M&G IS PRUDENTIAL'S UK AND EUROPEAN FUND MANAGER, WITH OVER £111 BILLION OF FUNDS UNDER MANAGEMENT
EGG PLC IS AN INNOVATIVE FINANCIAL SERVICES COMPANY, PROVIDING A RANGE OF BANKING AND FINANCIAL SERVICES PRODUCTS THROUGH ITS INTERNET SITE, WWW.EGG.COM
JACKSON NATIONAL LIFE IS A LEADING LIFE INSURANCE COMPANY IN THE UNITED STATES AND HAS MORE THAN 1.5 MILLION POLICIES AND CONTRACTS IN FORCE
PRUDENTIAL CORPORATION ASIA (PCA) IS THE LEADING EUROPEAN LIFE INSURER IN ASIA WITH 23 LIFE AND FUND MANAGEMENT OPERATIONS ACROSS 12 COUNTRIES. ACROSS THE REGION PCA HAS 11 OPERATIONS WITH A TOP FIVE MARKET SHARE
2003 Customer service centre opened in Mumbai 1931 Launched the first Unit Trust in the UK
1998 Egg launched 2000 Initial Public Offering of just over a 20 per cent share in Egg 2001 Egg achieved a break-even position 2002 Launch of French operation 2003 Egg achieved record growth of 635,000 net new customers in the UK
1961 Jackson National founded 1986 Acquired by Prudential 1994 Entered the bank distribution channel, with the establishment of the Institutional Marketing Group 2000 Acquired IFC Holdings, further strengthening JNL's presence in the broker-dealer market 2003 Launch of Curian Capital, a registered investment advisor 1923 Established first Asian operation 1994 PCA regional office established 2000 Re-entered the Indian life insurance market with the launch of ICICI Prudential 2003 Launch of second CITIC Prudential operation in China (Beijing)
UK Products • Annuities • Corporate Pensions • With-profits Bonds • Savings and Investment • Protection
Product Distribution Channels • Direct to customers (telephone, internet and mail) • Independent Financial Advisers • Business to Business (consulting actuaries and benefit advisers) • Partnerships (affinities and banks)
RETAIL PRODUCTS • Open Ended Investment Companies (OEICs) • Unit Trusts • Investment Trusts • Individual Savings Accounts (ISAs) • Personal Equity Plans (PEPs)
INSTITUTIONAL BUSINESS • Segregated fixed interest, pooled pension funds, structured and private finance
JNL offers fixed, equity-indexed and variable annuities, term and permanent life insurance and institutional products
JNL 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 broker-dealers, independent agents, banks, regional broker-dealers and the registered investment advisor channel
Currently, PCA has a network of over 100,000 agents serving more than five million customers around the region
Brea, California Chicago, Illinois Denver, Colorado New York, New York Purchase, New York Roseland, New Jersey Santa Monica, California Tampa, Florida
£555 MILLION UP 16 PER CENT ON 2002 (AT CONSTANT EXCHANGE RATES)
Achieved Profits Basis Results UK and Europe Insurance Operations 359 516 M&G 83 71 Egg (34) (20)
UK and Europe Operations 408 567 US Operations 216 265 Prudential Asia 378 516 Other Income and Expenditure (including Asia development expenses) (208) (215)
Operating profit before amortisation of goodwill and exceptional items† 794 1,133 Amortisation of goodwill (98) (98) Short-term fluctuations in investment returns 682 (1,406) Effect of changes in economic assumptions (540) (467) Profit on sale of UK general business operations – 355
Operating profit before amortisation of goodwill and exceptional items† 357 449
*Statutory basis results for 2002 have been restated for altered accounting policy for certain reinsurance contracts on the adoption of the revised Statement of Recommended Practice on accounting for insurance business issued by the Association of British Insurers in November 2003.
02 PRUDENTIAL PLC ANNUAL REPORT 2003 2003 was not an easy year for the life insurance industry but I believe Prudential ended the year in a strong position and is well placed to take advantage of the upturn in world markets. Many people still think of us as a UK business, but the reality is that we are a major international financial services group with strong businesses also in Asia and the United States. This geographic diversification has grown significantly over recent years and is reflected in the percentage of total sales generated by our overseas operations, which increased from 40 per cent in 1998 to over 70 per cent in 2003.
Prudential regards financial education as an important objective in each of the geographic regions in which we operate, as well as forming a core part of our wider Group Corporate Responsibility programme. We run several initiatives to raise the financial literacy of consumers, our customers and our employees. Within the UK, our ‘Plan for Life Learning’ programme has been established in partnership with charities, research bodies and international organisations to deliver local programmes and encourage responsible policy development. This work runs alongside Prudential UK’s ‘Plan from the Pru’ which was launched in 2002 to encourage people to take more control of their financial health by providing them with a free, simple, step-by-step guide to finances focusing on key life stages. Education is also a part of the core philosophy of our businesses in Asia and the United States. PRUuniversity, for example, has been run by Prudential Corporation Asia since 2001, with the objective of providing high-quality training for its staff, sales agents and business partners.
Related to these issues, I was pleased at the end of last year to be asked by the Chief Executive of the Financial Services Authority to serve on a group which is looking at ways to improve financial services capability. Further details of these and other initiatives in which Prudential is involved can be found in the Corporate Responsibility section of this Annual Report.
Looking ahead, our Asian and US businesses are particularly well positioned for growth in their respective markets. And in the UK, although we are cautious about the operating environment in the short term, we believe that there are significant opportunities in the longer-term. The balance and diversity of the Group puts us in a strong position to generate attractive returns for shareholders.
AT PRUDENTIAL, WE ARE VERY AWARE OF OUR RESPONSIBILITY TO OUR CUSTOMERS: THEY HAVE PLACED THEIR TRUST IN US AND WE BELIEVE THAT MORE CAN BE DONE TO HELP PROSPECTIVE AND EXISTING CUSTOMERS UNDERSTAND THE NATURE OF THE FINANCIAL DECISIONS THEY ARE TAKING.
POSITIONING THE BUSINESS FOR GROWTH Prudential Corporation Asia (PCA) maintained its strong record of growth, reporting an increase of 16 per cent in APE sales and one per cent in new business achieved profits at CER. PCA has well-established life insurance and fast-growing mutual fund operations across the region and we estimate that it ended 2003 with top-five market shares in eight of its 12 life insurance markets, two of its seven mutual fund markets and for Hong Kong’s Mandatory Provident Fund. Gross investment in the business in 2003 was just under £150 million and we plan to maintain this level of investment both this year and in 2005. However, based on current business plans and as more of our individual businesses in Asia become net generators of cash after financing their own development, we expect PCA to become a net capital contributor to the Group in 2006. Asia is one of the fastest-growing regions for savings in the world and PCA remains focused on delivering long-term, profitable and sustainable growth.
Against this background, Prudential UK has maintained its financial strength and focused on higher margin products where it has competitive advantage. It has also grown market share in key product areas, developed innovative new products, strengthened and diversified its distribution capabilities and maintained its focus on cost management. In 2003, the long-term fund earned a return of 16.5 per cent and over the last 10 years it has generated a compound annual return of 8.6 per cent, reflecting the benefits of our diversified investment policy. The fund remains well capitalised and is one of the strongest in the UK. The free asset ratio at the end of 2003 was approximately 10.5 per cent without taking account of future profits or implicit items. Although we remain relatively cautious for the UK in the first half of 2004, we believe that the long-term demographics are attractive and that as consumers increasingly look to financially strong and trusted brands when making their investment decisions, Prudential UK is well placed for growth.
Egg continued to make excellent progress in the UK. It more than doubled its operating profit to £73 million, increased its customer base to almost 3.2 million and it now has a market share of almost six per cent of UK credit card balances. In France, Egg has 130,000 customers with 66,000 credit cards in issue. Egg France reported an operating loss for the year of £89 million and Group pre-tax losses were £34 million compared with £20 million in 2002.
MAXIMISING OUR STRENGTHS The influence of changing demographic trends is having a huge impact on our business. Saving for retirement and the management of capital in retirement have become growing issues in many of our markets, fuelled in the West by increasing longevity and ageing populations and in the emerging markets by increased urbanisation, market liberalisation, improving education standards, and a rapidly growing middle class that wants to save more of their income. Prudential is in a particularly strong position to take advantage of these demographic changes, given our international diversification and financial strength.
As a major international financial services group, one of our key strengths is our ability to maximise the synergies that exist across the Group for the benefit of our customers.
OUTLOOK 2003 was a tough year for the life insurance industry but we ended it in a strong position and our international diversification, financial strength, and broad range of products and distribution channels mean we are well placed for future growth.
PCA’s primary business is the manufacture and distribution of life insurance and medium to long-term savings products through agency and third party distribution channels. A key driver of its success has been the rate at which it has been able to expand its agency force, and the productivity achieved by its agents. PCA now has 112,000 agents across Asia, up 26 per cent since 2002. The largest increases in agent numbers were in India as PCA’s joint venture with ICICI continued to expand its coverage. However, while agency continues to be the principal distribution channel, PCA has also successfully diversified distribution to include a number of alternative channels including brokers, banks and direct marketing. Bancassurance has continued to provide a material source of new business. Across the region, PCA now has a total of 29 bancassurance agreements in 11 countries and these generated 13 per cent of APE sales in 2003. APE from all alternative distribution channels grew by 14 per cent in 2003 and represented 22 per cent of regional APE sales.
PCA’s retail fund management operations continue to build scale with year-end funds under management of £6.6 billion up 26 per cent compared with 2002, driven principally by strong fund inflows in its existing market-leading operations in India and Taiwan and also by good results in its newer operations in Malaysia.
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. Gross investment in 2003 was £145 million and net investment was £97 million. Prudential plans to maintain broadly the same level of gross investment in each of 2004 and 2005. Based on current plans and projections, PCA is set to become a net contributor to the Group’s capital position in 2006 as more of its businesses become net generators of cash after funding their own development.
During 2003, JNL continued to focus on retail markets consistent with its stated goal of operating on a selffinancing basis. Despite a challenging climate for retail investors with the lowest interest rates seen in the US since the 1960s coupled with volatile equity markets, it has delivered strong results.
In 2003, JNL’s retail sales of £3.6 billion represented its second best year, only 10 per cent lower at CER than the record sales delivered in 2002. This was driven by record sales of variable annuities, which at £1.9 billion were up 55 per cent on 2002 at CER. While JNL was able to gain share in the fixed annuity marketplace, fixed annuity sales in 2003 of £1.4 billion were 45 per cent below the prior year at CER. This is due to the continued low interest rate environment in the US limiting demand for this product and JNL’s prudent capital management. There was a relatively high rate of election of the fixed account option within variable annuities for the full-year 2003 of 48 per cent compared with 58 per cent in 2002, although this had fallen below 30 per cent in November and December. The election level of the fixed account option is important since such premiums are managed within the general account and require higher levels of capital to back the business than if the premiums remained within the variable annuity separate account. Total sales for the year were down 23 per cent on 2002 at CER to £4.1 billion due to the lower retail sales together with a reduction in sales of institutional products. Institutional sales are made opportunistically, based on capital availability and return expectation. Lower institutional sales reflected JNL’s focus on retail markets, and the active management of its capital position during the year.
The MSB operating result of £162 million for US operations was six per cent ahead of 2002 at reported exchange rates.
The success of JNL’s focus on fixed and variable annuities is demonstrated by strong growth in assets. In 2003, JNL had total assets of US$56 billion, more than double the assets held in 1995, the year in which JNL launched its first variable annuity product. Variable annuity assets reached over US$10 billion in 2003. At 30 September 2003, JNL was the 11th largest life insurance company in the US in terms of general account assets.
NBAP fell 37 per cent to £148 million in 2003 from £234 million in 2002 at reported exchange rates. At CER, the decrease was 31 per cent, reflecting lower APE sales (down 24 per cent) and a lower margin (from 39 per cent in 2002 to 35 per cent in 2003). The fall in margin was due to the net change in economic assumptions (described in the Financial Review) offset by certain targeted revisions to annuity commissions.
In 2003, 93 per cent of JNL’s sales came from products launched since the beginning of 2002, demonstrating its strength in product design and execution. In 2002, JNL revamped its annuity product line, including the launch of Perspective II, an innovative, unbundled variable annuity. In 2003, JNL modified its variable annuity product offering further. In March 2003, JNL launched an annual reset equity-linked indexed annuity product. It also revised its life insurance offer to enhance its position through the launch of a revised term insurance product in June 2003 and a revised universal life product in September 2003, as well as recruiting a specialist life wholesaling team.
Distribution in the US is highly fragmented, and JNL’s strategy is to focus on the most profitable channels. JNL has positioned itself with a large base of intermediaries who provide comprehensive financial advice. JNL provides a valuable service offering to its intermediaries to help them increase their productivity in meeting increasingly complex customer needs.
Prudential UK continues to be a market leader in its other chosen product segments including corporate pensions and bulk and individual annuities. In 2003, it had a 48 per cent market share of the group additional voluntary contributions market and a 23 per cent share of the individual annuity market (source: ABI, annuity marketshare excluding income drawdown and purchased life annuities). Over the next five years Prudential expects approximately 350,000 of its in-force pension policies to mature. Based on historic conversion levels Prudential expects over 50 per cent of these policyholders to acquire a Prudential annuity.
NBAP of £166 million was 29 per cent lower than 2002, and on a like-for-like basis (after adjusting for revised economic assumptions as outlined in the Financial Review) was 27 per cent lower. This was as a result of lower new business sales and reduced new business margins of 27 per cent due to product mix, compared with 30 per cent in 2002.
Prudential UK operates a diversified distribution model covering four different channels. The direct to customer channel, which accounted for 18 per cent of APE sales in 2003, focuses on generating revenue from Prudential’s in-force customer base. The fast growing business to business channel represented 32 per cent of APE sales in 2003. This channel distributes corporate pensions through worksite marketing using Prudential’s strong links with consulting actuaries and benefit advisers. Sales through the intermediaries division, where the focus is on distribution of a wide range of medium to long-term savings products through retail independent financial advisers, accounted for 48 per cent of APE sales in 2003. The recently established partnerships channel accounted for two per cent of APE sales and has responsibility for developing relationships with banks, other distributors and retail brands.
Partnership agreements with Abbey to sell with-profit bonds, and with Zurich to underwrite annuities, resulted in single premium sales of £98 million in 2003 compared with £11 million in 2002.
Prudential UK continues to develop and launch innovative new products, with products launched since the beginning of 2000 accounting for 37 per cent of APE sales in 2003 (excluding DWP rebates). This includes developments across all product ranges including the Flexible Lifetime Annuity, the International With-Profit Bond, the Prospect Bond and the Flexible Investment Plan.
Prudential Assurance Company’s long-term fund remains well capitalised with a AA+ rating from Standard & Poor’s and an Aa1 rating from Moody’s and is among the strongest long-term funds in the UK. On a comparable basis to 2002, the free asset ratio of the Prudential Assurance Company long-term fund was approximately 10.5 per cent on the statutory basis at 31 December 2003 compared with 8.4 per cent at the end of 2002. Prudential does not include implicit items in this valuation such as the present value of future profits.
M&G M&G is Prudential’s UK and European fund management business. It has over £111 billion of funds under management, of which £87 billion relates to Prudential’s long-term business. M&G operates in markets where it has a leading position and competitive advantage, including retail fund management, institutional fixed income, pooled life and pension funds, property and private finance. As at 31 December 2003, M&G was the third largest retail fund manager in the UK in terms of funds under management (source: IMA) and is one of the largest fund managers in the UK.
In 2003, M&G continued to develop new external business lines with attractive margins. Over 20 per cent of M&G’s underlying profits in 2003 came from businesses that did not exist five years ago. A further contributor to profit has been the cost savings achieved through the successful outsourcing of M&G’s retail administration to International Financial Data Services in November 2003.
Performance-related fees in 2003 were £13 million. This included £8 million of fees for M&G’s management of the Prudential Assurance Company and Scottish Amicable longterm and annuity funds. Over three years, Prudential’s main with-profits fund generated annual returns one per cent higher than its strategic benchmark and 2.5 per cent higher than its competitor benchmark. PPM Ventures also had a good year, with the profitable realisation of investments earning £5 million in performance-related fees.
M&G’s property division, which primarily invests on behalf of the Prudential Assurance Company, also enjoyed a successful year. With over £12.5 billion invested in the property market, Prudential Property Investment Managers is the largest institutional property manager in the UK.
During 2003, it continued to grow funds under management and is well placed to capitalise on new opportunities to expand the services offered to its customers.
Egg Egg is an innovative financial services company, providing a range of banking and financial services products through its internet site.
Net interest income in the UK of £263 million was up 18 per cent on 2002 reflecting the strong growth in retail assets and a slight improvement in net margins. Credit card quality continued to remain strong with the card portfolio having significantly lower arrears levels than the industry (source: Fair Isaacs).
Unsecured lending in the UK grew by £1.5 billion leading to a balance of £4.8 billion (2002: £3.3 billion). Personal loan sales were at a record level, with draw-downs of £1.7 billion more than double last year. Egg Card balances grew by £685 million to £3 billion during the year.
SALES AND FUNDS UNDER MANAGEMENT Prudential continued to benefit from the strength of its international operations with total new insurance business and investment product sales reaching £31.5 billion, an increase of 11 per cent on 2002 at constant exchange rates (CER). At reported exchange rates, total new business inflows were up five per cent.
other movements of £2.4 billion. Net investment flows in Asia were £1.5 billion, up 38 per cent while total net investment flows in M&G were £1.4 billion, a 30 per cent decline over 2002. At CER net investment flows were down four per cent.
ACHIEVED PROFITS BASIS RESULTS Prudential is required to account for its long-term insurance business on the modified statutory basis (MSB) of reporting under UK accounting rules. The Group's formal financial statements are therefore prepared on this basis. Results prepared on this basis broadly reflect the UK solvencybased reporting regime and, for overseas territories, adjusted local or US GAAP. Some aspects of the MSB results are indicative of cash flow generation and, to an extent, resemble a traditional deferral and matching basis of accounting. However, MSB results do not 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 statutory profits from which may arise over many years.
In the directors' opinion, the achieved profits basis provides a more realistic reflection of the current performance of the Group's long-term insurance operations than results on the MSB basis as it reflects the business performance during the accounting period under review.
The achieved profits basis results for long-term business are prepared in accordance with the Association of British Insurers (ABI) guidance for achieved profits reporting issued in December 2001. This guidance requires that where capital market operations are developed, the economic assumptions used for the projection of cash flows are to be on an ‘active’ basis, which is primarily based on appropriate government bond returns at each period end. The effects of changed assumptions on the adjusted opening balance sheet value are reflected in the profit reported for the year to 31 December 2003 and excluded from operating profit.
The increase in the UK primarily reflects increases in the 15-year gilt yield from 4.5 per cent at the end of 2002 to 4.8 per cent at the end of 2003. In the UK, the risk margin over the risk free rate was maintained at 2.6 per cent.
In the US, the 10-year Treasury bond rate increased by 0.4 percentage points and the risk margin over the 10-year Treasury bond rate was maintained at 3.1 per cent.
In the UK, the expected long-term inflation rate assumption increased from 2.5 per cent to 3.1 per cent which is measured by the difference between conventional and index-linked gilts. This change is a function of the active basis rather than a change in the long-term view of future inflation levels.
In Asia, the weighted risk discount rate (determined by weighting each Asian country’s economic assumptions by reference to the achieved profits basis operating results for new business written in 2003) rose from 9.6 per cent in 2002 to 10.4 per cent in 2003. The discount rates used vary from 4.3 per cent to 19.5 per cent.
For JNL, in determining the assumptions for achieved profits basis reporting the level of capital required to support the business (the ‘target surplus’) has been taken, as in 2002, to be 200 per cent of the Company Action Level Risk Based Capital, calculated in accordance with the National Association of Insurance Commissioners risk-based capital standards for life insurance companies.
The overall impact on the Group’s achieved profit result for 2003 of using the revised economic assumptions compared with those used in the prior year, was to reduce new business achieved profit (NBAP) by around £47 million.
Achieved profits shareholders’ funds were £428 million lower than they would have been under the 2002 assumptions.
This result comprises an 18 per cent reduction in NBAP to £605 million at CER and a reduction in the in-force profit, which was down 29 per cent to £351 million at CER. At reported exchange rates, NBAP was down 22 per cent and the in-force profit was down 34 per cent.
NEW BUSINESS ACHIEVED PROFIT (NBAP) Group NBAP from insurance business of £605 million was 18 per cent below 2002 at CER reflecting lower sales and margins in the UK and the US, partially offset by increased sales in Asia. The average Group NBAP margin fell from 41 per cent in 2002 to 38 per cent. At reported exchange rates, NBAP was down 22 per cent.
N ew b us in es s ac hi ev ed p ro fit
Although the UK aggregate margin was adversely affected by sales mix, aggregate individual and bulk annuity margins have increased significantly over the last five years from 11 per cent in 1999 to 45 per cent in 2003. This reflects the proportionate increase in annuity business being written in Prudential Assurance Company’s (PAC) shareholder-backed funds, including Prudential Retirement Income Limited (PRIL) which is wholly owned by the PAC shareholders’ fund. In 2003, 44 per cent of all individual annuities business was written in shareholder-backed funds compared with 34 per cent in 2002.
In 2003 the ex-Scottish Amicable internal vestings (annuity sales arising from maturing in force pension books) were transferred from Prudential Annuities Limited (PAL), which is a subsidiary of the 90:10 fund, to the PAC Non-Profit SubFund (NPSF). Prudential-branded internal vestings continue to be written in PAL and the vast majority of bulk annuity business continues to be written in PRIL (2003: 96 per cent).
Over the next few years Prudential expects to continue to write all non-participating bulk annuity and external individual annuity business in PRIL. Prudential expects to write all internal vestings of ex-Scottish Amicable pensions business in the PAC NPSF in the future. All Prudentialbranded internal vesting pensions business will continue to be written in PAL. The net impact is expected to be that over 90 per cent of bulk annuities and 40 per cent of individual annuities will be supported by shareholder capital.
Prudential’s focus on profitable corporate pension business has enabled it to increase the margin on corporate pensions (excluding stakeholder pensions) from 14 per cent in 1999 to 16 per cent in 2003, despite the knock-on margin impact on all pensions business since stakeholder pensions were introduced. Margins on with-profits bonds remain above 40 per cent, although they have reduced over the last few years from over 60 per cent in 1999 due to the lower future bonus rate assumptions as a result of lower expected investment returns.
In Asia, NBAP of £291 million was up one per cent at CER reflecting a 16 per cent increase in APE sales on CER offset by a reduction in the new business margin from 60 per cent to 52 per cent in 2003. This fall in margin reflects the net impact of changes in product and country mix combined with a revision to a number of operating and economic assumptions. Included within this decline in margin is a four per cent negative impact relating to the introduction of the risk-based capital regime in Taiwan. In addition, changes in country mix accounted for a further one per cent of the fall in the overall margin. Changes in product mix combined with the impact of changes in other economic and operating assumptions including the fall in margin in Japan following the refocusing of business in 2003, accounted for a further three per cent fall in the overall Asian new business margin. At reported exchange rates, NBAP was down five per cent.
Negative assumption changes of £67 million includes the £50 million personal pensions persistency assumption charge disclosed at the half-year for poor persistency experience on business sold through the closed direct salesforce channel. Renewal expense assumptions have been strengthened by £29 million during 2003 due to an increase in unit costs and an increase in the allocation of costs to shareholders due to a fall in the proportion of with-profit sales from 52 per cent of total sales in 2002 to 43 per cent in 2003.
Annuitant mortality assumptions were revised during 2003 to assume future improvements in mortality for males and females at levels projected on the Continuous Mortality Investigation (CMI) medium cohort table as published by the Institute and Faculty of Actuaries. For the purposes of prudent statutory reserves, improvement rates in male mortality were subject to a minimum of two per cent per year. The combined effect of these changes together with a realignment to recent mortality experience was a charge of £18 million in 2003.
Prudential UK incurred a £29 million charge for restructuring its UK and European operations including £11 million relating to the re-engineering of its European long-term business.
The US in-force profit increased significantly from £17 million in 2002 to £71 million in 2003. This reflects a £55 million reduction in the negative spread variance to negative £17 million and a lower negative charge for changes in assumptions of £21 million in 2003 compared with negative £54 million in 2002. The change in assumptions in 2003 reflects a revision to unit expense factors. At the end of 2003 JNL’s prospective spread on interest sensitive annuities and life was 170 basis points. The average crediting rate on JNL’s interest sensitive annuities and life book was 4.4 per cent at the end of December compared with an average guaranteed rate of 3.7 per cent.
Net losses on bonds, including defaults and impairments, are included within the operating result on a five-year averaged basis with a charge in 2003 of £137 million compared with £133 million in 2002. Actual losses in 2003 of £39 million were a significant improvement over the £289 million recorded in 2002.
The in-force result also included a negative expense variance of £8 million due to litigation settlement expenses in 2003 for two class action suits. In addition, the in-force result was affected by an increase in market value adjustment (MVA) benefits paid out in 2003, partially offset by higher than assumed surrender charge income. The increase in MVA benefits is due to the low interest rate environment resulting in unrealised gains on bonds, a portion of which is paid to policyholders when they surrender their policies.
The increase in underlying profit was achieved despite continuing weakness in equity markets, with market rises in the second half of the year still leaving the FTSE All-Share Index averaging 11 per cent less over the year than in 2002. Underpinning this increase were M&G’s diversified revenue streams aligned with a sharp focus on cost control. Higher revenues from fixed income and property, together with the expansion of new business streams, offset lower equity revenues while the retail business achieved cost savings through outsourcing its retail administration to International Financial Data Services.
National Planning Holdings and PPM America earned profits of £19 million. Curian delivered a loss of £22 million, which reflects losses in its investment phase as funds under management continue to grow. JNL anticipates a similar loss for Curian in 2004. Together these businesses delivered a loss of £3 million.
Other net expenditure decreased by £8 million to £181 million. The 2002 result included a £24 million writedown of the Group’s 15 per cent interest in Life Assurance Holding Corporation Limited in 2002, whereas in 2003 no adjustment to the valuation was required. This resulted in an increase of £26 million in Group investment and other income to £29 million in 2003. Interest expenditure during 2003 was £143 million compared to £130 million in 2002. Head office costs (including PCA head office costs of £24 million) were £67 million, compared with £62 million in 2002.
ACHIEVED PROFITS – RESULT AFTER TAX The result after tax of £355 million and minority interests of positive £2 million, was a profit of £485 million. The effective tax rate at an operating profit level was 34 per cent, up from 25 per cent in 2002, primarily due to higher effective tax rates for JNL and Asia, partially offset by tax rate movements on other non-long term operations. The JNL rate was significantly higher than in 2002 due to the combined effect of operating assumption changes for expenses, capital charge effects and an exceptional tax credit in 2002.
The effective tax rate at a total achieved profit level was 42 per cent on a profit of £838 million. The overall effective rate of 42 per cent was higher than the 34 per cent effective rate on operating profits primarily due to no tax relief being available on the amortisation of goodwill and to a low effective rate of 24 per cent on losses from changes in economic assumptions, not all of which are tax affected. The effective tax rate at a total achieved profit level in 2002 was 68 per cent principally due to tax payable on the profit on disposal of UK general insurance business being relieved against capital losses available to the Group.
2003 ACHIEVED PROFITS SHAREHOLDERS’ FUNDS Analysis of movement in AP Shareholders’ Funds: 2002-2003 £bn
A B C D E F G H I J K L
MODIFIED STATUTORY BASIS RESULTS – OPERATING PROFIT Reference to operating profit relates to profit including investment returns at the expected long-term rate of return but excludes amortisation of goodwill, exceptional items and short-term fluctuations in investment returns.
The US Operations’ result, which is based on US GAAP subject to adjustments, of £162 million was 15 per cent ahead of 2002 at CER. At reported exchange rates the 2003 result was six per cent ahead of 2002. The increase primarily reflects lower amortisation of deferred acquisition costs (DAC) for variable annuity products, and higher fee and other income, offset by higher market value adjustment payments, higher average bond losses and the loss on Curian. The fall in variable annuity DAC amortisation in 2003 was primarily due to improved market performance. In 2002, the effect of poor equity market performance was to lower expected future profits in the variable annuity book to the level where the variable annuity DAC asset was impaired and a write-off was required.
This amortisation is calculated using a long-term return assumption which is implemented through the use of a mean reversion methodology. If the mean reversion was eliminated as of 31 December 2003, the variable annuity DAC carrying value would be reduced by approximately
The provision for guaranteed minimum death benefits (GMDB) on variable annuity products was reviewed and strengthened at the end of 2002. In addition, an increase to the recurring charge was required in respect of GMDB which is included within the 2003 result. No further strengthening beyond the recurring charge was required in 2003.
PCA’s operating profit before development expenses of £27 million was £98 million compared to £88 million in 2002. At CER, operating profit was £17 million up on the prior year. PCA’s three longest established operations in Singapore, Hong Kong and Malaysia saw their combined MSB profit increase by 16 per cent to £91 million. This was offset by expected losses at a number of PCA’s newer operations such as Japan and South Korea as they continued to build scale and fund new business strain.
MODIFIED STATUTORY BASIS RESULTS – PROFIT AFTER TAX MSB profit after tax and minority interests was £208 million, after a tax charge of £144 million. The effective rate of tax on MSB total profit in 2003 was 41 per cent.
EARNINGS PER SHARE Earnings per share based on achieved basis operating profit after tax and related minority interests but before amortisation of goodwill, were down 16.4 pence to 26.4 pence. Earnings per share based on MSB operating profit after tax and related minority interests but before amortisation of goodwill, were down 3.8 pence to 12.9 pence.
CASH FLOW The table below shows the Group holding company cash flow. Prudential believes that this format gives a clearer presentation of the use of the Group’s resources than the FRS 1 statement required by UK GAAP.
Cash remitted to Group: UK life fund transfer (in respect of earlier bonus declarations) 286 324 Cash remitted by business units 300 212
Tax received 77 59 Equity (scrip dividends and share options) 30 40 Corporate activities 58 543
Capital invested in business units: Increase (decrease) in cash 4 (130)
The Group received £586 million in cash remittances from business units in 2003 (2002: £536 million) comprising the shareholders’ statutory life fund transfer of £286 million relating to earlier bonus declarations, together with dividends and interest from subsidiaries of £300 million. The shareholder transfer in 2004 representing 2003’s profits from the PAC with-profits fund, is expected to be approximately £80 million lower than in 2003. Dividends and interest received include £84 million from M&G, £48 million from each of PCA and JNL and £120 million from Prudential UK Insurance Operations, including £100 million of special dividends from the PAC shareholders’ funds in respect of profits arising from earlier business disposals. A similar amount will also be distributed from PAC shareholders’ funds in 2004 and 2005. After dividends and interest paid, there was a net inflow of £12 million (2002: £97 million net outflow).
The Group also received £58 million from corporate activities (2002: £543 million). In 2002, this included 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 £177 million (2002: £545 million).
The valuation has been prepared on a conservative basis in accordance with the current Financial Services Authority (FSA) valuation rules, and without the use of implicit items. No allowance has been taken for the present value of future profits and the PAC long-term fund has not entered into any financial reinsurance contracts, with the exception of certain treaties with a value of approximately £49 million, which were transferred from Scottish Amicable Life when that Company’s business transferred into the PAC long-term fund at the end of 2002.
The test for equities is prescribed by the FSA and varies according to market conditions. Thus, following the recovery in equity markets in 2003, the test applied at 31 December 2003 is more stringent than the 14 per cent fall in equity values that was applied at 31 December 2002.
Prudential has been managing the fund on a realistic basis using a mean-reverting stochastic model for a number of years.
The PAC long-term fund is rated AA+ by Standard & Poor’s and Aa1 by Moody’s.
The table below shows the change in the investment mix of Prudential’s main with-profits fund over recent years: Cash and other asset classes 4 4 4
For the UK main with-profits fund 84 per cent of fixed income securities are investment grade with 27 per cent rated AA or above. For Prudential Annuities Limited 97 per cent of the fixed income securities are investment grade with 44 per cent rated AA or above. For Prudential Retirement Income Limited 99 per cent of total assets are investment grade with 56 per cent rated AA or above.
JNL’s invested asset mix on a US regulatory basis (including Jackson National Life of New York but excluding policy loans and reverse repo leverage) is as follows: Bonds: Investment Grade Public 58 60 58 Investment Grade Private 22 20 19 Non Investment Grade Public 3 4 5 Non Investment Grade Private 3 3 2
Asia Solvency margins have been maintained at levels at or above local regulatory requirements by the insurance operations in Asia. Across the region less than 20 per cent of non-linked funds are invested in equities.
INHERITED ESTATE The long-term fund contains the amount that the Company expects to pay out to meet its obligations to existing policyholders and an additional amount used as working capital. The amount payable over time to policyholders from the With-Profits Sub-Fund is equal to the policyholders'
In 1998, Prudential stated that deducting personal pensions mis-selling costs from the inherited estate of the WithProfits Sub-Fund would not impact the Company’s bonus or investment policy. The Company gave an assurance that if this unlikely event were to occur, it would make available support to the fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged.
The 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 £25 million was made in 2001 in the shareholders' fund for cases that may require redress. As at 31 December 2003, the provision was £8 million. In addition, there is a provision of £31 million in the closed Scottish Amicable Investment Fund (SAIF) in respect of mortgage endowments. The establishment of the provision in SAIF has no impact on shareholders. Scottish Amicable withdrew from the mortgage endowment product market in April 2001 and disbanded its network of tied agents in
Compensation of £11 million was paid in respect of mortgage endowment sales in PAC’s 90:10 fund in 2003 and subsequently a provision of £34 million has been established in the fund at 31 December 2003. This provision has no impact on the Group’s profit before tax.
Prudential has in place an unlimited global commercial paper programme. At 31 December 2003 commercial paper of £78 million, US$1,378 million and ¤274 million has been issued under this programme. Prudential also has in place a £5,000 million medium-term note (MTN) programme. At 31 December 2003 subordinated debt outstandings under this programme were £435 million and ¤520 million, and senior debt outstandings were US$18 million. In addition the holding company has access to £1,300 million committed revolving credit facilities and a £500 million committed securities lending liquidity facility, provided by 13 major international banks. These facilities have not been drawn on during the year. The commercial paper programme, the MTN programme, the committed revolving credit facilities and the committed securities lending liquidity facility are available for general corporate purposes and to support the liquidity needs of the parent company.
Prudential plc enjoys strong debt ratings from both Standard & Poor’s and Moody’s. Prudential long-term senior debt is rated AA– (negative outlook) and A2 (stable outlook) 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.
Due to the geographical diversity of Prudential's businesses, it is subject to the risk of exchange rate fluctuations. Prudential’s international operations in the US, Asia and Europe, which represent a significant proportion of operating profit and shareholders’ funds, generally write policies and invest in assets denominated in local currency. Although this practice limits the effect of exchange rate fluctuations on local operating results, it can lead to significant fluctuations in Prudential's consolidated financial statements upon translation of results into pounds sterling. The currency exposure relating to the translation of reported earnings is not separately managed, as it is not in the economic interests of the Group so to do. The impact of gains or losses on currency translations is recorded as a component of shareholders' funds within the consolidated statement of total recognised gains and losses. The impact of exchange rate fluctuations in 2003 is discussed elsewhere in this Financial Review.
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 on both an in-force and new business basis. Stochastic modelling of assets and liabilities is undertaken in the US, the UK and Asia to assess economic capital requirements for different confidence intervals and time horizons. In addition, reserve adequacy testing under a range of scenarios and dynamic solvency analysis is carried out,
including under certain scenarios mandated by the US, the UK and Asian regulators.
Defined benefit schemes are generally required to be subject to full actuarial valuation every three years to assess the appropriate level of funding for schemes having regard to their commitments. These valuations include assessments of the likely rate of return on the assets held within the separate trustee administered funds. PSPS was last actuarially valued on 5 April 2002 and this valuation demonstrated the Scheme to be 110 per cent funded, with an excess of actuarially determined assets over liabilities of 10 per cent, representing a fund surplus of £376 million. As a result no change in employers' contributions from the current 12.5 per cent of salaries was required.
Accordingly, the surplus is not recognised as an asset in the Group's financial statements that would normally, subject to amortisation, be appropriate under the requirements of SSAP 24 which the Group continues to adopt rather than FRS 17. The continued use of SSAP 24 is permitted under the provisions of FRS 17 until 2005 at which point the requirements of International Accounting Standards, in particular IAS 19, are expected to apply.
In the meantime, companies are required to publish details of pension scheme surpluses and deficits on the FRS 17 basis by way of disclosure. Details of the Group's FRS 17 disclosures are shown in note 17. Under FRS 17 the basis of valuation differs markedly from the full triennial valuation and SSAP 24 bases. In particular, it would require assets of the Scheme to be valued at their market value at the yearend, 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.
Surpluses and deficits on the Group's defined benefit schemes are attributable to the Prudential Assurance Company (PAC) life fund and shareholders' funds depending on the activity of the personnel involved. Such attribution is necessary to properly reflect the economic interests in and exposures to the schemes' financial position. The aforementioned volatility can be illustrated by considering the movements in the surplus and deficit over the last three years. For the PAC life fund the interest, net of tax, in the pension schemes’ FRS 17 basis financial position has changed from a surplus at 31 December 2001 of £392 million to a deficit at 31 December 2002 of £380 million, and a deficit at 31 December 2003 of £411 million. For the shareholders’ fund the interest, net of tax in the pension schemes’ FRS 17 basis financial position has changed from a surplus at 31 December 2001 of £101 million to a deficit at 31 December 2002 of £85 million, and a deficit at 31 December 2003 of £101 million. The modest change in 2003 reflects the negative impact of increased inflation assumptions, that are implicit within the yields on index-linked gilts, being offset by the positive value movements in scheme assets arising from the strong recovery in equity markets. The large reduction in 2002 reflects the steep fall in equity markets in that year.
The last actuarial valuation took place on 5 April 2002. On a broad assessment of the position, the Company expects though that the funding level has reduced from the 110 per cent. However, an update of the actuarial basis would be expected to reveal a more balanced funding level than the FRS 17 position suggests. This is primarily as a result of adopting an investment return assumption for funding which is based on the long-term expected returns of the assets held by the schemes, rather than bond assumptions prescribed by FRS 17.
At present the IASB's process for completing the standards for adoption in 2005 is almost complete but the areas that remain outstanding are of a particular significance to banks and insurers. The key outstanding areas are for accounting for financial instruments and insurance contracts. For financial instruments, the main uncertainties are in respect of two particular areas which are still the subject of continued development, namely in respect of when hedge accounting is permitted and, for those insurance contracts that carry insignificant insurance risk, how they will be required to be valued as financial instruments under IAS 39. The IASB has also yet to conclude on the final version of the standard to replace Exposure Draft 5 (ED 5) on accounting for insurance contracts.
Although the broad nature of the requirements that are expected to replace ED 5 are known there remain various detailed but significant points that arise from the combined effect of IAS 39, the IASB's macrohedging proposals, ED 5 and the IASB's latest deliberations that make any assessment of the likely impact at best tentative, and certainly subject to possible significant change. Furthermore, although the EU has approved those standards that are either less contentious, or required less amendment as part of the IASB's improvement project, the key outstanding issues are the subject of considerable discussion between the various EU bodies, including the European Central Bank, banking and insurance associations and the IASB. At present there is no clarity as to how these issues will be resolved in time for the 2005 deadline.
Unallocated surplus It is expected that the IAS equivalent of the Fund for Future Appropriations will continue to be permitted to be accounted for effectively as a liability in the balance sheet. As a consequence Prudential anticipates that IAS basis results for with-profit activities will continue to reflect the Company's 10 per cent interest in the actuarially determined surplus for distribution.
Investment valuation and derivative accounting The current version of IAS 39 is in many areas similar to the requirements of the US GAAP standards FAS 115 and FAS 133. Under IAS 39, unless designated under the very restrictive ‘held to maturity’ classification on an asset by asset basis, most financial assets are carried in the balance sheet at fair value.
There are though significant differences for the accounting for actuarial gains and losses and IAS 19 is expected to be altered before 2005.
The EU Financial Conglomerates Directive (FCD) is expected to be implemented into UK law for mixed activity financial services groups in 2005. This follows the implementation of the Insurance Groups Directive (IGD) in 2001. The FSA has published proposals as to how it intends to implement the FCD and amend the UK application of the IGD requirements in its consultative document CP 204 for 2005 application. At present the FSA is considering the comments of respondents on the proposals. The aim of the FCD is to impose, from 2005, additional prudential requirements in respect of regulated entities within financial conglomerates including, to a certain extent, any mixed financial holding company. The additional supervision will be organised at the level of the financial conglomerate and will cover capital adequacy, risk concentration and intragroup transactions. Although not required under the IGD the FSA is proposing to extend the imposition of additional prudential requirements to insurance groups at the holding company level.
RISK MANAGEMENT A significant part of the Group’s business involves the acceptance and management of risk. The Group’s risk management model requires the primary responsibility for risk management at an operational level to rest with business unit chief executives. The second line of defence of risk comprises oversight functions reporting to the Group Chief Executive together with business unit risk functions and risk management committees. The third line of defence comprises independent assurance from Internal Audit reporting to business unit and Group audit committees.
With-profits policies are supported by a with-profits fund and can be single premium (for example, Prudence Bond) or regular premium (for example, certain corporate pension products). Prudential’s primary with-profits fund is part of Prudential Assurance Company’s (PAC) long-term fund. The return to shareholders on with-profits products is in the form of a statutory transfer to PAC shareholders’ funds which is analogous to a dividend from PAC’s long-term fund and is dependent upon the bonuses credited or declared on policies in that year. Prudential’s with-profits policyholders currently receive 90 per cent of the distribution from the main with-profits fund as bonus additions to their policies and shareholders receive 10 per cent as a statutory transfer.
In 2003, profits distributed from Prudential’s main with-profits fund amounted to £2.1 billion, of which £1.9 billion (90 per cent) was added to policies as bonuses, and £209 million (10 per cent) is available for distribution to shareholders.
The majority of Prudential-branded non-participating business is written in PAC’s long-term fund or by subsidiaries owned by the fund. Prudential’s principal non-participating business is Prudential Annuities Limited, which is wholly owned by PAC’s with-profits fund which forms part of the long-term fund. The profits from this business accrue to the with-profits fund. In 2001, Prudential started to write certain annuity business through Prudential Retirement Income Limited (PRIL), the profits of which accrue solely to shareholders. The portion of annuity business written in PRIL has increased steadily and in 2003 was 39 per cent of all annuity business.
US 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 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.
Variable annuities are tax advantaged deferred annuities where the rate of return depends upon the performance of the underlying portfolio, similar in principle to UK unitlinked products. They are used for retirement planning and to provide income in retirement. The policyholder’s premiums are held apart from other assets, in a ‘separate’ account, which is analogous to a unit-linked fund. The policyholder can allocate the premiums between a variety of variable sub-accounts with a choice of fund managers and/or to guaranteed fixed-rate options. The value of the portion of the separate account allocated to variable subaccounts fluctuates with the underlying investment. Variable annuity policies provide for early surrender charges. In most cases, variable annuities also offer various types of death benefits, some of which are elective, guaranteeing that on death the policyholder receives a minimum value regardless of past market performance.
ASIA PRODUCTS AND DRIVERS OF PROFIT The life insurance products offered by Prudential in Asia include a range of with-profits (participating) and nonparticipating term, whole life and endowment and unitlinked policies. Prudential also offers health, disablement, critical illness and accident covers to supplement its core life products.
Unit-linked products combine savings with protection and the cash value of the policy depends on the value of the underlying unitised funds. Participating products provide savings with protection where the basic sum assured can be enhanced by a profit share (or bonus) from the underlying fund as determined at the discretion of the insurer. Nonparticipating products offer savings with protection where the benefits are guaranteed or determined by a set of defined market related parameters. Accident and Health (A&H) products provide mortality or morbidity benefits and include health, disablement, critical illness and accident covers. A&H products are commonly offered as supplements to main life policies but can also be sold separately.
ACHIEVED PROFITS REPORTING Prudential’s results are prepared on two bases of accounting, the supplementary achieved profits basis and the modified statutory basis (MSB) prepared under the Companies Act. 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 operate and why they are used.
The change in value is typically analysed as shown in the achieved profits basis shareholders’ funds chart into the following components: the value added from new business sold during the year; the change in value from existing business already in place at the start of the year; short-term fluctuations in investment returns and economic assumption changes; other items (for example, profit from other Group operations, tax, foreign exchange, exceptional items); and dividends.
As indicated above, achieved profits basis results are prepared by first of all making assumptions about all relevant factors including levels of future investment return, expenses, surrender levels and mortality. These best estimate assumptions are used to project future cash flows.
The present value of the future cash flows is then calculated using a discount rate which reflects both the time value of money and the risks associated with the cash flows. The risk discount rate is determined using the actual yield on long-term government bonds plus a risk margin. The projected future cash flows are prepared on a single set of assumptions specific to each business unit and the actual outcome may be different from that projected. Where the actual outcome is different, this will be reflected in the ‘experience variances’ for that year.
ACHIEVED PROFITS BASIS METHODOLOGY assumption where the directors believe a revision is required to the original estimates of future experience.
Set out below is an illustrative profit profile for a typical with-profits product. The pattern of actual profit emergence will vary by product.
ACTING RESPONSIBLY BUILDS TRUST Key Challenges We are an international business. With over half of our employees working outside the UK and 74 per cent of our sales generated abroad, we are acutely aware of the different uncertainties people face around the world and the significant impact that the way in which we choose to respond to a range of key global issues relevant to our business will have on our customers, employees, communities and others. We have identified these key issues as: • Changing Demographics and Consumer Choice.
Around the world, populations are ageing as people are living longer and birth rates decline. While living longer is good news for many, it creates a fresh set of challenges for societies. Financial service providers have a key role in providing solutions. The challenge is to develop products and services that respond to our customers’ needs today and tomorrow; • Consumer Confidence. Consumer confidence in savings has been affected by poorly performing equity markets and expectations of lower nominal investment returns, as well as a range of issues concerning the performance and capital of a number of insurance companies in the UK. Building trust among consumers and giving them the confidence to buy the products they will increasingly need means developing a sustainable business through responsible marketing, quality customer service, education, providing realistic returns and clearing away jargon; • Globalisation. As a leading international financial services provider we recognise the complex issues that result from corporations extending their facilities overseas. No international business can ignore the opportunities for growth and efficiencies that a global market presents, but our choices instantly affect people around the world. Socially acceptable business growth, based on internationally accepted standards of conduct, is key to how we operate; • Sustainable Development. Our natural resources are not limitless and it is essential that firms manage their environmental impacts efficiently. But sustainable development is about more than reducing the consumption of raw materials and limiting waste emissions. It also means ensuring human rights, treating staff and suppliers fairly and educating consumers.
Corporate Responsibility Means Integrity We aim to uphold our reputation, built over 150 years, for acting responsibly and with integrity, respecting the laws and regulations, traditions and cultures of the countries within which we operate as well as internationally accepted standards of responsible business conduct. Our policies, programmes and management systems support this approach and ensure that we understand and respond to material social, ethical and environmental risks and opportunities. A detailed report on our performance is given in our on-line corporate responsibility report at www.prudential.co.uk/cr and a summary of this is also available in hard copy from our corporate responsibility unit.
The standards we strive to achieve rightly go beyond our legal and regulatory obligations. We see responsible corporate behaviour as essential to maintaining successful relationships with, among others: our customers, who make our business viable; our employees, upon whose talent and commitment we depend; and local communities, from whom we recruit and to whom we market our products and services. We believe this approach is central to maintaining and building trust in our brand and business over the long term.
INFORMED DECISIONS BENEFIT EVERYONE Managing Our Responsibilities In 2003, we continued to develop and refine our corporate responsibility programme and to integrate it throughout our business.
Management and Policy Our international business conduct is supported by our Group Code of Business Conduct which sets out the standards we expect from our employees (and others acting on behalf of the Group) on issues such as the prevention of discrimination, bribery and corruption and insider dealing. In 2003, the Code was updated to include guidance on stakeholder dialogue and to ensure consistency with our new Group Human Rights Policy and US Sarbanes-Oxley legislation. It was re-communicated to employees by the Group Chief Executive and business unit compliance is audited annually by Prudential’s internal auditors.
Marketplace/Customers We are pursuing a radical approach to consumer information and marketing through ‘The Plan from the Pru’. The Plan was launched in 2002 to encourage people to take more control of their financial health by providing them with a free, simple, step-by-step guide to finances focusing on key life stages. At the Money Marketing Financial Services Awards in 2003, Prudential UK won four awards for ‘The Plan from the Pru’ campaign.
M&G is also concerned with simplifying terminology and has produced a series of ‘spin free guides’ designed to explain financial products in a straightforward manner.
MeetPRU is an opportunity for our customers in the UK to meet Prudential face to face. Members of the UK Executive host regular regional seminars where customers can ask questions and get direct feedback. Senior technical advisers are also on hand to answer individual product-related queries. Events have already been held in Belfast, Cardiff, Edinburgh, Newcastle, Norwich and Reading.
PruPIM is the leading private sector sponsor in this sustainable property investment project. Through this relationship we are also supporting the Kingston University team and others in bidding for further UK Government funding for socially responsible investment related projects. These include an initiative to educate property investors about environmental issues and an initiative to develop methods of measuring the environmental performance of buildings.
Our key objectives are to maintain a framework which allows us to meet all our legal obligations and to prevent incidents of work-related accidents and ill health. Our safety management system sets out our policies, assigns key responsibilities and performance standards to ensure the health and safety of our people, visitors and contractors.
Jackson National Life (JNL) provides a subsidised child development centre for the young children of JNL employees. The centre provides more than just childcare. JNL places a high priority on education for both its associates and their children at all age levels and the emphasis is on education and structured development programmes. Another unique aspect is that the subsidy available for parents is based on family income, with a greater discount for those on lower income.
Employee education is provided across our Asian markets through PRUuniversity, which is available to all staff and is offered in 12 languages. Programmes are centrally credited and many are endorsed by external learning institutions.
INITIATIVES EDUCATING TOMORROW’S CONSUMERS In the UK we sponsor the Personal Finance Education Group (pfeg) Excellence and Access project which aims to raise the quality and quantity of personal finance education in schools. Through this, 150,000 children have experienced personal finance education with 1,000 teachers participating in 300 secondary schools across 30 per cent of Local Education Authorities in England. Independent evaluation of the project by Brunel University concluded that this was the pupils’ best chance of improving their financial awareness, with more than 80 per cent of the teachers surveyed in the evaluation agreeing that personal finance education had improved in light of the project.
COMMITTED STAFF ARE THE BEST INVESTMENT In 2003 we were accredited as an Investor In People (IIP) for our operations in the UK and in India. IIP is the UK national standard that sets out levels of good practice for the training and development of staff to achieve business goals. We are one of the first companies to receive accreditation for multiple work sites which also includes our offshore office in Mumbai, India.
3. PHILIP BROADLEY FCA (Age 43) Group Finance Director. Appointed in May 2000. Previously he was with the UK firm of Arthur Andersen where he became a partner in 1993. He specialised in providing services to clients in the financial services industry, including regulators and government agencies in the UK and the US.
5. MICHAEL McLINTOCK (Age 42) Executive director. Appointed in September 2000. He is also Chief Executive of M&G, a position he held at the time of M&G’s acquisition by Prudential in March 1999. He joined M&G in October 1992. He is also a non-executive director of Close Brothers Group plc and CoFunds Holdings Limited.
8. BART BECHT (Age 47) Independent non-executive director. Appointed in May 2002. He is 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.
12. ROB ROWLEY (Age 54) Senior independent non-executive director and Chairman of the Audit Committee. Appointed in July 1999. He is executive Deputy Chairman of Cable & Wireless Public Limited Company, and a non-executive director of Taylor Nelson Sofres plc. He retired as a director of Reuters Group PLC in December 2001, where he was Finance Director from 1990 to 2000.
13. SANDY STEWART (Age 70) Independent non-executive director. Appointed in October 1997. He is Chairman of Murray Extra Return Investment Trust plc. He is also Chairman of the Scottish Amicable (supervisory) Board, which is a special committee of the Board of The Prudential Assurance Company Limited. He was previously a practising solicitor and Chairman of Scottish Amicable Life Assurance Society.
We have also carried out a comprehensive review of the revised Combined Code (applicable to reporting years commencing on or after 1 November 2003) and have outlined below some of the steps already taken to comply with the new provisions, particularly with regard to Board evaluation, formal induction and professional development. In addition, a senior independent director has been formally appointed, and we have revised the terms of reference of the Audit, Remuneration and Nomination Committees. We have also updated the terms of the letters of appointment for non-executive directors, to bring them into line with the requirements of the revised Combined Code.
During 2003 the Board met 10 times and held a separate strategy day. Each year one of the Board meetings is held at one of the Group’s business operations to facilitate a fuller understanding of the diversity of the business. In 2003, the September Board meeting was held at Jackson National Life’s offices in California in the US. A further 12 Board Committee meetings took place during the year. The Board’s terms of reference set out those matters specifically reserved to it for decision, in order to ensure that it exercises control over the Group’s affairs. These include approval of the annual and interim results, strategy and corporate objectives, operating plans, significant transactions and matters affecting the Company’s share capital.
The Board is accountable for ensuring that an effective system for succession planning and management development is in place. This is delivered through an established review process that is applied across all the businesses and covers both executive and senior management succession and development. The Board reviews the outcomes of the review annually and actions arising from the review are implemented as part of the management development agenda.
The Audit Committee normally meets six times a year and assists the Board in meeting its responsibilities under the Code for 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 assessing that the external audit is conducted in a thorough, objective and cost-effective manner. It also reviews the Internal Audit annual work plan.
The Audit Committee monitors regularly the non-audit services being provided to the Group by its external auditors, and has developed a formal Auditor Independence Policy to check this does not impair their independence or objectivity, and that the Group maintains a sufficient choice of appropriately qualified audit firms.
The Audit Committee reviews all services being provided by the external auditors quarterly to review the independence and objectivity of the external auditors, taking into consideration relevant professional and regulatory requirements, so that these are not impaired by the provision of permissible non-audit services. The Audit Committee assesses the qualification, expertise and resources, effectiveness and independence of the external auditors annually. At the end of each annual audit cycle, the Audit Committee assesses the effectiveness of the audit process.
The external audit was last put out to competitive tender in 1999 when the present auditors were appointed. The audit fee paid in 2003 has been set having regard to the Smith guidance that the audit fee should of itself provide an appropriate return to the auditors.
The Audit Committee reviews the Group’s statement on internal control systems prior to endorsement by the Board, and reviews the policies and process for identifying, assessing and managing business risks. The Committee also receives the minutes of the Disclosure Committee and the Group Risk Committee established in January and February 2003 respectively and monitors their activities. Further information on these Committees appears on pages 36 and 37.
The Audit Committee reviews the interim and annual financial statements before their submission to the Board, paying particular attention to: critical accounting policies and practices and any changes in them; decisions requiring a major element of judgement; unusual transactions; clarity of disclosures; significant audit adjustments; going concern assumption; compliance with accounting standards; and compliance with obligations under the Combined Code and other applicable laws and regulations. The Committee is regularly briefed on the development of accounting standards, and during the year has reviewed the status of the Group project to implement International Financial Reporting Standards.
The Audit Committee reviews the Group’s procedures for handling allegations from whistleblowers. At each meeting, it receives and reviews a report on the number of calls to the confidential reporting line or other confidential communications received and investigated since the last meeting, and actions taken in response to these calls.
The Remuneration Committee is comprised exclusively of the independent non-executive directors of the Company. While the Chairman and Group Chief Executive are not members, they attend meetings unless they have a conflict of interest.
The Nomination Committee, which is comprised of a majority of independent non-executive directors, meets as required to consider candidates for appointment to the Board and to make recommendations to the Board in respect of those candidates. In doing so, it evaluates the balance of skills, knowledge and experience on the Board and makes recommendations regarding appointments based on merit and against objective criteria, and the requirements of the Company’s business. In appropriate cases, search consultants are used to identify suitable candidates.
Board Committees – Terms of Reference The full terms of reference of the Audit, Remuneration and Nomination Committees are available on the Company’s website at www.prudential.co.uk under the section headed ‘About Prudential’. Hard copies may be obtained upon written request to the Company Secretary at the Company’s registered office.
Copies of any instructions and advice given by an independent professional adviser to a director are supplied by the director to the Company Secretary who will, unless otherwise instructed by the director concerned, circulate to other directors sufficient information to ensure that other members of the Board are kept informed on issues arising which affect the Company or any of its subsidiaries.
Sir David Clementi 10 n/a n/a 2 Sir David Barnes1 4 n/a 3 1
Bridget Macaskill4 3 n/a 2 n/a Clark Manning 10 n/a n/a n/a Michael McLintock 10 n/a n/a n/a Roberto Mendoza 10 n/a 7 n/a
Mark Tucker6 5 n/a n/a n/a Mark Wood 10 n/a n/a n/a Notes 1. Resigned as a director on 8 May 2003. 2. Was a member of the Audit Committee until 8 May 2003. 3. Became a member of the Nomination Committee on 6 November 2003. 4. Appointed as a director on 1 September 2003. 5. Appointed as a director on 8 May 2003. 6. Resigned as a director on 30 June 2003.
All directors are required to submit themselves for re-election at regular intervals and at least every three years, and at the Annual General Meeting following their attaining the age of 70.
PERFORMANCE EVALUATION During 2003 an evaluation was carried out of the performance of the Board and its Committees, in line with the requirements of the revised Combined Code. The aim was to improve individual contributions, the effectiveness of the Board and its Committees and the Group’s performance.
The Annual General Meeting will be held at The Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on Thursday 6 May 2004 at 11.00am.
Accordingly, some changes to business processes and controls have been made to ensure that the Company is in compliance with the applicable sections of the Act.
At the beginning of 2003 a Group Risk Committee was established. The Group Risk Committee is chaired by the Group Finance Director and its membership includes representatives of the business unit and Group functions who have input into the operation of the Group Risk Framework. The Group Risk Committee is the senior management forum responsible for oversight of the Group Risk Framework across the business unit and Group functions, including monitoring operational risk and related policies and processes as they are applied throughout the Group. The Group Risk Committee reports to the Group Chief Executive, who has overall responsibility for the risks faced by the Group. The Group Risk Committee is supported in this role by the Group Risk Function and the
Risk Committees and Risk Functions in each business unit. Quarterly risk reports from the business units and Group are reported to the Group Risk Committee covering all risks of Group significance. Regular reports are also made to the Group and business unit Audit Committees by management, internal audit, compliance and legal functions.
As a provider of financial services, including insurance, the Group’s business is the managed acceptance of risk. The system of internal control is an essential and integral part of the risk management process. As part of the annual preparation of its business plan, all of the Group’s businesses and functions are required to carry out a review of risks. This involves an assessment of the impact and likelihood of key risks and of the effectiveness of the controls in place to manage them. The assessment is reviewed regularly throughout the year. In addition, business units review opportunities and risks to business objectives regularly with the Group Chief Executive and Group Finance Director.
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 on the Combined Code (the Turnbull guidance). Internal Audit undertakes a review for the Audit Committee of the operation of the risk management process throughout the Group.
The Group’s internal control framework includes detailed procedures laid down in financial and actuarial procedure manuals. The Group prepares an annual business plan with three-year projections. Executive management and the Board receive monthly reports on the Group's actual performance against plan, together with updated forecasts.
INTRODUCTION What this report covers This report to shareholders: • sets out our remuneration policy for 2003; • explains the policy under which our executive and nonexecutive directors were remunerated for the year ended 31 December 2003; • sets out tables of information showing details of the remuneration and share interests of all the directors for the year ended 31 December 2003; • sets out the remuneration policy for executive directors for 2004.
Compliance with the Directors’ Remuneration Regulations This report has been approved by the Board and as required by The Directors’ Remuneration Report Regulations 2002 (the Regulations), a resolution will be put to shareholders at the Annual General Meeting inviting them to consider and approve it. This report complies with the requirements of the Regulations and KPMG Audit Plc have audited the sections contained in pages 44 to 52 as required by the Regulations.
THE REMUNERATION COMMITTEE Role of the Remuneration Committee The Board believes that a properly constituted and effective Remuneration Committee is key to ensuring that executive directors’ remuneration is aligned with shareholders’ interests and enhances the competitiveness of the Company. The terms of reference of the Remuneration Committee are available on the Company’s website and a copy may be obtained from the Secretary to the Remuneration Committee, Group Secretarial Department. The Board has delegated to the Remuneration Committee the setting of the remuneration policy and individual remuneration packages for executive directors. The fees of non-executive directors are a matter for the Board itself. The Chairman and the Group Chief Executive attend Remuneration Committee meetings to provide background and context on matters relating to the remuneration of the other executive directors, but do not attend when their own remuneration is discussed. No director has any involvement in determining his or her own remuneration. The Remuneration Committee meets on at least four occasions each year and more frequently if necessary.
Membership of the Remuneration Committee The members of the Remuneration Committee during 2003, who are listed below, were all independent non-executive directors: Roberto Mendoza (Chairman) Sir David Barnes
(joined the Committee on 8 May 2003) Rob Rowley Sandy Stewart
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; • a significant element of performance-related reward will be provided in the form of shares; • the total remuneration package for each director will be set in relation to the relevant employment market; • performance measures will include both absolute financial measures and comparative measures as appropriate to provide a clear alignment between the creation of shareholder value and reward; • performance will be rewarded at both a regional and Group level.
Total remuneration levels Total remuneration means basic salary and short- and long-term incentives. Award levels for short- and long-term incentives for the Group Chief Executive are 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 services companies. This approach reflects the international scope of Prudential’s business. The total remuneration levels for the other executive directors are set similarly by reference to levels in their relevant markets. All pay data is externally provided.
Elements of the remuneration package Basic salary The Remuneration Committee normally reviews executive directors’ salaries each year on an individual basis having regard to business results, individual accountabilities and performance, and market conditions.
Annual incentive awards are determined as a percentage of basic salaries at the end of the year. Jonathan Bloomer, Philip Broadley and Mark Wood were eligible for annual awards of up to 110 per cent of their basic salary. Under their plans, the award for on-target performance is 50 per cent of basic salary, paid in cash. The remuneration of the executive directors is further aligned with the interests of shareholders in that any part of the annual incentive award made for performance above on-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.
REMUNERATION REPORT CONTINUED FOR YEAR ENDED 31 DECEMBER 2003 40 PRUDENTIAL PLC ANNUAL REPORT 2003
Restricted Share Plan The Group’s primary long-term incentive plan for a number of years has been the Restricted Share Plan (RSP) which was designed to provide rewards linked to the returns to shareholders.
In 2003, for Jonathan Bloomer, the conditional RSP award was equivalent to 200 per cent of his basic salary at the time the award was granted. For Philip Broadley, Clark Manning and Mark Wood, the awards were equivalent to 160 per cent of basic salary. For Michael McLintock the award was equivalent to 80 per cent of basic salary. The award made to Mark Tucker lapsed on his resignation from the Board since Prudential’s performance at the time of leaving did not meet the threshold performance required for a release of shares to be made. Mark Tucker’s other outstanding RSP awards similarly lapsed.
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 Prudential UK & Europe over the three-year performance period. Awards are made following the end of the 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 is 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 is paid. For payouts for performance between these points a sliding scale applies.
Mark Norbom Mark Norbom, who joined the Board on 1 January 2004, is eligible for a 2004 annual award of up to 110 per cent of basic salary, on the basis described in the section on Annual Incentive Plans on page 39, except that in order to secure his appointment it was agreed that his 2004 bonus will not be lower than the target level of 50 per cent of salary.
It is intended that an award under the 2004 Restricted Share Plan of 160 per cent of his basic salary will be made to Mark Norbom. To reflect his role as Chief Executive of Asia, Mark Norbom also participates in the 2004 Asian Long-term Incentive Plan which is a cash-based plan that rewards the growth in value of our major Asian businesses over the three-year performance period. Any award is made following the end of the performance period. No payment under the 2004 plan is made unless the growth of the Asian business, as measured under the plan, is greater than a growth rate of 15 per cent per annum compound over the performance period. At this level of performance 50 per cent of basic salary may be paid under the plan. The on-target payout that may be made, for which a growth rate of 35 per cent per annum compound is required, is a payment of 100 per cent of basic salary. If a growth rate of 50 per cent per annum compound or more is achieved, a maximum payment of 150 per cent of basic salary is made.
In order to secure the appointment of Mark Norbom, it was necessary to compensate him for the loss of substantial amounts of long-term remuneration from his previous company which included restricted stock, stock options, deferred compensation and his accrued supplemental pension. He will have rights to Prudential plc shares, a substantial portion of which will vest on his 55th birthday in 2013. The rest of the shares will vest in tranches on the first, second, third, fourth and fifth anniversary of his joining Prudential. This vesting schedule is set out below: The equivalent of dividend distributions will be made from share awards during the restricted period.
1 Jan 1 Jan 1 Jan 1 Jan 1 Jan 20 Feb
CHAIRMAN’S LETTER OF APPOINTMENT AND BENEFITS The Chairman is paid annual fees and the notice periods are 12 months from either party. The Chairman participates in a medical insurance scheme, has life assurance cover and has the use of a car and driver. He is entitled to a supplement to his fees, intended for pension purposes. He is not a member of any Group pension scheme providing retirement benefits.
Prior to his appointment as an executive director, Clark Manning participated in the Brooke Holdings Inc Change of Control Severance Plan that provides payments in the event of the termination of his employment within 24 months, resulting from a change of control of Jackson National Life. The compensation to which Clark Manning is entitled under the plan is based on 2.5 times his annual compensation and immediate vesting of his long-term incentive plans. Under the terms of his appointment as an executive director, his participation in the plan will cease
Executive directors, with the exception of Michael McLintock, are required to give 12 months’ notice of termination to the Company. Michael McLintock is required to give six months’ notice to the Company. The details on Mark Norbom who joined in 2004 are included here for comparison.
BENEFITS AND PROTECTIONS Executive directors receive certain benefits, principally the provision of a cash allowance for a car (except for Clark Manning), participation in medical insurance schemes and, in some cases, the use of a car and driver and security arrangements. Mark Norbom will also receive expatriate allowances during his assignment in Asia. No benefits are pensionable. The executive directors’ pension arrangements and life assurance provisions including those for Mark Norbom are set out in the Pensions and Life Assurance section on pages 50 to 52.
Ann Burdus 21 Nov 1996 AGM 2003 Resigned 31 Dec 20032
In addition, the Company provides certain protections for directors and senior managers against personal financial exposure that they may incur in their capacity as such.
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 and reflect their individual responsibilities including membership of the Audit and Remuneration Committees as appropriate. The Board reviews the fees annually and the policy was changed in 2003.
Up to June 2003 the basic fee for Board membership was £40,000 per annum. From June 2003 the basic fee was increased to £50,000 per annum.
REMUNERATION REPORT CONTINUED FOR YEAR ENDED 31 DECEMBER 2003 44 PRUDENTIAL PLC ANNUAL REPORT 2003
Non-executive directors Sir David Barnes (resigned 8 May 2003) 16 – – 16 42
Notes 1. The highest paid director for 2003 was Michael McLintock whose total emoluments were £1,902,615 which included £372,000 from the 2000 M&G Chief Executive Long Term Incentive Plan and £2,863 from gains made from the exercise of share options from the Company’s SAYE scheme. 2. No expense allowances were paid. 3. Sir David Clementi joined on 1 December 2002.
4. It is intended that a deferred share award valued at £27,300 will be made to Philip Broadley. This is included in the 2003 bonus figure. 5. Clark Manning’s bonus figure excludes a contribution of £6,116 from a profit sharing plan that has been made into a 401k retirement plan which is included in the table on pension contributions on page 52. 6. It is intended that a deferred share award valued at £244,000 will be made to Michael McLintock. This is included in the 2003 bonus figure. 7. Mark Tucker resigned but did not work for his whole notice period and was paid salary only until he left Prudential on 30 June 2003. Following his resignation and in order to ensure a smooth transition, he provided consultancy advice to the Company for three months for which he was paid £117,500 in addition to the payments set out above.
8. Mark Tucker’s annual bonus was prorated for his service up to 30 June 2003 and was subject to his satisfying certain non-competition and non-solicitation conditions. It is expected to be paid on or around 30 June 2004.
9. Mark Tucker’s benefits include an allowance of £46,419 for housing paid to reflect his expatriate circumstances. Medical insurance cover was provided for Mark Tucker and his wife up to 31 December 2003.
EXECUTIVE DIRECTORS – OTHER NON-EXECUTIVE DIRECTOR EARNINGS Executive directors who are released to serve as non-executive directors of other external companies retain the earnings resulting from such duties. In 2003, Michael McLintock earned £37,083 from an external company. No other executive director served with an external company.
DIRECTORS’ LONG-TERM INCENTIVE PLANS Restricted Share Plan Details of conditional awards that have been made under the Restricted Share Plan are shown on page 45. These shares are held in trust and represent the conditional awards out of which rights may be granted, at the end of the relevant performance period, dependent on the performance conditions.
In respect of awards made in 2001 under the Restricted Share Plan, the Company's TSR was ranked 66th out of the 95 relevant comparator companies remaining in the FTSE 100 (i.e., the 69th percentile) for the three-year performance period
The awards made in respect of 2002 and 2003 under the Restricted Share Plan run to 31 December 2004 and 31 December 2005 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 81 and 66 on the basis of TSR performance at 31 December 2003.
The table below shows the outstanding awards made under the Restricted Share Plan.
Jonathan Bloomer 56,859 56,859 – Nil 472.25 17 Mar 00 17 Mar 07
OTHER LONG-TERM INCENTIVE PLANS Details of cash awards under other long-term incentive plans are set out below.
Face value of Face value of conditional conditional awards Conditionally Payments awards Date of outstanding at awarded made outstanding at end of 1 Jan 2003 in 2003 in 2003 31 Dec 2003 performance
Phantom JNL options 245 Nil – 31 Dec 02 Phantom JNL shares 122 Nil – 31 Dec 02 Phantom JNL options 489 489 31 Dec 03 Phantom JNL shares 245 245 31 Dec 03 Phantom JNL options 734 734 31 Dec 04 Phantom JNL shares 367 367 31 Dec 04 Business cash LTIP 1,586 1,586 31 Dec 04 Business cash LTIP 1,586 1,586 31 Dec 05
3. Mark Tucker’s Business cash LTIPs awarded in 2002 and 2003 lapsed.
REMUNERATION REPORT CONTINUED FOR YEAR ENDED 31 DECEMBER 2003 48 PRUDENTIAL PLC ANNUAL REPORT 2003
Mark Tucker Deferred 2001 annual incentive award 19,096 1,057 20,153 30 Jun 042
Deferred 2002 annual incentive award 57,8681 3,171 61,039 30 Jun 042
The interests of directors in shares of the Company are shown below, including changes between 31 December 2003 and 12 March 2004. All interests are beneficial except 646 shares in respect of Bridget Macaskill and 6,175 shares in respect of Sandy Stewart.
2. Jonathan Bloomer’s interest in shares included 100 American Depositary Receipts (representing 200 ordinary shares).
4. Mark Norbom had interests in shares comprising 1,250 American Depositary Receipts (representing 2,500 shares) at 31 December 2003, immediately before joining the Board.
REMUNERATION REPORT CONTINUED FOR YEAR ENDED 31 DECEMBER 2003 50 PRUDENTIAL PLC ANNUAL REPORT 2003
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 Savings-Related 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.
Options exercise Options Options outstanding 31 Dec Exercise Earliest Latest outstanding Exercised date forfeit granted at 31 Dec 2003 price exercise exercise at 1 Jan 2003 in 2003 (pence) in 2003 in 2003 2003 (pence) (pence) date date
Notes 1. The total gain made by directors in 2003 on the exercise of share options from the Company’s SAYE scheme was £2,863.
2. Mark Tucker’s SAYE award was exercised on 1 July 2003 after leaving the Company, in accordance with the rules of the scheme.
4. The highest and lowest share prices during 2003 were 487 pence and 281 pence respectively.
UK INLAND REVENUE APPROVED PENSION SCHEMES Executive directors employed in the UK are eligible for one of two Inland Revenue approved pension schemes on the same basis as other employees who joined at that time.
The Prudential Staff Pension Scheme (PSPS) – DB Section is a non-contributory defined benefit arrangement, which provides a pension of 1/60th of Final Pensionable Earnings for each year of service on retirement at age 60 with an option to commute pension for a tax free cash sum. This section also provides on death in service a lump sum of four times pensionable salary, a spouse’s pension of the greater of 25 per cent of pensionable salary or 54 per cent of prospective pension at 60, and children’s pensions of the greater of 8.33 per cent of pensionable salary or 18 per cent of prospective pension at 60 in accordance with the scheme rules. On death in retirement, a spouse’s pension of 50 per cent of the pension available at retirement before commutation is payable and a lump sum is also payable if death occurs in the first five years of retirement. Some of the
Mark Tucker, having commenced employment in the UK before 1989, was 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. In recent years all pensions have been increased fully in line with the Retail Prices Index. Members currently contribute four per cent of basic salary towards the cost of the benefits but prior to 1 January 2004 contributed 2.4 per cent of basic salary. No employees with employment offers after 30 June 2003 are eligible for membership of this scheme.
OTHER SUPPLEMENTARY ARRANGEMENTS Sir 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. The premiums paid by the Company to this scheme are a taxable benefit.
In addition, these directors are eligible for death benefits broadly equivalent to the PSPS death benefits (both the lump sum and the capitalised value of spouse’s and children’s pensions) on that part of their basic salary not covered by the Inland Revenue approved scheme under the Prudential Supplementary Life Assurance Scheme. The premiums paid by the Company to this scheme are a taxable benefit.
Mark Norbom, who joined the Board on 1 January 2004, is provided with a salary supplement for pension purposes, and life assurance provision of four times his basic salary under the Prudential Supplementary Life Assurance Scheme. The premiums paid by the Company to this scheme are a taxable benefit.
REMUNERATION REPORT CONTINUED FOR YEAR ENDED 31 DECEMBER 2003 52 PRUDENTIAL PLC ANNUAL REPORT 2003
Details of directors’ pension entitlements under Inland Revenue approved defined benefit schemes and the pre-tax amount of any salary supplements and contributions to FURBS or other pension arrangements paid by the Company are set out below: Additional pension earned during year ended
Allowing Ignoring for inflation inflation Transfer value of Amount of Pre-tax salary on on accrued benefit (B-A) less supplements and pension pension at 31 Dec4 contributions contributions
Clark Manning 45 – – – – – – – 15
4. The transfer value equivalent has been calculated in accordance with Actuarial Guidance Note GN11.
The Directors’ Report of Prudential plc for the year ended 31 December 2003 comprises these pages and the sections of the Annual Report referred to in these pages.
FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION The consolidated balance sheet on pages 60 and 61 shows the state of affairs of the Group at 31 December 2003. The Company’s balance sheet appears on page 62 and the consolidated profit and loss account on pages 56 to 58. Information prepared on the achieved profits basis of financial reporting is provided on pages 103 to 114. A summary of the statutory basis results is shown on page 55. There is a five-year review of the Group on pages 98 and 99.
PAYMENT POLICY It is the policy of the Group to agree terms of payment when orders for goods and services are placed and to pay in accordance with those terms. Trade creditor days, based on the ratio of amounts which were owed to trade creditors at the year-end to the aggregate of the amounts invoiced by trade creditors during the year, were 21 days.
DIRECTORS A list of the present directors appears on pages 30 and 31.
EMPLOYEES The following information is given principally in respect of employees of the Group in the UK. The policy towards employees overseas is the same but the practical application of the policy varies according to local requirements.
EQUAL OPPORTUNITY Prudential recognises, respects and values difference and diversity. Its equal opportunities policy is to be fair, responsible and caring in all aspects of the business. The Group seeks to ensure all employees and applicants to its businesses are given equal opportunity in all aspects of employment to ensure that the Group’s businesses attract, retain and promote the best available talent. All the businesses work to embed these principles in all aspects of their management practices and to ensure that this is evident to employees in their day-to-day work.
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 one-to-one staff briefings and through the Group’s intranet site. Prudential’s European Employee Forum provides an opportunity for elected employee representatives to consult with senior management on strategic European business issues. M&G’s Staff Consultative Committee promotes communication and consultation throughout M&G and is the forum for dialogue on a range of issues of interest to staff.
DONATIONS Prudential is committed to supporting the communities where it is an employer. In 2003 the Group spent £4.1 million in support of the community. Within this, direct donations to charitable organisations amounted to £2.8 million, of which approximately £2.3 million came from EU operations. This is broken down as follows: Education £1,058,000; Social and Welfare £927,000; Environment and Regeneration £85,000; Cultural £95,000 and Staff Volunteering £96,000. The aggregate figure for charitable donations from Prudential's non-EU subsidiaries (Jackson National Life and Prudential Corporation Asia) amounted to £0.5 million. It is the Group's policy not to make donations to political parties or to incur political expenditure, within the meaning of those expressions as defined in the Political Parties, Elections and Referendums Act 2000, and the Group did not make any such donations or incur any such expenditure in 2003.
AUDITORS A resolution for the re-appointment of KPMG Audit Plc as auditors of the Company will be put to the Annual General Meeting on 6 May 2004.
Operating profit (based on long-term investment returns) before amortisation of goodwill and exceptional items
M&G 83 71 US broker-dealer and fund management (3) 14 Egg (34) (20) Other income and expenditure (analysed on page 75) (181) (189)
Group operating profit before amortisation of goodwill and exceptional items* 357 449
Earnings per share Based on operating profit after tax and related minority interests before amortisation of goodwill* 12.9p 16.7p Based on total statutory profit for the financial year after minority interests – basic 10.4p 23.5p
CONSOLIDATED PROFIT AND LOSS ACCOUNT YEAR ENDED 31 DECEMBER 2003 56 PRUDENTIAL PLC ANNUAL REPORT 2003
Gross premiums written 11 – 329 Outwards reinsurance premiums 11 – (329)
Premiums written, net of reinsurance – – Change in the gross provision for unearned premiums 155 6 Change in the provision for unearned premiums, reinsurers’ share (155) (6)
Change in the provision for claims: Gross amount 68 10 Reinsurers’ share (67) (8)
Following the sale of the Group's UK home and motor business in 2002, the whole of the general business technical account relates to discontinued operations (see note 11).
Gross premiums written 6 13,781 16,669 Outwards reinsurance premiums (290) (216)
Change in the provision for claims: Gross amount (29) (4) Reinsurers’ share (3) 12
Change in provisions for linked liabilities, net of reinsurance (4,728) 1,346
Allocated investment return transferred (to) from the non-technical account (77) 199
CONSOLIDATED PROFIT AND LOSS ACCOUNT CONTINUED YEAR ENDED 31 DECEMBER 2003 58 PRUDENTIAL PLC ANNUAL REPORT 2003
Balance on the long-term business technical account* 338 401 Tax credit attributable to balance on the long-term business technical account* 20 154 172
Balance on the long-term business technical account before tax* 8 492 573
Allocated investment return transferred from (to) the long-term business technical account 77 (199) Investment expenses and charges 16 (189) (191) Unrealised losses on investments (10) (217) Allocated investment return transferred to the general business technical account (7) (8) Other income: UK investment management result 83 71 US broker-dealer and fund management result (3) 14 Profit on sale of UK general business operations 11 – 355
Other charges: UK banking business result 11 (34) (20) Amortisation of goodwill 21 (98) (98)
Profit on ordinary activities before tax* 8 350 501 Tax on profit on ordinary activities* 20 (144) (42)
Dividends: Interim (at 5.3p (8.9p) per share) (106) (178) Final (at 10.7p (17.1p) per share) (214) (341)
Profit on ordinary activities before tax (including actual investment returns)* 8 350 501
Dividend per share 16.0p 26.0p *The 2002 figures for these lines have been restated (see note 4).
CONSOLIDATED STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES YEAR ENDED 31 DECEMBER 2003
RECONCILIATION OF MOVEMENTS IN CONSOLIDATED SHAREHOLDERS’ CAPITAL AND RESERVES YEAR ENDED 31 DECEMBER 2003
(note 28) (note 28) reserve total £m £m £m £m 1 January 2002, as originally reported 100 533 3,317 3,950 Prior year adjustment* (74) (74)
Total recognised gains relating to 2002, as restated* 216 216 Dividends (519) (519) New share capital subscribed 40 40 Transfer for shares issued in lieu of cash dividends (23) 23 31 December 2002, as originally reported 100 550 3,018 3,668 Prior year adjustment* (55) (55)
New share capital subscribed 30 30 Transfer for shares issued in lieu of cash dividends (27) 27 31 December 2003 100 553 2,625 3,278 *The figures for these lines have been restated (see note 4).
Investments Land and buildings 22 10,965 10,766 Investments in participating interests 23 56 73 Other financial investments 24 109,219 104,299
Cash at bank and in hand 34 1,221 1,115 Present value of acquired in-force long-term business* 27 108 133 Own shares (ordinary shares of parent company) 28 34 34
Technical provisions Provision for unearned premiums – 155 Long-term business provision* 100,287 99,048 Claims outstanding 891 961
Obligations of Jackson National Life under funding and stocklending arrangements 32 3,762 5,098 Other creditors including taxation and social security: Banking business liabilities: Jackson Federal Bank 894 902
Amounts owed to subsidiary undertakings (17) (14) Tax payable (184) (126) Final dividend (214) (341) Sundry creditors (29) (19) Accruals and deferred income (44) (43)
Capital and reserves Share capital 28 100 100 Share premium 28 553 550 Profit and loss account 30 969 1,076
Financing Issue of borrowings 34 829 86 Reduction in credit facility utilised by investment subsidiaries managed by PPM America 34 (151) (165) Issues of ordinary share capital 34 30 40
64 PRUDENTIAL PLC ANNUAL REPORT 2003 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 2003, the Group operated in the UK through its subsidiaries, primarily The Prudential Assurance Company Limited (PAC), Prudential Annuities Limited, Prudential Retirement Income Limited, M&G Group plc and Egg plc. In the US the Group’s principal subsidiary is Jackson National Life Insurance Company.
The consolidated financial statements are prepared in accordance with applicable accounting standards under UK Generally Accepted Accounting Practice (UK GAAP), including Financial Reporting Standards (FRS) and Statements of Standard Accounting Practice (SSAP) and also in accordance with the revised Statement of Recommended Practice, ‘Accounting for Insurance Business’, issued in November 2003 by the Association of British Insurers (the revised SORP).
FRS 17, ‘Retirement benefits’ was issued in November 2000. This standard specifies how costs of providing retirement benefits, in particular for defined benefit schemes, should be recognised and disclosed in the financial statements. Under FRS 17 none of the requirements need be recognised in the primary financial statements for the years ended 31 December 2003 and 2002. However, for the 2003 financial statements disclosure is required of the impact of FRS 17 on the opening and closing balance sheet positions, profit and loss account, and statement of total recognised gains and losses to illustrate the effect if the standard had been recognised in these primary financial statements. The Company has adopted the standard in this respect and details are disclosed in note 17.
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. 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.
Premiums and claims Premium and annuity considerations for conventional with-profits policies and other protection-type life insurance policies are recognised when due. Premium and annuity considerations for linked policies, unitised with-profits policies and other investmenttype policies are recognised when received or, in the case of unitised or unit linked policies, when units are issued. Premiums exclude any taxes or duties assessed based on premiums.
For with-profits business, the amortisation of the DAC asset is taken into account in determining the transfer from or to the fund for future appropriations. Movements on the DAC asset and amortisation for with-profits business have no direct impact on the profit attributable to shareholders.
For the business of Jackson National Life the determination of the expected emergence of margins, against which the amortisation profile of the DAC asset is established, is dependent on certain key assumptions. For single premium deferred annuity business, the key assumption is the expected long-term spread between the earned rate and the rate credited to policyholders. For variable annuity business, the key assumption is the expected long-term level of equity market returns which, for 2003 and 2002, was 8.4% per annum implemented using a mean reversion methodology. These returns affect the level of future expected profits through their effects on fee income and the required level of provision for guaranteed minimum death benefit claims.
The assumptions to which the estimation of the long-term business provision for these contracts is particularly sensitive are the interest rate used to discount the provision and the assumed future mortality experience of policyholders. The net premium reserves are calculated using assumptions for interest, mortality, morbidity and expense, but without assumptions for withdrawals. These assumptions are determined as prudent best estimates at the date of valuation. Interest rates used in establishing policyholder benefit provisions for conventional with-profits policies in the consolidated financial statements range from 3.0% to 5.0% at 31 December 2003 and 31 December 2002. There have been no significant changes to other key assumptions.
66 PRUDENTIAL PLC ANNUAL REPORT 2003 3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Pension annuities The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year and range from 1.96% to 5.14% at 31 December 2003 and 2.4% to 5.4% at 31 December 2002. Mortality rates used in establishing policyholder benefit provisions are based on published mortality tables adjusted to reflect actual experience. The only other noteworthy change to assumptions in 2003 was with respect to mortality, where the shape of the set of assumptions has been changed as part of the regular monitoring of mortality developments.
Accumulating with-profits business For accumulating with-profits business, the calculation of the long-term business provision is based on a gross premium bonus reserve valuation. In general terms, a gross premium valuation basis is one in which the premiums brought into account are the full amounts receivable under the contract. The method includes explicit estimates of premiums, expected claims, future regular bonuses, costs of maintaining contracts and future renewal expenses. Cash flows are discounted at the valuation rate of interest. The methodology for UK companies is included in the FSA rules. The discount rate is based on the expected return on the assets deemed to back the liabilities as prescribed by the FSA rules.
For PAC business the calculation is based on a valuation under which future reversionary bonuses are added to the guaranteed liabilities existing at the valuation date. The provision is then calculated as the present value of future policyholder benefits plus the present value of future expenses, without assumption for withdrawals.
An addition is made in respect of future premiums if this produces a higher provision. The assumptions to which the estimation of the long-term business provision is particularly sensitive are the assumed future reversionary bonuses, the interest rate used to discount the provision, the assumed future per policy expenses and the assumed future mortality experience of policyholders.
For Asian operations in countries where local GAAP is not well established and in which the business written is primarily non-participating and linked business, US GAAP is used as the most appropriate proxy to local GAAP. The future policyholder benefit provisions for non-linked business are determined using the net level premium method, with an allowance for surrenders, maintenance and claim expenses. Rates of interest used in establishing the policyholder benefit provisions vary by operation depending on the circumstances attaching to each block of business. As with the other Asian operations mentioned above, the assumptions to which the future policyholder benefit provisions are most sensitive are the interest rate used to discount the liabilities and the future mortality and morbidity experience of policyholders. In Taiwan, interest rates range from 1.5% to 6.5%. In Japan, they range from 0.9% to 1.6%.
Although the basis of valuation of Prudential’s overseas operations is in accordance with the requirements of the Companies Act 1985 and ABI SORP, the valuation of policyholder benefit provisions for these businesses may differ from that determined on a UK modified statutory basis for UK operations with the same features.
3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Fund for future appropriations The fund for future appropriations (FFA) represents the excess of assets over policyholder liabilities for the Group’s with-profits funds. The annual excess (shortfall) of income over expenditure of the with-profits funds, after declaration and attribution of the cost of bonuses to policyholders and shareholders, is transferred to (from) the FFA each year through a charge (credit) to the profit and loss account. The balance retained in the FFA represents cumulative retained earnings arising on the with-profits business that has not been allocated to policyholders or shareholders. The balance retained in the FFA is determined after full provision for deferred tax on unrealised appreciation on investments. The FFA in respect of the Scottish Amicable Insurance Fund is wholly attributable, but not yet allocated, to policyholders of that fund. Details are shown in note 9.
Investment returns Investment returns comprise investment income, realised gains and losses and changes in unrealised gains and losses, except for changes in unrealised gains and losses on debt securities held by Jackson National Life. Subject to provisions for permanent diminutions in value, debt securities held by Jackson National Life are carried at amortised cost.
Under the provisions of the revised SORP, any reinsurance contract, where elements can be identified that do not result in the transfer of significant insurance risk, should be accounted for in two parts. Typically the elements that do not transfer significant insurance risk contain a financing component. For those contracts that do contain a financing component, the financing liability is recorded as a deposit due to the reinsurer. Previously, under the accounting policy applied up until 2002, an asset representing the present value of future margins on the ceded business from which the financing will be repaid has been recognised on the consolidated balance sheet to the extent the reinsurer has assumed the risk that such margins will emerge. However, on the change of accounting policy arising from the adoption of the revised SORP such assets are no longer established. Consistent with the altered accounting policy, the prior year adjustments reported in the 2003 financial statements, and as explained in more detail in note 4, include the removal of such assets from the restated 2002 results.
68 PRUDENTIAL PLC ANNUAL REPORT 2003 3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Tax The Group’s UK subsidiaries each file separate tax returns. Jackson National Life and other foreign subsidiaries, where permitted, file consolidated income tax returns. In accordance with UK tax legislation, where one domestic UK company is a 75% owned subsidiary of another UK company or both are 75% owned subsidiaries of a common parent, the companies are considered to be within the same UK tax group. For companies within the same tax group, trading profits and losses arising in the same accounting period may be offset for purposes of determining current and deferred taxes.
Deferred tax on changes in the fair value of investments is recognised in the profit and loss account. The deferred tax liability in respect of revaluation of investments is reflected in shareholders’ funds and the fund for future appropriations. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.
The balance of the long-term business technical account is net of the total tax attributable to the long-term business. In order to present the profit on long-term insurance activities in the non-technical account on a pre-tax basis, a tax credit attributable to the shareholders’ portion of the tax provision for long-term business, calculated at the effective tax rate (where appropriate on a long-term basis) of the underlying business, is added. This shareholder tax add-back is then included in the tax expense on the profit on ordinary activities within the non-technical account. Further details are provided in note 20.
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.
Pension costs These financial statements have been prepared in accordance with the provisions of SSAP 24, ‘Pension costs’. Disclosures of the movements in the financial position of the Company’s defined benefit schemes, applying the methodology prescribed by FRS 17, are shown in note 17. Contributions to the Group’s defined benefit plans are calculated and expensed on a basis that spreads the costs over the service lives of participants. Contributions in respect of defined contribution plans are accrued by the Group when incurred.
Other financial investments Other financial investments include equity securities, debt and other fixed income securities, mortgages and other loans, loans to policyholders and deposits with credit institutions.
Equity securities and debt and other fixed income securities Equity securities are carried at fair value. Debt and other fixed income securities are carried at fair value, except for those held by Jackson National Life, which, subject to provision for permanent diminutions in value, are carried at amortised cost. Fair value is based on quoted market prices for listed securities, and on quotations provided by external fund managers, brokers, independent pricing services or values as determined by the directors for unlisted securities. Changes in fair value are recognised in investment returns during the year of the change. Debt and other fixed income securities held by Jackson National Life are carried at amortised cost as permitted by paragraph 24 of Schedule 9A to the Companies Act 1985. The amortised cost basis of valuation is appropriate under the provisions of the ABI SORP for Jackson National Life’s redeemable fixed income securities as they are held as part of a portfolio of such securities intended to be held to maturity. Further details of the valuation basis for fixed income securities of Jackson National Life are explained in note 12.
Shares in subsidiary undertakings Shares in subsidiary undertakings in the balance sheet of the Company are shown at the lower of cost and estimated realisable value.
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 12.
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.
70 PRUDENTIAL PLC ANNUAL REPORT 2003 3. SIGNIFICANT ACCOUNTING POLICIES CONTINUED Linked business funds Certain long-term business policies are linked to specific portfolios of assets or to an investment-related index. Such policies provide benefits to policyholders that are wholly or partly determined by reference to the value of or income from specific investments or by reference to fluctuations in the value of an index of investments. The assets supporting the linked policies are maintained in segregated accounts in conformity with applicable laws and regulations. The segregated assets are reported at fair value within assets held to cover linked liabilities on the consolidated balance sheet. The technical provisions for linked liabilities on the consolidated balance sheet are determined based on the fair value of the underlying assets supporting the policies.
Banking business assets and liabilities Banking business assets consist primarily of certificates of deposit and short-term deposits with credit institutions carried at fair value and mortgage loans carried at recoverable amount, being outstanding principal balances, net of allowances for loan losses. Loan provisions are recorded for the overall loan portfolio to cover bad debts which have not been separately identified but which are known from experience to be present in the portfolio. For loans in default, specific loan provisions are recorded. General provisions are raised in respect of losses, which although not specifically identified, are known from experience to be present in any such portfolios. The level of general provision is determined by the application of a number of basis points to the aspects of the portfolio which are not currently identified as delinquent but which experience suggests contains lending which will ultimately lead to losses. The number of basis points applied to the portfolios are regularly assessed against recent experience and adjusted if appropriate. Changes in loan provisions during the year are included in the consolidated profit and loss account.
Business acquisitions Business acquisitions are accounted for by applying the purchase method of accounting, which adjusts the net assets of the acquired company to fair value at the date of purchase. The difference between the fair value of the net assets of the acquired company and the fair value of the consideration given represents goodwill. Revenues and expenses of acquired entities are included in the consolidated profit and loss account from the date of acquisition in the year acquired. Gross premiums of the entities are separately presented in the consolidated profit and loss account.
Shareholders’ dividends Shareholders’ dividends are accrued in the period to which they relate regardless of when they are declared. Where scrip dividends are issued, the value of such shares, measured as the amount of the cash dividend alternative, is credited to reserves and then the amount in excess of the nominal value of the shares issued is transferred from the share premium account to retained profit.
4. IMPLEMENTATION OF REVISED ABI STATEMENT OF RECOMMENDED PRACTICE The Company has implemented the revised Statement of Recommended Practice (SORP) for accounting for insurance business that was issued by the Association of British Insurers in November 2003. The only significant effect of the revised SORP on the Group's financial statements is for altered timing of profit recognition and related assets and liabilities for those reinsurance contracts where elements can be identified that do not result in the transfer of significant insurance risk.
Profit on ordinary activities before tax 350 501 Tax (144) (42)
Previous basis of recognition applying 1998 version of the SORP Memorandum Previously only published
Profit for the year before minority interests 193 440 Minority interests 2 9
Balance sheet Present value of future margins relating to advances from reinsurers 85 118 Present value of acquired in-force long-term business 94 113 Other assets, net of liabilities 3,141 3,437
72 PRUDENTIAL PLC ANNUAL REPORT 2003 5. SUPPLEMENTAL EARNINGS INFORMATION The Group uses operating profit based on long-term investment returns before amortisation of goodwill and exceptional items 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. The significant operations that require adjustment for the difference between actual and long-term investment returns are Jackson National Life and certain businesses of Prudential Asia.
Actual gains attributable to shareholders: Long-term gains credited to operating results: Excess (shortfall) of actual gains over long-term gains (391) 87 (478) (200) (278) (467) 189
For the purposes of determining the long-term investment returns of Jackson National Life, from 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, from 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.
For 2002, the other principal component of actual gains attributable to shareholders is revaluation gains of fixed income securities of certain Asian operations. For 2001 and earlier years the principal other component that required calculation of the expected long-term rate of return was UK equity securities that were held as portfolio investments backing UK general business liabilities and related solvency capital. This business was disposed of in 2002. For these investments the long-term rate of return applied in 2001 was 7.5%. The long-term dividend yield was assumed to be 2.6%.
Weighted average shares for basic earnings per share 1,996 1,988 Shares under option at end of year (note 28) 16 14 Number of shares that would have been issued at fair value on assumed option exercise (14) (11)
Insurance Products – New Business Premiums Single Regular Annual Equivalents £m £m £m £m £m £m
Department of Work and Pensions rebate business 280 215 – – 28 22
Total UK and Europe Insurance Operations 4,258 5,588 190 220 616 780
Annual Equivalents are calculated as the aggregate of regular new business premiums and one tenth of single new business premiums.
Total UK and Europe Operations* 0 0 256 372 49 51 305 423
Prudential Asia (net of development expenses of £27m (£26m)) 71 62 71 62
Group operating profit before amortisation of goodwill and exceptional items* 0 0 492 573 (135) (124) 357 449
(closed to new business and wholly attributable but not allocated to policyholders)† 1,404 437 Other funds 11,242 7,226
Comprising: UK and Europe Operations* 102,554 93,036 Jackson National Life 23,854 24,074 Prudential Asia 6,687 5,557 *The 2002 figures for these lines have been restated (see note 4).
†The Scottish Amicable Insurance Fund (SAIF) is a separate sub-fund within the PAC long-term business fund. This sub-fund contains all the with-profits business and all other pension business that was transferred from the Scottish Amicable Life Assurance Society to PAC in 1997. No new business is written in the sub-fund. The SAIF sub-fund is managed to ensure that all the invested assets of SAIF are distributed to SAIF policyholders over the lifetime of the SAIF policies. With the exception of certain amounts in respect of unitised with-profits life business, all future earnings arising in SAIF are retained for existing SAIF with-profits policyholders. Any excess (deficiency) of revenue over expense within SAIF during a period is offset by a transfer to (from) the SAIF fund for future appropriations. Shareholders have no interest in the profits of SAIF, although they are entitled to the investment management fees paid on this business. Should the assets of SAIF be inadequate to meet the guaranteed benefit obligations to the policyholders of SAIF, the PAC long-term fund would be liable to cover any such deficiency. With the exception of certain guaranteed annuity products (as described in note 33), SAIF with-profits policies do not guarantee minimum rates of return to policyholders.
10. SEGMENTAL INFORMATION – SHAREHOLDERS’ FUNDS Core Core structural structural borrowings of Restated borrowings of
Analysis of shareholders’ capital and reserves £m £m £m £m £m £m
Assets Loans and advances to banks 330 239 Loans and advances to customers 6,718 5,546 Debt securities 4,157 4,268 Other banking business assets 449 473
Liabilities Customer accounts 6,452 8,016 Debt securities issued (note 32) 1,423 1,015 Securities sold under agreements to repurchase (note 32) 829 0 Deposits by banks 1,610 501 Other banking business liabilities 473 350
Total banking business liabilities 10,787 9,882 Debenture loans (note 32) 451 202 Other liabilities including tax 23 20 11,261 10,104 Shareholders’ funds:
US GAAP and adjust and reversal and other segmental result for per JNL for minority of FAS 115 minor UK Modified Statutory financial interests and FAS 133 Other US adjustments Basis GAAP purposes Reconciliation from JNL 2003 US GAAP basis statements (note (iii)) effects subsidiaries (note (iv)) (note (v))
result to UK GAAP result for US Operations US$m US$m US$m US$m US$m US$m £m
Realised investment gains (losses), net of related change to amortisation of acquisition costs (note (ii)) (US GAAP as published also includes the change in the fair value of hedging instruments) (217) 144 (73) 73
Short-term fluctuations in investment returns 153 153 93 Amortisation of goodwill (2) (6) (8) (5)
Tax (charge) credit: on realised investment gains and losses and minority interests 81 (56) 25 (25) on short-term fluctuations in
Movements in shareholders’ funds Net income (as shown above) 323 (118) 205 13 46 264 Capital contributions 49 49 16 65 Net movement in other comprehensive
Total movement in year 652 (452) 200 9 15 224 Shareholders’ funds at beginning of year 3,750 47 3,797 121 27 3,945
Shareholders’ funds at end of year 4,402 (405) 3,997 130 42 4,169
12. US OPERATIONS – ADDITIONAL DETAIL ON BASIS OF PRESENTATION OF RESULTS CONTINUED (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.
(iv) Presentation of investment returns within the UK basis performance statements Profit (loss) on ordinary activities before tax With the exception of the elimination of FAS 133 effects, as explained in note (ii), and revaluation gains on certain equity-based securities that are recorded within Other Comprehensive Income under US GAAP, the total profit (loss) under UK GAAP is the same as under US GAAP.
Average for 2003 applied to profit and loss account 1.64 Year end 2003 applied to shareholders’ funds 1.79 13. INVESTMENT INCOME Long-term business Non-technical technical account account £m £m £m £m
Total* 1,844 1,805 3 3 *The 2002 figures for these lines have been restated (see note 4).
Total interest payable 132 147 189 190 Investment management expenses 349 352 0 1
Long-term business interest payable includes £81m (£96m) in respect of products in the nature of funding arrangements entered into by Jackson National Life.
17. INFORMATION ON STAFF AND PENSION COSTS The average numbers of staff employed by the Group during the year were: UK and Europe Operations 11,473 12,687 US Operations 2,742 2,661 Prudential Asia 6,797 5,741
Wages and salaries 710 678 Social security costs 54 51 Other pension costs (see below) 48 47
Actuarial valuation and funding The Group operates a number of pension schemes around the world. The largest scheme is the Prudential Staff Pension Scheme (PSPS). This Scheme is primarily a defined benefit scheme but no employees with employment offers after 31 July 2003 are eligible for membership of the defined benefit section of the Scheme. On the FRS 17 basis of valuation described below, 91% of the liabilities of Group defined benefit schemes are accounted for within PSPS.
FRS 17 basis disclosure (i) Basis of valuation and scheme assets and liabilities Using external actuarial advice provided by Watson Wyatt Partners for the valuation of PSPS and by Aon Limited for the M&G scheme, and internal advice for the Scottish Amicable scheme, the most recent full valuations have been updated to 31 December 2003 applying the principles prescribed by FRS 17.
The key assumptions adopted for the FRS 17 basis valuations were: Price inflation 2.70% 2.25% Rate of increase in salaries 4.70% 4.25% Rate of increase of present and future pensions 2.70% 2.25% Rate used to discount scheme liabilities 5.40% 5.50%
The long-term expected rates of return have been determined after applying due consideration to the requirements of paragraph 54 of FRS 17, in particular, taking account of the values of the assets and equity market levels at the balance sheet dates.
The present value of the liabilities of the three schemes at 31 December 2003 was £4,592m (31 December 2002 £4,117m). The resulting scheme deficit arising from the excess of liabilities over assets at 31 December 2003 comprised £457m attributable to the PAC with-profits fund and £145m attributable to shareholder operations. At 31 December 2002, the resulting scheme deficit comprised £426m attributable to the PAC with-profits fund and £121m attributable to shareholder operations.
17. INFORMATION ON STAFF AND PENSION COSTS CONTINUED (ii) Pension scheme liability attributable to shareholder operations if FRS 17 had been adopted Movements on the pension scheme liability attributable to shareholder operations that would have been recognised in the Group’s primary statements had FRS 17 been implemented are as follows: Profit and Net pension loss account Actuarial Net pension liability charge losses liability attributable attributable attributable Contributions attributable to to to paid by to shareholders shareholders shareholders shareholder shareholders 1 Jan 2003 (note (a)) (note (b)) operations 31 Dec 2003 £m £m £m £m £m
Operating charge (all current service cost) (62) (65) Finance income (expense): Interest on pension scheme liabilities (222) (212) Expected return on pension scheme assets 261 300
Total profit and loss account charge (23) 23 less: amount attributable to PAC with-profits fund† 11 (24)
Profit and loss account charge attributable to shareholders (12) (1) †Since shareholder profits in respect of the PAC with-profits 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.
Actual less expected return on pension scheme assets (8% (26%) of pension scheme assets) 311 (932) Experience losses on scheme liabilities (0% (1%) of the present value of scheme liabilities) (3) (38) Changes in assumptions underlying the present value of scheme liabilities (372) (219)
Total actuarial losses (1% (29%) of the present value of the scheme liabilities) (64) (1,189) less: amounts attributable to the PAC with-profits fund 41 914
Pre-tax impact on the statement of total recognised gains and losses attributable to shareholders (23) (275) Related deferred tax 7 82
(iii) Pension scheme liability attributable to the PAC with-profits fund if FRS 17 had been adopted Movements on the pension scheme liability attributable to the PAC with-profits fund that would have been recognised in the Group’s primary statements had FRS 17 been implemented are as follows: Charge to Net pension long-term Net pension liability technical Actuarial liability attributable account losses Contributions attributable to PAC attributable attributable paid by to PAC with-profits to PAC to PAC PAC with-profits fund with-profits with-profits with-profits fund 1 Jan 2003 fund fund fund 31 Dec 2003 £m £m £m £m £m
Tax charge attributable to long-term business charged to the long-term technical account (828) (829) Transfer to fund for future appropriations charged to the long-term technical account (5,021) (5,030) Operating profit before amortisation of goodwill 357 356 18. DIRECTORS’ REMUNERATION Information on directors’ remuneration is given in the Remuneration Report on pages 38 to 52. Apart from the transactions with directors shown below, no director had an interest in shares, transactions or arrangements which requires disclosure, other than those given in the above Report.
These transactions are on normal commercial terms and in the ordinary course of business.
Tax services: Statutory audit fees include £0.1m (£0.1m) in respect of the Company. Fees, excluding statutory audit fees, payable to KPMG Audit Plc and its associates include £3.0m (£4.9m) for work performed in the UK.
The Audit Committee regularly monitors the non-audit services provided to the Group by its auditors and has developed a formal Auditor Independence Policy which sets out the types of services that the auditors may provide, consistent with the guidance in Sir Robert Smith’s report ‘Audit Committees – Combined Code Guidance’ and with the provisions of the US Sarbanes-Oxley Act. The Audit Committee annually reviews the auditors’ objectivity and independence.
(a) Between current and deferred tax expense (benefit) £m £m £m £m
UK corporation tax* 318 334 (38) 44 Double tax relief (15) (18) (3) (4)
Total tax on operating profit (based on long-term investment returns)* 106 120 Tax on short-term fluctuations in investment returns 38 (91) Tax on profit on sale of UK general business operations – 13
Current tax charge for the period* 175 86 *The 2002 figures for these lines have been restated (see note 4).
(ii) Deferred tax The components of the net deferred tax liability are as follows. The balances have not been discounted.
(b) By fund Scottish Amicable Insurance Fund 87 11 PAC with-profits fund† 1,225 884 Jackson National Life (172) (207) Other long-term business operations 50 42 Other operations (36) (34)
A potential deferred tax asset of £115m (£94m), which may arise from trading losses of approximately £378m (£349m), is sufficiently uncertain that it has not been recognised. With regard to £104m of the asset, the trading losses would be recoverable only if there were sufficient future trading profits in the jurisdictions where the losses have arisen. The balance is dependent upon the outcome of a case before the European Court of Justice regarding Group relief claims in connection with European subsidiaries.
(c) Reconciliation of movements in deferred tax Deferred tax liability at beginning of year 696 2,005 Exchange movements 28 (3) Deferred tax charged (credited) to profit and loss account for the year 430 (1,306)
Balance at beginning of year 1,604 1,687 Additions in respect of acquisitions: Good Morning ITMC, Korea† (2) 8 Zebank, France and Investment Funds Direct Holdings Limited – 7
Charge to profit and loss account: Balance at end of year 1,504 1,604 †The reduction in 2003 relates to deferred consideration included in 2002 that is no longer payable.
The balance at beginning of year comprises cost of £1,935m (£1,920m) less accumulated amortisation of £331m (£233m).
Current value: Leasehold with a term of over 50 years 4,153 4,120 Leasehold with a term of less than 50 years 188 174
The cost of land and buildings was £7,490m (£7,617m). The value of land and buildings occupied by the Group was £181m (£198m).
23. INVESTMENTS IN PARTICIPATING INTERESTS Cost Carrying value £m £m £m £m
Interests in associate undertakings 23 23 9 12 Interests in joint ventures 40 52 23 37
Operating profit for the year after tax (2) (2) Amortisation of goodwill (1) (1)
Interests in joint ventures are valued on a net equity basis and mainly reflect ventures with the Bank of China in Hong Kong and ICICI in India. The differences between the investments on a gross and net equity basis are not material. The other participating interest relates to the Group’s 15% interest in Life Assurance Holding Corporation Limited, a holding company for UK life assurance companies.
88 PRUDENTIAL PLC ANNUAL REPORT 2003 24. OTHER FINANCIAL INVESTMENTS Cost Current value £m £m £m £m
Shares and other variable yield securities and units in unit trusts 23,987 24,731 34,877 30,007 Debt securities and other fixed income securities – carried at market value 43,169 40,941 44,586 42,604 Debt securities and other fixed income securities – carried at amortised cost 20,093 20,572 20,005 20,596 Loans secured by mortgages 2,783 2,467 2,815 2,503 Loans to policyholders secured by insurance policies 716 774 716 774
Amounts included in the above relating to listed investments were: Shares and other variable yield securities and units in unit trusts 33,584 29,129 Debt securities and other fixed income securities – carried at market value 37,351 35,883 Debt securities and other fixed income securities – carried at amortised cost 17,322 17,672
The market value of debt securities and other fixed income securities carried at amortised cost was £21,202m (£21,328m). All debt securities carried at amortised cost are held by long-term business operations.
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 £199m (£429m). For securities carried at amortised cost where the purchase price exceeded maturity value, the unamortised difference at the year end was £360m (£179m).
Depreciation: Balance at beginning of year (264) (312) Exchange movement 11 12 Provided during year (64) (76)
Balance at beginning of year* 133 161 Exchange movement (7) (10) Amortisation: Pre-tax* (26) (27)
The balance at beginning of 2003 comprises cost of £272m less accumulated amortisation of £82m and tax of £57m.
28. SHARE CAPITAL AND SHARE PREMIUM The authorised share capital of the Company is £150m comprising 3,000,000,000 ordinary shares of 5 pence each.
The Company has established trusts to facilitate the delivery of shares under employee incentive plans and savings-related share option schemes. At 31 December 2003, 9.5m Prudential plc shares with a market value of £45m were held in such trusts of which 3.9m shares were held by trusts under employee incentive plans. These shares have been accounted for as own shares in the consolidated balance sheet with a carrying value of £17m.
(note (i)) 349 322 349 322 £300m 6.875% Bonds 2023^ 300 300 300 300 £250m 5.875% Bonds 2029^ 250 250 250 250 £435m 6.125% Subordinated Notes 2031^† 426 426 426 426 US$1,000m 6.5% Perpetual Subordinated
Notes 2004 21 41 21 41 Medium Term Notes 2023 14 – 14 – Commercial paper 2003 – 420 – 420
Egg debenture loans (note (v)): Other borrowings of long-term business operations: Scottish Amicable Finance plc (note (vi)): £100m 8.5% undated Guaranteed Bonds 100 100 100 100 Bank loans and overdrafts 20 – 20 –
Total borrowings 3,103 2,310 192 296 1,150 1,767 4,445 4,373 ^Debenture loans issued by the holding company. The interests of the holders of the Subordinated Notes and the Subordinated Capital Securities are subordinate to the entitlements of other creditors of the holding company. †Net of issue costs.
Long-term loans credit institutions Other borrowings Total £m £m £m £m £m £m £m £m
Borrowings are repayable as follows: Within one year or on demand 46 80 1,095 1,670 1,141 1,750 Between one and two years 140 – 17 28 – 41 157 69 Between two and five years 150 305 – 20 150 325 After five years 2,813 2,005 129 168 55 56 2,997 2,229
Recorded in the consolidated balance sheet on page 61 as: Subordinated liabilities 1,322 748 Debenture loans 1,781 1,562
(vii) 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 £3,247m (£3,554m). In addition, Jackson National Life has entered into stocklending arrangements. Obligations under these arrangements totalled £515m (£1,544m). These amounts are shown on the consolidated balance sheet within creditors.
(viii) Jackson National Life, through its subsidiary Jackson Federal Savings Bank, has bank borrowings of £261m (£239m). The advances are secured by mortgage loans and mortgage backed securities.
(ix) Under the terms of the Group’s arrangements with its main UK banker, the bank has a right of set off between credit balances (other than those of long-term funds) and all overdrawn balances of those Group undertakings with similar arrangements.
Provisions in respect of the costs associated with the review have been included in the change in the long-term business provision in the Group’s profit and loss account and the transfer to or from the fund for future appropriations has been determined accordingly. The following is a summary of the changes in the pension mis-selling provision for the years ended 31 December 2003 and 31 December 2002: £m £m
Balance at beginning of year 730 1,065 Changes to actuarial assumptions and method of calculation (131) (50) Discount unwind 21 53 Redress to policyholders (56) (292) Payment of administrative costs (34) (46)
The costs associated with the mis-selling review have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders' pay-out values have been unaffected by pension mis-selling.
33. CONTINGENCIES AND RELATED OBLIGATIONS CONTINUED Free Standing Additional Voluntary Contribution Business Review In February 2000, the FSA ordered a review of Free Standing Additional Voluntary Contribution business, which constitutes sales of personal pensions to members of company pension schemes. Individuals who purchased these pensions instead of the Additional Voluntary Contributions (AVC) scheme connected to their company’s pension scheme may have been in a better financial position investing their money, and any matching contributions from their employers, in their company’s AVC scheme. The FSA’s review was to ensure that any employees disadvantaged due to not being properly informed of the benefits foregone from not investing in their AVC scheme were compensated.
Mortgage Endowment Products Review In common with several other UK insurance companies, the Group used to sell low-cost endowment products related to repayment of residential mortgages. At sale, the initial sum assured is set at a level such that the projected benefits, including an estimate of the annual bonus receivable over the life of the policy, will equal or exceed the mortgage debt. Because of a decrease in expected future investment returns since these products were sold, the FSA is concerned that the maturity value of some of these products will be less than the mortgage debt. The FSA has worked with insurance companies to devise a programme whereby the companies write to customers indicating whether they may have a possible shortfall and outline the actions that the customers can take to prevent this possibility.
Guarantees and Commitments Guarantee funds in both the UK and the US provide for payments to be made to policyholders on behalf of insolvent life insurance companies. These guarantee funds are financed by payments assessed on solvent insurance companies based on location, volume, and types of business. The Group estimated its reserve for future guarantee fund assessments for Jackson National Life to be £26m at 31 December 2003. Similar assessments for the UK businesses were not significant. The directors believe that the reserve is adequate for all anticipated payments for known insolvencies.
Jackson National Life has unfunded commitments related to its investments in limited partnerships totalling £216m at 31 December 2003. These commitments were entered into in the normal course of business and the directors do not expect a material adverse impact on the operations to arise from them.
The Group has provided, from time to time, other guarantees and commitments to third parties entered into in the normal course of business but the directors do not consider that the amounts involved are significant.
The Group believes that it would be beneficial if there were greater clarity as to the status of the inherited estate and therefore it has discussed with the Financial Services Authority the principles that would apply to any re-attribution of the inherited estate. No conclusions have been reached. Furthermore, the Group expects that the entire inherited estate will need to be retained within the long-term fund for the foreseeable future to provide working capital and so it has not considered any distribution of the inherited estate to policyholders and shareholders.
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 2003, the excess of SAIF assets over guaranteed benefits was £1,404m. Due to the quality and diversity of the assets in SAIF, the excess of assets stated above and the ability of SAIF to revise guaranteed benefits in the event of an asset shortfall, the directors believe that the probability of either the Prudential Assurance long-term fund or the Group’s shareholders’ funds having to contribute to SAIF is remote.
Operating profit before tax before amortisation of goodwill and exceptional items* 357 449 Add back interest charged to operating profit 189 190 Adjustments for non-cash items: Tax on long-term business profits* (154) (172) Amounts retained and invested in long-term business operations (242) (553) Increase in net banking business assets (223) (72)
Net assets (disposed of) acquired (27) 2 Net cash consideration received 27 340
Increase in cash and short-term deposits, net of overdrafts 481 26 Net sales of portfolio investments (149) (83) Increase in loans (829) (86) Reduction in credit facility utilised by investment subsidiaries managed by PPM America 151 165 Share capital issued (30) (40)
Movements arising from cash flow (376) (18) Investment appreciation, exchange translation and other items (108) (80) Transfer to retained profit in respect of shares issued in lieu of cash dividends 27 23 Portfolio investments net of financing at beginning of year (1,541) (1,466)
Portfolio investments net of financing at end of year (1,998) (1,541)
Shareholders’ funds (as above) 2,271 2,736 Long-term business operations 117,913 112,329 Investments in participating interests 56 73
Shareholders’ funds (as above) 410 332 Long-term business operations 811 783
Total cash at bank and in hand (per consolidated balance sheet) 1,221 1,115
We have audited the financial statements on pages 56 to 96. We have also audited the information on pages 44 to 52 in the directors’ remuneration report that is required to be audited.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements and the part of the directors’ remuneration report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements and the part of the directors’ remuneration report to be audited.
Short-term fluctuations in investment returns 91 (205) (480) (48) 28 Merger break fee – – 338 – – Profit on business disposals – 355 – 239 –
Shareholders’ funds and borrowings Statutory basis: Borrowings of holding company and related finance subsidiaries (2,427) (2,297) (1,980) (1,568) (1,760)
Total statutory basis capital and reserves 3,278 3,613 3,876 3,891 3,404 Additional achieved profits basis retained profit 3,765 3,583 4,274 4,885 4,884
Achieved profits basis capital and reserves 7,043 7,196 8,150 8,776 8,288
Share statistics Earnings per share: Based on operating profit after tax and related minority interests before amortisation of goodwill and exceptional items 12.9p 16.7p 23.6p 26.1p 26.0p
UK and Europe Operations Long-term business: New business: Operating profit: Statutory basis capital and reserves 1,296 1,305 1,187 1,227 1,282 Additional achieved profits basis retained profit 2,812 2,472 3,268 3,984 3,899
Achieved profits basis capital and reserves 4,108 3,777 4,455 5,211 5,181
Insurance and investment funds under management (£bn) 125 112 121 129 142
Statutory basis capital and reserves 2,329 2,449 2,498 2,333 1,945 Additional achieved profits basis retained profit 161 283 319 423 588
Achieved profits basis capital and reserves 2,490 2,732 2,817 2,756 2,533
Insurance and investment funds under management (£bn) 30 32 34 30 25
Statutory basis capital and reserves 627 579 402 315 217 Additional achieved profits basis retained profit 792 828 687 478 376
Insurance and investment funds under management (£bn) 13 11 8 6 3 Prior year figures have been restated where relevant to be consistent with 2003 accounting policies and presentation.
A number of factors (risk factors) affect Prudential’s operating results, financial condition and trading price. These factors include economic and market conditions, foreign currency exchange rate fluctuations, regulation, government policy and legislation, competition, credit ratings, and operational systems and processes.
The EU Insurance Groups Directive, which was implemented in the UK in 2001, together with the Financial Conglomerates Directive, which will be implemented by 2005, will require European financial services groups to demonstrate net aggregate surplus capital in excess of solvency requirements at the Group level in respect of shareholder-owned entities. The EU is also currently reviewing future solvency requirements (the Solvency II review). The manner of the implementation of these directives is likely to lead to Prudential being required to maintain a somewhat higher level of capital at the Group level than currently necessary in respect of its businesses, or alternatively, to constrain the growth of those businesses, or to take other appropriate action. In addition, an inconsistent application of these directives by regulators in different EU member states may place Prudential at a competitive disadvantage to other European financial services groups.
The resolution of several issues affecting the UK financial services industry, could have a negative impact on Prudential’s reported results or on its relations with current and potential customers.
Prudential is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its business, both in the UK and internationally. This could be a review of business sold in the past under previous acceptable market practices at the time. Pending legal and regulatory actions include proceedings relating to aspects of Prudential’s business and operations and which are typical of the business it operates, including in the latter case businesses it has closed. Although Prudential believes it has adequately reserved in all material aspects for the costs of litigation and regulatory matters, no assurance can be provided that such reserves are sufficient. It is possible that Prudential’s future performance could be affected by an unfavourable outcome in these matters.
Prudential’s businesses are conducted in highly competitive environments and Prudential’s continued profitability depends on its management’s ability to respond to these pressures.
The markets for UK, US and Asian financial services are highly competitive, with several factors affecting Prudential’s ability to sell its products, including price and yields offered, financial strength and ratings, range of product lines and product quality, brand strength and name recognition, investment management performance and historical bonus levels. In some of its markets Prudential faces competitors who are larger, have greater financial resources or a greater market share, offer a broader range of products or have higher bonus rates or claims-paying ratios.
Within Asia, Prudential’s main regional competitors are international financial companies, including AIG, Allianz, ING and Manulife.
Downgrades in Prudential’s financial strength and credit ratings could significantly impact its competitive position and hurt its relationships with creditors or trading counterparties. Prudential’s financial strength and credit ratings, which are intended to measure its ability to meet policyholder obligations, are an important factor affecting public confidence in most of Prudential’s products, and as a result its competitiveness. Downgrades in Prudential’s ratings could have an adverse effect on its ability to market products and retain current policyholders. In addition, the interest rates Prudential pays on its borrowings are affected by its debt credit ratings, which are in place to measure Prudential’s ability to pay its contractual obligations. On 20 December 2002, Moody’s downgraded the financial strength rating of Prudential Assurance’s long-term fund from Aaa (on review for possible downgrade) to Aa1 (stable outlook). On 29 January 2003, Standard & Poor’s downgraded the financial strength rating of Prudential Assurance’s long-term fund from AAA (negative outlook) to AA+ (stable outlook). Prudential believes the downgrades that it, and the rest of the UK insurance industry, experienced have not to date had a discernible impact on its performance.
Prudential’s long-term senior debt is rated as A2 (stable outlook) by Moody’s, AA– (negative outlook) by Standard & Poor’s and aa– by AM Best. Prudential’s short-term debt is rated as P-1 by Moody’s and A1+ by Standard & Poor’s.
Operational risks are present in all of Prudential’s businesses, including the risk of direct or indirect loss resulting from inadequate or failed internal and external processes, systems and human error or from external events. Prudential’s business is dependent on processing a large number of complex transactions across numerous and diverse products, and is subject to a number of different legal and regulatory regimes. In addition, Prudential manages several outsourced operations which include certain UK processing and IT functions. In turn, Prudential is reliant upon the operational processing performance of its outsourcing partners.
Further, because of the long-term nature of much of Prudential’s business, accurate records have to be maintained for significant periods. Prudential’s systems and processes are designed to ensure that the operational risks associated with its activities are appropriately controlled, but any weakness in the systems could have a negative impact on its results of operations during the effective period. Prudential has not experienced or identified any operational risks in its systems or processes during 2003, or subsequently which have caused, or are expected to cause, a significant negative impact on its results of operations.
Certain of the subsidiaries have regulatory restrictions that can limit the payment of dividends.
UK and Europe Insurance Operations 359 516 M&G 83 71 Egg (34) (20)
Profit (loss) for the financial year before minority interests 483 (154)
Profit (loss) for the financial year after minority interests 485 (145)
EARNINGS PER SHARE – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2003
Based on profit (loss) for the financial year after minority interests of £485m (£(145)m) 5 24.3p (7.3)p
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES – ACHIEVED PROFITS BASIS YEAR ENDED 31 DECEMBER 2003 £m £m
Net decrease in shareholders’ capital and reserves 14 (153) (954) Shareholders’ capital and reserves, at beginning of year 7,196 8,150
Shareholders’ capital and reserves at end of year 14 7,043 7,196
Total assets less liabilities, excluding insurance funds* 136,373 126,280 Less insurance funds Technical provisions, net of reinsurers’ share* 120,449 115,004 Fund for future appropriations 12,646 7,663 Less shareholders’ accrued interest in the long-term business* (3,765) (3,583)
Share capital 100 100 Share premium 553 550 Statutory basis retained profit* 2,625 2,963 Additional achieved profits basis retained profit* 3,765 3,583
The supplementary information on pages 103 to 114 was approved by the Board of directors on 19 March 2004.
3. ECONOMIC ASSUMPTIONS Under the ABI guidance, for most countries, the basis for setting long-term expected rates of returns on investments and risk discount rates are set by reference to period end rates of return on fixed interest securities. This ‘active’ basis of assumption setting has been applied in preparing the results of all the Group’s UK, US and European long-term business operations. For the Group’s Asian operations, the active basis is appropriate for business written in Japan, Korea and US dollar denominated business written in Hong Kong.
(applying the rates listed above to the investments held by the fund) 6.8% 6.6% Expected long-term rate of inflation 3.1% 2.5%
US Operations (Jackson National Life) Expected long-term spread between earned rate and rate credited to policyholders for single premium deferred annuity business 1.75% 1.75% US 10 year treasury bond rate at end of year 4.3% 3.9% Risk margin included within the risk discount rate 3.1% 3.1% Risk discount rate(i) 7.4% 7.0%
Weighted pre-tax expected long-term nominal rates of investment return 7.4% 7.1% Weighted expected long-term rate of inflation 3.4% 3.0% Weighted risk discount rate(i) 10.4% 9.6%
(i) For all operations, a discount rate is applied to post-tax cash flows to determine post-tax results. For most operations, these results are then grossed up for the effective rate of tax to derive the pre-tax results. For Jackson National Life, pre-tax results are determined by applying the risk discount rate to pre-tax cash flows adjusted for the impact of capital charges.
(ii) Operating profit Investment returns, including investment gains, in respect of long-term insurance business are recognised in operating results at the expected long-term rate of return. For the purposes of calculating investment return to be recognised in operating results of UK operations, where equity holdings are a significant proportion of investment portfolios, values of assets at the beginning of the reporting period are adjusted to remove the effects of short-term market volatility.
For the purposes of determining the long-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 long-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.
Effect of changes in economic assumptions (540) 130 (410) (410) (20.5)p
The annual result is impacted by the movement in this cost from year to year which comprises a charge against new business profit with a partial offset for the release of capital requirements for business in-force.
In determining the cost of capital of Jackson National Life, it has been assumed that an amount equal to 200% of the risk based capital required by the National Association of Insurance Commissioners at the Company Action Level must be retained. The impact of the related capital charge is to reduce Jackson National Life’s result by £19m (£24m) and its shareholders’ funds by £164m (£138m).
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 pensions scheme asset or liability; (ii) For that element of the net pensions scheme asset or liability that is attributable to the PAC with-profits fund, an adjustment of the Group fund for future appropriations by an equal but opposite amount; and
(iii) For shareholder financed long-term business, an adjustment of the composition of achieved profits basis shareholders’ funds between the components of the modified statutory basis shareholders’ funds and additional shareholders’ reserves (reflecting the additional shareholders’ interest recognised on the achieved profits basis).
UK and Europe Insurance Operations 166 (50) 116 233 (69) 164 Jackson National Life(i) 148 (72) 76 234 (116) 118 Prudential Asia 291 (80) 211 307 (84) 223
Jackson National Life Unwind of discount 145 156 Return on surplus assets (over target surplus) 33 41 Averaged realised losses on bonds in excess of long-term default assumption(iii) (note 10) (66) (59) Experience variances against current assumptions: Spread(iii) (iv) (17) (72)
Prudential Asia Unwind of discount 115 95 Profit arising from reorganisation of long-term funds – 59 Change in operating assumptions(v) (27) 42 Other items and experience variances (1) 13
(i) The unwind of discount for UK and Europe Insurance 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 and Europe long-term business operations. Surplus assets retained within the main with-profits fund are smoothed for this purpose to remove the effects of short-term investment volatility.
The spread variance on the current and previous bases of presentation is set out below: £m £m
Using basis applied in 2002 Annual Report 54 2 Less: Long-term default assumption (71) (74)
(v) The £27m charge in 2003 for changes to operating assumptions primarily reflects expense assumption changes in Japan. The 2002 credit of £42m arose from revisions to mortality assumptions.
Actual investment returns on investments less long-term returns included within operating profit(iii) 96 (295) Investment return related gain (loss) due primarily to changed expectation of profitability on variable annuity business arising from current year equity returns* 36 (145)
*This adjustment arises due to market returns for 2003 and 2002 being higher (lower) than the assumed long-term rate of return. This gives rise to higher (lower) than expected year-end values of variable annuity assets under management with a resulting effect on the projected value of future account values, and hence future profitability.
(iii) Jackson National Life – Actual investment returns on investments less long-term returns comprises: £m £m
(iv) Jackson National Life – Actual less averaged realised gains and losses (including impairments) for fixed income securities £m US$m equivalent
Five year total (1,119) (684) Five year average included in operating result (224) (137) Representing: Long-term default assumption (116) (71) Averaged losses in excess of the long-term default assumption (note 9) (108) (66)
Averaged realised gains differ from those reported on the statutory basis for the impact of amortisation of policy acquisition costs attributable to realised gains and losses. These have been included in the statutory basis gains averaging calculation for the years 1999 to 2003. On the achieved profits basis deferred acquisition costs do not feature as part of the methodology. Accordingly the realised gains and losses included in the averaging process are exclusive of the amortisation of policy acquisition costs attributable to realised gains and losses.
(v) Short-term fluctuations for Prudential Asia for 2002 of £66m primarily reflect bond value movements.
(i) The £122m charge for 2003 for UK and Europe Insurance Operations reflects increases in the risk discount rate of 0.3% and in the investment return assumption of 0.2% and other consequential impacts of an economic nature on the modelled emergence of the shareholders’ share of cost of bonus.
(iii) The £155m charge for 2003 for Prudential Asia reflects the net impact of revisions to the underlying long-term investment return assumptions and discount rate, combined with the impact of the introduction of a risk-based capital regime by the Taiwanese regulators.
Tax charge (credit) on profit (loss) on ordinary activities (including tax on actual investment returns) 355 (329)
Before capital charge: Excluding assets in excess of target surplus 1,741 1,965 Assets in excess of target surplus 842 830
Other operations Goodwill(ii) 1,445 1,540 Holding company net borrowings(iii) (1,995) (2,071) Other assets (424) (189)
14. RECONCILIATION OF MOVEMENT IN SHAREHOLDERS’ FUNDS Long-term business operations Total
Long-term business: New business (note 8) 166 148 291 605 605 Business in-force (note 9) 193 71 87 351 351
US broker-dealer and fund management (3) (3) Other income and expenditure (181) (181)
Tax (note 12): Tax on short-term fluctuations in investment returns (162) (46) (6) (214) 2 (212) Tax on effect of change in economic assumptions 37 92 1 130 130
Shareholders’ capital and reserves at 1 January 2003 3,026 2,657 1,407 7,090 106 7,196
114 PRUDENTIAL PLC ANNUAL REPORT 2003 15. RESULTS SENSITIVITY TO ALTERNATIVE ASSUMPTIONS (i) Estimated results for 2002 based on economic assumptions applied for the 2003 results
Operating profit UK and Europe Insurance Operations 228 (68) 160 384 Jackson National Life(i) 203 (99) 104 144 Prudential Asia 288 (77) 211 85
(i) Jackson National Life: Before capital charge 130 Capital charge (26)
Shareholders’ funds If the economic assumptions applied for 2003 had been in place at 31 December 2002 the achieved profits basis shareholders’ funds at that date would have been lower by £414m. This represents a pre-tax loss of £540m less related tax credit of £130m (as analysed by business operation in note 14) and an adjustment for exchange losses to reflect rates at 31 December 2002 of £4m.
Pre-tax operating profit from new business for the year Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 75 103 Decrease in rates of 1% (81) (100)
Risk discount rates: Increase in rates of 1% (74) (85) Decrease in rates of 1% 87 102
Shareholders’ funds at the year end Pre-tax expected long-term nominal rates of investment return: Increase in rates of 1% 897 750 Decrease in rates of 1% (930) (774)
STATEMENT OF DIRECTORS' RESPONSIBILITIES IN RELATION TO THE ACHIEVED PROFITS BASIS SUPPLEMENTARY INFORMATION
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.
Under the terms of engagement we are required to report to the Company our opinion as to whether the supplementary information has been properly prepared in accordance with the guidance using the methodology and assumptions set out on page 106. We also report if we have not received all the information and explanations we require for this audit.
BASIS OF AUDIT OPINION We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the supplementary information. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the supplementary information, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
An explanation of the achieved profits basis of reporting is provided on pages 25 and 26 of the Group's financial statements.
The Company has decided to change the basis on which the scrip dividend alternative operates so that shareholders will on this occasion and in future know the exact number of shares that they will receive in lieu of their cash dividend, prior to choosing whether or not to take scrip and completing a form of election. The reference price is calculated as the average of the middle market quotations for the Company's shares as derived from the Daily Official List of the London Stock Exchange for the five business days which commenced on 17 March 2004.
Further details of the scrip dividend alternative will be mailed to shareholders in early April 2004.
All enquiries regarding ADR holder accounts should be directed to JP Morgan, the authorised depositary bank, at JP Morgan Service Center, PO Box 43013, Providence, RI 02940-3013, US, or telephone 00 1 781 575 4328.
FORM 20-F The Company is subject to the reporting requirements of the Securities and Exchange Commission (SEC) in the US 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 2910-2914 Two Pacific Place 88 Queensway Hong Kong www.prudential-asia.com
This statement may contain certain ‘forward-looking statements’ with respect to certain of Prudential’s plans and its current goals and expectations relating to its future financial condition, performance, results, strategy and objectives. Statements containing the words ‘believes’, ‘intends’, ‘expects’, ‘plans’, ‘seeks’ and ‘anticipates’, and words of similar meaning, are forward-looking. By their nature, all forward-looking statements involve risk and uncertainty because they relate to future events and circumstances which are beyond Prudential's control including among other things, UK domestic and global economic and business conditions, market related risks such as fluctuations in interest rates and exchange rates, and the performance of financial markets generally; the policies and actions of regulatory authorities, the impact of competition, inflation, and deflation; experience in particular with regard to mortality and morbidity trends, lapse rates and policy renewal rates; the timing, impact and other uncertainties of future acquisitions or combinations within relevant industries; and the impact of changes in capital, solvency or accounting standards, and tax and other legislation and regulations in the jurisdictions in which Prudential and its affiliates operate. This may for example result in changes to assumptions used for determining results of operations or re-estimations of reserves for future policy benefits. As a result, Prudential’s actual future financial condition, performance and results may differ materially from the plans, goals, and expectations set forth in Prudential's forward-looking statements. Prudential undertakes no obligation to update the forward-looking statements contained in this statement or any other forward-looking statements it may make.
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.
Consolidated Shareholders’ Capital and Reserves 60 Consolidated Balance Sheet 62 Balance Sheet of the Company 63 Consolidated Cash Flow Statement 64 Notes on the Financial Statements 97 Statement of Directors’ Responsibilities 97 Independent Auditors’ Report to the
Account – Achieved Profits Basis 104 Earnings Per Share – Achieved Profits Basis 104 Statement of Total Recognised Gains and