCE OPERATIONS United Kingdom and Europe Prudential allocates shareholder capital to support new business growth across a wide range of products in the UK. The weighted average post-tax Internal Rate of Return (IRR) on the capital allocated to new business growth in the UK in 2004 was 12 per cent. This reflected an IRR of 20 per cent for annuity products, seven per cent for unit-linked bonds, three per cent for corporate pensions and one per cent for protection products.
United States For Jackson National Life, the average IRR on new business was 13 per cent which we believe to be above the returns being earned currently in the US life insurance industry.
We have, however, achieved or exceeded the target in each of Asia’s markets in 2004 except for Thailand and Japan. In Japan the returns on capital are below our target, a result of restructuring and withdrawing from some business lines in 2003. The restructured business needs to build scale to achieve its target. In Thailand the returns on capital are below our target as this operation is relatively small. In aggregate, IRR on new business exceeded 20 per cent on average risk discount rates for 2004 of 9.6 per cent.
CASH FLOW The table on page 19 shows the Group holding company cash flow. Prudential believes that this format gives a clearer presentation of the use of the Group’s resources than the FRS 1 statement required by UK GAAP.
The Group received £521 million in cash remittances from business units in 2004 (2003: £586 million) comprising the shareholders’ statutory life fund transfer of £208 million relating to earlier bonus declarations, together with dividends and interest from subsidiaries of £313 million. The shareholder transfer in 2005 representing 2004’s profit from the PAC with-profits fund, is expected to be approximately £198 million.
Prudential UK paid a £100 million special dividend from the PAC shareholders’ funds in respect of profit arising from earlier business disposals. A similar amount will also be distributed from PAC shareholders’ funds in 2005. The level of scrip dividend takeup in 2004 (for both the 2003 final and 2004 interim dividend) was greater than the corresponding take-up in 2003, in part due to the change in basis of the election offered to shareholders. After dividends and interest paid, there was a net inflow of £173 million (2003: £42 million).
The Group invested £347 million during 2004 in its business units (2003: £173 million). Investment in the UK amounted to £189 million. This amount is expected to increase to around £250 million in 2005. Investment in Asia in 2004 of £158 million is expected to remain broadly the same in 2005. In 2006, based on current plans and expectations, Prudential expects Asia to be a net capital provider to the Group.
Prudential has in place an unlimited global commercial paper programme. At 31 December 2004 commercial paper of £517 million, US$761 million and ¤445 million had been issued under this programme. Prudential also has in place a £5,000 million medium-term note (MTN) programme. At 31 December 2004 subordinated debt outstandings under this programme were £435 million and ¤520 million, and senior debt outstandings were US$18 million. In addition the holding company has access to £1,400 million committed revolving credit facilities, provided by 14 major international banks and a £500 million committed securities lending liquidity facility. These facilities have not been drawn on during the year. The commercial paper programme, the MTN programme, the committed revolving credit facilities and the committed securities lending liquidity facility are available for general corporate purposes and to support the liquidity needs of the parent company.
Cash remitted by business units: UK life fund transfer* 208 286 UK other dividends (including special dividend) 100 120 JNL 62 48 Asia 67 48 M&G 84 84
The Group is funded centrally, except for Egg, which is responsible for its own financing. The Group’s core debt is managed to be within a target level consistent with its current debt ratings. At 31 December 2004, the gearing ratio, on an achieved profits basis including hybrid debt (net of cash and short-term investments) was 13 per cent compared with 23 per cent at 31 December 2003.
Based on the achieved profits basis operating profit from continuing operations and interest payable on core structural borrowings, interest cover was 8.3 times in 2004 compared with 6.6 times in 2003 (or 7.0 times based on restated achieved profit in 2003).
TREASURY POLICY The Group operates a central treasury function, which has overall responsibility for managing its capital funding programme as well as its central cash and liquidity positions.
FUND FOR FUTURE APPROPRIATIONS During 2004, the Fund for Future Appropriations, which represents the excess of assets over policyholder liabilities for the Group’s with-profits funds on a statutory basis, grew to £16.7 billion from £12.7 billion in 2003. This reflects an increase in the cumulative retained earnings arising on with-profits business that have yet to be allocated to policyholders or shareholders. The change in 2004 predominantly reflects the positive investment return earned by the PAC with-profits fund as a result of investment gains in the UK equity market.
DEVELOPMENTS IN REGULATORY SOLVENCY REQUIREMENTS The Financial Groups Directive (FGD), which affects groups with significant cross-sector activities in insurance and banking/investment services, came into force for Prudential from 1 January 2005. Prior to this, since 1 January 2001 Prudential was required to meet the solvency requirements of the Insurance Groups Directive (IGD), as implemented by the Financial Services Authority (FSA). The FSA has implemented the FGD by applying the sectoral rules of the largest sector, hence a group such as Prudential is classified as an insurance-led conglomerate and is required to focus on the capital adequacy requirements of the IGD, the Fourth Life Directive and the Insurance Company Accounts Directive.
Due to the geographically diverse nature of Prudential’s operations, the application of these requirements to Prudential are complex. In particular, for many of our Asian operations, the assets, liabilities and capital requirements have to be recalculated based on FSA regulations as if the companies were directly subject to FSA regulation. Our current estimate of our FGD position is that at the end of 2004 we had a surplus of at least £800 million, excluding goodwill but including the surplus regulatory capital of Egg.
The PAC long-term fund is rated AA+ (stable outlook) by Standard & Poor’s and Aa1 (stable outlook) by Moody’s.
For the UK main with-profits fund 86 per cent of fixed income securities are investment grade with 23 per cent rated AA or above. For Prudential Annuities Limited 98 per cent of the fixed income securities are investment grade with 46 per cent rated AA or above. For Prudential Retirement Income Limited 98 per cent of total assets are investment grade with 57 per cent rated AA or above.
Asia Prudential Corporation Asia maintains solvency margins in each of its operations so that these are at or above the local regulatory requirements. Across the region, approximately 30 per cent of non-linked funds are invested in equities.
Bonds: Investment Grade Public 60 58 60 Investment Grade Private 20 19 19 Non Investment Grade Public 4 5 4 Non Investment Grade Private 3 2 2
A provision of £7 million was held at 31 December 2004 by shareholders’ funds to cover potential compensation in respect of mis-selling claims for Scottish Amicable mortgage endowment products sold since the acquisition of Scottish Amicable in 1997. In addition, a provision of £47 million was held at 31 December 2004 for the closed Scottish Amicable Insurance Fund (SAIF) in respect of mortgage endowment products sold prior to acquisition. This provision has no impact on shareholders. No further Scottish Amicable mortgage endowment products were sold after April 2001.
The Company believes that it would be beneficial if there were greater clarity as to the status of the inherited estate and therefore it has discussed with the Financial Services Authority (FSA) the principles that would apply to any re-attribution of the inherited estate. No conclusions have been reached. Furthermore, the Company expects that the entire inherited estate will need to be retained within the long-term fund for the foreseeable future to provide working capital and so it has not considered any distribution of the inherited estate to policyholders and shareholders.
The costs associated with the mis-selling review of Prudential’s with-profits personal pensions have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders’ pay out values have been unaffected by personal pension mis-selling.
The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing. This review was completed on 30 June 2002 and consequently the assurance has not applied to new business issued since 1 January 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and single premium top-ups, transfers and switches to existing arrangements. The assurance will continue to apply to any policy in force as at 31 December 2003, both for premiums paid before 1 January 2004 and for subsequent regular premiums (including future fixed, retail price index or salary related increases and Department for Work and Pensions rebates).
The employers’ contribution is required to be paid as a minimum in future years, irrespective of assets in the Scheme and, under the current Scheme rules, access to the surplus through refunds from the Scheme is not available. Accordingly, the surplus is not recognised as an asset in the Group’s financial statements that would normally, subject to amortisation, be appropriate under the requirements of SSAP 24 which the Group continues to adopt rather than FRS 17. The continued use of SSAP 24 is permitted under the provisions of FRS 17 until 2005, at which point the requirements of International Accounting Standards, in particular IAS 19, will apply.
Under FRS 17 the basis of valuation differs markedly from the full triennial valuation and SSAP 24 bases. In particular, it would require assets of the Scheme to be valued at their market value
at the year end, while pension liabilities would be required to be discounted at a rate consistent with the current rate of return on a high-quality corporate bond. As a result, the difference between FRS 17 basis assets and liabilities can be volatile for value movements in assets and a basis of setting inflation assumptions that is referenced to market expectations implied within index-linked bonds. For those schemes such as PSPS, which hold a significant proportion of their assets in equity investments, the volatility can be particularly significant.
If FRS 17 had been fully implemented for 2004, it is estimated that a £10 million shareholder charge (after tax) in the profit and loss account, and a shareholder charge of £6 million (after tax) in the statement of total recognised gains and losses would have been reported.
The Group operates a comprehensive planning process. The Board receives regular reports on the performance of the Group against plan with frequent financial projections.
The profits from almost all Prudential’s new non-participating business written since 1 July 2004 accrue solely to shareholders. Such business is written in the non-profit sub-fund within PAC’s long-term fund, or in various shareholder-owned direct or indirect subsidiaries, the most significant of which is Prudential Retirement Income Limited (PRIL). There is a substantial volume of in-force non-participating business in PAC’s with-profits fund and that fund’s wholly-owned subsidiary Prudential Annuities Limited (PAL); profits from this business accrue to the with-profits fund. The vast majority of external non-profit annuity business is now written in PRIL and, with effect from 1 July 2004, immediate annuities arising from vesting deferred annuity policies were reinsured to PRIL.
Equity-linked indexed annuities are deferred annuities that enable policyholders to obtain a portion of an equity-linked return but provide a guaranteed minimum return. JNL guarantees an annual
minimum interest rate of three per cent, but actual earnings may be higher and are based on a participation in an equity index over its indexed option period. JNL’s profit arises from the difference between a) the premiums received plus the associated investment income and b) the combined cost of expenses (general expenses, costs of purchasing fixed interest securities and options) and the policyholder’s account value (which is subject to the minimum guarantee).
JNL offers a choice of guarantee benefit options within its variable annuity product range which customers can elect and pay for.
Asia The life insurance products offered by Prudential Corporation Asia include a range of with-profits (participating) and non-participating term, whole life and endowment and unit-linked policies. Prudential also offers health, disablement, critical illness and accident cover to supplement its core life products.
products are commonly offered as supplements to main life policies but can also be sold separately.
ACCOUNTING POLICIES AND DEVELOPMENT UK GAAP There have been no changes in accounting policies for the preparation of the 2004 UK GAAP results with the exception of UITF Abstract 38 ‘Accounting for ESOP Trusts’. Under UITF Abstract 38 the cost of acquiring shares held in trusts for employee incentive plans is required to be presented as a deduction from shareholders’ funds. The effect of the change in policy is to reduce shareholders’ funds at 1 January 2004 from the previously published 31 December 2003 level by £38 million. The impact on the profit and loss account is immaterial.
As the amount of information required to be published is considerable, it is reported in a separate section of the Financial Review on pages 100 to 109.
The Group will report interim 2005 IFRS basis results in July 2005. Aside from the fact that JNL’s hedging strategy is brought more into focus than under UK GAAP (see below), the IFRS changes of themselves are not material to an understanding of the Group’s financial position. However, we recognise that the market will need time to become familiar with the changes and their impact on the presentation of the financial statements, so it is our intention to publish comparative IFRS basis results on 2 June 2005.
IASB and EU developments on technical requirements The International Accounting Standards Board (IASB) has now, with some exceptions, completed its deliberations, and fully issued all of the standards to constitute the stable platform for 2005 reporting. New standards issued from 1 April 2001 are called IFRSs whilst those issued prior to this date (including those amended subsequently under the IASB’s improvement project) are referred to as International Accounting Standards (IASs).
Substantially all of these standards have been subjected to a process of review under EU auspices, recommended for approval by the EU’s Accounting Regulatory Committee (ARC), and then formally approved.
The IASB is continuing to consider the restrictions that should apply under IAS 39 (on financial instruments) to companies’ ability to record the fair value movements on assets and liabilities to the profit and loss account. The IASB’s continued consideration of these issues reflects concern expressed by some European institutions at the current version of the standard.
Application of IFRS to Prudential The description that follows of the expected impact on the results of the Prudential Group reflects the version of IAS 39 in place at the date of signing of the annual report and the expected version of IAS 19 on employee benefits, which incorporates pension costs. In addition, due to the recent changes made by the IASB, the latest version of IAS 19 which permits actuarial gains and losses to be accounted for directly within equity, has yet to be approved by the ARC. In the event that the IASB subsequently makes further changes to these or other accounting standards, or the ARC does not approve them, the descriptions below of the expected effect on the results may require revision.
Expected impact of application of IFRS basis reporting Insurance operations Insurance contract accounting: Under IFRS 4 ‘Insurance Contracts’ for those contracts with significant insurance risk and those with discretionary participating features (such as conventional and unitised withprofits contracts), UK GAAP will continue to apply until the IASB introduces a comprehensive (Phase 2) standard for insurance contracts. Under IFRS 4, we estimate that about 85 per cent of the Group’s insurance contracts are classified in this category.
It should be noted however that, by the UK insurance industry’s adoption of the requirements of FRS 27, UK GAAP for with-profits contracts of UK life funds will also alter to reflect the FSA realistic reporting regime. The change essentially alters the basis of providing for future bonuses on, and valuing guarantee features of, with-profits contracts. In turn this affects the residual amount that has yet to be allocated between policyholders and shareholders (the Fund for Future Appropriations). The estimated impact on the 2004 year end position is shown on pages 103 and 104. Profit recognition for this business on the UK GAAP and IFRS bases will though continue to reflect the Company’s 10 per cent interest in the actuarially determined surplus for distribution.
Contracts where UK GAAP will no longer apply for 2005 IFRS basis reporting are those contracts which do not contain significant insurance risk. The only area where Prudential’s contracts are potentially affected by the measurement changes required under IFRS to any degree of significance is those unit-linked contracts in the UK that will be required to be valued as investment contracts under IAS 39. Given the weighting within the UKIO book of in-force contracts and 2004 product sales mix the impact of the IFRS changes for 2004 in this area is though likely to be modest.
Guaranteed Investment Contracts (GICs) of Jackson National Life, and a very small number of contracts in the Group’s Asian operations are also subject to potential measurement change under IAS 39. The current measurement approach for GICs is though almost the same as the amortised cost approach being applied under IFRS. The potential changes to the Asian contracts are immaterial in their financial effect.
On presentational effects, under IAS 39, premiums and claims on these UK unit-linked contracts, GICs and minor Asian contracts will be recorded as movements on contract liabilities in the balance sheet. Although profit does not alter for this change, the presentation in the Group’s income statement is affected so that premium income and the charge for claims and surrenders are reduced. In this regard the change is similar conceptually to that required under deposit accounting as applied under US GAAP.
It should be noted, for the avoidance of confusion, that IFRS 4 rules are very different from those under US GAAP as to the category of policies that are classified as ‘investment contracts’. Most of the Group’s contracts that would be classified as investment contracts under US GAAP, will continue to be accounted for under IFRS as either insurance contracts, or investment contracts with discretionary participating features with the facility to continue to account under IFRS on UK GAAP (the MSB method of reporting).
Unallocated surplus: Notwithstanding the fact that the IFRS basis of reporting in 2005 will incorporate the FSA’s realistic basis of provisioning for UK with-profits funds, IFRS 4 permits unallocated surplus, that is the IFRS equivalent of the Fund for Future Appropriations, to continue to be accounted for as a liability in the balance sheet. It is the Group’s intention to continue to account for unallocated surplus on this basis.
Investment valuation and derivative accounting: Under IAS 39, except for loans and receivables, and unless designated under the very restrictive held to maturity classification on an asset by asset basis, most financial assets, including derivatives, are carried in the balance sheet at fair value. To this extent IAS 39 is in many areas similar to the requirements of the US GAAP standards FAS 115 and FAS 133 and at a practical level, is consistent with the basis of valuation applied under UK GAAP for the vast majority of financial assets of the Group’s UK and Asian operations.
On application of IAS 39, movements in the fair value of investments are recorded in either the profit and loss account or directly to shareholder reserves in the balance sheet, depending upon the designation and the impact of hedge accounting rules. Derivative instruments are generally also carried at fair value with
movements in value being recorded in the profit and loss account. Hedge accounting, whereby value movements on derivatives and hedged items are recorded together in the performance statements, is permissible only if certain hedge effectiveness criteria are met.
The changes from UK GAAP treatment arising from these requirements is expected to be concentrated on the accounting for the investments and derivatives of Jackson National Life (JNL). Currently, under UK GAAP the fixed income securities of JNL are, unless impaired, accounted for at amortised cost with derivatives similarly treated. In applying IFRS the Group has decided to account for JNL’s fixed income securities on an ‘available for sale’ (AFS) basis whereby the fixed income securities are accounted for at fair value with movements in that fair value being recorded in shareholders reserves rather than the income statement. In this respect the treatment is as applied by many US insurers under US GAAP. Value movements for JNL’s derivatives will however be booked in the income statement as required by IAS 39.
■ whether it is possible or desirable, without an unacceptable level of costs and restraint on commercial activity, to achieve the accounting hedge effectiveness required under IAS 39.
In this regard, the issues surrounding IAS 39 application are very similar to those considered by other US life insurers when FAS 133 was first applied for US GAAP reporting. Taking account of these considerations, we have decided that, except for certain minor categories of derivatives, it is not sensible to seek to achieve hedge accounting under IAS 39 by completely reconfiguring the structure of JNL’s derivative book. As a result of this decision the total profit and loss account results will be more volatile as the movements in value of JNL’s derivatives will be reflected within it. This is despite the fact that JNL’s derivative activity achieves a high level of economic hedge effectiveness. It is recognised that as an accompaniment to future IFRS basis results announcements the Group will need to demonstrate this economic hedge effectiveness.
Derivatives will be the only products for which changes in fair value will affect the result for the year. However, for interest rate swaps that economically hedge fixed rate personal loans, by matching them against the variable rate savings book, Egg will apply macro cash flow hedge accounting under IAS 39. Changes in the fair value of these hedges will be recorded direct to equity in the balance sheet and not the income statement (except where hedging is ineffective).
There are many other changes arising from IFRS adoption but these are not expected to be material to an understanding of the Group’s financial position. The main other changes that affect the Group’s income statement and balance sheet are in respect of: ■ stock based compensation. However, it should be noted that, in relative terms to some companies, the size of share based emoluments for Prudential is low; ■ property, which is mostly held by the PAC with-profits fund; ■ consolidation of investment funds and venture fund investments of the PAC with-profits fund. IFRS has different criteria for when consolidation is required; ■ grossing up adjustments for carrying values of derivative assets and liabilities; and
Transition arrangements on first time adoption of IFRS Timetable Under UK Listing Authority requirements, the Group will be obliged to publish IFRS basis results for the first time for interim 2005 reporting. The Group intends publishing comparative IFRS basis results for 2004 on 2 June 2005.
The comparative basis results to be published in June 2005 will be accompanied by pro forma basis information on a basis that incorporates the effects of IAS 39 and IFRS 4 on the results of the Group’s insurance operations. This is so as to act as a guide to the market of the scale of the changes to the 2004 results consistent with the accounting policies to be applied for 2005.
The use of a pro forma-based approach to comparative results reflects the mixed nature of the Group’s activities and the approach taken to hedging for the different operations.
A Closing 1999 achieved profits basis shareholders’ funds B New business achieved profit C In-force achieved profit D Other E Short-term fluctuation in investment return and change in economic assumptions F Dividends paid out to shareholders G Closing 2004 achieved profits basis shareholders’ funds levels of future investment return, expenses, surrender levels and mortality. These best estimate assumptions are used to project future cash flows. The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the risks associated with the cash flows. The risk discount rate is determined using the actual yield on long-term government bonds plus a risk margin. The projected future cash flows are prepared on a single set of assumptions specific to each business unit and the actual outcome may be different from that projected. Where the actual outcome is different, this will be reflected in the experience variances for that year.
The assumptions used for the achieved profits basis of accounting are set out on page 116 in the notes that accompany the supplementary achieved profits basis accounts. An indication of the sensitivity of the results to changes in the key assumptions of interest rate and investment return is provided on page 124.
The achieved profits basis profit emerging in each subsequent accounting period will comprise the unwinding of the discount (which arises from discounting future cash flows for one fewer period) and the profit or loss arising from any difference between the actual cash flow and the cash flow which had been assumed in the accounting period under review, together with the effect of any changes of assumption where the directors believe a revision is required to the original estimates of future experience.
Set out on the following page is an illustrative profit profile for a typical with-profits product. The pattern of actual profit emergence will vary by product.
Member companies, of which Prudential is one, agreed to adopt the Principles for supplementary reporting no later than the financial year end commencing 1 January 2005. Prudential will fully adopt the Principles for the first time in respect of full year 2005 results.
Improving Financial Capability Given the increasing variety and complexity of financial products, there is an urgent need to provide financial education and we play an active role around the world in addressing this issue. Four years into our financial education programme, we are seeing significant progress. In the UK, via partnerships with charities such as Citizens Advice, thousands of adults and children are now benefiting. Last year, we extended our work to China. Already, about 1,000 women in 211 State Owned Enterprises in Beijing have graduated from Prudential Corporation Asia’s new Invest In Your Future programme. This draws on the skills of our female colleagues who understand the issues currently facing women in China. The programme has proved both popular and successful and we now intend to extend the initiative to elsewhere in China and into Vietnam.
In the wake of Asia’s tsunami tragedy, we established the Prudential Caring Fund in late December 2004. Prudential staff and Company matching has amassed a total of £800,000. The funds will be channelled into four hard-hit countries where we have a presence: Indonesia, India, Malaysia and Thailand. Prudential Corporation Asia is working with aid agencies to determine how best to allocate these funds, to ensure they have the maximum impact. In particular, we are focusing our support on children, some of the most vulnerable victims of the tragedy.
ACTING RESPONSIBLY BUILDS TRUST Success in the long term depends not just on our financial results, but also on how we behave. We, like other UK insurers, are increasingly being asked to disclose our views on and response to a range of social, environmental and ethical issues. Globalisation, for example, is a trend that no international business can afford to ignore, offering opportunities for growth and efficiency. But the choices we make as a company affect people, including our customers and employees around the world.
Prudential operates a Group Governance Framework which is underpinned by a Group Governance Manual and associated processes. This encompasses all key policies and procedures, responsibility for which is allocated to named contacts within Group Head Office. These include our Group Code of Business Conduct, our Corporate Responsibility Policy and our Health and Safety Policy. Responsibility for compliance with these policies within the business units rests with each business unit’s management.
We are investigating how to incorporate CR issues into an external assurance programme on which we will report during 2005.
Maintaining Universal Standards In 2003, Prudential UK opened an offshore call centre and back office processing unit in Mumbai, India. Prudential Process Management Services is a wholly-owned subsidiary of Prudential plc and employs around 1,000 people. The Mumbai operation has enabled Prudential’s UK business to significantly reduce its operating costs whilst improving its customers’ experience, for example, through the replacement of telephone computerised interactive voice technology with an immediate connection to a well trained member of staff. The work environment, training and technology standards are the same as those offered in the UK and, for the second year running, Prudential UK, including its Mumbai centre, was accredited as an Investor in People.
M&G’s approach to socially responsible investment (SRI) is set out in the booklet Issues Arising from Share Ownership, available at www.prudential.co.uk/cr SRI has mostly focused on equity markets, with the property investment community slower to address the issue of sustainability. However, with more than £14.8 billion of funds under management Prudential Property Investment Managers Limited, a subsidiary of M&G, is the UK’s largest commercial property investment manager and accounts for approximately 80 per cent of Prudential’s direct environmental impact in the UK. As a leading participant in the Institutional Investor’s Group on Climate Change, we are creating awareness of the implications of climate change for property investment and how the industry should address this.
Further information about our approach to equal opportunities and employee involvement can be found on pages 53 and 54.
3. PHILIP BROADLEY FCA Group Finance Director. Aged 44. Appointed in May 2000. He is currently Deputy Chairman of the 100 Group of Finance Directors and a member of the Insurance Advisory Group of the International Accounting Standards Board. He is also President of the Przezornosc Charitable Foundation, which has been established in Poland in recognition of former policyholders with whom the Company lost contact. Previously he was with the UK firm of Arthur Andersen where he became a partner in 1993. He specialised in providing services to clients in the financial services industry, including regulators and government agencies in the United Kingdom and the United States.
4. CLARK MANNING FSA MAAA Executive director. Aged 46. Appointed in January 2002. He is also President and Chief Executive Officer of Jackson National Life. He was previously Chief Operating Officer, Senior Vice President and Chief Actuary of Jackson National Life, which he joined in 1995.
He joined M&G in October 1992. He is also a nonexecutive director of Close Brothers Group plc.
In addition, he is a member of the International Advisory Board of Marsh & McLennan Companies Inc., and from 1 April 2005 he will also be a member of Actis Capital LLP.
10. BRIDGET MACASKILL Independent non-executive director. Aged 56. Appointed in September 2003. She rejoined the Board of Prudential having previously resigned due to a potential conflict of interest in March 2001. She is a non-executive director of J Sainsbury plc. She was previously Chairman and Chief Executive Officer of OppenheimerFunds Inc., a major New York based investment management company.
11. ROBERTO MENDOZA Independent non-executive director and Chairman of the Remuneration Committee. Aged 59. Appointed in May 2000. He is also the nonexecutive Chairman of Egg plc, and Chairman of Integrated Finance Limited. He was previously Vice Chairman and director of JP Morgan & Co, Inc., a non-executive director of Reuters Group PLC and The BOC Group plc, and a Managing Director of Goldman Sachs.
14. ROB ROWLEY FCMA Senior independent non-executive director and Chairman of the Audit Committee. Aged 55. Appointed in July 1999 (as an independent nonexecutive director), June 2000 (as Chairman of the Audit Committee) and December 2003 (as Senior Independent Director). He is executive Deputy Chairman of Cable and Wireless plc, a non-executive director of Taylor Nelson Sofres plc and a non-executive director of Liberty International plc. He retired as a director of Reuters Group PLC in December 2001, where he was Finance Director from 1990 to 2000.
During 2004 the Board met 14 times and held a separate strategy day. Each year one of the Board meetings is held at one of the Group’s business operations to facilitate a fuller understanding of the diversity of the business. In September 2004, a Board meeting was held in Scotland, following a series of presentations made to Board members on the UK business and future market opportunities by the Prudential UK management team at its Craigforth centre. All of the directors, save for Bridget Macaskill who missed one scheduled meeting due to injury, attended all of the eight scheduled Board meetings. The majority of the directors attended most of the remaining six additional Board meetings. Where a director was not able to attend any of the additional meetings, their views were canvassed prior to that meeting. A further 14 Board Committee meetings took place during the year. The Board’s terms of reference, which are regularly reviewed, set out those matters specifically reserved to it for decision, in order to ensure that it exercises control over the Group’s affairs. These include, amongst other things, approval of the annual and interim results, strategy and corporate objectives, operating plans, significant transactions and matters affecting the Company’s share capital.
A corporate governance framework approved by the Board maps out the internal approvals processes and those matters which are delegated to business units. These principally relate to the operational management of the Group’s businesses and include pre-determined authority limits delegated by the Board to the Group Chief Executive for further delegation by him in respect of matters which are essential to the effective day-to-day running and management of the business.
The chief executive of each business unit, who in respect of his business unit responsibilities reports to the Group Chief Executive, has authority for management of that business unit and has established a management board comprising its most senior executives. In accordance with the Group Governance Framework, business unit chief executives are required to certify annually their compliance with the requirements of the framework.
Other commitments of the Chairman and changes during the year are detailed in his biography on page 32. The Board is satisfied that these other commitments are not such as to interfere with the performance of the Chairman’s duties for the Group.
BOARD COMMITTEES The Board has established the following standing committees of non-executive directors with written terms of reference which are kept under regular review: YEAR ENDED 31 DECEMBER 2004CORPORATE GOVERNANCE REPORT
The Committee has formal terms of reference set by the Board, which are reviewed regularly.
Membership All the members of the Audit Committee are independent nonexecutive directors. The members of the Committee (and their relevant experience) are: ■ Rob Rowley (Chairman) – formerly Finance Director of Reuters Group PLC; currently also executive Deputy Chairman of Cable and Wireless plc; ■ Kathleen O’Donovan – formerly Finance Director of BTR plc and audit partner at Ernst & Young; currently also a non-executive director of EMI Group plc and the Court of the Bank of England, and Chairman of the Audit Committee of the Bank of England and of the Audit Committee of the EMI Group plc; and
Meetings The Audit Committee met nine times during the year. Additionally, by invitation, the Chairman of the Board, Group Chief Executive, Group Finance Director, heads of Group Internal Audit, Group Risk and Group Compliance, as well as the external auditor attended the meetings. The Committee also meets solely with both external and internal auditors at least once a year.
Internal control and risk management The Audit Committee reviewed the Group’s statement on internal control systems prior to its endorsement by the Board. It also reviewed the policies and processes for identifying, assessing and
From the 2006 year end, the Group will need to undertake an assessment of the effectiveness of internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. In common with other companies which have to comply with this legislation, this has required the Group to undertake a significant project to document and test its internal controls over financial reporting. The Committee has overseen the progress of this project through regular status reports submitted by management. In 2004 the Committee commissioned an independent review of progress towards compliance with Section 404 to be undertaken by the Group’s external auditor, KPMG Audit Plc, and the results will be reported to the Committee during the first half of 2005.
The effectiveness of internal audit was assessed through a review, carried out by external advisers, and through regular dialogue with the Group Chief Internal Auditor. An internal review of the role of internal audit was also undertaken, to ensure that its activities and resources are most effectively organised to support the Committee’s oversight responsibilities.
External audit The Audit Committee has a key oversight role in relation to the external auditor, KPMG Audit Plc, whose primary relationship is with the Committee. The Group’s Auditor Independence Policy ensures that the independence and objectivity of the external auditor is not impaired, and that the Group maintains a sufficient choice of appropriately qualified audit firms. The policy sets out four key principles which underpin the provision of non-audit services by the external auditor, namely that the auditor should not: ■ audit its own firm’s work; ■ make management decisions for the Group; ■ have a mutuality of financial interest with the Group; and
The Committee reviewed the policy in December 2004, and a revised policy was approved.
The Group has a policy that at least once every five years, the Audit Committee undertakes a formal review to assess whether the external audit should be re-tendered. The external audit was last put out to competitive tender in 1999 when the present auditor was appointed. In February 2004, the Committee formally considered the need to re-tender the audit and concluded that, in view of the satisfactory performance of the external auditor and the cost of undertaking a tender exercise, it was inappropriate to do so, and the external auditor’s reappointment was approved by the Committee.
Financial reporting The Audit Committee reviewed the interim and annual financial statements before their submission to the Board, paying particular attention to critical accounting policies and practices and any changes in them; decisions requiring a major element of judgement; unusual transactions; clarity of disclosures; significant audit adjustments; the going concern assumption; compliance with accounting standards; and compliance with obligations under the Code and other applicable laws and regulations.
The Committee is regularly briefed on the development of accounting standards, and during the year continued to review the progress of the Group project to implement International
Financial Reporting Standards. This project is discussed in more detail on pages 24 to 27.
Audit Committee effectiveness During the year, the Audit Committee undertook a formal review of its own effectiveness and engaged independent external advisers to review the Committee’s compliance with the requirements of the Code and the Sarbanes-Oxley Act. Further to these reviews, some minor improvements to the documentation of the Committee’s work and its terms of reference have been implemented.
The Remuneration Committee normally has scheduled meetings at least three times a year and a number of additional meetings, as required, to review remuneration policy. The Remuneration Committee determines the remuneration packages of the Chairman and executive directors. During 2004, a total of six meetings were held. In framing its remuneration policy, the Committee has given full consideration to the provisions of Section 1B of and Schedule A to the Code. The Remuneration Report prepared by the Board is set out in full on pages 42 to 52. In preparing the Report, the Board has followed the provisions of the Code and The Directors’ Remuneration Report Regulations 2002.
Nomination Committee Report Sir David Clementi (Chairman) Jonathan Bloomer Bridget Macaskill (from 18 March 2004) Kathleen O’Donovan (from 6 May 2004) Rob Rowley Sandy Stewart (until 6 May 2004)
During the year the Nomination Committee initiated the search for additional non-executive directors. The Nomination Committee employed professional search consultants who oversaw the initial process. Candidates were interviewed initially by the Chairman and the Senior Independent Director and subsequently by other directors.
BOARD COMMITTEES – TERMS OF REFERENCE The full terms of reference of the Audit, Remuneration and Nomination Committees are available on the Company’s website at www.prudential.co.uk under the section headed ‘About Prudential’. Hard copies may be obtained upon written request to the Company Secretary at the Company’s registered office.
Clark Manning 14 (14) n/a n/a n/a Michael McLintock 14 (14) n/a n/a n/a
**During 2004 there were six scheduled Audit Committee meetings and three additional meetings.
Figures in brackets indicate the maximum number of meetings in the period in which the individual was a Board or Committee member.
The Group is one of the UK’s largest institutional investors and the Board does not believe that this situation compromises the independence of those non-executive directors who are also on the boards of companies in which the Company has a shareholding. The Board also believes that such shareholdings should not preclude the Company from having the most appropriate and highest calibre non-executive directors.
A programme of on-going professional development was undertaken for all directors in 2004, which covered a number of sector specific and business issues as well as legal, accounting and regulatory changes and developments. A cornerstone of the programme was a series of presentations made to the Board by the Prudential UK management team on its UK business and future market opportunities, at Craigforth in September. Throughout their period in office the directors are continually updated on the Group’s businesses and the regulatory and industry specific environments in which it operates. These updates are by way of written briefings and meetings with senior executives and, where appropriate, external sources. Directors are also advised on appointment of their legal and other duties and obligations as a director of a company listed on the London Stock Exchange both in writing and in face-to-face meetings with the Company Secretary.
All directors are required to submit themselves for re-election at the AGM at least every three years, and annually following their reaching the age of 70.
PERFORMANCE EVALUATION An evaluation was carried out of the performance of the Board and its Committees, and of the individual directors, for the year 2004, in line with the requirements of the Code. The aim was to improve individual contributions, the effectiveness of the Board and its Committees and the Group’s performance.
The Company regularly holds discussions with major shareholders and a programme of meetings took place during 2004. Board members also regularly receive copies of the latest analysts’ and brokers’ reports on the Company and the sector, to further develop their knowledge and understanding of external views about the Company. The Chairman and the Senior Independent Director gave feedback to the Board on issues raised with them by major shareholders. Should major shareholders wish to meet newly appointed directors they are welcome to do so.
The Annual General Meeting will be held at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on 5 May 2005 at 11.00am. The Company believes the Annual General Meeting is an important forum for both institutional and private shareholders and encourages attendance by all its shareholders. At its Annual General Meeting in 2004, the Company indicated the balance of proxies lodged for and against each resolution after it had been dealt with on a show of hands, and the total percentage of share capital voted on all resolutions. This practice provides shareholders present with sufficient information regarding the level of support and opposition to each resolution. The Company discloses the number of the proxy votes cast on each resolution on its website after the Annual General Meeting. In 2005, as a result of a delay in finalising FRS 27 ‘Life Assurance’ released on 13 December 2004, the Company has been unable to comply with the Code requirement that shareholders should be sent the Notice of Annual General Meeting at least 20 working days before the
The Company has already adopted procedures to comply with all applicable provisions of the Act.
In particular in relation to Section 302 of the Act which covers disclosure controls and procedures, a Disclosure Committee has been established, reporting to the Group Chief Executive, chaired by the Group Finance Director and comprising members of senior management. The objectives of this Committee are to: ■ assist the Group Chief Executive and the Group Finance Director in designing, implementing and periodically evaluating the Company’s disclosure controls and procedures; ■ monitor compliance with the Company’s disclosure controls and procedures; ■ review and provide advice to the Group Chief Executive and Group Finance Director with regard to the scope and content of all public disclosures of the Company which are of material significance to the market or investors; and
■ review and consider, and where applicable follow up on, matters raised by other components of the disclosure process, including assessments made by the Group Audit Committee, internal audit or the external auditor of the Company’s internal controls to the extent they are relevant to the disclosure process.
The provisions of Section 404 of the Act require Prudential’s management to report on the effectiveness of internal control over financial reporting in its annual report on Form 20-F which is filed with the US Securities and Exchange Commission. The first requirement for this report is for the year ending 31 December 2006, and in common with other companies which have to comply with this requirement, the Group has undertaken a significant project to document and test its internal control over financial reporting in the format required by the Act. This project is on schedule to support certification as at 31 December 2006.
FINANCIAL REPORTING The directors have a duty to report to shareholders on the performance and financial position of the Group and are responsible for preparing the financial statements on pages 56 to 95 and the achieved profits basis supplementary information on pages 113 to 124. It is the responsibility of the auditor to form an independent opinion, based on its audit of the financial statements and its review of the supplementary financial statements; and to report its opinions to the Company’s shareholders. Its opinions are given on pages 97 and 125.
the Group. They are used by the business units and Group during risk identification, analysis, aggregation and reporting of risk. The Group’s risk management framework includes the following committees: Group Operational Risk Committee The Group Operational Risk Committee is chaired by the Group Finance Director and its membership includes representatives of the business unit and Group functions who have input into the operation of the Group Risk Framework. The Group Operational Risk Committee is the senior management forum responsible for oversight of the Group Risk Framework across the business unit and Group functions, including monitoring operational risk and related policies and processes as they are applied throughout the Group. The Group Operational Risk Committee reports to the Group Chief Executive, who has overall responsibility for the risks faced by the Group. The Group Operational Risk Committee is supported in this role by the Group Risk Function and the Risk Committees and Risk Functions in each business unit. Quarterly risk reports from the business units and Group are reported to the Group Operational Risk Committee covering all risks of Group significance. Regular reports are also made to the Group and business unit audit committees by management, internal audit and compliance functions.
Group Balance Sheet Management Committee The Group Balance Sheet Management Committee is chaired by the Group Finance Director and is the senior management forum responsible for oversight of the Group’s balance sheet strategy, including debt capacity and capital structure. Its membership includes management involved in the operation of the Group’s policies for balance sheet management, including liquidity, financing and capital adequacy. The Group Balance Sheet Management Committee reports to the Group Chief Executive.
The Group’s internal control framework includes detailed procedures laid down in financial and actuarial procedure manuals. The Group prepares an annual business plan with three-year projections. Executive management and the Board receive monthly reports on the Group’s actual performance against plan, together with updated forecasts.
Compliance with the Directors’ Remuneration Regulations This report has been approved by the Board and, as required by The Directors’ Remuneration Report Regulations 2002 (the Regulations), a resolution will be put to shareholders at the Annual General Meeting inviting them to consider and approve it. This report complies with the requirements of the Regulations and KPMG Audit Plc have audited the sections contained in pages 47 to 52 as required by the Companies Act 1985.
Membership of the Remuneration Committee The members of the Remuneration Committee during 2004, who are listed below, were all independent non-executive directors: Roberto Mendoza (Chairman) Bart Becht (until 31 August 2004) Michael Garrett (from 1 September 2004) Bridget Macaskill Kathleen O’Donovan James Ross (from 6 May 2004) Rob Rowley Sandy Stewart (until 6 May 2004)
Advisers to the Remuneration Committee During 2004 the Group Human Resources Director was invited to provide the Committee with her views and advice on matters considered by the Committee. The Committee appointed Towers
The Board welcomes the introduction of the revised Combined Code which came into effect in 2004 and has reviewed the provisions in Schedule A, Schedule B and Schedule C and the revised Combined Code’s provisions relating to the Code on Corporate Governance and Code of Best Practice regarding directors’ remuneration.
REMUNERATION POLICY The aim of the Company’s remuneration policy is to be able to recruit and retain the highest calibre executives. To achieve this objective, Prudential must continue to use remuneration practices relevant to the different markets in which the Company does business around the world. The Remuneration Committee considers remuneration within the context of the UK’s regulatory framework and shareholder views, and is guided by UK corporate governance standards.
companies. This approach reflects the international scope of Prudential’s business. The total remuneration levels for the other executive directors are set similarly by reference to levels in their relevant markets. All pay data is externally provided.
REMUNERATION POLICY FOR EXECUTIVE DIRECTORS FOR 2004 AND 2005 The policy on remuneration levels and elements of the remuneration package for 2005 are set out below. The policy remains unchanged from 2004.
The levels of annual incentive awards are set as a percentage of salary and are as follows: Notes Michael McLintock’s annual incentive award is in line with remuneration levels in the investment management industry and is based on the profits of M&G, the fund performance of M&G and Group and individual performance.
**Clark Manning is also eligible to receive an annual bonus which provides for a percentage share of a bonus pool geared to the profits of Jackson National Life. He is additionally eligible to participate in a US tax qualified all-employee profit sharing plan.
Long-term incentive plans The policy described below is for 2004 and it is intended that the same awards will be made in 2005. Our long-term incentive plans are designed to drive the underlying financial performance of the business i.e. both value creation/business performance and relative Total Shareholder Return (TSR). The plans also recognise that strong regional performance is critical to Group performance. In order to grow the value of Prudential for shareholders, the Board needs to focus on growing each area of business. Executive directors that run a business area therefore also participate in a long-term incentive plan geared to their business reflecting those responsibilities. In all cases the performance period is three years and for example the 2004 awards run from the beginning of 2004 to the end of 2006.
For any awards under the RSP to vest, the Remuneration Committee must also be satisfied with the Company’s underlying financial performance over the performance period. At the end of each performance period, depending on the Company’s performance, executive directors may be granted a right to receive shares at no cost to the individual.
No award is made if the Company’s TSR performance is ranked below 50th percentile. For performance at 50th percentile, an award of 25 per cent of the maximum award is made. The maximum grant will be made only if the TSR ranking of the Company is 20th percentile or above. Between these points, the size of the grant made will be calculated on a straight line sliding scale. In normal circumstances, directors may take up their right to receive shares at any time during the following seven years.
Details of all outstanding RSP awards are set out in the section on the Restricted Share Plan on pages 48 and 49.
Business-specific long-term incentive plans Clark Manning To reflect his role as Chief Executive of Jackson National Life, Clark Manning participates in a cash-based long-term plan that rewards the growth in appraisal value of Jackson National Life. The award payout equals an initial award value multiplied by a factor equalling the Prudential plc share price at the end of the performance period
divided by the price at the beginning. In order for any award to be made under the 2004 plan the appraisal value growth of Jackson National Life over the performance period must be eight per cent per annum compound or greater. At this level of performance the initial award value is US$864,240. If the on-target performance level of 11.5 per cent per annum compound is achieved the initial award value is doubled. If the annual growth rate is at least 17.5 per cent the initial award increases to a maximum of three times the initial award. For performance between these points payouts are on a straight line sliding scale.
Mark Norbom To reflect his role as Chief Executive of Asia, Mark Norbom participates in the Asian Long-term Incentive Plan which is a cashbased plan that rewards the growth in value of our Asian businesses.
Under the 2005 award the plan will only pay out if the growth of the Asian business, as measured under the plan, is greater than 15 per cent per annum compound over the performance period. At this level of performance a payment of 50 per cent of basic salary is made. The on-target payout is 100 per cent of salary, for which an annual growth rate of 35 per cent is required. If an annual growth rate of 50 per cent or more is achieved, the maximum of 150 per cent of basic salary is paid. For performance between these points payouts are on a straight line sliding scale.
At this level of performance a payment of 50 per cent of basic salary is made. The on-target payout is 75 per cent of basic salary for which a growth rate of 11.5 per cent is required. If a growth rate of 17.5 per cent or more is achieved the maximum of 100 per cent of basic salary is paid. For performance between these points payouts are on a straight line sliding scale.
Executive directors, with the exception of Michael McLintock, are required to give 12 months’ notice of termination to the Company. Michael McLintock is required to give six months’ notice to the Company.
Except for Clark Manning, the executive directors are eligible to participate in either the Company’s UK or International Savings-Related Share Option Scheme. Options granted under these schemes are not subject to performance conditions.
POLICY ON EXTERNAL APPOINTMENTS Subject to the Board’s approval, executive directors are able to accept external appointments as non-executive directors of other organisations.
The basic fee is £50,000 per annum. The additional Audit Committee chairmanship fee is £40,000 per annum. An additional fee of £5,000 per annum is paid to the other members of the Audit Committee. The Remuneration Committee chairmanship fee is £20,000 per annum, although the Chairman of the Remuneration Committee waived the last increase to the chairmanship fee and receives only £10,000 per annum.
The non-executive directors use the net value of £25,000 of their total annual fees to purchase shares in the Company on a quarterly basis. These shares are held at least until retirement from the Board.
This graph shows the Company’s Total Shareholder Return performance against the FTSE 100 index, which is a broad equity market index of UK companies of comparable size and complexity to Prudential.
Total Shareholder Return over the performance period is the growth in value of a share plus the value of dividends paid, assuming that the dividends are reinvested in the Company’s shares on the day on which they were paid.
DIRECTORS’ SHAREHOLDINGS The current shareholding policy is that as a condition of serving, all executive and non-executive directors are required to have beneficial ownership of 2,500 shares in the Company. This interest in shares must be acquired within two months of appointment to the Board if the director does not have such an interest in that number upon appointment. As stated on page 45, non-executive directors have also used a proportion of their fees to purchase additional shares in the Company on a quarterly basis.
Notes 1. Jonathan Bloomer’s interests in shares included 100 American Depositary Receipts (representing 200 ordinary shares) at 1 January 2004 and 31 December 2004.
2. Mark Norbom’s interests in shares included 1,250 American Depositary Receipts (representing 2,500 ordinary shares) at 1 January 2004 and 1,265.50 American Depositary Receipts (representing 2,531 ordinary shares) at 31 December 2004.
The interests of directors in shares of the Company's listed subsidiary, Egg plc, are shown below, including changes between *Updated to 22 March 2005 on page 126.
Mark Norbom (from 1 January 2004, notes 6, 7 and 8) 475 395 233 239 1,342 – Mark Tucker (until 30 June 2003, note 9) – – – – 454
Non-executive directors Sir David Barnes (until 8 May 2003) – – 16
2. In 2004 a deferred share award valued at £27,300 from his 2003 annual bonus was made to Philip Broadley. This is included in the 2003 total and further details are shown in the section on Other Share Awards on page 50.
5. It is intended that a deferred share award valued at £435,547 from his 2004 annual bonus will be made to Michael McLintock. This is included in the 2004 bonus figure.
6. It is intended that a deferred share award valued at £157,795 from his 2004 annual bonus will be made to Mark Norbom. This is included in the 2004 bonus figure.
9. Mark Tucker’s 2003 annual bonus which was paid in July 2004 is included in the 2003 total. Mark Tucker was paid £363,267 from his 2001 long-term incentive plan, details of which are set out in the table Business-specific Long-Term Incentive Plans on page 49.
10. It is intended that a deferred share award valued at £168,550 from his 2004 annual bonus will be made to Mark Wood. This is included in the 2004 bonus figure.
The Remuneration Committee reviewed each executive director’s individual contribution and the strong operating performance of the Group in 2004 against the 2004 business plans and was satisfied that the bonus payments made for the year are fully justified.
The 2004 and 2005 awards are described in detail on page 43. For RSP awards prior to 2004, no rights are granted if the Company’s TSR performance as ranked against the comparator group is at the 60th percentile or below. The maximum grant is made only if the TSR ranking of the Company is 20th percentile or above. Between these points, the size of the grant made is calculated on a straight line sliding scale. In normal circumstances, directors may take up their right to receive shares at any time during the following seven years.
The awards made in respect of 2003 and 2004 under the Restricted Share Plan run to 31 December 2005 and 31 December 2006 respectively. As at 31 December 2004, TSR performance under these plans was ranked respectively at percentile positions 82nd and 79th on the basis of TSR performance.
In determining the 2004 conditional awards the shares were valued at their average share price during the preceding calendar year, and the price used to determine the number of shares was 398.3 pence (2003: 570.3 pence).
Notes 1. In respect of awards made in 2001 under the Restricted Share Plan, the Company's TSR was ranked at 69th percentile at the end of the three-year performance period on 31 December 2003 and as a result the 2001 awards lapsed.
Year of RSP rights for Rights RSP rights Exercise price at Earliest Latest grant outstanding at Issue on outstanding at Price paid price 31 Dec 2004 exercise exercise of right 1 Jan 2004 11 Nov 2004 31 Dec 2004 for award (pence) (pence) date date
Jonathan Bloomer 2000 56,859 2,791 59,650 – Nil 453 17 Mar 00 17 Mar 07
Business-Specific Long-Term Incentive Plans Details of all outstanding awards under other long-term incentive plans up to and including 2004 are set out in the table below and described on pages 43 and 44. Except where stated, the performance period for all awards was three years.
Clark Manning Phantom JNL options 2000 437 Nil – 31 Dec 03
Mark Norbom’s first award under the Asia Long-Term Incentive Plan was made in 2004 as described on page 44.
Mark Tucker’s 2001 cash long-term incentive plan had the same performance conditions as described for Mark Norbom’s cash long-term plan on page 44. The compound growth rate of the Asia operations at the end of 2003 was 37.7 per cent per annum. The award was pro-rated for Mark Tucker’s service to 30 June 2003 during the performance period and a payment of £363,267 was made in July 2004. Mark Tucker’s cash long-term incentive plans awarded in 2002 and 2003 lapsed.
Mark Wood’s 2001 and 2002 cash long-term incentive plans had the same performance conditions as described for his cash plan in the Remuneration Policy section on page 44. For the 2001 and 2002 awards the compound growth rate of the UK appraisal value was below the threshold for a payment to be made in respect of the award.
2. Non-competition and non-solicitation conditions having been satisfied, Mark Tucker’s deferred awards under the 2001 and 2002 annual incentive plans were released to him in July 2004.
Year of Options exercise Options Options for Rights Options price at exercise price (pence) Earliest Latest initial outstanding Exercised date forfeit granted Issue on outstanding at 31 Dec 2004 price adjusted for exercise exercise grant at 1 Jan 2004 in 2004 (pence) in 2004 in 2004 11 Nov 2004 31 Dec 2004 (pence) (pence) Rights Issue date date
Notes 1. The total gain made by directors in 2004 on the exercise of share options from the Company’s ESOS and SAYE schemes was £559,020 (2003: £2,863).
DIRECTORS’ PENSIONS AND LIFE ASSURANCE It is the Company’s policy to offer executive directors the facility to save for retirement through efficient pension vehicles and UK executive directors are offered a combination of Inland Revenue approved pension schemes and supplementary provision.
Changes to UK pensions regulations take effect from April 2006. The Company is actively considering whether or not any changes to its policy are necessary.
The schemes are defined benefit arrangements. Philip Broadley and Mark Wood participate in a non-contributory scheme that provides a pension of 1/60th of Final Pensionable Earnings for each year of service on retirement at age 60. Michael McLintock participates in a contributory scheme that provides a target pension of 2/3rds of Final Pensionable Earnings on retirement at age 60 for an employee with 30 years or more potential service, for which his contribution is four per cent of basic salary. Jonathan Bloomer only receives a lump sum death benefit of four times basic salary up to the earnings cap from the pension scheme.
On death in service a total sum from all these schemes of four times pensionable salary plus spouse’s and children’s pensions are payable. No employees with employment offers after 30 June 2003 were eligible for membership of the defined benefit schemes.
Sir David Clementi 55 – – – – – – – 121 Jonathan Bloomer 50 – – – – – – – 282
Clark Manning 46 – – – – – – – 15
Total contributions to directors’ pension arrangements were £1,124,000 (2003: £905,000) of which £353,000 (2003: £320,000) related to money purchase schemes.
ROBERTO MENDOZA SIR DAVID CLEMENTI CHAIRMAN OF THE REMUNERATION COMMITTEE CHAIRMAN
The Directors’ Report of Prudential plc for the year ended 31 December 2004 comprises these pages and the sections of the Annual Report referred to in these pages.
FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION The consolidated balance sheet on pages 60 and 61 shows the state of affairs of the Group at 31 December 2004. The Company’s balance sheet appears on page 62 and the consolidated profit and loss account on pages 56 to 58. Information prepared on the achieved profits basis of financial reporting is provided on pages 113 to 124. A summary of the statutory basis results is shown on page 55. There is a five year review of the Group on pages 98 and 99.
Changes in the Company’s share capital during 2004 are given in note 28 on page 88.
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 amounts which were owed to trade creditors at the year end to the aggregate of the amounts invoiced by trade creditors during the year, were 22 days.
DIRECTORS A list of the present directors is set out on pages 32 and 33. Mark Norbom, James Ross and Michael Garrett were appointed as directors on 1 January 2004, 6 May 2004 and 1 September 2004 respectively. Keki Dadiseth was appointed as a director with effect from 1 April 2005. In accordance with the Articles of Association, James Ross, Michael Garrett and Keki Dadiseth will retire and offer themselves for election at the Annual General Meeting on 5 May 2005. Sandy Stewart resigned as a director on 6 May 2004, and Bart Becht resigned as a director on 31 August 2004. Clark Manning, Roberto Mendoza and Mark Wood will retire by rotation at the Annual General Meeting and offer themselves for re-election.
The trustees of each of the Group’s UK pension schemes include elected individuals.
DONATIONS Prudential is committed to supporting the communities where it is an employer. In 2004 the Group spent £4.5 million in support of the community. Within this, direct donations to charitable organisations amounted to £2.7 million, of which approximately £2.2 million came from EU operations. This is broken down as follows: Education £940,000; Social and Welfare £898,000; Environment and Regeneration £84,000; Cultural £176,000 and Staff Volunteering £69,000. The aggregate figure for charitable donations from Prudential’s non-EU subsidiaries (Jackson National Life and Prudential Corporation Asia) amounted to £0.5 million. It is the Group’s policy not to make donations to political parties or to incur political expenditure, within the meaning of those expressions as defined in the Political Parties, Elections and Referendums Act 2000, and the Group did not make any such donations or incur any such expenditure in 2004.
ANNUAL GENERAL MEETING The Company’s Annual General Meeting will be held on 5 May 2005 at The Queen Elizabeth II Centre, Broad Sanctuary, Westminster, London SW1P 3EE at 11.00am.
SHAREHOLDERS The number of accounts on the share register at 31 December 2004 was 69,632 (2003: 76,805). Further information about shareholdings in the Company is given on page 126. As at 1 March 2005 the Company had received notification in accordance with Sections 198 to 208 of the Companies Act 1985 from Legal & General Investment Management Limited of a holding of 4.02 per cent of the Company’s ordinary share capital. Changes (if any) to significant shareholdings are updated to 22 March 2005 on page 126.
Long-term business: UK and Europe Insurance Operations 305 256 US Operations – continuing operations 196 143
Balance on the long-term business technical account before tax (analysed on pages 57 and 58) 629 479
– discontinued operations (37) (89) Other Income and Expenditure (analysed on page 74) (193) (181)
Items excluded from operating profit before amortisation of goodwill: Amortisation of goodwill (97) (98) Short-term fluctuations in investment returns 229 91 Profit or loss on the sale or termination of discontinued operations: Profit on business disposals 48 – Egg France closure cost (113) –
Tax on profit on ordinary activities: Tax on operating profit before amortisation of goodwill (177) (106) Tax on items excluded from operating profit before amortisation of goodwill (55) (38)
Change in the provision for claims: Gross amount 74 68 Reinsurers’ share (51) (67)
Change in long-term business provision: Gross amount (5,267) (3,935) Reinsurers’ share 133 (15)
Profit for the financial year before minority interests 418 206 Minority interests 10 2
Dividends: Interim (at 5.19p (5.09p) per share)^ (109) (106) Final (at 10.65p (10.29p) per share)^ (253) (214)
Reconciliation of operating profit before amortisation of goodwill to profit on ordinary activities†
Operating profit based on long-term investment returns before amortisation of goodwill 8 583 357 Amortisation of goodwill 21 (97) (98)
Operating profit based on long-term investment returns 486 259 Short-term fluctuations in investment returns 5 229 91 Profit or loss on the sale or termination of discontinued operations: Profit on business disposals 34 48 – Egg France closure cost 11 (113) –
Profit on ordinary activities before tax (including actual investment returns) 8 650 350
Based on operating profit after tax and related minority interests before amortisation of goodwill of £408m (£257m) and 2,129m (2,076m) shares* 5 19.2p 12.4p
Based on profit for the financial year after minority interests of £428m (£208m) and 2,129m (2,076m) shares* 5 20.1p 10.0p
Diluted earnings per share Based on profit for the financial year after minority interests of £428m (£208m) and 2,132m (2,078m) shares* 5 20.1p 10.0p
^ Dividend amounts per share have been restated where relevant to take account of the Rights Issue in 2004. † Operating profit and operating earnings per share include investment returns at the expected long-term rate of return but exclude amortisation of goodwill and exceptional items. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities and basic earnings per share include these items together with actual investment returns. This basis of presentation has been adopted consistently throughout these financial statements.
YEAR ENDED 31 DECEMBER 2004 58 PRUDENTIAL PLC ANNUAL REPORT 2004
Restated Ordinary retained share Share profit capital premium and loss Restated
Total recognised losses relating to 2003 (45) (45) New share capital subscribed 30 30 Transfer for shares issued in lieu of cash dividends (27) 27
Consideration paid for own shares* (3) (3) Movement in cost of own shares* 1 1
Total recognised gains relating to 2004 267 267 Proceeds from Rights Issue, net of expenses 17 1,004 1,021 Other new share capital subscribed 2 117 119 Transfer for shares issued in lieu of cash dividends (116) 116
Other assets Banking business assets: Jackson Federal Bank 34 – 975
Total assets* 174,540 161,709 *The 2003 figures for these lines have been restated (see note 4).
Technical provisions in respect of non-linked business Long-term business provision 104,138 100,287 Claims outstanding 826 891
Creditors Creditors arising out of direct insurance operations 340 382 Creditors arising out of reinsurance operations 10 12
Obligations of Jackson National Life under funding and stocklending arrangements 32 3,308 3,762 Other creditors including taxation and social security: Banking business liabilities: Jackson Federal Bank 34 – 894
Less liabilities: amounts falling due within one year Debenture loans 32 (130) –
Other borrowings 32 (9) – Amounts owed to subsidiary undertakings (1,959) (2,359)
Acquisitions and disposals Net cash inflow from disposal of European businesses – 27
Financing Issue of borrowings 35 111 829 Reduction in credit facility utilised by investment subsidiaries managed by PPM America 35 (31) (151) Issues of ordinary share capital, net of expenses of £23m (£nil) 35 1,140 30
Net purchases (sales) of portfolio investments 35 843 (149) Increase in cash and short-term deposits, net of overdrafts 35 12 481
In accordance with FRS 1, this statement excludes the cash flows of long-term business funds.
1. NATURE OF OPERATIONS Prudential plc (the Company) together with its subsidiaries (collectively, the Group or Prudential) is an international financial services group with its principal operations in the United Kingdom, the United States and Asia. During 2004, the Group operated in the UK through its subsidiaries, primarily The Prudential Assurance Company Limited, Prudential Annuities Limited, Prudential Retirement Income Limited, M&G Group plc and Egg plc. In the US the Group’s principal subsidiary is Jackson National Life Insurance Company. In Asia the Group’s main operations are in Hong Kong, Japan, Malaysia, Singapore and Taiwan.
2. BASIS OF PREPARATION 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 revised Statement of Recommended Practice, ‘Accounting for Insurance Business’, issued in November 2003 by the Association of British Insurers (the revised SORP). The results of US operations and certain Asian operations are prepared on the basis of US GAAP, with non-insurance balances adjusted where necessary to comply with UK GAAP.
The consolidated financial statements of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Prudential has a controlling interest, using accounts drawn up to 31 December 2004. The results of subsidiaries are included in the financial statements from the date acquired to the effective date of disposal. All intercompany transactions are eliminated on consolidation except for investment management fees of £253m (£217m) charged by M&G and the Group’s US and Asia fund management operations to long-term business funds.
The consolidated profit and loss account comprises a general business technical account (property and casualty insurance business), a long-term business technical account (life insurance, pension, disability and sickness insurance and annuity business), and a non-technical account. The insurance operations are presented by category of income and expenditure in each respective technical account. The balances (profits on insurance activities for the year) from the general and long-term business technical accounts are then included in the non-technical account and combined with the Group’s non-insurance businesses (principally banking and fund management) to determine the consolidated profit for the financial year.
In accordance with FRS 1, ‘Cash flow statements’, the statement of cash flows reflects only the cash flows of the Group’s non-insurance businesses included in the non-technical account and amounts transferred to shareholders’ funds from the Group’s long-term businesses.
3. SIGNIFICANT ACCOUNTING POLICIES There have been no changes in the Group’s accounting policies from those used in the 2003 statutory accounts with the exception of the implementation of UITF 38 as described in note 4.
Premiums and claims Premium and annuity considerations for conventional with-profits policies and other protection-type life insurance policies are recognised when due. Premium and annuity considerations for linked policies, unitised with-profits policies and other investment-type policies are recognised when received or, in the case of unitised or unit-linked policies, when units are issued. Premiums exclude any taxes or duties assessed based on premiums.
The overwhelming majority of the liabilities for business in force of UK insurance operations are held by The Prudential Assurance Company Limited (PAC) and its subsidiaries Prudential Annuities Limited (PAL) and Prudential Retirement Income Limited (PRIL). The key features of the liabilities of these companies are as follows: Conventional with-profits and other protection-type policies The future policyholder benefit provisions on conventional with-profits and other protection-type policies are calculated using the net premium method. The net premium is calculated such that it would be sufficient at the outset of the policy to provide only for the discounted value of the original guaranteed death and maturity benefits on the chosen valuation assumptions. The provision is then calculated by subtracting the present value of future net premiums from the present value of future benefits (including vested bonuses) using a prudent discount rate.
Under the net premium valuation method, vested bonuses are included in the cash flows assessed but future allocations of bonuses are not included explicitly, although they are implicitly taken into account in the discount rate used, which is based on the return available on suitable investments. The detailed methodology for UK companies is included in regulations contained in the FSA rules. In particular, the returns available from equity and property assets are based on expected income and/or earnings and no allowance is made for potential future capital growth.
The assumptions to which the estimation of the long-term business provision for these contracts 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 5.0% at 31 December 2004 and 31 December 2003. There have been no significant changes to other key assumptions.
Pension annuities The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year and range from 1.5% to 5.0% at 31 December 2004 and 2.0% to 5.1% at 31 December 2003. Mortality rates used in establishing policyholder benefit provisions are based on published mortality tables adjusted to reflect actual experience. The only other noteworthy change to assumptions in 2004 was with respect to mortality, where the shape of the set of assumptions has been changed as part of the regular monitoring of mortality developments.
3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Accumulating with-profits business For accumulating with-profits business, the calculation of the long-term business provision is based on a gross premium bonus reserve valuation. In general terms, a gross premium valuation basis is one in which the premiums brought into account are the full amounts receivable under the contract. The method includes explicit estimates of premiums, expected claims, future regular bonuses, costs of maintaining contracts and future renewal expenses. Cash flows are discounted at the valuation rate of interest. The methodology for UK companies is included in the FSA rules. The discount rate is based on the expected return on the assets deemed to back the liabilities as prescribed by the FSA rules.
Additional details for PAC, PAL and PRIL are given in the statutory accounts of those companies.
3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Fund for future appropriations The fund for future appropriations (FFA) represents the excess of assets over policyholder liabilities for the Group’s with-profits funds.
The annual excess (shortfall) of income over expenditure of the with-profits funds, after declaration and attribution of the cost of bonuses to policyholders and shareholders, is transferred to (from) the FFA each year through a charge (credit) to the profit and loss account. The balance retained in the FFA represents cumulative retained earnings arising on the with-profits business that has not been allocated to policyholders or shareholders. The balance retained in the FFA is determined after full provision for deferred tax on unrealised appreciation on investments. The FFA in respect of the Scottish Amicable Insurance Fund is wholly attributable, but not yet allocated, to policyholders of that fund. Details are shown in note 9.
General Insurance General insurance business is accounted for on an annual accounting basis.
Claims Claims incurred include settlement and handling costs of paid and outstanding claims arising from events occurring in the year and adjustments to prior years’ claims provisions. Outstanding claims include claims incurred up to, but not paid at, the end of the accounting period, whether or not reported.
Investment returns in respect of long-term business, including those on assets matching solvency capital, are included in the long-term business technical account. Other investment returns are included in the non-technical account.
Current tax expense is charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. To the extent that losses of an individual UK company are not offset in any one year, they can be carried back for one year or carried forward indefinitely to be offset against profits arising from the same company.
Deferred tax assets and liabilities are recognised in accordance with the provisions of FRS 19. The Company has chosen not to apply the option available of recognising such assets and liabilities on a discounted basis to reflect the time value of money. Except as set out in FRS 19, deferred tax is recognised in respect of all timing differences that have originated but not reversed by the balance sheet date.
3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Tax continued Deferred tax on changes in the fair value of investments is recognised in the profit and loss account. The deferred tax liability in respect of revaluation of investments is reflected in shareholders’ funds and the fund for future appropriations. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
Stock-Based Compensation The Group offers share award and option plans for certain key employees and a Save As You Earn plan (SAYE plan) for all UK and certain overseas employees. The arrangements for distribution to employees of shares held in trust relating to share award plans and for entitlement to dividends depend upon the particular terms of each plan. Shares held in trust relating to these plans are conditionally gifted to employees. Compensation costs for non-SAYE plans are recorded over the periods during which share awards or options are earned. Compensation costs are based on the quoted market prices of the shares at the grant date less any amounts paid or payable by employees in respect of the awards. In addition, shares are issued to a qualifying share ownership trust with the excess of the market price subscribed at the date of transfer by the trust over nominal value recorded by the Company in its share premium account.
Pension Costs These financial statements have been prepared in accordance with the provisions of SSAP 24, ‘Pension costs’. Disclosures of the movements in the financial position of the Company’s defined benefit schemes, applying the methodology prescribed by FRS 17, are shown in note 17. Contributions to the Group’s defined benefit plans are calculated and expensed on a basis that spreads the costs over the service lives of participants. Contributions in respect of defined contribution plans are accrued by the Group when incurred.
Deposits with credit institutions Deposits with credit institutions comprise items, the withdrawal of which are subject to time constraints, and are carried at fair value. Changes in fair value are included in investment returns for the year.
Shares in Subsidiary Undertakings Shares in subsidiary undertakings in the balance sheet of the Company are shown at the lower of cost and estimated realisable value.
Securities Lending The Group is party to various securities lending agreements under which securities are loaned to third parties on a short-term basis. The loaned securities are not removed from the Group’s consolidated balance sheet; rather, they are retained within the appropriate investment classification. The Group’s policy is that collateral in excess of 100% of the fair value of securities loaned is required from all securities borrowers and typically consists of cash, debt securities, equity securities or letters of credit.
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 that 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.
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.
In years prior to 2001, long-term investment returns for Jackson National Life included within UK basis operating profit were estimated as the aggregate of investment income and averaged realised gains and losses for both debt securities and other types of security. Comparatives for the aggregate long-term gains credited to operating results for the years 1993 to 2000 in the table shown above have not been restated for the refinement in policy, as the effect is not material.
From 2002, the other principal component of actual gains attributable to shareholders has been the revaluation gains of fixed income securities of certain Asian operations. For 2001 and earlier years the principal other component that required calculation of the expected long-term rate of return was UK equity securities that were held as portfolio investments backing UK general business liabilities and related solvency capital. This business was disposed of in 2002. For these investments the long-term rate of return applied in 2001 was 7.5%. The long-term dividend yield was assumed to be 2.6%.
The overwhelming majority of long-term gains and losses, and the difference between actual and long-term gains, arises from the accounting treatment of averaging realised gains and losses of Jackson National Life's fixed income securities over a five-year period within operating results. The only significant part of the investment portfolio for shareholder backed business where an assumed rate has been applied in the calculation of long-term gains to be included in operating profits is the aforementioned 8.0% for equity-related investments of Jackson National Life. For this part of the portfolio, a 1% change would alter operating results by approximately £4m.
(note 8) (note 20) interests Net per share £m £m £m £m Pence
Amortisation of goodwill (97) (97) (4.6)p Short-term fluctuations in investment returns: Profit or loss on the sale or termination of discontinued operations: Profit on business disposals 48 (19) 29 1.4p 2003 (restated*) Operating profit based on long-term investment returns
† The adjustment from post-tax long-term investment returns to post-tax actual investment returns includes investment returns that are attributable to external equity investors in two investment funds managed by PPM America. These two funds are consolidated as quasi-subsidiaries but, except to the extent of Group participation in the funds, they have no net impact on pre-tax or post-tax operating profit. Total profit, before and after tax, incorporating the adjustment from long term to actual investment returns, includes gains of £9m (£4m) attributable to the minority interests in these funds.
A reconciliation of the weighted average number of ordinary shares used for calculating basic and diluted earnings per share is set out below. The numbers for 2003 have been restated to take account of the Rights Issue in 2004.
Weighted average shares for diluted earnings per share 2,132 2,078 6. SEGMENTAL INFORMATION – ANALYSIS OF LONG-TERM BUSINESS GROSS PREMIUMS WRITTEN
UK and Europe Insurance Operations 9,186 7,264 Jackson National Life 4,717 4,369 Asian Operations 2,452 2,148
Insurance Products Investment Products Gross Premiums Gross Inflows Total £m £m £m £m £m £m
Department of Work and Pensions rebate business 265 280 – – 27 28
Total UK and Europe Insurance Operations 6,357 3,938 181 190 817 584
Annual Premium Equivalents are calculated as the aggregate of regular new business premiums and one tenth of single new business premiums.
UK and Europe Insurance Operations 0 0 305 256 305 256
Investment return and other income 44 29 44 29 Interest payable on core structural
9. SEGMENTAL INFORMATION – NET ASSETS A segmental analysis of the fund for future appropriations and the technical provisions net of reinsurers’ share is set out below which, although liabilities, provides a more useful indication of the assets supporting the business: Restated
Fund for future appropriations: Scottish Amicable Insurance Fund of Prudential Assurance Company (PAC)
† The Scottish Amicable Insurance Fund (SAIF) is a separate sub-fund within the PAC long-term business fund. This sub-fund contains all the with-profits business and all other pension business that was transferred from the Scottish Amicable Life Assurance Society to PAC in 1997. No new business is written in the sub-fund. The SAIF sub-fund is managed to ensure that all the invested assets of SAIF are distributed to SAIF policyholders over the lifetime of the SAIF policies. With the exception of certain amounts in respect of unitised with-profits life business, all future earnings arising in SAIF are retained for existing SAIF with-profits policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period is offset by a transfer to (from) the SAIF fund for future appropriations. Shareholders have no interest in the profits of SAIF, although they are entitled to the investment management fees paid on this business. Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency. With the exception of certain guaranteed annuity products (as described in note 33), SAIF with-profits policies do not guarantee minimum rates of return to policyholders.
Net assets shareholder net assets shareholder before core financed before core financed Restated shareholder operations Shareholders’ shareholder operations shareholders’ borrowings (note 32) funds borrowings (note 32) funds
US Operations†: Broker-dealer and fund management (note 12) 64 64 71 71
Other Operations relating to M&G and acquired Asian businesses 1,352 1,445 US Operations 15 53 Egg – 6
Gross premiums written Underwriting result Investment return Operating profit £m £m £m £m £m £m £m £m
Interest receivable from: Loans and advances to customers 553 461 Debt securities 180 177
Operating income 497 420 Administrative expenses (232) (214) Provision for bad and doubtful debts (182) (127) Other expenses (40) (24)
In July 2004, Egg announced that it intended to take the necessary steps to withdraw from the French market at an expected cost of £113m. After taking into account tax relief of £32m, the effect on minority interests was £17m. This business, which has been treated as discontinued operations in these financial statements, incurred losses up to the date of the announcement of £37m (£89m).
12. US OPERATIONS – ADDITIONAL DETAIL ON BASIS OF PRESENTATION OF RESULTS The results of US Operations, mainly Jackson National Life (JNL), are consolidated into the Group accounts based on US Generally Accepted Accounting Principles (US GAAP). However, certain adjustments are made in the Group’s consolidated financial statements to the US GAAP results reported in Jackson National Life’s own financial statements in order to comply with UK GAAP, with the Group’s accounting policies, and to reflect appropriately the US Operations segmental result, as set out below: Reverse FAS 115 US GAAP
and FAS 133 adjusted Long-term effects (notes for minority investment US Operations
(i) and (ii)) interests returns segmental result for US GAAP and adjust and reversal and other UK Modified Statutory per JNL for minority of FAS 115 minor Basis GAAP purposes Reconciliation from JNL 2004 US GAAP basis financial interests and FAS 133 Other US adjustments (note (v))
statements (note (iii)) effects subsidiaries (note (iv)) result to UK GAAP result for US Operations US$m US$m US$m US$m US$m US$m £m
Profit before tax after minority interests 980 (261) 719 9 (2) 726 396
Tax (charge) credit: on realised investment gains and losses (33) 6 (27) 27 on short-term fluctuations in investment returns (103) (103) (56)
Shareholders’ funds at end of year 4,872 (496) 4,376 123 35 4,534
Comprising: Jackson National Life 4,411 2,298 Broker-dealer and fund management 123 64
Operating profit Under US GAAP, the convention is to refer to operating income as income before realised gains and losses and related amortisation of acquisition costs. Under UK GAAP, consistent with the ABI SORP, operating profit is determined after inclusion of long-term investment returns i.e. investment income and estimated long-term capital gains. Details of the method for determining long-term returns for Jackson National Life are explained in note 5.
Income from: Gains (losses) on the realisation of investments 1,722 651 (1) 5
Financed by with-profits funds: With-profits business 39 41 Non-participating business† 9 9
(iii) Policyholders’ Bonuses Bonuses declared for the year in respect of the Group’s with-profits business are included in the change in long-term business provision or, where the policy is no longer in force, in claims incurred. The total cost of policyholders’ bonuses was £2,233m (£2,325m).
Long-term business interest payable includes £78m (£81m) in respect of products in the nature of funding arrangements entered into by Jackson National Life.
Interest on other borrowings in the non-technical account includes £1m (£2m) in respect of non-recourse borrowings of investment funds managed by PPM America, £33m (£26m) in respect of Egg debenture loans and £25m (£18m) in respect of commercial paper and other borrowings that support a short-term fixed income securities reinvestment programme. Further details on borrowings are included in note 32.
17. INFORMATION ON STAFF AND PENSION COSTS The average number of staff employed by the Group during the year were: UK and Europe Operations 10,849 11,473 US Operations 2,589 2,742 Asian Operations 8,277 6,797
Wages and salaries 762 710 Social security costs 62 54 Other pension costs (see below) 49 48
Pension Costs The Group has chosen not to fully implement FRS 17 ‘Retirement benefits’ for the 2004 financial statements. Pension costs shown above have been determined applying the principles of SSAP 24 ‘Pension costs’. £31m (£32m) of the costs related to defined benefit schemes and £18m (£16m) to defined contribution schemes. In addition, £15m (£12m) of the costs related to overseas defined contribution schemes.
Actuarial valuation and funding The Group operates a number of pension schemes around the world. The largest scheme is the Prudential Staff Pension Scheme (PSPS). This Scheme is primarily a defined benefit scheme but no employees with employment offers after 31 July 2003 are eligible for membership of the defined benefit section of the Scheme. On the FRS 17 basis of valuation described below, 90% of the liabilities of Group defined benefit schemes are accounted for within PSPS.
The Group also operates two smaller defined benefit schemes for UK employees in respect of Scottish Amicable and M&G activities, whose aggregate pension costs on a SSAP 24 basis are materially the same as the funding cost. For all three schemes the projected unit method was used for the most recent full actuarial valuations.
17. INFORMATION ON STAFF AND PENSION COSTS CONTINUED FRS 17 basis disclosure (i) Basis of valuation and scheme assets and liabilities Using external actuarial advice provided by Watson Wyatt Partners for the valuation of PSPS and by Aon Limited for the M&G scheme, and internal advice for the Scottish Amicable scheme, the most recent full valuations have been updated to 31 December 2004 applying the principles prescribed by FRS 17.
The key assumptions adopted for the FRS 17 basis valuations were: Rate of increase in salaries 4.80% 4.70% 4.25% Rate of increase of present and future pensions 2.80% 2.70% 2.25% Rate used to discount scheme liabilities 5.30% 5.40% 5.50%
The assets in the schemes and the expected rates of return were: Long-term Long-term Long-term expected expected expected
Assets rate of Assets rate of Assets rate of £m return £m return £m return
The present value of the liabilities of the three schemes at 31 December 2004 was £4,869m (31 December 2003 £4,592m). The resulting scheme deficit arising from the excess of liabilities over assets at 31 December 2004 comprised £494m attributable to the PAC with-profits fund and £155m attributable to shareholder operations. At 31 December 2003, the resulting scheme deficit comprised £457m attributable to the PAC with-profits fund and £145m attributable to shareholder operations.
The movements in the difference between scheme assets and liabilities were: £m £m
17. INFORMATION ON STAFF AND PENSION COSTS CONTINUED (ii) Estimated pension scheme liability attributable to shareholder operations if FRS 17 had been adopted Movements on the pension scheme liability attributable to shareholder operations that would have been recognised in the Group’s primary statements had FRS 17 been implemented are as follows: Profit and Net pension loss account Actuarial Net pension liability charge losses liability attributable attributable attributable Contributions attributable to to to paid by to shareholders shareholders shareholders shareholder shareholders 1 Jan 2004 (note (a)) (note (b)) operations 31 Dec 2004 £m £m £m £m £m
Profit and loss account charge attributable to shareholders (14) (12) (1)
(iii) Estimated pension scheme liability attributable to the PAC with-profits fund if FRS 17 had been adopted Movements on the pension scheme liability attributable to the PAC with-profits fund that would have been recognised in the Group’s primary statements had FRS 17 been implemented are as follows: Charge to Net pension long-term Net pension liability technical Actuarial liability attributable account losses Contributions attributable to PAC attributable attributable paid by to PAC with-profits to PAC to PAC PAC with-profits fund with-profits with-profits with-profits fund 1 Jan 2004 fund fund fund 31 Dec 2004 £m £m £m £m £m
17. INFORMATION ON STAFF AND PENSION COSTS CONTINUED Comparison of FRS 17 basis results with results on SSAP 24 basis Balance sheet
Fund for future appropriations 16,686 16,242 12,657 12,246 *Surplus on actuarial basis of valuation not recognised due to minimum contribution requirement under Scheme rules (see page 80).
Mortgages and other borrowings from Egg plc at 31 December 2004 4 171
Audit services: Statutory audit fees 3.8 3.6 US GAAP reporting 0.8 0.7 Regulatory audit 0.9 0.5 Achieved profits basis audits 0.1 0.1
Statutory audit fees include £0.1m (£0.1m) in respect of the Company. Fees, excluding statutory audit fees, payable to KPMG Audit Plc and its associates include £4.6m (£3.0m) for work performed in the UK.
20. TAX (i) Profit and Loss Account Tax Charge (Credit) The tax expense for certain long-term business operations is attributable to shareholders and policyholders. The shareholders’ portion of tax is determined using the long-term tax rate of the underlying business applied to the profits transferred to the non-technical account. A summary of the tax expense attributable to the long-term business technical account and shareholders’ profits in the non-technical account is shown below: Long-term business Non-technical account technical account (attributable to (attributable to shareholders’
Current: Deferred: Long-term business Non-technical account technical account (attributable to (attributable to shareholders’
Adjustments in respect of prior years – UK 35 (24) 1 (13)
Total tax on operating profit (based on long-term investment returns) 177 106 Tax on short-term fluctuations in investment returns 68 38 Tax on profit on business disposals 19 – Tax on Egg France closure cost (32) –
(d) Factors affecting tax charge for the period The tax assessed in the period is higher than the standard rate of corporation tax in the UK and the differences are explained on the following page. The standard rate of tax has been determined by using the UK rate of corporation tax enacted for the period for which the profits will be taxed.
20. TAX CONTINUED (d) Factors affecting tax charge for the period continued £m £m
Profit on ordinary activities multiplied by standard rate of corporation tax in the UK of 30% (30%) 195 105 Effects of: Differences in basis between taxable gains and book gains (8) 3 Different tax rates on overseas earnings 6 13 Deferred tax not recognised on tax losses carried forward 19 21 Different tax bases of long-term insurance (current and deferred) (15) (12) Non-taxable amortisation of goodwill 29 30 Adjustments in relation to prior years (13) (10) Capital allowances for period in excess of depreciation for the period – (4) Short-term timing differences 11 11
(e) Factors that may affect future tax charges The possible tax benefit of approximately £430m, which may arise from capital losses valued at approximately £1.7bn, is sufficiently uncertain that it has not been recognised. The circumstances in which the amount would be recoverable are a combination of the following: the agreement of the value of the losses with the Inland Revenue, the availability of future capital profits that are within the charge to capital gains tax and the agreement of the Inland Revenue to the utilisation of the losses against certain capital gains arising in the UK long-term business operations.
(ii) Deferred Tax The components of the net deferred tax liability are as follows. The balances have not been discounted.
(a) By category of timing difference Unrealised gains on investments 1,489 1,205 Deferred acquisition costs 403 408 Short-term timing differences (560) (626) Long-term business technical provisions and other insurance items 213 204 Capital allowances (23) (37)
*Includes deferred tax charges in respect of non-participating annuity business written by a subsidiary, Prudential Annuities Limited, financed by the PAC with-profits fund.
A potential deferred tax asset of £114m (£115m), which may arise from trading losses of approximately £408m (£378m), is sufficiently uncertain that it has not been recognised. With regard to £100m (£104m) of the asset, the trading losses would be recoverable only if there were sufficient future trading profits in the jurisdictions where the losses have arisen. The balance is dependent upon the outcome of a case before the European Court of Justice regarding Group relief claims in connection with European subsidiaries.
The balance at beginning of year comprises cost of £1,933m (£1,935m) less accumulated amortisation of £429m (£331m). The cumulative goodwill charged directly to shareholders' funds in respect of acquisitions prior to 1998 amounted to £589m (£589m).
The cost of land and buildings was £7,919m (£7,490m). The value of land and buildings occupied by the Group was £186m (£181m).
Interests in associate undertakings 18 23 4 9 Share of joint ventures: Gross assets 110 67 Gross liabilities (88) (44)
Interests in joint ventures 46 40 22 23 Other participating interest – 24 – 24
A summary of the movement in interests in associate undertakings is set out below: Total
Share of Share of carrying capital reserves Goodwill value £m £m £m £m
The only associate undertaking at the end of the year is IfOnline plc, a company whose principal activity is mortgage intermediation. Egg plc has a 39% share in the share capital of IfOnline plc. In September 2004, the Company sold its other associate undertaking, a 25% share in the share capital of Hazell Carr Pensions Consulting plc, for £5m. The profit on sale before tax of £2m is included in investment income in the long-term business technical account. The amount of operating profit attributable to these undertakings was £nil (loss of £2m).
24. OTHER FINANCIAL INVESTMENTS Cost Current value £m £m £m £m
Shares and other variable yield securities and units in unit trusts 25,017 23,987 38,426 34,877 Debt securities and other fixed income securities – carried at market value 45,373 43,169 47,319 44,586 Debt securities and other fixed income securities – carried at amortised cost 19,529 20,093 19,431 20,005 Loans secured by mortgages 2,742 2,783 2,802 2,815 Loans to policyholders secured by insurance policies 707 716 707 716
Amounts included in the above relating to listed investments were: Shares and other variable yield securities and units in unit trusts 37,429 33,584 Debt securities and other fixed income securities – carried at market value 39,046 37,351 Debt securities and other fixed income securities – carried at amortised cost 15,022 17,322
Consistent with the Group’s accounting policy set out on page 69, amortised cost has been applied as current value for certain fixed income securities. Where appropriate, the current value of such investments has been reduced to impaired value.
For those debt securities and other fixed income securities carried at amortised cost where the maturity value exceeded purchase price, the unamortised difference at the year end was £134m (£199m). For securities carried at amortised cost where the purchase price exceeded maturity value, the unamortised difference at the year end was £388m (£360m).
Depreciation: Balance at beginning of year (266) (264) Exchange movement 6 11 Provided during year (65) (64)
The balance at beginning of year comprises cost of £256m (£272m) less accumulated amortisation of £103m (£82m) and tax of £45m (£57m).
28. SHARE CAPITAL AND SHARE PREMIUM The authorised share capital of the Company is £170m (divided into 3,000,000,000 ordinary shares of 5 pence each and 2,000,000,000 sterling preference shares of 1 pence each) and US$20m (divided into 2,000,000,000 US dollar preference shares of 1 cent each) and ¤20m (divided into 2,000,000,000 Euro preference shares of 1 cent each). None of the preference shares has been issued. A summary of the ordinary shares in issue is set out below: Share Share capital premium
At beginning of year 4,000 2,526 Transfer from other subsidiary undertaking 608 – Investment in subsidiary undertaking 1,021 – Exchange rate movements – (13) Net repayment of loans – (351) Provision against loans – (33)
At end of year 5,629 2,129 30. PROFIT OF THE COMPANY The profit of the Company for the year was £124m (£186m). After dividends of £361m (£320m) and a transfer from the share premium account of £116m (£27m) in respect of shares issued in lieu of cash dividends, retained profit at 31 December 2004 amounted to £848m (£969m).
31. SUBSIDIARY UNDERTAKINGS The principal subsidiary undertakings of the Company at 31 December 2004, all wholly owned except Egg Banking plc and PCA Life Assurance Company Limited were: Main activity Country of incorporation
Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for Prudential Retirement Income Limited which operates mainly in England and Wales. Egg Banking plc is a subsidiary of Egg plc, a listed subsidiary of the Company. The ordinary shares of Egg plc, of which there is only one class, are 78% owned by the Company, 1% owned by other companies within the Prudential Group and 21% owned by shareholders external to the Prudential Group. At 31 December 2004, the ordinary shares of PCA Life Assurance Company Limited were 97% owned by the Company. In February 2005 this increased to 99%.
Core structural borrowings of shareholder financed operations: Holding company and finance subsidiaries: US$1,000m 6.5% Perpetual Subordinated
Total core structural borrowings of shareholder financed operations 2,639 2,566 158 1 2,797 2,567
Egg debenture loans (note (vi)): Other borrowings of long-term business operations: Scottish Amicable Finance plc (note (vii)): Bank loans and overdrafts 44 20 44 20
Borrowings are repayable as follows: Within one year or on demand 130 – 55 46 1,248 1,095 1,433 1,141 Between one and two years – 140 8 17 – – 8 157 Between two and five years 400 150 – – – – 400 150
(i) The ¤500m 5.75% borrowings have been swapped into borrowings of £333m with interest payable at 6 month £Libor plus 0.962%.
(iii) The ¤20m Medium Term Subordinated Notes were issued at 20-year Euro Constant Maturity Swap (capped at 6.5%). At 31 December 2004 these had been swapped into borrowings of £14m with interest payable at 3 month £Libor plus 1.2%.
(v) Non-recourse borrowings issued by investment subsidiaries managed by PPM America include secured senior and subordinated debt. The senior debt is secured on the investments held by the relevant subsidiaries. Interest rates on the senior debt are variable based on a market rate and mostly ranged from 1.57% to 2.38% (1.57% to 2.16%). The interests of the holders of the subordinated debt issued by these subsidiaries are subordinate to the entitlements of the holders of the senior debt. In addition to the debt of these subsidiaries, PPM America manages investment companies with liabilities of £753m (£943m) pertaining to debt instruments issued to external parties. In all instances the holders of the debt instruments issued by these subsidiaries and other companies do not have recourse beyond the assets of those subsidiaries.
(viii) Jackson National Life has entered into a programme of funding arrangements under contracts which, in substance, are almost identical to Guaranteed Investment Contracts. The liabilities under these funding arrangements totalled £2,862m (£3,247m). In addition, Jackson National Life has entered into stocklending arrangements. Obligations under these arrangements totalled £446m (£515m). These amounts are shown on the consolidated balance sheet within creditors.
Pension Mis-Selling Review In 1988, the UK government introduced new pensions legislation intended to encourage more individuals to make their own arrangements for their pensions. During the period from April 1988 to June 1994, many individuals were advised by insurance companies, Independent Financial Advisers and other intermediaries to not join, to transfer from or to opt out of their occupational pension schemes in favour of private pension products introduced under the UK Income and Corporation Taxes Act 1988. The UK insurance regulator (previously the Personal Investment Authority, now the Financial Services Authority, (FSA)) subsequently determined that many individuals were incorrectly advised and would have been better off not purchasing the private pension products sold to them. Industry participants are responsible for compensating the persons to whom private pensions were mis-sold. As a result, the FSA required that all UK life insurance companies review their potential cases of pension mis-selling and pay compensation to policyholders where necessary and, as a consequence, record a provision for the estimated costs. The Group met the requirement of the FSA to issue offers to all cases by 30 June 2002.
Provisions in respect of the costs associated with the review have been included in the change in the long-term business provision in the Group’s profit and loss account and the transfer to or from the fund for future appropriations has been determined accordingly. The following is a summary of the changes in the pension mis-selling provision for the years ended 31 December 2004 and 31 December 2003: Balance at beginning of year 530 730 Changes to actuarial assumptions and method of calculation (32) (131) Discount unwind 22 21 Redress to policyholders (26) (56) Payment of administrative costs (7) (34)
The costs associated with the mis-selling review have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders’ pay-out values have been unaffected by pension mis-selling.
In 1998, Prudential stated that deducting mis-selling costs from the inherited estate would not impact its bonus or investment policy and it gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing.
This review was completed on 30 June 2002 and consequently the assurance has not applied to new business issued since 1 January 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and single premium top-ups, transfers and switches to existing arrangements. The assurance will continue to apply to any policy in force as at 31 December 2003, both for premiums paid before 1 January 2004 and for subsequent regular premiums (including future fixed, retail price index or salary related increases and Department of Work and Pensions rebate business). The maximum amount of capital support available under the terms of the assurance will reduce over time as claims are paid on the policies covered by it.
Guaranteed Annuities Prudential Assurance used to sell guaranteed annuity products in the UK and held a provision of £49m at 31 December 2004 within the main with-profits fund to honour guarantees on these products. The Group’s main exposure to guaranteed annuities in the UK is through the Scottish Amicable Insurance Fund (SAIF) and a provision of £648m was held in SAIF at 31 December 2004 to honour the guarantees. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund, this provision has no impact on shareholders.
Guarantees and Commitments Guarantee funds in both the UK and the 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. The Group estimated its reserve for future guarantee fund assessments for Jackson National Life to be £10m at 31 December 2004. Similar assessments for the UK businesses were not significant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies.
Jackson National Life has commitments for future payments related to equity index call options totalling £8m at 31 December 2004. These commitments are accounted for on a deferred basis and therefore are off-balance sheet. The commitments were entered into in the normal course of business to hedge obligations associated with the issuance of equity index-linked immediate and deferred annuities and fall due for payment over the next three years.
Jackson National Life has unfunded commitments related to its investments in limited partnerships totalling £157m at 31 December 2004. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
The Group has provided, from time to time, certain guarantees and commitments to third parties including funding the purchase or development of land and buildings and other related matters. At 31 December 2004, the aggregate amount of commitments and guarantees in respect of land and buildings was approximately £42m.
In 1997, the business of Scottish Amicable Life Assurance Society, a mutual society, was transferred to Prudential Assurance. In effecting the transfer, a separate sub-fund, the Scottish Amicable Insurance Fund (SAIF), was established within Prudential Assurance’s long-term business fund. This sub-fund contains all the with-profits business and all other pension business that was transferred. No new business has been or will be written in the sub-fund and the sub-fund is managed to ensure that all the invested assets are distributed to SAIF policyholders over the lifetime of the SAIF policies. With the exception of certain amounts in respect of the unitised with-profits life business, all future earnings arising in SAIF are retained for SAIF policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period is offset by a transfer to (from) the SAIF fund for future appropriations. Shareholders have no interest in the profits of SAIF but are entitled to the investment management fees paid on this business. With the exception of certain guaranteed annuity products mentioned earlier in this note, the majority of SAIF with-profits policies do not guarantee minimum rates of return to policyholders.
Both of the above investments were held by long-term business funds of the Group. Accordingly the proceeds from these disposals do not feature in the Group's consolidated cash flow statement.
Operating profit before amortisation of goodwill 583 357 Add back interest charged to operating profit 213 189 Adjustments for non-cash items: Tax on long-term business profits (195) (150) Amounts retained and invested in long-term business operations (579) (242) Increase in net banking business assets (24) (223) Other items 95 157
Increase in cash and short-term deposits, net of overdrafts 12 481 Net purchases (sales) of portfolio investments 843 (149) Increase in loans (111) (829) Reduction in credit facility utilised by investment subsidiaries managed by PPM America 31 151 Share capital issued, net of expenses of £23m (£nil) (1,140) (30)
Movements arising from cash flow (365) (376) Investment appreciation, exchange translation and other items 163 (108) Transfer to retained profit in respect of shares issued in lieu of cash dividends 116 27 Portfolio investments net of financing at beginning of year (1,998) (1,541)
Represented by: Investments (including short-term deposits) 3,402 2,271 Cash at bank and in hand 431 410
Share capital and share premium (1,677) (653) Cumulative charge to Group profit and loss account reserve in respect of shares issued to qualifying employee share ownership trust 159 159
Shareholders’ funds (as above) 3,402 2,271 Long-term business operations 126,227 117,913 Investments in participating interests 26 56
Company law requires the directors to prepare financial statements for each financial period which give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss for that period. In preparing those financial statements, the directors are required to: ■ select suitable accounting policies and then apply them consistently; ■ make judgements and estimates that are reasonable and prudent; ■ state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; and
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITOR The directors are responsible for preparing the Annual Report and the directors’ remuneration report. As described above, this includes responsibility for preparing the financial statements in accordance with applicable United Kingdom law and accounting standards. Our responsibilities, as independent auditor, 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 corporate governance statement on pages 34 to 41 reflects the Company’s compliance with the nine provisions of the 2003 Financial Reporting Council 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 read the other information contained in the Annual Report, including the corporate governance statement and the unaudited part of the directors’ remuneration report, and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements.
■ the financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985.
Results for the year Long-term business: New business: Operating profit before amortisation of goodwill and exceptional items: US broker-dealer and fund management (14) (3) 14 16 7 Asia fund management 19 13 6 – –
Short-term fluctuations in investment returns 229 91 (205) (480) (48) Profit on business disposals 48 – 355 – 239 Egg France closure cost (113) – – – – Merger break fee – – – 338 –
Profit after tax and minority interests: Operating profit (including post-tax long-term investment returns) 408 257 333 466 511 Profit for the year (including post-tax actual investment returns) 428 208 468 395 577
Shareholders’ funds and borrowings Statutory basis: Borrowings of holding company and related finance subsidiaries (2,667) (2,427) (2,297) (1,980) (1,568)
Insurance and investment funds under management (£bn) 187 168 155 163 165
Comparative figures for earnings per share, dividend per share, market price and average number of shares have been restated to take account of the Rights Issue in 2004. Comparative figures for shareholders' funds have been restated as a result of the implementation of UITF Abstract 38 ‘Accounting for ESOP Trusts’.
UK and Europe Operations Long-term business: New business: Operating profit: Total operating profit from continuing operations 484 394 470 361 360
Insurance and investment funds under management (£bn) 140 125 112 121 129
Total operating profit from continuing operations 182 140 131 281 461
Insurance and investment funds under management (£bn) 31 30 32 34 30
Statutory basis capital and reserves 819 627 579 402 315 Additional achieved profits basis retained profit 919 792 828 687 478
1. BACKGROUND The Accounting Standards Board (ASB) published FRS 27 ‘Life Assurance’ in December 2004. The implementation of FRS 27 is governed by a Memorandum of Understanding (MoU) agreed between the UK’s leading life assurance companies, the Association of British Insurers, and the ASB. Under the terms of the MoU certain unaudited narrative and numerical disclosures are required to be published in the companies’ Annual Reports.
■ information on the assumptions used in the measurement of liabilities and the terms and conditions of options and guarantees relating to life assurance contracts. For those liabilities to policyholders resulting from options and guarantees that are not measured at fair value or on a statistical basis that takes into account all possible outcomes of the option or guarantee additional information is required.
The disclosures in this section of the Financial Review do not form part of the Company’s financial statements and are unaudited.
ADDITIONAL INFORMATION ON LIABILITIES, GUARANTEES AND OPTIONS, AND CAPITAL OF LIFE INSURANCE BUSINESSES
Technical provisions: Prudential Retirement Income Limited6 5,978 Non-profit unit-linked business of other subsidiaries 13,587 Other 1,362
US Operations Policy reserves and liabilities on non-linked business: Reserves for future policyholder benefits and claims payable 471 Deposits on investment contracts 17,832 Guaranteed Investment Contracts 987 Unit-linked (variable annuity) business 5,392
Asian Operations With-profits and other non-linked business7 6,143 Fund for Future Appropriations of Asia subsidiaries5 385 Unit-linked business 1,713
Total Group: Technical provisions and unit-linked liabilities 128,083 Fund for Future Appropriations 16,686 1. Includes inwards reassurance of all with-profits business written in the UK and Europe by other Group companies. For the purposes of this table and subsequent explanation, references to the WPSF also include, for convenience, the amounts attaching to the Defined Charges Participating Sub-Fund.
5. The Fund for Future Appropriations (FFA) represents the excess of assets over policyholder liabilities for with-profits funds and which has yet to be allocated between policyholders and shareholders. The SAIF FFA is wholly attributable to SAIF policyholders but has yet to be allocated.
3. UNITED KINGDOM AND EUROPE INSURANCE OPERATIONS Prudential’s long-term products in the UK consist of life insurance, pension products and pension annuities.
For many years, UK with-profits product providers, such as Prudential, have been required by law and regulation to consider the reasonable expectations of policyholders in setting bonus levels. This concept is established by statute but is not defined.
Prudential’s fixed-increase annuities incorporate automatic increases in annuity payments by fixed amounts over the policyholder’s life. The RPI annuities that Prudential offers provide for a regular annuity payment to which an additional amount is added periodically based on the increase in the UK Retail Prices Index. Prudential’s with-profits annuities, which are written in the WPSF, combine the income features of annuity products with the investment smoothing features of with-profits products and enable policyholders to obtain exposure to investment return on the WPSF’s equity shares, property and other investment categories over time.
The technical provisions are the discounted value of future claim payments, adjusted for investment expenses and future administration costs. The interest rate used for discounting claim payments is derived from the yield on the assets held with an allowance for default and mismatching risk. At 31 December 2004 the interest rates applied ranged from 1.5% to 5.0%. The mortality assumptions, which vary by age and gender, are differentiated between those applicable for group and individual business.
3(c) Scottish Amicable Insurance Fund The Scottish Amicable Insurance Fund (SAIF) is a ring-fenced sub-fund of the PAC long-term fund and was formed following the acquisition of the mutually owned Scottish Amicable Life Assurance Society in 1997. No new business may be written in SAIF, although regular premiums are still being paid on policies in force at the time of the acquisition and incremental premiums are permitted on these policies.
The process for determining policyholder bonuses of SAIF withprofits policies, which constitute the vast majority of obligations of the funds, is similar to that for the with-profits policies of the WPSF. However, in addition, the surplus assets in SAIF are allocated to policies in an orderly and equitable distribution over time as enhancements to policyholder benefits i.e. in excess of those based on asset share.
Provision is made for the risks attaching to some SAIF unitised with-profits policies that have Market Value Reduction (MVR)free dates and for those SAIF products which have a guaranteed minimum benefit on death or maturity of premiums accumulated at 4% per annum.
The Group’s main exposure to guaranteed annuities in the UK is through SAIF and a provision of £648m was held in SAIF at 31 December 2004 to honour the guarantees. As SAIF is a separate sub-fund solely for the benefit of policyholders of SAIF, this provision has no impact on the financial position of the Group’s shareholders’ funds.
The cost of guarantees, options and smoothing is very sensitive to the bonus, MVR and investment policy the Company employs and therefore the stochastic modelling incorporates a range of management actions that would help to protect the fund in adverse investment scenarios. Substantial flexibility has been included in the modelled management actions in order to reflect the discretion that the Company retains in adverse investment conditions, thereby avoiding the creation of unreasonable minimum capital requirements. The management actions assumed are consistent with our management policy for with-profits funds and our disclosures in the publicly available Principles and Practices of Financial Management.
3(f) FRS 27 Basis of Reporting the Financial Position of UK Regulated With-Profits Funds The Peak 2 approach underpins the changed requirements of FRS 27, which the Group will adopt in 2005, as part of the implementation of International Financial Reporting Standards (IFRS) basis reporting.
Under FRS 27, the main changes that are required for UK withprofits funds are: ■ de-recognition of deferred acquisition costs and related deferred tax; ■ inclusion on the FSA Peak 2 basis of the value of in-force nonparticipating business written by the WPSF and SAIF; and
Adjusted realistic liabilities represent the Peak 2 realistic liabilities for with-profits business included in Form 19 of the FSA regulatory returns, but after excluding the element for shareholders’ share of the future bonuses. This latter item is recognised as a liability for the purposes of regulatory returns but, for accounting purposes under FRS 27, consistent with the current basis of financial reporting, shareholder transfers are recognised only on declaration.
Applying this methodology the accounting position for the PAC with-profits fund (including the Hong Kong branch and SAIF) at 31 December 2004 is estimated to be as follows: Realistic liabilities £69.0bn The realistic liabilities of the WPSF and SAIF comprise: ■ the estimated realistic value of with-profits liabilities for the purposes of FSA regulatory returns; less
Excess of £8.9bn of realistic assets over realistic liabilities This excess has been determined on the accounting basis described above. For the avoidance of doubt, it has not been calculated on the same basis as the regulatory basis free assets referred to on page 21.
The principal reconciling items between the excess of £8.9bn and the £5bn referred to on page 21 are the shareholders’ share of future bonuses on WPSF policies and excess assets held within SAIF.
Approximately 22% of the interest-sensitive fixed annuities JNL wrote in 2004 provide for a market value adjustment, that could be positive or negative, on surrenders in the surrender period of the policy. This formula based adjustment approximates the change in value that assets supporting the product would realise as interest rates move up or down. The minimum guaranteed rate is not affected by this adjustment.
Equity indexed annuities Equity indexed annuities account for 6% of JNL’s policyholder reserves at 31 December 2004. Equity indexed annuities vary in structure, but generally are deferred annuities that enable policyholders to obtain a portion of an equity linked return but provide a guaranteed minimum return. These guaranteed minimum rates are generally set at 3%.
Variable annuities At 31 December 2004, variable annuities (VA) accounted for 26% of JNL’s policyholder reserves. Variable annuities are deferred annuities that have the same tax advantages and payout options as interest-sensitive and equity-indexed fixed annuities.
Life insurance JNL’s life insurance products accounted for 10% of JNL policyholder reserves at 31 December 2004. The products offered include term life insurance and interest sensitive life insurance.
Under US GAAP investment contracts are accounted for by applying in the first instance a retrospective deposit method to determination of the liability for policyholder benefits. This is then augmented by potentially three additional amounts. These amounts are for: ■ any amounts that have been assessed to compensate the insurer for services to be performed over future periods (i.e. deferred income); ■ any amounts previously assessed against policyholders that are refundable on termination of the contract; and
The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognising the excess rateably over the accumulation period based on total expected assessments. At 31 December 2004, the GMDB liability was valued using a series of deterministic investment performance scenarios, a mean investment return of 8.4% and assumptions for lapse, mortality and expense that are the same as those used in amortisation of capitalised acquisition costs.
JNL regularly evaluates estimates used and adjusts the additional GMDB and GMIB liability balances, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used for calculating the GMIB liability at 31 December 2004 are consistent with those used for calculating the GMDB liability.
The GMWB liabilities are recognised currently as accumulated charges for the benefit. This benefit has been issued since 2003 and both charges to date and projected excess benefits are minimal at 31 December 2004.
With the exception of the GMDB, GMIB and GMWB features of variable annuity contracts the financial guarantee features of JNL’s contracts are, in most circumstances, not explicitly valued under the standard US GAAP basis of calculation, but the impact of any interest guarantees would be reflected as they are earned in the current account value (i.e. the US GAAP liability).
For traditional life insurance contracts, reserves for future policy benefits are determined under FAS 60 using the net level premium method and assumptions as of the issue date as to mortality, interest, policy lapsation and expenses plus provisions for adverse deviation.
5. ASIAN OPERATIONS 5(a) Technical Provisions At 31 December 2004, the aggregate UK GAAP carrying value of technical provisions (net of reinsurance) for Asian Operations was some £7.9bn as follows: £m
5(c) Guarantees Subject to local market circumstances and regulatory requirements, the guarantee features described above in respect of UK business broadly apply to similar types of participating contracts written in the PAC Hong Kong branch, Singapore and Malaysia. Participating products have both guaranteed and non-guaranteed elements.
Non-participating long-term products are the only ones where the insurer is contractually obliged to provide guarantees on all benefits. Investment linked products have the lowest level of guarantee if indeed they have any.
Cash value and interest rate guarantees are of three types: ■ Maturity values Maturity values are guaranteed for non-participating products and on the guaranteed portion of participating products. Declared annual bonuses are also guaranteed once vested. Future bonus rates and cash dividends are not guaranteed in participating products; ■ Surrender values Surrender values are guaranteed for non-participating products and on the guaranteed portion of participating products. The surrender value of declared reversionary bonuses are also guaranteed once vested; and
The most significant book of non-participating business in Prudential Corporation Asia is Taiwan’s whole of life contracts. For these contracts there are floor levels of policyholder benefits that accrue at rates set at inception which are set by reference to minimum terms established by local regulation also at the time of inception. These rates do not vary subsequently with market conditions.
On the US GAAP basis the calculations are deterministic, that is to say based off a single set of projections, and expected long-term rates of return are applied.
6(b) Basis of Preparation and Capital Requirements Each of the Group’s long-term business operations is capitalised to a sufficiently strong level for its individual circumstances. Details by the Group’s major operations are shown below.
UK and Europe Insurance Operations PAC WPSF and SAIF In common with other large UK regulated with-profits funds PAC is required to hold capital equivalent to the greater of their regulatory requirement (based on EU Directives) (i.e. the regulatory peak) and the new FSA basis calculation of expected liabilities (i.e. the realistic peak).
Other UK subsidiaries The available capital of £0.5bn reflects the excess of regulatory basis assets over liabilities, before deduction of the capital resources requirement of £0.3bn.
Jackson National Life The regulatory framework for Jackson National Life (JNL) is governed by the requirements of the US National Association of Insurance Commissioners (NAIC) approved risk based capital standards. Under the requirements, life insurance companies report on a formula based capital standard that they calculate by applying factors to various asset, premium and reserve items. The formula takes into account the risk characteristics of a company, including asset risk, insurance risk, interest rate risk and business risk.
The available capital of JNL shown above of £1.8bn reflects US regulatory basis assets less liabilities after setting aside reserves for asset valuation and interest maintenance. The asset valuation reserve is designed to provide for future credit-related losses on fixed income securities and losses on equity investments. The interest maintenance reserve is designed by state regulators to defer recognition of non-credit related realised capital gains and losses.
Group shareholders' funds 4.3 less: shareholders' funds of non-insurance and other operations (0.3) add: Fund for Future Appropriations (per published balance sheet i.e. Peak 1 basis) 16.7 add: subordinated debt of SAIF and JNL 0.2 less: adjustments to restate these amounts on to a regulatory basis (including Peak 2 basis for WPSF and SAIF) (12.0)
Total available capital in the life assurance business on local regulatory bases to meet local regulatory requirements 8.9
Distributed as United Kingdom and Europe: PAC: available capital of with-profits funds (including Hong Kong branch and SAIF) on the Peak 2 realistic basis* 6.0 Other UK subsidiaries 0.5
Asian Operations The available capital shown above of £0.6bn represents the excess of regulatory basis assets over liabilities before deduction of required capital of £0.2bn. These amounts have been determined applying the local regulations in each of the operations.
At the country level, the Group’s businesses in Asia are subject to comprehensive and supervisory schemes in the jurisdictions in which they operate. The Hong Kong business branch of PAC and its capital requirements are subsumed within those of the PAC long-term fund. For other material operations the details of the basis of determining regulatory capital and requirements are as follows: Singapore A new risk-based regulatory framework was introduced at the start of 2005 to replace the previous framework that used a net premium approach.
For participating business, a gross premium reserve, determined using prudent best estimate assumptions and which makes allowance for future bonus, is held. The amount held is subject to a minimum of the higher of the assets attributed to participating business and a gross premium reserve calculated on specified assumptions, but without allowance for future bonus, that include prescribed provisions for adverse deviations (PADs).
From 1 January 2005, capital requirements are determined using a risk-based capital approach.
Taiwan Basic policy reserves are determined using a net premium method. Both mortality and interest rates are specified. For more recent issues, the valuation rate of interest has been linked to the prevailing market rate on 10-year government bonds.
With regard to solvency, the adjusted solvency capital assets of the company must exceed 200% of the risk related capital requirement value at risk. It is thus a risk-based capital approach.
For Jackson National Life (JNL), capital retention is maintained at a level consistent with an appropriate rating by Standard & Poor’s. Currently JNL is rated AA. JNL can pay dividends on its capital stock only out of earned surplus. Dividends which exceed the greater of 10% of JNL’s statutory surplus or statutory net gain from operations for the prior year require prior regulatory approval.
6(d) Sensitivity to Changed Market Conditions and Capital Management Policies Prudential manages its assets, liabilities and capital locally, in accordance with local regulatory requirements and reflecting the different types of liabilities Prudential has in each business. As a result of the diversity of products offered by Prudential and the different regulatory requirements in which it operates, Prudential employs differing methods of asset/liability and capital management, depending on the business concerned.
For example, for businesses that are most sensitive to interest rate changes, such as immediate annuity business, Prudential uses cash flow analysis to create a portfolio of fixed income securities whose value changes in line with the value of liabilities when interest rates change. This type of analysis helps protect profits from changing interest rates. This type of analysis is used in the UK for annuity business and by JNL for its interest-sensitive and equity-indexed fixed annuities and stable value products.
The International Organisation of Securities Commissions (IOSCO) has recommended that annual reports of publicly held companies include a section on risk factors which discusses inherent risks in the business and trading environment. The US Securities and Exchange Commission (SEC) requires listed companies to disclose prominently risk factors that are specific to the companies or their industries in their annual reports on Form 20-F filed with the SEC. The EU Prospectus Directive (due to be implemented by mid-2005) also requires disclosure of risk factors. Prudential has therefore decided voluntarily to follow this recommendation and to include in the Annual Report a description of risk factors; a similar description will be included in Prudential’s US annual report on Form 20-F.
Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. Prudential’s businesses are inherently subject to market fluctuations and general economic conditions. In the UK, this is because a significant part of Prudential’s shareholders’ profit is related to bonuses for policyholders declared on its with-profits products, which are broadly based on historic and current rates of return on equity, real estate and fixed income securities, as well as Prudential’s expectations of future investment returns.
In all markets in which Prudential operates, its businesses are susceptible to general economic conditions and changes in investment returns which can change the level of demand for Prudential’s products. Past uncertain trends in international economic and investment climates which have adversely affected Prudential’s business and profitability could be repeated. This adverse effect would be felt principally through reduced investment returns and credit defaults in fixed interest corporate bonds, and may continue to affect the business unless conditions improve. In addition, falling investment returns could impair Prudential’s operational capability, including its ability to write significant volumes of new business.
Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations in the markets in which it operates. Changes in government policy, legislation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential’s product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. For instance, these changes include possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements. In the UK the FSA’s depolarisation reforms and the rules relating to stakeholder products could have a significant effect on the types of products sold by Prudential, how its products are priced, distributed and sold and on shareholders’ return on with-profits business.
Further, heightened competition for talented and skilled employees with local experience, particularly in Asia, may limit the Group’s potential to grow its business as quickly as planned.
Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and hurt its relationships with creditors or trading counterparties. Prudential’s financial strength and credit ratings, which are intended to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in most of Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings could have an adverse effect on its ability to market products and retain current policyholders. In addition, the interest rates Prudential pays on its borrowings
Prudential’s short-term debt is rated as P-1 by Moody’s and A1+ by Standard & Poor’s.
Adverse experience against the assumptions used in pricing products and reporting business results could significantly affect Prudential’s results of operations. Prudential needs to make assumptions about a number of factors in determining the pricing of its products and for reporting the results of its long-term business operations.
Long-term business 381 365 Fund management 19 13 Development expenses (15) (27)
Operating profit from continuing operations before amortisation of goodwill* 1,124 861 *The results for Egg and Jackson National Life exclude the results of discontinued operations as set out below: Egg France (37) (89) Jackson Federal Bank 17 22
Operating loss from discontinued operations before amortisation of goodwill (20) (67)
Operating profit before amortisation of goodwill UK and Europe Insurance Operations 450 359
Amortisation of goodwill (97) (98) Short-term fluctuations in investment returns 10 679 682 Effect of changes in economic assumptions 11 (100) (540) Profit or loss on the sale or termination of discontinued operations: Profit on business disposals 48 – Egg France closure cost (113) –
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES – ACHIEVED PROFITS BASIS
Based on profit for the financial year after minority interests of £1,046m (£485m) 5 49.1p 23.4p
Earnings per share for 2003 have been restated to take account of the Rights Issue in 2004.
Profit for the financial year after minority interests 1,046 485 Exchange movements, net of related tax of £12m (£18m) (229) (348)
Total recognised gains relating to the financial year 817 137 Proceeds from Rights Issue, net of expenses 1,021 – Other new share capital subscribed 119 30
The supplementary information on pages 113 to 124 was approved by the Board of directors on 1 March 2005.
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 Work and Pensions rebate business has been treated as single premium business.
The key economic assumptions are described below: UK and Europe Insurance Operations Pre-tax expected long-term nominal rates of investment return: UK equities 7.1% 7.3% Overseas equities 6.8% to 7.8% 6.6% to 7.9%
Post-tax expected long-term nominal rate of return: Pension business (where no tax applies) 6.5% 6.8% Life business 5.7% 5.9%
US Operations (Jackson National Life) Expected long-term spread between earned rate and rate credited to policyholders for single premium deferred annuity business 1.75% 1.75% US 10 year treasury bond rate at end of year 4.3% 4.3% Risk margin included within the risk discount rate 3.1% 3.1% Risk discount rate(i) 7.4% 7.4%
Weighted pre-tax expected long-term nominal rates of investment return(iii) 6.6% 7.4% Weighted expected long-term rate of inflation 3.0% 3.4% Weighted risk discount rate(i) 9.6% 10.4%
(ii) The economic assumptions for the Asian Operations shown above have been determined by weighting each country’s economic assumptions by reference to the achieved profits basis operating result for new business written in the relevant year.
(iii) Consistent with prior periods, for the Taiwan operation, the projections include an assumption of phased progression from current rates to the long-term expected rates over a remaining period of eight years. This takes into account the effect on bond values of rising interest rates.
Adjustment for amortisation of goodwill (97) – (97) – (97) (4.6)p Adjustment from post-tax long-term investment returns to post-tax actual investment returns (after related
Effect of changes in economic assumptions (540) 130 (410) – (410) (19.7)p
(i) The adjustment from post-tax long-term returns to post-tax actual investment returns includes investment returns that are attributable to external equity investors in two investment funds managed by PPM America. These two funds are consolidated as quasi-subsidiaries but, except to the extent of Group participation in the funds, they have no net impact on pre-tax or post-tax operating profit. Total profit, before and after tax, incorporating the adjustment from long-term to actual investment returns includes gains of £9m (£4m) attributable to the minority interests in these funds.
6. COST OF CAPITAL A charge is deducted from the annual result and the balance sheet value for the cost of capital supporting solvency requirements for the Group’s long-term business. This cost is the difference between the nominal value of solvency capital and the present value, at risk discount rates, of the projected release of this capital and investment earnings on the capital.
7. PENSION COSTS The impact of pension costs on the achieved profits basis results of long-term business has been determined in the context of the methodology described in note 2. Accordingly, for long-term business, the achieved profits basis value of new business written in the reporting period and the value of in-force business at the balance sheet date have been determined after incorporating projections of attributable pension costs into the estimates of future cash flows for the contracts concerned. Experience variances for expenses include any difference between the actual and assumed contributions to defined benefit pension schemes. The achieved profits basis results and shareholders’ funds for long-term business are, therefore, not affected by whether or not the Group has adopted FRS 17 ‘Retirement benefits’ in preparing its achieved profits basis results.
As explained in note 1, the achieved profits basis results include statutory basis results for operations other than those conducting longterm business. In preparing results for these operations the Group has continued to apply SSAP 24.
UK and Europe Insurance Operations(i) 220 (66) 154 166 (50) 116
(i) The 2003 UK new business result includes £9m in respect of certain investment mandates previously reported as UK Corporate Pensions but now included as M&G institutional investment flows.
9. OPERATING PROFIT FROM BUSINESS IN FORCE Operating profit from new business is measured using the revised economic assumptions shown in note 3 and after applying any revised operating assumptions. The profit and loss account impact for revised operating assumptions is shown below: £m £m
Asian Operations Unwind of discount 122 115 Change in operating assumptions(v) (56) (27) Other items and experience variances 3 (14)
Long-term business: UK and Europe Insurance Operations(i) 402 531 Jackson National Life(ii) 207 132 Asian Operations(v) 48 1
Share of investment return of funds managed by PPM America that are consolidated into Group results but attributable to external investors (note 5) 9 4
(i) Short-term fluctuations in investment returns represent for UK and Europe Insurance Operations the difference between actual investment returns attributable to shareholders on the achieved profits basis and the expected returns as described in note 3. The £402m of positive fluctuations in 2004 reflect the difference between the PAC with-profits fund actual investment return of 13.4% and the longterm assumed rate of 6.5%.
Actual less averaged realised gains and losses (including impairments) for fixed income securities(iv) 161 98 Actual less long-term return on equity-based investments 23 0 Investment depreciation on preference shares (1) (2)
(iv) Jackson National Life – Actual less averaged realised gains and losses (including impairments) for fixed income securities £m
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 2000 to 2004. 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.
UK and Europe Insurance Operations(i) (19) (122) Jackson National Life(ii) (53) (263) Asian Operations(iii) (28) (155)
Tax on operating profit Long-term business: UK and Europe Insurance Operations 134 133 Jackson National Life 103 67 Asian Operations(i) 96 117
Tax charge on profit on ordinary activities (including tax on actual investment returns) 485 355
UK and Europe Operations Long-term business operations: Smoothed shareholders’ funds(i) 3,894 3,469 Actual shareholders’ funds less smoothed shareholders’ funds 157 (45)
Jackson National Life (net of core structural borrowings of £130m (£140m))(iii)
Asian Operations Long-term business operations 1,672 1,358 Fund management operations 66 61
Other Operations Goodwill(ii) 1,352 1,445 Holding company net borrowings(iii) (1,106) (1,995) Other assets(iv) (616) (462)
(i) UK long-term business smoothed shareholders’ funds reflect an adjustment to PAC life fund assets, for the purposes of determining the unwind of discount included in operating profits, to remove the effects of short-term volatility in market values of assets.
Holding company net borrowings (1,106) (1,995) Core structural borrowings – Jackson National Life (130) (140)
(iv) The 2003 figures for these lines have been restated for the implementation of UITF Abstract 38 ‘Accounting for ESOP Trusts’.
Insurance National Asian business Other Group Operations Life Operations operations operations total £m £m £m £m £m £m
Egg - continuing operations 43 43 Asia fund management 19 19 US broker-dealer and fund management (14) (14) Other income and expenditure (193) (193)
Operating profit (loss) from continuing operations 450 317 366 1,133 (9) 1,124 Operating profit (loss) from discontinued operations 17 17 (37) (20)
Profit (loss) for the financial year 584 353 282 1,219 (173) 1,046
Adjustment for net of tax losses of Curian subsidiary owned by Jackson National Life (12) (12) 12 Consideration paid for own shares (4) (4) Proceeds from issues of share capital by parent company 1,140 1,140
Net increase in shareholders’ capital and reserves 627 113 314 1,054 537 1,591
Shareholders’ capital and reserves at 1 January 2004: Prior year adjustment on implementation of UITF 38 (38) (38)
Analysed as: Additional shareholders’ interest on achieved profits basis 3,162 234 919 4,315 4,315
Achieved profits basis shareholders’ funds 4,051 2,532 1,672 8,255 341 8,596
Achieved profits basis shareholders' funds 4,051 2,532 1,672 8,255 341 8,596
(ii) Net worth consists of statutory solvency capital and unencumbered capital.
(i) Jackson National Life: Before capital charge 92 Capital charge (24)
Shareholders’ funds If the economic assumptions applied for 2004 had been in place at 31 December 2003, the achieved profits basis shareholders’ funds at that date would have been lower by £72m. This represents a pre-tax loss of £100m less related tax credit of £29m (as analysed by business operation in note 14) and an adjustment for exchange losses to reflect rates at 31 December 2003 of £(1)m.
Shareholders’ funds at the year end Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 907 897 Decrease in rates of 1% (984) (930)
The guidance issued in December 2001 by the Association of British Insurers entitled ‘Supplementary Reporting for Long-Term Insurance Business (the Achieved Profits Method)’ (the guidance) requires the directors to prepare supplementary information presented under the achieved profits method in accordance with the guidance.