At Prudential our aim is lasting relationships with our customers and policyholders, through products and services that offer value for money and security. We also seek to enhance our Company’s reputation, built over 150 years, for integrity and for acting responsibly within society.
Total Recognised Gains and Losses 52 Reconciliation of Movements in Consolidated
Shareholders’ Capital and Reserves 53 Balance Sheet of the Company 54 Consolidated Cash Flow Statement 55 Notes on the Financial Statements 86 Statement of Directors’ Responsibilities 86 Independent Auditors’ Report to the Members of Prudential plc 87 Five Year Review 89 Achieved Profits Basis Supplementary
Account – Achieved Profits Basis 90 Earnings per Share – Achieved Profits Basis 90 Statement of Total Recognised Gains and
Shareholders’ Capital and Reserves – Achieved Profits Basis 91 Summarised Consolidated Balance Sheet – Achieved Profits Basis 92 Notes on the Achieved Profits Basis Supplementary Information 102 Statement of Directors’ Responsibilities in Relation to the Achieved Profits Basis Supplementary Information 102 Independent Auditors’ Report to Prudential plc on the Achieved Profits Basis Supplementary Information 103 Shareholder Information 104 How to Contact Us
1848 Prudential founded 1929 Group Pensions established 1997 Scottish Amicable acquired by Prudential 2002 Relaunch of the Prudential brand and launch of The Plan from the Pru 1931 Launched the first Unit Trust in the UK
1999 Acquired by Prudential 2001 International operations launched in Germany, Austria, Luxembourg and Italy 2002 M&G successfully converted its Unit Trust range to Open Ended Investment Companies (OEICs)
M&G is Prudential’s UK and European fund manager, responsible for managing over £112 billion of funds (as at December 2002). It is a leading fixed income manager with successful initiatives in project finance and securitised vehicles
Product Distribution Channels • Direct to customers (telephone, Internet and mail) • Intermediaries (IFAs, consulting actuaries, workplace, affinities and banks)
Europe Prudential Europe Vie, a single premium savings product, sold through local distribution partners in France
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
2000 Initial Public Offering of just over a 20% share in Egg 2001 Egg achieved a break-even position 2002 International launch in France
Prudential Corporation Asia (PCA) is the leading European life insurer in Asia with 22 life and fund management operations in 12 countries. Across the region, PCA now has 11 operations with an estimated top five market share
Markets products in 50 states and the District of Columbia (in the State of New York through Jackson National Life Insurance Company of New York) through independent agents, broker-dealers and financial institutions
Currently, PCA has a network of over 89,000 agents serving four million customers around the region
2000 Prudential acquired IFC Holdings, further strengthening JNL's presence in the broker-dealer market
UK Operations 577 607 US Operations 265 319 Prudential Asia 516 415 Prudential Europe 14 8 Other Income and Expenditure (including development expenses) (223) (178)
Operating profit from continuing operations 1,133 1,114 Discontinued UK general business operations – 72
Operating profit before amortisation of goodwill and exceptional items 432 622
Operating profit includes investment returns at the expected long-term rate of return but excludes amortisation of goodwill and the profit on sale of UK general business operations. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities includes these items together with actual investment returns. This basis of presentation has been adopted consistently throughout this report.
Prudential undertakes no obligation to update the forward-looking statements contained in this report or any other forward-looking statements we may make.
Since joining the Company at the beginning of December, I have been impressed with the quality of businesses we have around the world. People often think of us as simply a UK life insurer with some overseas operations. The reality is that we are a major international financial services group with a strong franchise, excellent people and a strategy focused on delivering value for our shareholders and policyholders over the long-term. Seventy per cent of our new business achieved profit is now derived from overseas and our financial position is among the strongest in our peer group.
These factors enabled us to report total Group insurance and investment sales of £27.6 billion, an increase of 29 per cent, and an achieved basis operating profit of £1,133 million, up two per cent. These results were particularly pleasing as they were achieved against the background of some of the most challenging market conditions we have seen for many years.
Clearly, we were not immune to these difficult economic and market conditions but our performance shows that we have built a good platform on which to continue delivering growth in the future. Jonathan Bloomer, Group Chief Executive, talks in more detail about our focus on delivering value in his review on the following pages of this Report. A commentary about our businesses in Asia, the United States and the United Kingdom can be found in the Business Review on pages 6 to 13.
The difficult market conditions affected our modified statutory profits which fell to £432 million. The main causes of this were the lower bonuses paid by the UK Life Assurance business and the credit losses arising in our US Assurance business. Turning to the issue of dividends, the Board announced a total dividend for 2002 of 26 pence, a small increase on the previous year. But, looking to the future, the Board has felt that it needed, given the uncertainty in capital markets, to retain flexibility and could not recommit to the policy of progressive dividend increases from the current level. We recognise that this has created uncertainty for shareholders and we will seek to address this when we reach the interim results in July.
We are required to account for our insurance business on the modified statutory basis (MSB) of reporting under UK accounting rules. In essence, this determines our statutory profit and reserves and is an indicator of the cashflow generated by continuing operations. What MSB does not do, however, is provide a measure of the value that is generated each year for shareholders by companies such as Prudential that write long-term insurance business, the profits from which arise over many years.
Therefore, along with our major UK-registered competitors, we also report our results on the achieved profits (AP) basis. This is designed to place a current value on the future projected cashflows that will emerge over time from business written to date and to reflect the business performance during the accounting period under review. As such, it provides an indicator of the value being added by today’s management in a given accounting period.
In good markets most attention concentrates on achieved profits performance; and in difficult markets more attention focuses on modified statutory profit. Long-term shareholders should look at both measures. I appreciate that it is frustrating for shareholders not to have one easy earnings performance measure; but life assurance is a long-term business and not easily captured by conventional accounting standards.
Looking to the long-term development of our business, one of our greatest assets is of course our staff. As I have visited some of our businesses around the world since joining the Group, I have been impressed with their professionalism and commitment and I would like to thank all of them for their considerable efforts.
During the year, there have been some changes to the Board. Sir Roger Hurn announced his intention to step down from the Board in April but agreed to stay on as Chairman until a successor had been identified and was in place. Sir Roger made a significant contribution to the development of the Company and I know that my colleagues on the Board are very grateful for the support, advice and guidance he gave over the three years he was with the Group.
In May, Bart Becht joined as a non-executive director. Bart, who is Chief Executive of Reckitt Benckiser plc, has a wealth of international experience and he has already made a valuable contribution to our discussions at the Board.
Looking ahead, the industry faces many challenges in the current environment. However, I believe that there are significant opportunities for a company which, in addition to its brand and financial strength, has a significant presence internationally. I was delighted to be asked to take on the role of Chairman. I am cautious about the immediate outlook for the markets, but optimistic about the long-term outlook for Prudential.
Over the last few years we have developed and grown the Group significantly. We have expanded our Asian business, developed Egg and shareholder backed businesses in the UK and grown Jackson National in the US. In doing this we have managed the need for capital while recognising the importance of distributions to our shareholders.
Focus on Sustainable Value In 2002 we made good progress towards achieving our goal of doubling the intrinsic value of the Group over four years. One of the key measures of whether we are on track is new business achieved profits which, to double in four years, would need to compound at an annual growth of 19 per cent. In 2002 they grew by 15 per cent. While we believe that 2003 will be a particularly stretching year, our priority will be to continue to develop and deliver our strategy to build value across the Group.
The success of Prudential’s strategy is clear from the 2002 full-year results. Total Group insurance and investment sales were £27.6 billion, an increase of 29 per cent on 2001. On an annual premium equivalent (APE) basis insurance sales were up nine per cent to £1.9 billion, reflecting growth of 23 per cent and 18 per cent in the US and Asia respectively. Approximately 74 per cent of total Group sales came from outside the UK, demonstrating the benefits of the Group’s international diversification.
The results showed generally improving margins for new business as the Group continued to benefit from a focus on high-margin business. Margins in 2002 for the US increased from 35 per cent to 39 per cent and in Asia from 59 per cent to 60 per cent. In the UK, margins for long-term business declined slightly, moving from 30 per cent in 2001 to 29 per cent in 2002. Group new business achieved profit rose by 15 per cent in 2002 to £774 million.
WE WILL INVEST FOR VALUE WE WILL ALLOCATE CAPITAL TO THOSE AREAS OF OUR BUSINESS WHERE WE SEE THE GREATEST VALUE CREATION OPPORTUNITIES.
Asia is one of the fastest-growing regions for savings in the world, with a combination of favourable demographic trends and increasing market liberalisation. In Prudential Corporation Asia (PCA), we have well-established life insurance and rapidly growing mutual fund operations across the region. Our focus has been to grow these businesses organically and supplement this growth with some small in-fill acquisitions such as the Korean mutual fund business we bought in the second half of 2002.
In what is a very fragmented market with a huge number of players, JNL has developed into one of the leading life insurers in the US. However, instead of focusing on becoming a scale player purely in terms of size, it has a value-based definition of scale, meaning that it only seeks leading positions in segments of the market that it can serve profitably. This, together with a cost base below the industry average, modern and highly sophisticated IT systems, and diversified and flexible products and distribution, mean that JNL is positioned to benefit from growth in the US savings market.
UK Insurance Operations UK insurance operations continued to implement its programme for change announced in November 2001: a clear and renewed focus on the brand; emphasis on profitable growth in the chosen product segments; broadening distribution; achieving a step reduction in operating costs; and preserving financial strength over the long term.
‘The Plan from the Pru’ was launched in September 2002 providing customers with a financial plan which guides people through the key financial stages of their lives.
Total new business achieved profit of £222 million was nine per cent lower than 2001 reflecting a revision to economic assumptions and the challenging UK market conditions.
Successful marketing campaigns and an effective pricing policy helped the business to achieve a significant increase in sales of single premium individual annuities for the year, which were up 39 per cent to £1.76 billion. Single premium bulk annuities also performed well with a 23 per cent increase in total sales for the year to £710 million. The UK insurance operation has retained its position as a leading player in this market, winning the £389 million C&A pension scheme account in the final quarter of the year.
While corporate pension sales on an APE basis were down slightly on 2001, total sales were up 23 per cent, reflecting the move towards single premium products.
In November 2001 the Company announced a target for cost savings of £175 million by the end of 2004 and in July 2002 increased this target to £200 million. These savings arise from the creation of the single customer service organisation, the rationalisation of support services and a refocusing of IT investment. Of this amount, it is estimated that £65 million (on an achieved profit basis) will be attributable to shareholders. Good progress has been made and £130 million of savings were delivered in 2002 with an annualised value of £155 million. Prudential remains confident of achieving this important reduction in operating costs.
In September 2002 the Company announced plans to establish an offshore service centre in India to improve customer contact service and achieve additional cost savings. The new processing centre will be established in Mumbai and is now expected to be operational in 2003.
As a result of the continuing depressed levels of world stock markets, bonuses were reduced on conventional and unitised with-profits policies in February 2003. This followed earlier reductions on unitised with-profits policies in September and December 2002. These actions were taken to protect the strong financial position of the with-profits fund and to protect the long-term interests of customers. 2002 was a turbulent year for global equity markets, with the FTSE 100 falling by 24.5 per cent during the year. However, the investment return on Prudential’s with-profits fund was negative 8.1 per cent in the year to 31 December 2002 reflecting its diversified investment mix.
Following a review of its retail IT systems platform, M&G entered an agreement with International Financial Data Services (IFDS) in November 2002 to outsource all of M&G’s retail administration. This will deliver significant cost benefits and ensure M&G has the best IT systems platform to support its retail business. The migration will be completed towards the end of 2003.
M&G is a founder investor in CoFunds, the funds supermarket established to service financial intermediaries. At the end of 2002 CoFunds had in excess of £650 million in assets under administration.
M&G’s property and private equity arms, which primarily invest on behalf of the Prudential Assurance Company, also enjoyed a successful year. With over £11 billion invested in the property market, Prudential Property Investment Managers is the largest property manager in the UK. The property business made its first overseas investments and, in the face of continued difficult markets, the private equity business continued to build its international capabilities.
In its institutional business, M&G continued to leverage its position as an innovator in fixed income and private finance during 2002. The institutional fixed income business won £1.2 billion of net new mandates during the year, with an additional £0.4 billion of institutional money secured in 2002 but not yet received. A further £0.2 billion of institutional mandates were received via PPM South Africa. M&G’s private finance group’s successful initiatives in project finance and securitised vehicles raised a further £0.5 billion in net new fund inflows.
The latest Investment Management Association figures show that M&G has continued to counter the industry trend by experiencing an increase in gross retail sales compared to a fall in sales across the industry as a whole. With its strong performance over a number of funds, M&G also increased its market share by nine per cent in the total retail market and 13 per cent in the PEP/ISA market. Market share of funds sold via intermediaries also increased significantly, by 12 per cent overall and by 27 per cent for PEPs and ISAs.
Source: Investment Management Association net retail sales of Unit Trusts and OEICs
Eg g un iq ue c us to m er s (0
Other operating income increased by £60 million to £103 million primarily reflecting fees and commissions earned from the larger credit card book, and the reduction in cashback on the credit card. There has also been an increase in commissions earned from selling creditor insurance at the point of sale on personal loans. In 2003 Egg UK’s key strategic goals are to continue to maximise value from its unsecured lending business in what are expected to be challenging conditions.
In France, Egg intends to enhance and extend its product range in line with developing the business in this market, and the next major product will be a new loan account, which it plans to launch in the second quarter of 2003. It is targeting to have in the region of 250,000 to 300,000 customers in France by the end of 2003.
New business achieved profits rose to £234 million in 2002 from £167 million in 2001. This is due to a 23 per cent increase in APE sales, together with an increase in new business margins from 35 per cent to 39 per cent. Business in force achieved profits of £17 million in 2002 were adversely affected by net bond losses totalling £289 million, resulting in a £133 million charge against current year operating profits on a five-year averaging basis. These losses arose out of the challenging credit environment in the US and equated to one per cent of JNL’s total invested assets.
JNL retained its leading position in fixed annuity sales, ranking seventh in total individual fixed annuity sales for the year to date 30 September 2002. Since 1995, the company has continually diversified its product portfolio and now also has a leading position in variable annuity sales, ranking sixth in variable annuity net flows and 17th in variable annuity sales for the full year 2002. JNL also has a leading position in equity-indexed annuity (EIA) sales, ranking sixth for sales of EIAs for the year to date 30 September 2002.
Broker dealer Bank Independent agents *Source: 1997-2001, Townsend & Schupp; 2002, Thomson Financial **Annualised information as of 30/9/02 (latest data available)
The company has built its distribution network both organically and through small acquisitions. Traditionally, JNL has had a strong presence with independent insurance producers selling life insurance, fixed annuities and, more recently, equity-indexed annuities. In 1994, JNL entered the bank distribution channel and has seen very strong sales growth in that area. In 2002, JNL ranked seventh in the US for total annuity sales through banks and fifth in sales of fixed annuities through banks. In the mid-1990s, the company began offering variable annuities to independent broker-dealers, and now has a strong position in that channel. In addition, at the beginning of 2002, JNL launched a very successful marketing initiative targeting regional broker-dealers.
Bancassurance, through distribution agreements with banks, has continued to provide a material source of new business.
Being a pioneer and leader in the introduction of capital efficient unit-linked life insurance remains a significant source of competitive advantage in both its established and newer markets: 30 per cent of PCA’s APE sales in 2002 came from unit-linked life products, up from 23 per cent in 2001.
PCA’s operations in Greater China achieved significant growth in 2002. In Hong Kong its market share on an APE basis for yearto -date 30 September 2002 was 10.4 per cent. Its joint venture with Bank of China International for Hong Kong’s MPF continues 12 Prudential plc Annual Report 2002 2002 APE sales by country (£513m total)
to grow well with Prudential’s funds under management up 51 per cent over 2001 to £136 million. In Taiwan, Prudential Life’s NBAP was up 91 per cent compared to 2001, while insurance APE sales were up seven per cent – the increased profitability reflecting the successful introduction of unit-linked products. In Guangzhou China, its joint venture with CITIC grew insurance APE sales by 39 per cent and it has recently secured a second licence in Beijing.
In 2002, PCA continued to pursue its long-term strategy of building a complementary, material and profitable regional mutual fund business. Progress to date has been very encouraging with market-leading positions in India and Taiwan, growing operations in Japan, Singapore, Malaysia and Hong Kong and the recent acquisition of a mid-sized investment trust management company in the large South Korean market. As at 31 December 2002 total mutual funds under management have increased to £5.1 billion, up 59 per cent on last year, with strong net inflows of £1 billion.
During 2002 PCA undertook a comprehensive review of the region’s life and mutual fund markets and updated its strategy to optimise growth and profit prospects within a rigorous capital allocation framework. The long-term prospects for the region, and for PCA as a significant force in the market, remain very positive. Continued successful implementation of Prudential’s strategy should deliver material and sustained profitable growth in the years ahead.
PCA remains well positioned to participate in Asia’s outstanding long-term growth prospects. It has a strong track record of successful delivery and a robust business model firmly focused on building businesses in markets and sectors that combine scale opportunities with secure long-term profitability and very attractive returns on capital.
Bank ■ ■ ■ ■ ■ ■ ■ ■ ■ ■
Total sales of insurance and investment products from outside the UK represented 74 per cent of the Group total of £27.6 billion, reflecting the international diversification of the Group.
The achieved profits basis results for long-term business are prepared in accordance with the ABI guidance for achieved profits reporting issued in December 2001. This guidance requires the economic assumptions used for the projection of cash flows to be on an ’active’ basis, that is primarily based on appropriate government bond returns at each period end. The effects of changed assumptions caused by movements in bond returns are reflected in the profit reported for the year to 31 December 2002.
The active basis is applied to the UK and the US operations, and those countries in Asia where there are well-developed government bond markets (Japan, Korea and US$ denominated business in Hong Kong). Assumptions in other Asian countries continued to be based on an assessment of long-term economic conditions as permitted by the guidance.
The 40 per cent increase in Jackson’s new business achieved profit to £234 million was driven by a 23 per cent increase in new insurance sales and an increase in new business margin from 35 per cent to 39 per cent. The margin increase primarily reflects an improvement in the fixed annuity spread assumption for new business and the revision to the discount rate.
Prudential Corporation Asia’s (PCA) new business achieved profit of £307 million is up 20 per cent on 2001 primarily due to strong sales growth across all regions (APE insurance sales up 18 per cent). The new business margin in Asia increased one per cent to 60 per cent reflecting a favourable shift in sales to higher margin linked products. NBAP by product type is now in the ratio of 21 per cent traditional products, 43 per cent unit linked products and 36 per cent accident and health products.
The negative experience variances include persistency variances principally arising from pension transfers and early vestings.
Europe in force profit of £3 million was £3 million higher than 2001, reflecting reduced negative variances.
The US in force profit has decreased significantly from £136 million in 2001 to £17 million in 2002. This is primarily due to defaults and impairments on corporate bonds, which are included within the operating result on a five-year averaged basis. The charge to operating profit has increased from £74 million in
Total Achieved Operating Profit Total achieved operating profit from continuing operations was £1,133 million, up two per cent from £1,114 million in 2001.
This result reflects a 15 per cent improvement in new business achieved profit from £673 million to £774 million offset by reduced in force profit down 21 per cent from £673 million to £533 million.
In addition, results from other continuing operations including development expenses and other shareholders’ income improved from a loss of £175 million in 2001 to a loss of £158 million, principally due to a much-reduced operating loss at Egg and lower development expenses, partially offset by an increase in other shareholders’ expenses. UK re-engineering costs of £16 million compare with £57 million in 2001.
New Business Achieved Profit Group new business achieved profit from insurance business of £774 million was 15 per cent ahead of prior year, reflecting strong growth in the US and Asia, partially offset by a fall in profit from the UK insurance operations. The growth in new business achieved profit reflects a nine per cent increase in insurance sales on an annual premium equivalent (APE) basis, together with an increase in new business achieved profit margin from 38 per cent to 40 per cent.
UK Insurance Operations’ new business achieved profit of £222 million is nine per cent lower than 2001. This reflects a five per cent fall in APE sales in challenging market conditions and the revised economic assumptions. The new business margin moved from 30 per cent in 2001 to 29 per cent in 2002 and reflects the revised economic assumptions. However on a
Direct to Prudential. Egg International recorded a £50 million loss in 2002 including £47 million relating to the investment in the development of Egg’s French business.
National Planning Holdings, the US broker dealer, and PPM America, the US fund manager, together delivered profits of £14 million, down from £16 million in 2001.
Other net expenditure increased by £59 million to £189 million. This included a £24 million write-down of the Group’s 15.3 per cent interest in Life Assurance Holding Corporation Ltd in 2002 compared with a positive revaluation of £12 million in 2001. In addition, funding costs have increased by £12 million over 2001.
Achieved Profits – Result Before Tax The result before tax and minority interests was a loss of £483 million compared to a loss of £455 million in 2001.
Actual losses in 2002 were £289 million. This includes a number of one-off event risks where investment grade bonds fell to below investment grade status almost overnight, for example, WorldCom. The seven largest individual bond losses accounted for 52 per cent of the total gross losses, of which WorldCom was the largest at £82 million. The difference between the full year loss of £289 million and the charge recognised through operating profit of £133 million, an amount of £156 million, is recorded within short-term investment fluctuations.
During 2002 further sub-divisions of long-term funds approved by the regulators allowed the value of shareholders’ interest in certain non-participating policies to be fully recognised for the first time; the one-off impact to achieved profits of this exercise totalled £59 million.
Non-insurance Operations M&G’s operating profit of £71 million compares to £75 million in 2001. Operating profit, excluding investment income, of £52 million was £2 million higher than 2001, a significant achievement in the context of depressed equity markets, where average market levels as represented by the FTSE All-Share are 17 per cent lower year on year. This increase reflects the benefits of M&G’s diversified revenues, with fixed income and property offsetting the effect of lower equity markets, together with disciplined cost management. The result has also been affected by a £3 million increase in losses from M&G International, which were £15 million in 2002.
Prudential Asia’s operating profit before development expenses was £88 million (£44 million in 2001). This includes an £8 million gain arising from the reorganisation of long-term funds approved by the regulators which allowed the value of the shareholders’ interest in certain non-participating policies to be recognised for the first time. This result is after the significant investment that has occurred in 2002, as PCA builds high-quality customer-focused distribution channels in Japan and Korea. Further significant investment is planned for 2003. The Group’s more established operations in Singapore, Hong Kong and Malaysia reported further growth in statutory profits, up 43 per cent to £79 million.
The effective tax relief rate at a total achieved profit level was 68 per cent on a loss of £483 million, primarily due to tax payable on the profit on disposal of UK general business operations being relieved against capital losses available to the Group. The effective tax rate at a total achieved profit level in 2001 was 47 per cent.
Group operating profit from continuing operations on the modified statutory basis (MSB) of £432 million was £118 million lower than 2001.
Cash remitted to Group: UK life fund transfer (in respect of earlier bonus declarations) 324 307 Cash remitted by business units 212 154
The Group received £536 million in cash remittances from business units in 2002 (2001 £461 million) comprising the shareholders’ statutory UK life fund transfer relating to earlier bonus declarations, together with dividend and interest from subsidiaries. After dividends and interest paid, there was a net outflow of £97 million (2001 £136 million net outflow). The Group also received £543 million from corporate activities (2001 £283 million) including cash proceeds arising from the sale of the General Insurance business and exceptional tax receipts. Together with the proceeds of equity issuance and Group relief, this gave rise to a total net surplus of £545 million (2001 £160 million). In September 2002 the Group provided JNL with £321 million of capital to support high volumes of fixed annuity writings and to replace capital consumed by bond losses and impairments. This follows £69 million provided in 2001. During 2002 the Group invested £354 million (2001 £512 million), primarily in its shareholder-backed business in the UK and in Asia, including for the development of the Japanese business. In aggregate this gave rise to a financing requirement of £130 million (2001 £421 million) which was satisfied through an increase in core debt.
Funds Under Management Insurance and investment funds under management at 31 December 2002 totalled £155 billion, compared to £163 billion at the end of 2001. This reduction is mainly due to a fall in the market value of investments which more than offset the net sales achieved during the year. The total includes £131 billion of Group investments under management and £24 billion of external funds under management.
Solvency requirements in the UK include the establishment of a resilience reserve which makes prudent allowance for potential future movements in investment values. As at 31 December 2002, the overall liability was determined based on the following resilience scenario: • a fall in equity values of 14 per cent; • a fall in property values of 15 per cent; • the worst of a rise in bond values of 3 per cent and a fall in bond values of 13 per cent.
The investment return on the Prudential main with-profits fund was negative 8.1 per cent in the year to 31 December 2002 compared with the falls in the FTSE 100 and the FTSE All-Share of 24.5 per cent and 25.0 per cent respectively over the same period.
Asia Solvency levels have been maintained at local regulatory levels by the insurance operations in Asia. Across the region less than 20 per cent of non-linked funds are invested in equities. The balance is principally invested in fixed income securities.
To meet our obligations to existing policyholders, we expect to have to pay out over time assets equal to policyholders’ accumulated ’asset shares’ plus any additional payments that may be required, by way of smoothing or to meet guarantees.
The balance at any time of the main with-profits fund, which is not expected to be paid out to the current generation of with-profits policyholders as claim values, represents the major part of Prudential Assurance’s working capital and is called the ’inherited estate’.
To ensure that policyholders’ benefits are secure, we are required by regulations to hold a substantial amount of capital in our long-term fund, so that we can demonstrate at all times that the fund is solvent and able to meet its obligations to all policyholders. The inherited estate provides most of this solvency capital.
The size of the inherited estate, by its nature as working capital, fluctuates from year to year depending on investment returns, and the extent to which the capital is required to meet smoothing costs, guarantees and any other unforeseen events. We estimate that at 31 December 2002, the inherited estate, after taking into account pension mis-selling costs and anticipated costs of fundamental strategic change, is around £5 billion.
In the normal course of events the inherited estate is required to support the in force business, so neither policyholders nor shareholders can have any expectation that they will receive any distribution of the inherited estate, other than through the normal process of smoothing and meeting guarantees in adverse investment conditions.
However, we believe that it would be beneficial if there were to be greater clarity as to the status of the inherited estate. With that in mind, we have been considering the principles that would apply to any re-attribution of the inherited estate to either policyholders or shareholders. Discussions have been held with the Financial Services Authority (FSA) to this end. We have not considered or discussed any actual distribution as our current expectation is that, for the foreseeable future, the entire inherited estate will need to be retained within the long-term fund to provide working capital. However, in the light of current market conditions, the amount and timing of any re-attribution of the estate remains very uncertain.
a customer was prepared to take a risk that their mortgage might not be repaid at the end of the term. The costs of this fine and policyholder redress will be met from this provision. No further provision was required in 2002. No provision is required in respect of mortgage endowments sold by PAC.
Shareholders’ Funds On the achieved profits basis, which recognises the shareholders’ interest in long-term businesses, shareholders’ funds at 31 December 2002 were £7.2 billion, a decrease of £954 million from 31 December 2001. The decrease principally reflects short-term fluctuations in investment returns, together with dividends declared, the effect of changes in economic assumptions and adverse foreign exchange movements, offset by operating profits of £1,133 million and profit on business disposals of £355 million.
Prudential has in place an unlimited global commercial paper programme. At 31 December 2002 commercial paper of £1,632 million has been issued under this programme. In addition, the holding company has access to £1,200 million committed revolving credit facilities provided by 12 major international banks. These facilities have not been drawn on during the year. The commercial paper programme and the committed revolving credit facilities are available for general 2002 achieved profits shareholders’ funds (£m)
Europe and other operations 214 corporate purposes and to support the liquidity needs of the parent company.
Prudential plc enjoys strong debt ratings from both Standard & Poor’s and Moody’s. Prudential senior debt is rated AA- and A2 from Standard & Poor’s and Moody’s respectively, while shortterm ratings are A1+ and P-1.
It is Prudential's policy that all free-standing derivatives are used to hedge exposures or facilitate efficient portfolio management. Amounts at risk are covered by cash or by corresponding assets.
The Group transacts business in sterling and US dollars and various currencies in Asia. The currency exposure relating to the translation of reported earnings is not separately managed although its impact is reduced by interest payments on foreign currency borrowings and by the use of average exchange rates for the translation of foreign currency revenues.
Gearing = (senior debt + hybrid)/ (senior debt + hybrid + APSHF)
Asset and Liability Management Prudential manages its assets and liabilities locally, in accordance with local regulatory requirements and reflecting the differing types of liabilities Prudential has in each business. As a result of the diversity of products Prudential offers and the different regulatory environments in which it operates, Prudential employs different methods of asset/liability management. Most of Prudential's methods fall into two major categories: cash flow analysis under a range of scenarios by JNL for interest-sensitive business and stochastic modelling/scenario testing for the UK long-term fund.
As permitted under FRS 17 ‘Retirement Benefits’, Prudential has continued to adopt the requirements of SSAP 24 in the reported profit and loss account and balance sheet of the Group. Details of the financial reporting effect are shown in note 19.
FRS 17, ‘Retirement Benefits’, was issued in November 2000. The Accounting Standards Board has issued proposals to defer the mandatory full adoption date of the standard until 2005. If implemented in full, the standard would require that companies include the whole of any pension surplus or deficit of defined benefit schemes in their balance sheets and would change the way in which pension surpluses and deficits are reported. In particular, it would require assets of the scheme to be valued at their market value at the company's 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.
In addition, for those schemes such as PSPS, which hold a significant proportion of their assets in equity investments, the difference between FRS 17 basis assets and liabilities can be highly volatile.
On the achieved profits basis the shareholders’ interest in the net pension scheme liability is less than two per cent of achieved profits basis shareholders’ funds.
as supplementary information. In broad terms the achieved profits basis applies long-standing actuarial techniques under which all projected cash flows on contracts in force are valued.
In addition, the EU is reviewing further solvency requirements (the Solvency II project), for which the intention is to ensure policyholder protection through establishing solvency requirements better matched to the true risks of the business, taking into account developments in non-traditional methods of risk control such as alternative risk transfer products, asset liability management and the use of derivatives. A key aim is to provide transparency and comparability, thus ensuring a level playing field. As with the PSB, a risk-based capital approach and the use of internal models is expected to be introduced under Solvency II.
US Retail Products and Drivers of Profit Jackson National Life’s (JNL’s) principal retail savings products are savings products sold as single premium fixed, variable or equity-linked indexed deferred annuities.
Interest-sensitive fixed annuities are products which allow for tax-deferred accumulation of funds, with flexible payout options. They are used for retirement planning and for providing income in retirement. The policyholder pays JNL a single premium, which 22 Prudential plc Annual Report 2002
is credited to the policyholder’s account. Periodically, interest is credited to the policyholder’s account and administrative charges are deducted, as appropriate. JNL may reset the interest rate on each policy anniversary, subject to a guaranteed minimum, in line with state regulations. When the annuity matures, JNL either pays the policyholder the amount in the policyholder account or begins making payments to the policyholder in the form of an immediate annuity product. This latter product is similar to a UK annuity in payment. Fixed annuity policies provide for early surrender charges for the first seven to nine years of the policy. In addition, the policy may be subject to a market value adjustment at the time of early surrender. JNL’s profits on fixed annuities arise primarily from the spread between the return it earns on investments and the interest credited to the policyholder’s account (net of any surrender charges or market value adjustment) less management expenses.
Prudential's business in Asia is focused on regular premium products that provide both savings and protection benefits. In 2002, the new business achieved profit mix was 43 per cent unit-linked, 21 per cent non-linked and 36 per cent Accident and Health products.
Achieved Profits Reporting Prudential’s results are prepared on two bases of accounting, achieved profits basis and modified statutory basis (MSB). Over the life of any given product, the total profit recognised will be the same under either the MSB or the achieved profits basis. However, the two methods recognise the emergence of that profit differently, with profits emerging earlier under the achieved profits basis than under MSB. This section explains how the two bases are calculated and why they are used.
Insurance companies in many countries use comparable bases of accounting for management purposes. We believe that the achieved profits basis provides useful information for shareholders. The principle of achieved profits basis accounting is that it reports the total amount of the cash earnings, in present value terms, that are expected to emerge over time from business already sold and still in force making full allowance for the risks attached to these future cash flows. In determining these expected cash earnings Prudential takes account of recent experience in assessing likely persistency, mortality and expenses. Economic assumptions as to future investment returns and inflation are based on market data.
The achieved profits method provides a good indicator of the value being added by today’s management in a given accounting period and demonstrates whether shareholder capital is being deployed to best effect. In contrast, for many types of contract, the MSB result does not reflect the long-term benefit that will arise in the future from current management initiatives and capital expenditure in the year under review, focusing instead on the amounts accruing to shareholders in the current year only, from business already in force.
Achieved profits basis results are prepared by first making assumptions about a number of factors including levels of 24 Prudential plc Annual Report 2002
The total profit that emerges over time from an individual contract as calculated using the achieved profits basis is the same as that calculated under the modified statutory basis. However, since the achieved profits basis reflects discounted future cash flows under this methodology the profit emergence is advanced; thereby linking more closely to the consequences of current management actions and the risks and benefits from business sold in the year.
The achieved profits basis can be illustrated by considering a theoretical individual contract. Using assumptions for the drivers of future income and expenditure (including levels of future investment return, expenses, surrender levels and mortality) a profile of future cash flows can be estimated. These cash flows are then discounted back to the point of sale to give a new business profit.
The achieved profits basis profits emerging in a given 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.
Illustration Modified statutory basis and achieved profits basis cumulative profit profiles for a typical with-profits product
The savings gap in the UK is estimated by the Association of British Insurers to be as much as £27 billion. Our Plan aims to provide people with access to the information they need to allow them to think about and address their own savings gap. It includes providing them with information about a number of products which are not provided by Prudential. It is supported by a free telephone number so that customers can discuss their individual needs with staff who have been specially trained in clear communications.
• In the US, JNL helps to meet the costs of continuing education opportunities for staff, in addition to providing a range of training options including courses delivered via computer technology.
• In the UK, the ‘You Choose’ programme enables employees to create their individual benefits portfolio from a selection of lifestyle and leisure benefits including additional holiday or access to health schemes. On launch in October 2002 80 per cent of employees took the opportunity to change their benefits to a more flexible and individual portfolio.
RESPONSIBILITY • Is integral to our relationships with our customers, our people, shareholders, local communities.
• Provides a basis for growth and enhances our financial success over the long term.
Detailed information about our CR policies and programmes can be found in our on-line CR report (www.prudential.co.uk).
Previously he was with the UK firm of Arthur Andersen where he became a partner in 1993.
6. Mark Tucker (Age 45) A director since 1999. Chief Executive of Prudential Corporation Asia since 1994. Previously General Manager of Prudential, Hong Kong from 1989 to 1992 and Senior Vice President of Operations of Jackson National Life from 1992 to 1994. Joined Prudential in 1986.
Non-executive Directors 8. Sir David Barnes CBE (Age 67) A director since 1999. Non-executive Deputy Chairman of Syngenta AG. Previously nonexecutive Chairman of Imperial Cancer Research Technology Limited. Deputy Chairman of AstraZeneca plc to April 2001 and prior to that Chief Executive of Zeneca Group PLC. Member of the Board of Trustees, British Red Cross Society. Previously Deputy Chairman of Business in the Community.
9. Bart Becht (Age 46) A director since May 2002. Chief Executive of Reckitt Benckiser plc. He joined Benckiser N.V. in 1988 and was appointed Chief Executive in 1995; Benckiser N.V. and Reckitt & Colman plc merged in December 1999. Previously he served in various functions in Procter & Gamble.
11. Roberto Mendoza (Age 57) A director since May 2000. Non-executive Chairman of Egg plc. Non-executive director of Reuters Group PLC, The BOC Group plc and Vitro SA. Founder member of Integrated Finance Limited. Member of the World Bank – IFC Bank Advisory Group. Trustee of the London Symphony Orchestra. Previously Vice Chairman and director and a member of the Corporate Office of JP Morgan & Co, Inc., and a managing director of Goldman Sachs.
12. Rob Rowley (Age 53) A director since 1999. Deputy Chairman of Cable & Wireless Public Limited Company and a non-executive director of Taylor Nelson Sofres plc and UK eUniversities Worldwide.
Retired as a director of Reuters Group PLC in December 2001.
Authority is delegated to the Group Chief Executive for implementing the strategy and for managing the Group. In discharging his responsibility, the Group Chief Executive is advised and assisted by a Group executive committee, comprising all the business unit heads and a Group head office team of functional specialists.
The head of each business unit, who in respect of their business unit responsibilities reports to the Group Chief Executive, has authority for management of that business unit and has established a management board comprising the most senior executives in that business unit.
Board Committees The Board has established the following standing committees of non-executive directors with written terms of reference: Audit Committee Rob Rowley (Chairman) Bart Becht Ann Burdus Sandy Stewart
The Audit Committee normally meets six times a year and assists the Board in meeting its responsibilities under the Code in ensuring an effective system of financial reporting, internal control and risk management. It provides a direct channel of communication between the external and internal auditors and the Board, and assists the Board in ensuring that the external audit is conducted in a thorough, objective and cost-effective manner. It also reviews the Internal Audit annual work plan. The terms of reference of the Audit Committee include reviewing with the management of the Company and the external auditors the performance of the external auditors and the extent of non-audit services; and the value for money obtained from auditors’ fees for both statutory audit work and non-audit work. The Audit Committee monitors regularly the non-audit services being provided to the Group by its auditors and has taken account of the developing requirements in the United Kingdom and the United States on the types of services that the external auditors may provide. No significant changes to the Audit Committee’s existing policies in this area have been required. The Audit Committee annually reviews the auditors’ independence. It also receives the minutes of the Disclosure Committee and the Group Risk Committee established in January and February 2003 respectively and monitors their activities. The minutes of Audit Committee meetings are circulated to the Board after each meeting.
The external audit was last put out to competitive tender in 1999 when the present auditors were appointed. During 2002 the Audit Committee, as part of its scrutiny of auditors’ performance, reviewed the audit fee paid to them. The basis of the fee had been fixed for three years at the time of their appointment. The audit fee paid in 2002 reflects the increase in the auditors’ reporting responsibilities, such as the Group’s US filing obligations, and the increase in the extent of the Group’s operations since 1999. The basis of the fee has also been set having regard to the guidance of the Smith Report that the audit fee should of itself provide an appropriate return to the auditors.
The Chairman, the Group Chief Executive, the Group Finance Director and other members of the senior management team, together with the external auditors, are invited to attend meetings of the Committee except when the Committee wishes to meet alone. The Committee also meets solely with both external and internal auditors at least once a year.
Since the year end, the terms of reference of the Audit Committee have been reviewed and amended in order to ensure they comply with the provisions of the US, Sarbanes-Oxley Act, 2002, as they affect UK companies with a dual-listing in the US.
On 20 January 2003, Sir Robert Smith’s report ‘Audit Committees – Combined Code Guidance’ was published. It is expected that the guidance will be incorporated into the Code later this year. The Audit Committee is currently reviewing the guidance contained in the report and the appropriateness of the best practice recommendations made and will consider further what, if any, additional changes are required.
packages of the executive directors. In framing its remuneration policy, the Committee has given full consideration to the provisions of Section 1B of and Schedule A to the Code. The Remuneration Report prepared by the Board is set out on pages 33 to 43. In preparing the Report, the Board has followed the provisions of Schedule B to the Code and The Directors’ Remuneration Report Regulations 2002.
Except in relation to the remuneration of the Group Chief Executive, when only the Chairman is consulted, the Remuneration Committee consults the Chairman and the Group Chief Executive about the Committee’s proposals relating to the remuneration of all executive directors. The Committee has access to professional advice inside and outside the Company.
Nomination Committee The Company has a standing Nomination Committee, with written terms of reference, the members of which are: David Clementi (Chairman) Sir David Barnes Ann Burdus Sandy Stewart
Directors’ Independence, Training and Re-election The non-executive directors were throughout the year and continue to be considered to be independent. Given the calibre and experience of our non-executive directors, and given that the roles of the Chairman of the Board, the Group Chief Executive, the Chairman of the Audit Committee and the Chairman of the Remuneration Committee were all held by different people, the Board did not believe that it was appropriate to recognise a senior independent director, other than these directors, to whom concerns can be conveyed in respect of relevant issues.
The Annual General Meeting will be held in the Churchill Auditorium at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on Thursday 8 May 2003 at 11.00 a.m. 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 2002, the Company indicated the balance of proxies lodged for each resolution after it had been dealt with on a show of hands and the total percentage of share capital voted on all resolutions. This practice provides shareholders present with sufficient information regarding the level of support and opposition to each resolution. The Company discloses the number of the proxy votes received to any shareholder upon request after the Annual General Meeting. The Notice of the Annual General Meeting and related papers are sent to shareholders at the same time as the Annual Report, and Annual Review and Summary Financial Statement at least 20 working days before the meeting. At the 2003 Annual General Meeting, as with last year’s meeting, questions will be sought from shareholders.
The Higgs Review While the Company has for some time had practices in place which comply with the majority of the recommendations in the Review, it believes a fuller debate is required before any changes to the Combined Code are made. The Company is currently carrying out a detailed review of its existing arrangements and will consider what changes, if any, are necessary for the promotion of best practice in the boardroom.
Businesses are required to confirm annually that they have undertaken risk management during the year as required by the Group Risk Framework and that they have reviewed the effectiveness of the system of internal control. The results of this review were reported to and reviewed by the Audit Committee, and confirmed that the processes described above and required by the Group Risk Framework were in place throughout the period covered by this report, and complied with Internal Control: Guidance for Directors on the Combined Code (the Turnbull guidance). Internal Audit undertakes a review for the Audit Committee of the operation of the risk management process throughout the Group.
Introduction What this report covers This report to shareholders: • Sets out our remuneration policy.
• Sets out tables of information showing details of the remuneration and share interests of all the directors for the year ended 31 December 2002.
Compliance with the Combined Code During the year, the Company has complied with Schedule A and Schedule B of the Combined Code’s provisions relating to the Principles of Good Governance and Code of Best Practice regarding directors’ remuneration.
Remuneration policy for executive directors For 2003, the Board, on the recommendation of the Remuneration Committee, has maintained the remuneration policy that was applied in 2002. The policy on remuneration levels and elements of the remuneration package is set out below. The Remuneration Committee will keep the policy relating to long-term incentives under review. Otherwise, it is expected that this policy will remain the policy in subsequent years, although the Remuneration Committee considers that a successful remuneration policy needs to be sufficiently flexible to take account of changes in the Company’s business environment and in remuneration practice so the policy may be subject to amendment in future years. Any changes in the policy after 2003 will be described in future Remuneration Reports.
Key principles of the remuneration policy The principles developed by the Remuneration Committee reflect the relative importance of those elements that are performance related and those which are fixed and are as follows: • A high proportion of total remuneration will be delivered through performance related reward.
Total remuneration levels Total remuneration means for these purposes basic salary and short and long-term incentives. Award levels for short and longterm incentives for the Group Chief Executive will be set by the Remuneration Committee by reference to the total remuneration levels of other Chief Executives of UK based major international companies and major UK financial companies. This approach reflects the international scope of Prudential’s business while ensuring that remuneration is determined by reference to UK pay levels. The total remuneration levels for the other executive directors will be set similarly by reference to levels in their relevant markets. All pay data will be externally provided.
For executive directors, annual incentive awards are determined as a percentage of their basic salaries at the end of the year. For 2003, Jonathan Bloomer, Philip Broadley, Mark Tucker and Mark Wood are eligible for awards of up to 110 per cent of their basic salary. The award for on target performance is 50 per cent of basic salary, to be paid in cash. These executive directors are further aligned with the interests of shareholders in that any part of the annual incentive award made for performance above target is made in Prudential shares. Receipt of these shares is deferred and the shares are normally only released after three years providing the director is still in employment. During the deferral period, dividends accumulate for the benefit of award holders.
Clark Manning is eligible to receive an annual bonus which provides for a percentage share of a bonus pool geared to the profits of Jackson National Life. In addition, his targets include elements that depend on Group and individual performance which provide 100 per cent of basic salary for target performance with a maximum of 120 per cent.
Long-term incentive plans Our long-term incentive plans are designed to drive the underlying financial performance of the business, i.e. value creation, and relative Total Shareholder Return (TSR). The plans also recognise that strong regional performance is critical to Group performance.
This is an important performance-related element of the total reward package for executive directors. It is designed to reward the achievement of TSR relative to other companies in the FTSE 100 at the beginning of each three-year performance period. This performance measure was chosen when the RSP was introduced as it reflected a combination of market practice, an assessment of Prudential’s main competitors and the focus of UK investors at that time. In addition, for awards under the RSP to vest, the Remuneration Committee must be satisfied with the Company’s underlying financial performance over the same period.
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 over the three-year performance period. All awards are geared to the change in the Prudential plc share price over the performance period. Any award is made following the end of the performance period. No award may be made under the 2003 plan unless the growth of Jackson National Life, as measured under the plan, is greater than eight per cent per annum compound over the performance period, for which a payment of $864,240 may be made, adjusted by a factor reflecting the Prudential plc share price change over the performance period. The on-target payout that may be made, for which a growth rate of 11.5 per cent per annum compound is required, is $1,728,480, also geared to the Prudential plc share price change. If a growth rate of 17.5 per cent per annum compound or more is achieved a maximum of 150 per cent of the target award, also geared to the Prudential plc share price change, may be paid. For payouts for performance between these points a sliding scale applies.
Michael McLintock To reflect his role as Chief Executive of M&G, Michael McLintock participates in the M&G Chief Executive Long-term Incentive Plan that is designed to provide a cash reward through phantom M&G share awards and phantom M&G share options. The change in the phantom share price equals the change in M&G profit, modified up or down by the investment performance of M&G, over the relevant period. The phantom share awards have a performance period of three years and the award vests at the end of the performance period. For 2003 the face value of the award is £225,000. Provided they have value, the phantom share options may be exercised in part or in full during annual exercise periods after three to seven years from the start of the performance period. For 2003 the phantom option award has a face value of £367,800.
Mark Wood To reflect his role as Chief Executive of UK & Europe, Mark Wood participates in a cash-based long-term plan that rewards the growth in appraisal value of UK & Europe over the performance period. Any award is made following the end of the three-year performance period. No award may be made under the 2003 plan unless the growth in appraisal value of the UK & Europe business, as measured under the plan, is greater than eight per cent per annum compound over the performance period. At this level of performance a payment of 50 per cent of basic salary may be made. The on-target payout, for which a growth rate of 11.5 per cent per annum compound is required, is 75 per cent of basic salary. If a growth rate of 17.5 per cent per annum compound or more is achieved, a maximum of 100 per cent of basic salary may be paid. For payouts for performance between these points a sliding scale applies.
Chairman’s Letter of Appointment and Benefits The Chairman joined the Company on 1 December 2002. He has a letter of appointment dated 5 September 2002 under which he is paid annual fees. The notice period is 12 months from either party. The Chairman participates in a medical insurance scheme, has life assurance cover and a car and driver is made available for his use. He is entitled to a supplement to his fees, intended for pension purposes. He is not a member of any Group pension scheme.
The contract for Clark Manning is a renewable one-year fixedterm contract. The contract is renewable automatically upon the same terms and conditions unless the Company or Clark Manning gives at least 90 days’ notice prior to the end of the relevant term. In the case of the former, Clark Manning is entitled to continued payment of salary and benefits for the period of one year from the day such notice is delivered to him. The contract can also be terminated by the Company or Clark Manning by giving 12 months’ notice. In mitigation of his loss, payments of Clark Manning’s salary during any period following the termination of employment will be reduced by the amount of any compensation earned by him from any subsequent employer or from any person for whom he performs services. Benefits to be provided during such period will also be cancelled to the extent that comparable benefits are available to him from these alternative sources.
Remuneration Report continued for year ended 31 December 2002 36 Prudential plc Annual Report 2002 *The contract can also be terminated by issuing a non-renewal notice as described above.
2. The commencement of Bart Becht’s initial term is subject to a resolution for his election being passed at the Annual General Meeting.
Policy on External Appointments Subject to the Board’s approval, executive directors are able to accept a limited number of external appointments as nonexecutive directors of other organisations.
Non-executive Directors’ Remuneration Non-executive directors are not eligible to participate in annual incentive plans, long-term incentive plans or pension arrangements. Their fees are determined by the Board subject to the overall limit set by the shareholders, within the Articles of Association, and reflect their individual responsibilities including membership of Board committees. The Board reviews the fees annually.
Roberto Mendoza, as Chairman of Egg, receives a fee of £75,000 per annum and Sandy Stewart, as Chairman of the supervisory board of the Scottish Amicable Insurance Fund, receives a fee of £30,000 per annum.
Performance Graph The line graph below represents the comparative Total Shareholder Return (TSR) of the Company during the five years from 1 January 1998 to 31 December 2002. In producing this graph it has been assumed that all dividends paid have been reinvested and share price averaging over a 90-day period has been used to reduce the effect of short-term share price volatility.
To ta l s ha re ho ld er re tu rn (%
Total Annual Other Total Salary/Fees Bonus Benefits 2002 payments* payments 2001
Chairman David Clementi (appointed 1 Dec 2002, note 3) 35 – 2 37 – – –
Executive directors Keith Bedell-Pearce (retired 31 Dec 2001, note 4) – – – – 551 – 551
Clark Manning (appointed 2 Jan 2002, note 5) 532 392 12 936 – – –
Bart Becht (appointed 9 May 2002) 32 – – 32 – – –
Sir Roger Hurn (resigned 30 Nov 2002, note 10) 275 – 17 292 309 – 309 Bridget Macaskill (resigned 16 Mar 2001) – – – – 8 – 8 *Excluding other payments, detailed below.
Notes 1. The highest paid director for 2002 was Mark Tucker, whose total emoluments were £1,455,227, which included £495,350 from the 1999 Asian Long-term Incentive Plan and £46,408 from the 1999 RSP award. Additionally in 2002 the Company made a pension contribution of £49,730 on his behalf to the Prudential Staff Pension Scheme.
4. For Keith Bedell-Pearce the 2001 total included an annual bonus payment and a payment recognising his contribution to the Company’s long term objectives, totalling £165,000 and made in 2002, which were disclosed in the 2001 Report.
5. Clark Manning’s bonus figure excludes a contribution of £6,654 from a profit sharing plan that has been made into a 401k retirement plan which is reported in the table on pension contributions on page 43.
7. Mark Tucker’s benefits include an allowance of £111,000 for housing paid to reflect his expatriate circumstances.
9. Mark Wood’s 2001 bonus included a payment of £275,000 in respect of his joining the Company. His 2001 bonus figure also included a deferred bonus of £39,720 in the form of shares the details of which are reported in the section on Other Share Awards on page 40.
The awards made in respect of 2001 and 2002 under the Restricted Share Plan run to 31 December 2003 and 31 December 2004 respectively and any grants under these plans will be based on the TSR ranking determined at the end of each of those performance periods. Performance under these plans was ranked respectively at percentile positions 63rd and 79th on the basis of TSR performance at 31 December 2002.
In determining the conditional awards to be made for 2002 the shares were valued at their average share price during the preceding calendar year, and the price used to determine the number of shares conditionally awarded in 2002 was 818.7 pence (2001 – 975.6 pence).
Market Rights Rights Market price of (options) Conditional (options) price at Market
Conditional 2002 award granted share Date of granted original price at share awards Conditional on date upon awards end of upon Date of date of date of outstanding award of grant vesting outstanding at performance vesting grant of award vesting at 1 Jan 2002 in 2002 (pence) in 2002 31 Dec 2002 period in 2002 rights (pence) (pence)
Keith Bedell-Pearce 28,664 6,450 –1 31 Dec 01 6,450 15 Mar 02 763 719.5
Rights granted under the Restricted Share Plan upon vesting prior to 31 December 2001 and not yet exercised are shown in the following table: RSP rights RSP rights Exercise Market price outstanding outstanding Price paid price at 31 Dec 2002 Earliest Latest at 1 Jan 2002 at 31 Dec 2002 for award (pence) (pence) exercise date exercise date
Jonathan Bloomer 56,859 56,859 – Nil 439 17 Mar 00 17 Mar 07
Other Long-term Incentive Plans Details of cash awards under other long-term incentive schemes are set out below.
Mark Wood Business cash LTIP 450 450 31 Dec 03 Business cash LTIP 450 450 31 Dec 04
Other Share Awards Under the Company’s previous short-term deferred bonus plan, known as the Share Participation Plan (SPP) there are deferred share awards held in trust for five years, which are shown in the table below.
The table below also includes the share awards that have been deferred from annual incentive plan payouts the value of which is included in the bonus figures in the Directors’ Remuneration table. The number of shares is calculated using the average share price over the three business days commencing on the day of the announcement of the Group’s annual financial results for the relevant year. For the 2001 awards the average share price was 657 pence.
Mark Tucker Deferred 2001 annual incentive award 18,2651 831 19,096 31 Dec 04
Mark Wood Awards on appointment 71,569 71,569 – 31 Jul 02 71,569 31 Jul 02 861 491.5
The interests of directors in shares of the Company are shown below, including changes between 31 December 2002 and 14 March 2003. All interests are beneficial except 6,175 shares in respect of Sandy Stewart.
Directors’ Share Options The Restricted Share Plan replaced the Executive Share Option Scheme (ESOS) in 1995 as the Group’s primary long-term incentive plan. Some outstanding options under ESOS remain unexercised and are set out below together with options under the SavingsRelated Share Option (SAYE) Scheme. The Savings-Related Share Option Scheme is open to all UK and certain overseas employees. Options under this Scheme up to Inland Revenue limits are granted at a 20 per cent discount and cannot normally be exercised until a minimum of three years has elapsed. No payment has been made for the grant of any options. The price to be paid for exercise of these options is shown in the table below. No variations to any outstanding options have been made.
2. No price was paid for the award of any option.
3. The highest and lowest share prices during 2002 were 824 pence and 333 pence respectively.
Mark Tucker, having commenced employment before 1989, is eligible for benefits from PSPS on all basic salary. Philip Broadley and Mark Wood are eligible for benefits from PSPS on basic salary up to the earnings cap. Jonathan Bloomer only receives a lump sum death benefit of four times basic salary up to the earnings cap from PSPS.
The M&G Group Pension Scheme (MGGPS) is a contributory defined benefit 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. The MGGPS also has an option to commute pension for a tax free cash sum. The scheme provides on death in service, a lump sum of four times pensionable salary and a spouse’s pension of 50 per cent of prospective pension at 60. On death in retirement, a spouse’s pension of 50 per cent of the pension available at retirement before commutation is payable and a lump sum is also payable if death occurs in the first five years of retirement. Some of the pension payable is guaranteed to increase in line with the Retail Prices Index capped at five per cent, but in recent years all pensions have been increased fully in line with the Retail Prices Index. Members currently contribute 2.4 per cent of basic salary towards the cost of the benefits.
US Directors Clark Manning participates in the JNL Defined Contribution Retirement Plan which is a US tax qualified defined contribution plan (a 401k plan) under which the total Company contribution for 2002 was £13,973.
Supplementary Arrangements David Clementi is provided with a salary supplement, part of which is a contribution to a personal pension, and life assurance provision of four times his annual fees under the Prudential Supplementary Life Assurance Scheme (PSLAS). The premiums paid by the Company to this scheme are a taxable benefit.
Jonathan Bloomer, Philip Broadley, Michael McLintock and Mark Wood are entitled to taxable salary supplements calculated on a formula based on their basic salary not covered for pension benefits under a UK Inland Revenue approved scheme.
Clark Manning 44 – – – – – – – 14 *Excluding inflation
Notes 1. The transfer value equivalent has been calculated in accordance with Actuarial Guidance Note GN11.
Total contributions to directors’ pension schemes, including payments by the Company to PSPS, MGGPS and PSLAS were
Employee Involvement The Group has effective communication channels through which employees’ views can be sought on issues which concern them. Throughout the Group there is close consultation between management and other employees on appropriate matters of concern, with a view to keeping employees informed about the progress of the Group’s business and the economic factors affecting it. Communication with employees is achieved in a number of ways, including staff briefings and through the Group’s intranet site. Prudential’s European Employee Forum provides an opportunity for elected staff representatives to consult with senior management on strategic European business issues. Each Prudential business in Europe is represented on the Forum. M&G’s Staff Consultative Committee promotes communication throughout M&G and is the forum for dialogue on a range of issues of interest to staff.
In 2002 employees were again invited to participate in the Prudential Savings-Related Share Option Scheme. The Scheme has now been operating for over 19 years and a majority of UK staff currently participate. The Prudential International SavingsRelated Share Option Scheme (ISSOS) for employees has been operating since 2000 in Hong Kong, Malaysia and Singapore, and since 2001 in Taiwan and India. On average 22 per cent of employees in those countries covered by the ISSOS currently participate.
Donations Prudential is committed to supporting the communities where it is an employer. In 2002 the Company spent £3.3 million on community support activity, including in-kind donations and staff time. Within this, direct donations to charitable organisations amounted to £1.6 million, of which £1.1 million came from EU operations. This is broken down as follows: Education £675,000; Social and Welfare £315,000; Environment £83,000; Children and Youth £31,000; Medical and Other £31,000; and Arts and Heritage £8,000. The total aggregate figure for charitable donations from Prudential’s non-EU subsidiaries (Jackson National Life and Prudential Corporation Asia) amounted to £0.5 million. Jackson National Life made political donations of $15,500 in 2002. However, the Group’s policy not to make donations to EU political parties or to incur EU political expenditure, within the normal meaning of those expressions, has not changed and the Group did not make any such donations or incur any such expenditure in 2002.
Auditors A resolution for the re-appointment of KPMG Audit Plc as auditors of the Company will be put to the Annual General Meeting.
Shareholders The number of accounts on the share register at 31 December 2002 was 86,400 (2001 84,936). Further information about shareholdings in the Company is given on page 103. At 14 March 2003 the Company had received notification in accordance with Sections 198 to 208 of the Companies Act 1985 from The Capital Groups Companies Inc. of a holding of 4 per cent of the Company’s share capital, from Fidelity Investments of a holding of 3.96 per cent of the Company’s share capital, and from Legal and General Investment Management Limited of a holding of 3 per cent of the Company’s share capital.
Operating profit before tax (based on long-term investment returns) before amortisation of goodwill
Tax on profit on ordinary activities: Tax on operating profit before amortisation of goodwill (122) (174) Tax on items excluded from operating profit before amortisation of goodwill 78 153
Statutory basis profit for the financial year after minority interests: Operating profit after tax and related minority interests before amortisation of goodwill 314 460 Items excluded from operating profit after tax before amortisation of goodwill 135 (71)
Total statutory basis profit for the financial year after minority interests 449 389
Dividend per share 26.0p 25.4p 46 Prudential plc Annual Report 2002
Premiums written, net of reinsurance – 57 Change in the gross provision for unearned premiums 6 (25) Change in the provision for unearned premiums, reinsurers’ share (6) 158
Change in the provision for claims: Gross amount 10 32 Reinsurers’ share (8) 158
Net operating expenses (including re-engineering costs of £nil (£7m)) 14 (3) (95)
Following the sale of the Group's UK home and motor general business operations on 4 January 2002 (see note 34), the whole of the general business technical account relates to discontinued operations.
Consolidated Profit and Loss Account continued year ended 31 December 2002
Change in long-term business provision: Gross amount (4,127) (7,233) Reinsurers’ share 59 221
Change in provisions for linked liabilities, net of reinsurance 1,346 901
Balance on the long-term business technical account 382 442 Tax credit attributable to balance on the long-term business technical account 16 174 235
Balance on the long-term business technical account before tax 7 556 677
Allocated investment return transferred to the long-term business technical account (199) (385) Investment expenses and charges 15 (191) (162) Unrealised losses on investments (217) (162) Allocated investment return transferred to the general business technical account (8) (37) Other income: UK investment management and products result 71 75 US broker dealer and fund management results 14 16 Merger break fee (net of related expenses) – 338 Profit on sale of UK general business operations 34 355 –
Profit for the financial year before minority interests 440 364 Minority interests 9 25
Investments Land and buildings 22 10,766 10,487 Investments in participating interests 23 73 87 Other financial investments 24 104,299 109,328
Cash at bank and in hand 33 1,115 1,436 Own shares (ordinary shares of parent company) 27 34 52 Present value of acquired in force long-term business 18 113 138 Present value of future margins relating to advances from reinsurers 118 135
Obligations of Jackson National Life under funding and stocklending arrangements 31 5,098 3,703 Other creditors including taxation and social security: Banking business liabilities: Jackson Federal Bank 902 868
Reconciliation of Movements in Consolidated Shareholders’ Capital and Reserves year ended 31 December 2002
Fixed assets Investments: Shares in subsidiary undertakings 28 5,500 5,179 Loans to subsidiary undertakings 28 2,160 1,584
Other borrowings (29) – Amounts owed to subsidiary undertakings (14) (8) Tax payable (126) – Final dividend (341) (332) Sundry creditors (19) (31) Accruals and deferred income (43) (44)
Operating activities Net cash inflow from operating activities 33 31 95
Net cash inflow from acquisitions, disposals and similar items 341 156
Financing Issue of borrowings 33 86 640 Movement on credit facility utilised by investment subsidiaries managed by PPM America 33 (165) 404 Issues of ordinary share capital 33 40 42
Net (sales) purchases of portfolio investments 33 (83) 1,777 Increase (decrease) in cash and short-term deposits, net of overdrafts 33 26 (1,125)
In accordance with FRS 1, this statement shows only the cash flows of general business and shareholders’ funds. Cash flows of long-term business operations are excluded.
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 2002, the Group operated in the UK through its subsidiaries, primarily The Prudential Assurance Company Limited (PAC), Prudential Annuities Limited, Prudential Retirement Income Limited, Scottish Amicable Life plc (SAL), M&G Group plc, and Egg plc. In December 2002 the business of SAL was transferred to PAC under a court-approved arrangement. In the US the Group’s principal subsidiary is Jackson National Life Insurance Company.
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 Statement of Recommended Practice, ‘Accounting for Insurance Business’, issued in December 1998 by the Association of British Insurers (the ABI SORP). The ABI SORP is currently under review and an Exposure Draft of the Revised SORP was issued for public consultation in November 2002. In preparing these financial statements the Company has not applied any of the changes proposed in the Exposure Draft. The results of US operations and certain Asian operations are prepared on the basis of US GAAP, adjusted where necessary to comply with UK GAAP.
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. For the year ended 31 December 2002 all transactions recorded in the general business technical account relate to discontinued operations. 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 general business, the Group’s other non-insurance businesses included in the non-technical account, and amounts transferred to shareholders’ funds from the Group’s long-term businesses.
Annual bonuses are declared and credited each year to all with-profits policies. The annual bonuses increase policy benefits and, once credited, become guaranteed. Annual bonuses are charged to the profit and loss account as a change in the long-term business provision in the year declared. Final bonuses are declared each year and accrued for policies scheduled to mature and death benefits expected to be paid during the next financial year. Final bonuses are not guaranteed and are only paid on policies that result from claims through the death of the policyholder or maturity of the policy within the period of declaration or by concession on surrender. No policyholder benefit provisions are recorded for future annual or final bonus declarations.
3. Significant Accounting Policies continued Long-term business provision continued 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%. The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year and range from 2.4% to 5.4%. Mortality rates used in establishing policyholder benefit provisions are based on published mortality tables adjusted to reflect actual experience. For accumulating with-profits business of The Prudential Assurance Company Limited, the provision has been taken as the lower of: • the accumulated fund or the value at the bid price of the notional number of units allocated to policyholders, in both cases excluding final bonus, and • the surrender or transfer value which, having regard to policyholders’ reasonable expectations, would be payable at the valuation date, or, if greater, the value of the guaranteed liabilities excluding final bonus calculated on a gross premium bonus reserve method.
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 8.
Revenue recognition Premiums are recognised when risks are assumed. The proportion of premiums written relating to periods of risk beyond any year-end is recorded as an unearned premium provision and subsequently recognised in earnings proportional to the period of the risk. Premiums are presented gross of commission and exclude any taxes or duties assessed based on premium.
3. Significant Accounting Policies continued Deferred acquisition costs Direct and indirect costs associated with the writing of new general insurance policies are deferred and amortised in a manner consistent with the method used for premium recognition described above.
Reinsurance In the normal course of business, the Group seeks to reduce loss exposure arising primarily from catastrophes or other significant adverse events by reinsuring certain levels of risk in various areas of exposure with other insurance companies or reinsurers. An asset or liability is recorded in the consolidated balance sheet representing premiums due to or payments due from reinsurers, and the share of losses recoverable from reinsurers.
3. Significant Accounting Policies continued Tax continued The tax charge for long-term business included in the long-term business technical account includes tax expense on with-profits funds attributable to both the policyholders and the shareholders. Different tax rules apply under UK law depending upon whether the business is life insurance or pension business. Tax on the life insurance business is based on investment returns less expenses attributable to that business. Tax on the pension business is based on the shareholders’ profits or losses attributable to that business. The shareholders’ portion of the long-term business is taxed at the shareholders’ rate with the remaining portion taxed at rates applicable to the policyholders.
The balance of the long-term business technical account is net of the total tax attributable to the long-term business. In order to present the profit on long-term insurance activities in the non-technical account on a pre-tax basis, a tax credit attributable to the shareholders’ portion of the tax provision for long-term business, calculated at the effective tax rate (where appropriate on a longterm basis) of the underlying business, is added. This shareholder tax add-back is then included in the tax expense on the profit on ordinary activities within the non-technical account. Further details are provided in note 16.
Stock-based compensation The Group offers share award and option plans for certain key employees and a Save As You Earn plan (SAYE plan) for all UK and certain overseas employees. 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. This amount includes the difference between the market price at the date of transfer to the trust and amounts payable by employees and is charged directly to the profit and loss account reserve within shareholders’ funds.
Land and buildings Investments in tenant and Group occupied leasehold and freehold (directly owned) properties are carried at estimated fair value, with changes in estimated fair value included in investment returns. Properties are valued annually either by the Group’s qualified surveyors or professional external valuers using The Royal Institution of Chartered Surveyors (RICS) guidelines. The RICS guidelines apply separate assumptions to the value of the land, buildings, and tenancy associated with each property. Each property is externally valued at least once every three years. The cost of additions and renovations is capitalised and considered when estimating fair value.
Investments in participating interests A participating interest is a beneficial equity investment where the Group exercises influence over the investee’s operating and financial policies. A participating interest where the Group exercises significant influence over the investee, generally through ownership of 20% or more of the entity’s voting rights, is considered to be an investment in associate. The Group’s investments in associates are recorded at the Group’s share of net assets. The carrying value of investments in associates is adjusted each year for the Group’s share of the entities’ profit or loss.
3. Significant Accounting Policies continued Other financial investments Other financial investments include equity securities; debt and other fixed income securities; mortgage and other loans; loans to policyholders and deposits with credit institutions.
Derivatives Derivative financial instruments are used to reduce or manage investment, interest rate and currency exposures, to facilitate efficient portfolio management and for investment purposes. The Group’s policy is that amounts at risk through derivative transactions are covered by cash or by corresponding assets. Derivative financial instruments are used to facilitate efficient portfolio management and for investment purposes. With the exception of derivatives held by Jackson National Life, these instruments are carried at fair value with changes in fair value included in investment returns. For Jackson National Life, the accounting for derivative financial instruments is explained in note 11.
As part of the efficient portfolio management of the Life Fund of The Prudential Assurance Company Limited, the fund may, from time to time, invest in cash settled forward contracts over Prudential plc shares. This is in order to avoid a mismatch of the Life Fund’s investment portfolio with the investment benchmarks set for its equity based investment funds. The contracts will form part of the long term investments of the Life Fund. These contracts are subject to a number of limitations for legal and regulatory reasons.
3. Significant Accounting Policies continued Tangible assets Tangible assets, principally computer equipment, software development expenditure, and furniture and fixtures, are capitalised and depreciated on a straight-line basis over their estimated useful lives, generally three to ten years. Leasehold improvements are depreciated over the life of the lease. Assets held under finance leases are capitalised at their fair value.
Further details of UK banking business assets and liabilities are contained in note 10.
Foreign currency translation The profit and loss accounts of foreign subsidiaries are translated at average exchange rates for the year. Assets and liabilities of foreign subsidiaries are translated at year-end exchange rates. Foreign currency borrowings that have been used to finance or provide a hedge against Group equity investments in overseas subsidiaries, are translated at year-end exchange rates. The impact of these currency translations is recorded as a component of shareholders’ funds within the statement of total recognised gains and losses.
4. Supplemental Earnings Information The Group uses operating profit based on long-term investment returns before amortisation of goodwill and before tax as a supplemental measure of its results. For the purposes of measuring operating profit, investment returns on shareholder financed business are based on expected long-term rates of return. The expected long-term rates of return are intended to reflect historical real rates of return and, where appropriate, current inflation expectations adjusted for consensus economic and investment forecasts. For 2002, the significant operations that require adjustment for the difference between actual and longer-term investment returns are Jackson National Life and certain businesses of Prudential Asia.
For the purposes of determining the longer-term investment returns of Jackson National Life for 2002 and 2001, realised gains and losses arising on debt securities (including losses arising on the recognition of permanent diminutions in value) have been averaged over five years for inclusion in operating profit. For equity-related investments of Jackson National Life for 2002 and 2001, a long-term rate of return of 7.75% has been assumed and this rate has been applied to the monthly average carrying value of such investments after excluding the estimated effect of short-term market movements.
In addition to the adjustments made for investment returns, as described above, operating profit excludes gains on business disposals and similar items.
(note 7) (note 16) interests Net per share £m £m £m £m Pence
Operating profit based on long-term investment returns before amortisation of goodwill and exceptional items 432 (122) 4 314 15.8p Amortisation of goodwill (98) – – (98) (4.9)p Short-term fluctuations in investment returns: Profit on sale of UK general business operations 355 (13) – 342 17.2p
Weighted average shares for diluted earnings per share 1,991 1,982 5. Segmental Information – Gross Premiums Written by Product Provider and Investment Product Contributions
Discontinued Long-term business Investment products general business Total £m £m £m £m £m £m £m £m
Department of Social Security rebate business 90 64 – – 9 6
GIC – Medium Term Notes 1,118 1,504 – – 112 150
Single new business insurance premiums include increments under existing group pension schemes and pensions vested into annuity contracts (at the annuity purchase price). Regular new business premiums are determined on an annualised basis.
Balance on Balance on long-term general business business technical technical account account before tax Other activities Total £m £m £m £m £m £m £m £m
Unrealised losses on investments (217) (162) (217) (162) Allocations to technical accounts (207) (422) (207) (422)
Investment return and other income* 3 51 3 51 Interest payable on core structural borrowings
Short-term fluctuations in investment returns (note 4) (205) (480) (205) (480) Merger break fee net of related expenses – 338 – 338 Profit on sale of UK general business operations (note 34) 355 – 355 –
Statutory basis profit on ordinary activities before tax – 72 556 677 (72) (364) 484 385 *Investment return and other income is shown after deducting interest payable on non-core borrowings, as described in note 15.
**During 2001 the Company announced the restructuring of the direct sales force and customer service channels of its UK Insurance Operations. Additional restructuring was undertaken in 2002 to further reduce operating costs. The total cost of this restructuring, including amounts borne by the main with-profits fund, was £38m (£200m) of which £14m (£48m) was attributable to shareholders on the modified statutory basis of reporting.
Comprising: UK Operations 92,377 98,832 Jackson National Life 24,074 25,055 Prudential Asia 5,557 4,894 Prudential Europe 649 634 *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 32), 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 shareholder operations Shareholders’ shareholder operations Shareholders’ borrowings (note 31) funds borrowings (note 31) funds £m £m £m £m £m £m
Analysis of shareholders’ capital and reserves UK Operations: Long-term business operations 541 541 494 494
Other operations: Other net (liabilities) assets (195) (195) 126 126 *Total goodwill comprises amounts in respect of: £m £m
US operations relating to purchase of broker dealer and banking businesses 58 63 Other operations relating mainly to M&G and acquired Asian businesses 1,546 1,624 66 Prudential plc Annual Report 2002
Operating profit Gross (based on long-term premiums written Underwriting result Investment return investment returns)
Interest receivable from: Loans and advances to customers 376 312 Debt securities 189 188
Administrative expenses (234) (185) Provision for bad and doubtful debts (85) (68) Other expenses (28) (24)
Assets Loans and advances to banks 239 67 Loans and advances to customers 5,546 4,712 Debt securities 4,268 3,061 Other banking business assets 473 197
Total banking business assets 10,526 8,037 Intragroup balances 3 4 Deferred tax asset 18 15 Goodwill 7 – Other assets including tax 11 28
Liabilities Customer accounts 8,016 5,945 Debt securities issued (note 31) 1,015 915 Securities sold under agreements to repurchase (note 31) 0 384 Deposits by banks 501 5 Other banking business liabilities 350 216
Profit and loss account Operating profit 275 8 283 (77) 3 209 139 Realised investment gains (losses), net of related change to amortisation of acquisition costs (including, for US GAAP, the change in the fair value of hedging instruments) (note (ii)) (722) 285 21 (416) 416
Profit before tax after minority interests (426) 293 0 (133) (47) (3) (183) (123)
Shareholders’ funds at end of year 3,750 47 3,797 27 3,824 2,374
(i) The valuation basis of debt securities – reversal of FAS 115 effects Under US GAAP debt securities classified as ‘available for sale’ under Financial Accounting Standard (FAS) 115 are carried in the balance sheet at fair value with movements on unrealised appreciation accounted for directly within shareholders’ reserves as ‘Other Comprehensive Income’. By contrast, consistent with the ABI SORP, for Group reporting purposes, all fixed income securities are carried at amortised cost subject to provision for permanent diminution in value. This accounting treatment is appropriate as the securities are held as part of a portfolio of such securities intended to be held to maturity. Movements in unrealised appreciation arising from changes in the fair value of these securities do not feature as a part of the Group’s UK GAAP accounting.
Net earnings for Jackson National Life on a US GAAP basis reflect increased volatility owing to fair value fluctuations on its derivative instruments, particularly for interest rate swaps that are regularly used to manage risks associated with movements in interest rates. However, the largely offsetting change in the fair value of hedged investments will remain as an adjustment taken directly to shareholders’ funds under US GAAP, as described in note (i). This position can be contrasted with the position under UK GAAP where hedge accounting for relevant derivative instruments is still appropriate. Accordingly, gains and losses recognised under FAS 133 are eliminated in order to comply with UK GAAP.
Average for 2002 applied to profit and loss account 1.50 Year end 2002 applied to shareholders’ funds 1.61 12. Investment Income Long-term business Non-technical technical account account £m £m £m £m
Financed by with-profits funds: With-profits business 42 44 Non-participating business** 10 8
Financed by with-profits funds: With-profits business 30 35 Non-participating business** 1 3
15. Investment Expenses and Charges Long-term business Non-technical technical account account £m £m £m £m
Interest payable on core structural borrowings – – 130 118 Interest on bank loans and overdrafts 35 45 0 0 Interest on other borrowings 112 137 60 44
Long-term business interest payable includes £96m (£128m) 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 £9m (£12m) in respect of non-recourse borrowings of investment funds managed by PPM America, £11m (£4m) in respect of Egg debenture loans and £40m (£28m) 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 31.
16. Tax (i) Profit and loss account tax (credit) charge The tax expense for certain long-term business operations is attributable to shareholders and policyholders. The shareholders’ portion of tax is determined using the long-term 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’
(a) Between current and deferred tax expense (benefit) Current: Deferred: (b) By category of tax expense (benefit)
Shareholder tax attributable to balance on the long-term business technical account: (c) By source of profit £m £m
Profit on ordinary activities multiplied by standard rate of corporation tax in the UK of 30% (30%) 145 116 Effects of: Utilisation of capital losses against profit on sale of UK general business operations and merger break fee (97) (95) Other differences in basis between taxable gains and book gains (losses) (15) (22) Different tax rates on overseas earnings (15) (7) Deferred tax not recognised on tax losses carried forward 28 16 Different tax bases of long-term insurance (current and deferred) (29) (7) Taxable foreign exchange gains (losses) not recognised in accounts (12) 7 Non-taxable amortisation of goodwill 29 29 Adjustments in relation to prior years (3) (6) Capital allowances for period in (excess) deficit for the period (2) 1 Effect of short-term timing differences 13 (30) Unrealised gains on general business and shareholder investments 57 48
The balance at beginning of 2002 comprises cost of £1,920m less accumulated amortisation of £233m.
Pension costs The Group has chosen not to fully implement FRS 17 ‘Retirement benefits’ for the 2002 financial statements. Pension costs shown above have been determined applying the principles of SSAP 24 ‘Pension costs’. £11m (£9m) of the Group’s pension costs related to overseas schemes.
19. Information on Staff and Pension Costs continued On an actuarial basis consistent with the methodology applied for the valuation at 5 April 2002, the position is not believed to be significantly different at 31 December 2002.
The key assumptions adopted for this valuation, and the FRS 17 basis valuation at 31 December 2001, were: Price inflation 2.25% 2.50% Rate of increase in salaries 4.25% 4.50% Rate of increase of present and future pensions 2.25% 2.50% Rate used to discount scheme liabilities 5.50% 5.75%
The movement in the difference between scheme assets and liabilities for the year ended 31 December 2002 comprises: £m
Current service cost (65) Contributions 34 Other finance income 88 Actuarial losses (1,189)
Gross of tax surplus (deficit) 144 (1) (275) 11 (121) Related deferred tax (liability) asset (43) 0 82 (3) 36
Total profit and loss account credit 23 less: amount attributable to PAC with-profit fund * (24)
*Since shareholder profits in respect of the PAC with-profit fund are a function of the actuarially determined surplus for distribution, the overall profit and loss account result is not directly affected by the level of pension cost or other expenses.
Total actuarial loss (29% of the present value of the scheme liabilities) (1,189) less: amounts attributable to the PAC life fund 914
Pre-tax impact on the statement of total recognised gains and losses attributable to shareholders (275) Related deferred tax 82
Gross of tax surplus (deficit) 441 24 (914) 23 (426) Related deferred tax (liability) asset (49) (3) 101 (3) 46
19. Information on Staff and Pension Costs continued Comparison of FRS 17 basis results with results on SSAP 24 basis adopted for the 2002 financial statements Balance sheet
Net pension scheme (liability) asset attributable to shareholders and PAC with-profit fund Nil* (465) Nil* 493 Fund for future appropriations 7,663 7,283 13,202 13,594 Shareholders’ funds 3,668 3,583 3,950 4,051 * Surplus on actuarial basis of valuation not recognised due to minimum contribution requirement under Scheme rules (see page 74).
Pensions costs (charged) credited to technical accounts and non-technical account for defined benefit and defined contribution schemes (42) 9
Statutory audit fees 3.3 2.3 Audit related services: Regulatory returns and achieved profits basis audits 0.8 0.6 US GAAP work 0.6 0.2
Current value: Leasehold with a term of over 50 years 4,120 4,071 Leasehold with a term of less than 50 years 174 107
Amounts included in the above relating to listed investments were: Shares and other variable yield securities and units in unit trusts 29,129 40,077 Debt securities and other fixed income securities – carried at market value 35,883 31,816 Debt securities and other fixed income securities – carried at amortised cost 17,672 18,308
Consistent with the Group’s accounting policy set out on page 60, amortised cost has been applied as current value for certain fixed income securities. Where appropriate, to reflect requirements the current value of such investments has been reduced to impaired value.
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 £429m (£344m). For securities carried at amortised cost where the purchase price exceeded maturity value, the unamortised difference at the year end was £179m (£148m).
Depreciation: Balance at beginning of year (312) (266) Provided during year (76) (108) Movement relating to acquisitions and disposals of businesses 10 (6) Other disposals 114 68
Net book value at beginning of year 241 288 27. Share Capital and Share Premium The authorised share capital of the Company is £120m comprising 2,400,000,000 shares of 5 pence each.
Number of 2002 2002 Issued shares of 5 pence each fully paid shares £m £m
At beginning of year 1,993,819,770 99.7 532.5 Shares issued under share option schemes and to qualifying share ownership trust 3,476,990 0.2 17.2 Shares issued in lieu of cash dividends 4,365,588 0.2 22.7 Transfer to retained profit in respect of shares issued in lieu of cash dividends (22.7)
At beginning of year 5,179 1,584 Investments in subsidiary undertakings 321 – Exchange rate movements – (20) Advances of new loans – 629 Provision against loans – (19) Repayment of loans – (14)
At end of year 5,500 2,160 29. Profit of the Company The profit of the Company for the year was £327m (£295m). After dividends of £519m (£504m) and a transfer from the share premium account of £23m (£20m) in respect of shares issued in lieu of cash dividends, retained profit at 31 December 2002 amounted to 30. Subsidiary Undertakings The principal subsidiary undertakings of the Company at 31 December 2002 were: Main activity Country of incorporation
Core structural borrowings of shareholder financed operations: Holding company and finance subsidiaries: ¤500m 5.75% Subordinated Notes 2021*†
Total core structural borrowings of shareholder financed operations 1,991 2,020 461 132 2,452 2,152
Medium Term Notes 2003 (note (ii)) 25 – 25 – Currency translation net liability on swap transactions (note (ii)) 13 – 13 – Non-recourse borrowings of investment subsidiaries managed by PPM America (note (iii)) 292 449 73 81 365 530
Egg debenture loans (note (iv)): Other borrowings of long-term business operations: Scottish Amicable Finance plc (note (v)): Borrowings are repayable as follows: Within one year or on demand 80 690 1,670 1,417 1,750 2,107 Between one and two years 28 – 41 – 69 – Between two and five years 305 172 20 – – 45 325 217
31. Borrowings continued (i) At 31 December 2002, the €500m 5.75% borrowings had effectively been swapped into borrowings of £309m with interest payable at 6 month £Libor plus 1.03%.
(iii) Non-recourse borrowings issued by investment subsidiaries managed by PPM America include secured senior and subordinated debt and a revolving credit facility. The senior debt is secured on the investments held by the relevant subsidiaries. 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. The terms of the revolving credit facility include a cross default provision with the subordinated notes. In addition to the debt of these subsidiaries, PPM America manages investment companies with liabilities of £1,048m (£1,353m) 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.
(vi) 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 £3,554m (£3,144m). In addition, Jackson National Life has entered into stocklending arrangements. Obligations under these arrangements totalled £1,544m (£559m). These amounts are shown on the consolidated balance sheet within creditors.
(vii) Jackson National Life, through its subsidiary Jackson Federal Savings Bank, has bank borrowings of £239m (£244m). The advances are secured by mortgage loans and mortgage backed securities.
32. Contingencies and Related Obligations Consistent with FRS 12, ‘Provisions, contingent liabilities and contingent assets’, appropriate provision has been made in the financial statements where Prudential has an obligation arising from the events or activities described below but not for contingent liabilities.
32. Contingencies and Related Obligations continued 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 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 UK regulator 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 has met the requirement of the FSA to issue offers to all Phase 1 (priority) cases and Phase 2 (non-priority) cases by 30 June 2002.
The calculation of the pension mis-selling provision is dependent upon a number of assumptions and requirements provided by the FSA. The costs associated with the pension mis-selling review have been met from Prudential Assurance’s inherited estate. Given the strength of Prudential Assurance’s with-profits fund, management believes that charging the costs to the inherited estate will not have an adverse effect on the level of bonuses paid to policyholders or on their reasonable expectations. In the unlikely event of this proving not to be the case, an appropriate contribution to the with-profits fund would be made from the shareholders’ funds. In view of the uncertainty, it is not practicable to estimate the level of any potential contribution.
Mortgage Endowment Products Review The Group’s main exposure to mortgage endowment products is through Scottish Amicable. The FSA issued a report in March 2001 raising concerns regarding Scottish Amicable’s conduct of sales of these products by its tied agents and in March 2003 it fined Scottish Amicable £750,000 in respect of cases where advisers did not place appropriate emphasis on identifying whether a customer was prepared to take the risk that their mortgage might not be repaid at the end of the term. A provision of £25m was made in 2001 in the shareholders’ fund for cases that may require redress, which the directors are satisfied continues to be adequate. Scottish Amicable withdrew from the mortgage endowment product market in April 2001 and disbanded its network of tied agents in October 2001.
32. Contingencies and Related Obligations continued Guaranteed Annuities In common with several other insurance companies, Prudential Assurance used to sell guaranteed annuity products in the UK and held a provision of £46m at 31 December 2002 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 £744m was held in SAIF at 31 December 2002 to honour the guarantees. SAIF is a separate sub-fund of the Prudential Assurance long-term business fund. Accordingly, this provision has no impact on shareholders.
Jackson National Life has commitments for future payments related to equity index call options totalling £21m, which are accounted for on a deferred basis and therefore were off-balance sheet at 31 December 2002. These 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. The commitments are due over the next five years.
Prudential has provided, from time to time, other guarantees and commitments to third parties entered into in the normal course of business but management does not consider that the amounts involved are significant.
Prudential believes that it would be beneficial if there were to be greater clarity as to the status of the inherited estate. With that in mind, it has been considering the principles that would apply to any re-attribution of the inherited estate to either policyholders or shareholders. Discussions have been held with the Financial Services Authority to this end. Prudential has not considered or discussed any actual distribution as its current expectation is that, for the foreseeable future, the entire inherited estate will need to be retained within the long-term fund to provide working capital. However, in the light of current market conditions, the amount and timing of any re-attribution of the estate remains very uncertain.
Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the Prudential Assurance long-term fund would be liable to cover any such deficiency. At 31 December 2002, the excess of SAIF assets over guaranteed benefits was £437m. Due to the quality and diversity of the assets in SAIF, the aforementioned amount of the excess of assets over guaranteed benefits and the ability of Prudential to revise guaranteed benefits in case of an asset shortfall, Prudential believes that the probability of either the Prudential Assurance long-term fund or Prudential shareholders’ funds having to contribute to SAIF is very remote.
Disposal of UK general business Total Total operations Acquisitions 2002 2001 Acquisitions and disposals £m £m £m £m
In addition to the above, Egg acquired Zebank SA and Investment Funds Direct Holdings Limited for a consideration of £28m. Goodwill arising on these transactions was £7m and net assets acquired were £21m. In the context of the Group’s cash flow statements, these transactions have been accounted for as a movement within banking business assets.
Increase (decrease) in cash and short-term deposits, net of overdrafts 26 (1,125) Net (sales) purchases of portfolio investments (83) 1,777 Increase in loans (86) (640) Movement on credit facility utilised by investment subsidiaries managed by PPM America 165 (404) Share capital issued (40) (42)
Represented by: Investments (including short-term deposits) 2,736 2,805 Cash at bank and in hand 332 193 Borrowings (per note 31) (4,118) (3,990) Share capital and share premium (650) (633) Cumulative charge to Group profit and loss account reserve in respect of shares issued to qualifying employee share ownership trust 159 159 84 Prudential plc Annual Report 2002
General business and shareholders (as above) 332 193 Long-term business 783 1,243
Total cash at bank and in hand (per balance sheet) 1,115 1,436
General business and shareholders (as above) 4,118 3,990 Long-term business 255 849
Total borrowings (per note 31) 4,373 4,839 34. Acquisitions and Disposals (i) Acquisitions Acquisitions in 2002 principally relate to the purchase of Good Morning Investment Trust Management Company (Good Morning ITMC) in Korea and, by Egg, Zebank SA in France and Investment Funds Direct Holdings Limited (Fundsdirect) in the United Kingdom.
Fair value of consideration (including deferred consideration and expenses) 16 28 44 Net assets acquired: Financial investments 6 – 6 Banking assets – 178 178 Banking liabilities – (157) (157)
(ii) Disposals The Company completed the transfer of its UK home and motor general business operations to Winterthur and the Churchill Group, its UK subsidiary, on 4 January 2002 for a consideration of £353m. After allowing for the costs of sale and other related items, the profit on sale was £355m before tax. As part of the transfer arrangements, the insurance liabilities of the business at 31 December 2001 and gross premiums written in 2002 were almost wholly reinsured to Winterthur.
Shareholders’ investment return and other income 3 51 64 84 181 Interest payable on core structural borrowings (130) (118) (131) (122) (97)
Profit on ordinary activities before tax (including actual investment returns) 484 385 947 750 1,141
Shareholders’ funds and borrowings Statutory basis: Borrowings of holding company and related finance subsidiaries (2,297) (1,980) (1,568) (1,760) (1,223)
Total statutory basis capital and reserves 3,668 3,950 3,971 3,404 3,298 Additional achieved profits basis retained profit 3,528 4,200 4,805 4,884 4,165
UK Operations Long-term business: New business: Gross premiums written and investment product contributions 9,592 9,238 9,036 10,279 7,114 Operating profit, before re-engineering costs: Statutory basis capital and reserves 1,292 1,203 1,247 1,229 533 Additional achieved profits basis retained profit 2,377 3,162 3,882 3,884 3,386
Achieved profits basis capital and reserves 3,669 4,365 5,129 5,113 3,919
Insurance and investment funds under management (£bn) 111 120 129 142 105
US Operations Long-term business: New business: Operating profit (including long-term investment returns): US broker dealer and fund management 14 16 7 (6) –
Statutory basis capital and reserves 2,449 2,498 2,333 1,945 1,660 Additional achieved profits basis retained profit 283 319 423 588 506
Achieved profits basis capital and reserves 2,732 2,817 2,756 2,533 2,166
Statutory basis capital and reserves 579 402 315 217 123 Additional achieved profits basis retained profit 828 687 478 376 255
Insurance and investment funds under management (£bn) 11.1 8.3 5.6 2.7 1.7
Prudential Europe Long-term business: New business: Operating profit before development expenses 9 5 8 6 4
Statutory basis capital and reserves 68 58 60 53 37 Additional achieved profits basis retained profit 40 32 22 15 9
Insurance and investment funds under management (£bn) 0.7 0.6 0.6 0.5 0.4 88 Prudential plc Annual Report 2002
UK Operations 577 607 US Operations 265 319 Prudential Asia 516 415 Prudential Europe 14 8 Other income and expenditure (including development expenses) (223) (178)
Operating profit before tax before amortisation of goodwill* 1,133 1,186 Amortisation of goodwill (98) (95) Short-term fluctuations in investment returns 10 (1,406) (1,402) Effect of change in economic assumptions 11 (467) (482) Merger break fee (net of related expenses) – 338 Profit on sale of UK general business operations 355 –
Loss on ordinary activities before tax (including actual investment returns) (483) (455)
Retained loss for the financial year (664) (721) *Operating profit includes investment returns at the expected long-term rate of return but excludes amortisation of goodwill and the profit on sale of UK general business operations. The directors believe that operating profit, as adjusted for these items, better reflects underlying performance. Profit on ordinary activities includes these items together with actual investment returns. This basis of presentation has been adopted consistently throughout this achieved profits basis supplementary information.
Based on operating profit after tax and related minority interests before amortisation of goodwill of £851m (£828m) 5 42.8p 41.9p
Based on loss for the financial year after minority interests of £(145)m (£(217)m) 5 (7.3)p (11.0)p
Loss for the financial year after minority interests (145) (217) Exchange movements (330) 53
Net decrease in shareholders’ capital and reserves 14 (954) (626) Shareholders’ capital and reserves, at beginning of year 8,150 8,776
Total assets less liabilities, excluding insurance funds 126,325 133,365 Less insurance funds Technical provisions, net of reinsurers’ share 114,994 116,213 Fund for future appropriations 7,663 13,202 Less shareholders’ accrued interest in the long-term business (3,528) (4,200)
Shareholders’ capital and reserves Share capital and share premium 650 633 Statutory basis retained profit 3,018 3,317 Additional achieved profits basis retained profit 3,528 4,200
The supplementary information on pages 90 to 101 was approved by the Board of directors on 21 March 2003.
1. Basis of Preparation of Results The achieved profits basis results include the results of the Group’s long-term insurance operations on the achieved profits basis. These results are combined with the statutory basis results of the Group’s other operations including banking, unit trusts, mutual funds and other non-insurance investment management business. The achieved profits basis results for long-term business for 2002 have been prepared in accordance with the guidance issued by the Association of British Insurers (ABI) in December 2001 ‘Supplementary Reporting for long-term insurance business (the achieved profits method)’. The information is supplementary to the financial statements on pages 47 to 85.
The profit and loss account charge or credit in respect of changes in economic assumptions, which is shown as an item excluded from operating profit, as shown in note 14, reflects the effect on shareholders’ funds at the start of the reporting period.
The key economic assumptions are described below: UK Operations Pre-tax expected long-term nominal rates of investment return: UK equities 7.0% 7.5% Overseas equities 7.0% to 7.8% 7.5 to 7.8%
Post-tax expected long-term nominal rate of return: Pension business (where no tax applies) 6.6% 7.1% Life business 5.7% 6.3%
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 31 December 2002 (2001) 3.9% 5.1% Risk margin included within the risk discount rate 3.1% 2.6% Risk discount rate(i) 7.0% 7.7%
Weighted pre-tax expected long-term nominal rates of investment return 7.1% 7.3% Weighted expected long-term rate of inflation 3.0% 3.0% Weighted risk discount rate(i) 9.6% 10.1%
4. Investment Return (i) Profit before tax With the exception of fixed interest investments held by Jackson National Life, investment gains and losses during the period (to the extent that changes in capital values do not directly match changes in liabilities) are included in the profit for the year and shareholders’ funds as they arise.
For the purposes of determining the longer-term returns, realised gains and losses arising (including impairment losses) on debt securities of Jackson National Life have been averaged over five years and combined with actual interest income and dividends. For equity-related investments of Jackson National Life, a longer-term rate of return of 7.75% has been assumed. This has been applied to the monthly average carrying value of such investments after excluding the estimated effect of short-term market movements.
5. Supplemental Earnings Information The Group’s supplemental measure of its results and reconciliation of achieved profits basis operating profit based on longer-term investment returns before amortisation of goodwill to achieved profits basis profit on ordinary activities, including the related basic earnings per share amounts, are as follows: Before Minority Basic tax Tax Post-tax interests Net earnings £m £m £m £m £m per share
Effect of change of economic assumptions (467) 181 (286) – (286) (14.4)p Profit on sale of UK general business operations 355 (13) 342 – 342 17.2p
Effect of change of economic assumptions (482) 167 (315) – (315) (16.0)p Merger break fee, net of related expenses 338 (6) 332 – 332 16.8p
Based on loss for the financial year after minority interests (455) 213 (242) 25 (217) (11.0)p
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.
Pre-tax Tax Post-tax Pre-tax Tax Post-tax £m £m £m £m £m £m * Jackson National Life net of tax profit: Before capital charge 142 108 Capital charge (note 6) (24) (35)
In determining the achieved profits basis value of new business written in the year the policies incept, premiums are included in projected cash flows on the same basis of distinguishing annual and single premium business as set out on page 64.
Jackson National Life Unwind of discount 156 200 Return on surplus assets (over target surplus) 41 44 Averaged realised investment losses (note 10) (133) (74) Experience variances against current assumptions: Spread(ii) 2 (12)
(i) The unwind of discount for UK long-term business operations represents the unwind of discount on the value of in force business at the beginning of the year (adjusted for the effect of current year assumption changes), the expected return on smoothed surplus assets retained within the main with-profits fund (see note 13), and the expected return on shareholders’ assets held in other UK long-term business operations. Surplus assets retained within the main withprofits fund are smoothed for this purpose to remove the effects of short-term investment volatility.
Long-term business: UK Operations(i) (1,019) (764) Jackson National Life(ii) (440) (521) Prudential Asia 66 (9) Prudential Europe (2) –
Five year total (1,000) Five year average included in operating result (see note 9) (200) (133)
12. Taxation Charge The profit for the year is in most cases calculated initially at the post-tax level. The post-tax profit is then grossed up for presentation purposes at the effective rates of tax applicable to the countries and periods concerned. For Jackson National Life the profit is calculated at the pre-tax level and the effective tax rate is the rate expected to be applicable on average over the remaining lifetimes of the policies.
Total tax on items not included in operating profit (615) (583)
Tax credit on loss on ordinary activities (including tax on actual investment returns) (329) (213) (i) Including tax relief on shareholders’ portion of UK re-engineering costs borne by the main with-profits fund.
US Operations Jackson National Life (net of surplus note borrowings of £155m (£172m))(iv)
Before capital charge: Excluding assets in excess of target surplus 1,965 2,442 Assets in excess of target surplus 830 463
Other operations Goodwill(iii) 1,546 1,624 Holding company net borrowings(iv) (2,071) (1,961) Other assets (195) 126
Net core structural borrowings of shareholder financed operations comprise: Holding company cash and short-term deposits 226 19 Core structural borrowings – central funds (2,297) (1,980)
Operating profit (loss) before amortisation of goodwill 510 251 490 6 1,257 (124) 1,133
Short-term fluctuations in investment returns (1,019) (440) 66 (2) (1,395) (11) (1,406) Effect of changes of economic assumptions (234) (76) (158) 1 (467) (467) Profit on sale of UK general business operations 355 355
(Loss) profit for the financial year (528) (86) 295 (2) (321) 176 (145)
Shareholders’ capital and reserves at 1 January 2002 3,656 2,683 1,089 90 7,518 632 8,150
(ii) Estimated impact on 2002 results based on alternative assumptions The key assumptions that affect the Group’s results are economic, in particular expected rates of investment return and risk discount rates. The sensitivity of the 2002 results to changes in these assumptions is set out below: Group Total £m 2002 Pre-tax operating profit from new business Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 103 Decrease in rates of 1% (100)
Risk discount rates: Increase in rates of 1% (417) Decrease in rates of 1% 474 16. Development Expenses Development expenses (excluding Asia regional head office costs) of £34m (£48m) were incurred in 2002 (2001). The reduction reflects reduced European development costs offset by increased development expenses arising from launch costs in Japan.
On the achieved profits basis of reporting, the impact of adoption of FRS 17 for long-term business would be limited to: (i) Balance sheet recognition of the FRS 17 basis net pension scheme asset or liability
(ii) For that element of the net pensions scheme asset or liability that is attributable to the PAC with-profit fund, adjustment of the Group fund for future appropriations by an equal but opposite amount, and
The guidance issued in December 2001 by the Association of British Insurers entitled ‘Supplementary Reporting for LongTerm 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.
In preparing the achieved profits basis supplementary information, the directors are required to: • select suitable methodologies and then apply them consistently; • determine assumptions on a realistic basis, having regard to past, current and expected future experience and to any relevant external data, and then apply them consistently; • state whether applicable accounting standards have been followed in relation to the residual assets, subject to any material departures disclosed and explained in the supplementary information; • prepare the supplementary information on the going concern basis unless it is inappropriate to presume that the Company will continue in business.
We have audited the supplementary information on pages 90 to 101 in respect of the year ended 31 December 2002. The supplementary information has been prepared in accordance with the guidance issued in December 2001 by the Association of British Insurers entitled ‘Supplementary Reporting for Longterm Insurance Business (the achieved profits method)’ (the guidance) using the methodology and assumptions set out on page 92. The supplementary information should be read in conjunction with the primary financial statements which are on pages 47 to 54.
Respective Responsibilities of Directors and Auditors As described above the directors’ responsibilities include preparing the supplementary information on the achieved profits basis in accordance with the guidance issued by the Association of British Insurers. Our responsibilities, as independent auditors, in relation to the supplementary information are established in the United Kingdom by the Auditing Practices Board, by our profession’s ethical guidance and the terms of our engagement.
Opinion In our opinion, the achieved profits basis supplementary information for the year ended 31 December 2002 has been properly prepared in accordance with the guidance using the methodology and assumptions set out on page 92.
Form 20-F The Company is subject to the reporting requirements of the Securities and Exchange Commission (SEC) in the USA as such requirements apply to foreign companies and files with the SEC its Form 20-F. Copies of Form 20-F can be found on the Company’s website at www.prudential.co.uk or on the SEC's website at www.sec.gov
Prudential Corporation Asia Suites 2910–14 Two Pacific Place 88 Queensway Hong Kong www.prudentialasia.com
Prudential plc is a holding company, subsidiaries of which are regulated by the FSA.
Photograph of Jonathan Bloomer on pages 4 and 28 has been supplied by NewsCast.
Prudential plc Registered office: Laurence Pountney Hill London EC4R 0HH United Kingdom www.prudential.co.uk