QuickLinks -- Click here to rapidly navigate through this document

As filed with the Securities and Exchange Commission on June 24, 2005



SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 20-F

Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2004

Commission File Number: 1-15040

PRUDENTIAL PUBLIC LIMITED COMPANY

(Exact Name of Registrant as Specified in its Charter)

England and Wales
(Jurisdiction of Incorporation)

Laurence Pountney Hill,
London EC4R 0HH, England
(Address of Principal Executive Offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of Each Class   Name of Each Exchange on Which Registered

American Depositary Shares, each representing 2 Ordinary Shares, 5 pence par value each

 

New York Stock Exchange

Ordinary Shares, 5 pence par value each

 

  New York Stock Exchange*

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

The number of outstanding shares of each of the issuer's classes of capital or common stock as of December 31, 2004 was:

2,375,393,020 Ordinary Shares, 5 pence par value each

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes    X          No          

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17                  Item 18    X  

* Not for trading, but only in connection with the registration of American Depositary Shares.




TABLE OF CONTENTS

 
   
  Page
Item 1.   Not Applicable    
Item 2.   Not Applicable    
Item 3.   Key Information   1
        Selected Historical Financial Information of Prudential   1
        Dividend Data   4
        Exchange Rate Information   5
        Risk Factors   6
        Forward-Looking Statements   11
Item 4.   Information on the Company   12
        Business of Prudential   12
            Overview   12
            Strategy   14
            Significant Subsidiaries   19
            UK and Europe Business   20
            US Business   43
            Asian Business   53
            Investments   58
            Description of Property   70
            Competition   71
            Intellectual Property   73
            Legal Proceedings   73
            Sources   74
        Supervision and Regulation of Prudential   75
            UK Supervision and Regulation   75
            US Supervision and Regulation   87
            Asian Supervision and Regulation   93
Item 5.   Operating and Financial Review and Prospects   95
        Introduction   95
        Factors Affecting Results of Operations   96
        International Financial Reporting Standards and Discretionary Changes   106
        Overview of Consolidated Results   117
        Analysis by Geographic Region   120
        Geographic Analysis by Nature of Income and Expense   129
        New UK Accounting Pronouncements   138
        US GAAP Analysis   139
        Liquidity and Capital Resources   154
        Introduction of the Euro   164
Item 6.   Directors, Senior Management and Employees   165
        Compensation   168
        Share Ownership   178
        Board Practices   180
        Employees   185
Item 7.   Major Shareholders and Related Party Transactions   186
        Major Shareholders   186
        Related Party Transactions   187
         

i


Item 8.   Financial Information   188
Item 9.   The Offer and Listing   189
        Comparative Market Price Data   189
        Market Data   189
Item 10.   Additional Information   190
        Memorandum and Articles of Association   190
        Material Contracts   196
        Exchange Controls   196
        Taxation   196
        Documents on Display   199
Item 11.   Quantitative and Qualitative Disclosures About Market Risk   200
        Overview   200
        Major Risks   201
        Asset/Liability Management   203
        Use of Derivatives   204
        World-Wide Operations   204
        Currency of Investments   205
        Currency of Core Borrowings   206
        Sensitivity Analysis   206
Item 12.   Not Applicable    
Item 13.   Defaults, Dividend Arrearages and Delinquencies   213
Item 14.   Material Modifications to the Rights of Security Holders   214
Item 15.   Controls and Procedures   215
Item 16A.   Audit Committee Financial Expert   215
Item 16B.   Code of Ethics   215
Item 16C.   Principal Accountant Fees and Services   215
Item 16E.   Purchases of Equity Securities by Prudential plc and Affiliated Purchasers   217
Item 17.   Not Applicable    
Item 18.   Financial Statements    
        Consolidated Financial Statements   F-1
        Condensed Financial Information of Registrant   S-1
Item 19.   Exhibits    

ii



Item 3. Key Information

SELECTED HISTORICAL FINANCIAL INFORMATION OF PRUDENTIAL

        The following table sets forth Prudential's selected consolidated financial data for the periods indicated. Certain data is derived from Prudential's audited consolidated financial statements prepared in accordance with UK GAAP under which insurance business is accounted for on the modified statutory basis ("MSB"). These accounting principles differ in certain significant respects from US GAAP. Note 36 of the notes to the Prudential audited consolidated financial statements included elsewhere in this document includes a description of the differences between UK GAAP and US GAAP that are significant to the financial statements and provides a reconciliation from UK GAAP consolidated profit and loss and consolidated shareholders' funds to US GAAP consolidated net income (loss) and consolidated shareholders' equity, respectively. Item 5, "Operating and Financial Review and Prospects—US GAAP Analysis" provides a discussion of the significant differences between UK GAAP and US GAAP. This table is only a summary and should be read in conjunction with Prudential's consolidated financial statements and the related notes included elsewhere in this document, together with Item 5, "Operating and Financial Review and Prospects".

        The following table presents the profit and loss account and balance sheet data for and as at the years ended December 31, 2000 to 2004 and has been derived from Prudential's audited consolidated financial statements audited by KPMG Audit Plc:

 
  Year Ended December 31,
 
 
  2004(1)
  2004
  2003
  2002
  2001
  2000
 
 
  (In $ Millions)

  (In £ Millions)

 
Profit and loss account data—UK GAAP basis                          
Gross premiums from continuing long-term business operations including acquisitions:   31,402   16,355   13,781   16,669   15,196   14,173  
Gross premiums from discontinued general business operations(2)         329   390   333  
Reinsurance and change in unearned premiums   (492 ) (256 ) (290 ) (545 ) (380 ) (130 )
   
 
 
 
 
 
 
Total earned premiums, net of reinsurance   30,910   16,099   13,491   16,453   15,206   14,376  
   
 
 
 
 
 
 
Investment returns:                          
  Continuing operations   28,157   14,665   15,617   (3,664 ) (1,227 ) 5,041  
  Discontinued operations   33   17   22   22   17   5  
   
 
 
 
 
 
 
Total investment returns   28,190   14,682   15,639   (3,642 ) (1,210 ) 5,046  
   
 
 
 
 
 
 
Operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and tax(3)                          
  Continuing operations:                          
    UK and Europe operations   929   484   394   470   361   360  
    US operations   349   182   140   131   281   461  
    Asian operations   250   130   71   62   25   36  
    Group activities   (370 ) (193 ) (181 ) (189 ) (130 ) (123 )
   
 
 
 
 
 
 
  Total continuing operations   1,158   603   424   474   537   734  
  Discontinued operations(2)   (39 ) (20 ) (67 ) (25 ) 89   38  
   
 
 
 
 
 
 
Operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and tax(4)   1,119   583   357   449   626   772  
Amortization of goodwill   (186 ) (97 ) (98 ) (98 ) (95 ) (84 )
Short-term fluctuations in investment returns(5)   440   229   91   (205 ) (480 ) (48 )
Profit on business disposals(6)   92   48     355     120  
Egg France closure cost(7)   (217 ) (113 )        
Merger break fee, net of related expenses           338    
Profit on Egg flotation             119  
   
 
 
 
 
 
 
Total profit on ordinary activities before tax   1,248   650   350   501   389   879  
   
 
 
 
 
 
 
Profit after tax and minority interests:                          
  Operating profit (including post-tax long-term investment returns)   783   408   257   333   466   511  
   
 
 
 
 
 
 
Profit for the period (including post-tax actual investment returns)   822   428   208   468   395   577  
   
 
 
 
 
 
 
                           

1


Statement of income and comprehensive income data—US GAAP basis                          
Insurance policy revenues   13,029   6,786   4,527   5,201   3,954   3,614  
Investment results   25,628   13,348   11,672   (1,832 ) 182   4,643  
Non-operating income:                          
  Merger break fee, net of related expenses           338    
  Profit on Egg flotation             119  
Other income   4,044   2,106   677   688   616   619  
   
 
 
 
 
 
 
Total revenue   42,701   22,240   16,876   4,057   5,090   8,995  
   
 
 
 
 
 
 
Net income (loss) from continuing operations (after minority interests)   1,302   678   692   (642 ) (308 ) 496  
Income from discontinued operations including profit on disposals (net of applicable tax)(2)   (132 ) (69 ) (27 ) 285   39   6  
Cumulative effect of changes in accounting principles(8)   (995 ) (518 )     (139 )  
   
 
 
 
 
 
 
Total net income (loss)   175   91   665   (357 ) (408 ) 502  
   
 
 
 
 
 
 
Total comprehensive income (loss)   35   18   655   (627 ) (68 ) 673  
   
 
 
 
 
 
 
 
  As of and for the year ended December 31,
 
  2004(1)
  2004
  Restated
2003

  Restated
2002

  Restated
2001

  Restated
2000

 
  (In $ Millions, Except Share Information)

  (In £ Millions, Except Share Information)

Balance sheet data—UK GAAP basis                          
Total assets*     335,117   174,540   161,709   151,977   156,521   154,679
Long-term business provision     199,945   104,138   100,287   99,048   98,422   90,910
Technical provision for linked liabilities     46,343   24,137   20,195   16,007   17,783   18,719
Subordinated liabilities and debenture loans     6,125   3,190   3,117   2,310   2,244   1,585
Total shareholders' funds*     8,220   4,281   3,240   3,577   3,835   3,840
Balance sheet data—US GAAP basis                          
Total assets     334,191   174,058   160,645   150,379   155,668   153,024
Policyholder benefit liabilities(8)     235,031   122,412   90,307   89,304   84,190   76,711
Separate account liabilities(8)     10,620   5,531   30,487   25,793   29,729   32,337
Total shareholders' equity     11,380   5,927   5,128   4,878   5,964   6,455
Other data                          
Long-term business                          
New business from continuing operations:                          
  Single premium sales(10)     21,940   11,427   8,473   11,802   10,610   9,788
  New regular premium sales(9)(10)     1,350   703   710   707   693   538
Gross investment product contributions(10)     48,207   25,108   22,113   17,392   11,303   6,852
Funds under management     359,040   187,000   168,000   155,000   163,000   165,000
Basic earnings per share:                          
  Based on operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and before tax on a UK GAAP basis^     52.6¢   27.4p   17.2p   21.7p   30.4p   37.9p
  Based on operating profit (based on long-term investment returns) before amortization of goodwill and after tax and related minority interests on a UK GAAP basis^     36.9¢   19.2p   12.4p   16.1p   22.7p   25.1p
  Based on total profit for the financial year after tax on a UK GAAP basis^     38.6¢   20.1p   10.0p   22.6p   19.2p   28.3p
  Net income (loss) per share on a US GAAP basis^     8.3¢   4.3p   32.0p   (17.3 )p (19.8 )p 24.6p
  Diluted earnings per share on a UK GAAP basis^     38.6¢   20.1p   10.0p   22.6p   19.2p   28.2p
  Diluted earnings (loss) per share on a US GAAP basis^     8.3¢   4.3p   32.0p   (17.2 )p (19.8 )p 24.5p
Dividend per share, as originally reported     30.8¢   16.05p   16.0p   26.0p   25.4p   24.5p
Dividend per share, as restated(11)^     30.4¢   15.84p   15.38p   25.00p   24.42p   23.56p
Equivalent cents per share(12)^         29.02¢   27.30¢   40.17¢   35.17¢   33.42¢
Market price at end of period^   $ 8.70   453p   454p   422p   765p   1,036p
Average number of shares (in millions)^         2,129   2,076   2,068   2,057   2,037

*
Comparative figures for these lines have been restated as a result of the implementation of UITF Abstract 38 'Accounting for ESOP Trusts'. See Note 4 of the notes to Prudential's consolidated financial statements.

^
Comparative figures for these lines have been restated to take account of Prudential's rights offering in 2004. See Note 15 of the notes to Prudential's consolidated financial statements. The restatement factor is 0.9614 based on a theoretical ex-rights price of 405.71 pence divided by the closing share price on the final day Prudential's shares traded cum-rights of 422.00 pence.

2



Certain other minor reclassifications and presentational changes have been made to the amounts presented for prior periods to conform these periods to the current presentation. Such reclassifications and presentational changes had no overall effect on the shareholders' funds, profits or cashflows.

(1)
Amounts stated in US dollars have been translated from pounds sterling at the rate of $1.92 per £1.00 (the noon buying rate in New York City on December 31, 2004).

(2)
Discontinued operations relate to UK personal lines property and casualty insurance business, Jackson Federal Bank and Egg France. See Notes 7 and 37 of the notes to Prudential's consolidated financial statements.

(3)
Investment returns credited to operating profit for investments attributable to shareholders are determined using the long-term rate of return. For the purposes of determining long-term investment returns, from 2001 Jackson National Life has averaged realized investment gains and losses arising on debt securities over five years. For equity related investments Jackson National Life has assumed a long-term rate of return of 8.0%. In 2000, long-term investment returns for Jackson National Life were estimated as the aggregate of investment income and averaged realized gains and losses for both debt securities and other types of security. Comparatives for the average long-term gains credited to operating results for 2000 have not been restated for the refinement in policy, as the effect is not material.

(4)
The Group uses operating profit based on long-term investment returns before amortization of goodwill and exceptional items as a supplemental measure of its results. For the purposes of measuring operating profit, investment returns on shareholder financed businesses are based on the 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 Corporation Asia. In addition to the adjustments made for investment returns, as described above, operating profit excludes amortization of goodwill and gains on business disposals and similar items.


In determining operating profit, the Group has used the expected long-term investment return and excluded amortization of goodwill and exceptional items as the directors believe that such presentation better reflects the group's underlying financial performance, on a statutory basis of measurement.


For a further discussion of operating profit before amortization of goodwill, exceptional items and tax and a reconciliation of operating profit based on long-term investment returns before amortization of goodwill, exceptional items and tax to profit on ordinary activities, including the related basic earnings per share amounts, see Note 5 of the notes to Prudential's consolidated financial statements.


Where operating profit before amortization of goodwill, exceptional items and tax is discussed elsewhere in this annual report, the above discussion as well as Note 5 should be referred to.


Due to the long-term nature of Prudential's business, the basis of presentation of operating profit may not be comparable with other UK companies. See Note 5 of the notes to Prudential's consolidated financial statements for a description of the basis.

(5)
Short-term fluctuations in investment returns represent the difference between the long-term return credited to operating profit and the actual investment returns achieved for the year.

(6)
Profit on business disposals is detailed in Note 16 of the notes to Prudential's consolidated financial statements.

(7)
In July 2004, Egg announced that it intended to take the necessary steps to withdraw from the French market at an expected cost of £113 million.

(8)
Effective January 1, 2004, the Group adopted SOP 03-01 "Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and Separate Accounts". This has resulted in business previously disclosed as separate accounts business being reclassified to the general account. The cumulative effect of this change in accounting principle is described in Note 37 of the notes to Prudential's consolidated financial statements.

(9)
New regular premium sales are reported on an annualized basis, which represents a full year of installments in respect of regular premiums irrespective of the actual payments made during the year.

(10)
New business premiums reflect the amount of business Prudential generated during each period shown and do not include renewal premiums on policies written during prior periods. Prudential considers new business premiums to be a measure of its operating performance because they represent new sales of insurance policies during a specified period, rather than its revenues or profitability during that period. This operating measure enables a comparison of operating performance across periods without regard to revenues or profitability related to policies sold in prior periods. Gross investment product contributions reflect the amount invested by Institutional and Retail customers in the period. Prudential considers these to be a measure of its operating performance because it measures the flow of monies into the funds managed by the Group. This operating measure enables a measurement of operating performance across periods.

(11)
The final dividend with respect to any year is paid in the following year. Final dividends are included in the year to which they relate rather than in the year paid. Annual dividends comprise both interim and final dividend payments.

(12)
The dividends have been translated into US dollars at the noon buying rate on the date each payment was made.

3



Dividend Data

        Under UK company law, Prudential may pay dividends only if "distributable profits" are available for that purpose. "Distributable profits" are accumulated, realized profits not previously distributed or capitalized less accumulated, realized losses not previously written off. Even if distributable profits are available, under UK law Prudential may pay dividends only if the amount of its net assets is not less than the aggregate of its called-up share capital and undistributable reserves (such as, for example, the share premium account) and the payment of the dividend does not reduce the amount of its net assets to less than that aggregate.

        As a holding company, Prudential is dependent upon dividends and interest from its subsidiaries to pay cash dividends. Many of its insurance subsidiaries are subject to regulations that restrict the amount of dividends that they can pay to Prudential. These restrictions are discussed in more detail in Item 4, "Information on the Company—Supervision and Regulation of Prudential—UK Supervision and Regulation—Regulation of Insurance Business—Distribution of Profits and With-profits Business" and Item 4, "—Information on the Company—Supervision and Regulation of Prudential—US Supervision and Regulation—General".

        Historically, Prudential has declared an interim and a final dividend for each year (with the final dividend being paid in the year following the year to which it relates). Subject to the restrictions referred to above, Prudential's directors have the discretion to determine whether to pay a dividend and the amount of any such dividend but must take into account the company's financial position.

        The following table shows certain information regarding the dividends per share that Prudential paid for the periods indicated in pence sterling and converted into US dollars at the noon buying rate in effect on each payment date. Interim dividends for a specific year generally have a record date in August and a payment date in October of that year, and final dividends generally have a record date in the following March and a payment date in the following May.

Year

  Interim Dividend
  Interim Dividend
  Final Dividend
  Final Dividend
 
  (pence)

  (US Dollars)

  (pence)

  (US Dollars)

2000   8.2   0.1165   16.3   0.2311
2001   8.7   0.1253   16.7   0.2405
2002   8.9   0.1382   17.1   0.2796
2003   5.3   0.0899   10.7   0.1883
2004   5.4   0.0991   10.65   0.1950

        The following table shows the same information but the comparative figures for 2000 to 2003 have been restated to take account of Prudential's rights offering in 2004. The restatement factor used for these periods is 0.9614 based on a theoretical ex-rights price of 405.71 pence divided by the closing share price on the final day Prudential's shares traded cum-rights of 422.00 pence. See Item 4, "Information on the Company—Growing the Business".

Year

  Interim Dividend
  Interim Dividend
  Final Dividend
  Final Dividend
 
  (pence)

  (US Dollars)

  (pence)

  (US Dollars)

2000   7.89   0.1121   15.67   0.2221
2001   8.36   0.1204   16.06   0.2313
2002   8.56   0.1329   16.44   0.2688
2003   5.09   0.0863   10.29   0.1867
2004   5.19   0.0952   10.65   0.1950

        In February 2003, Prudential's Board of Directors (the "Board") announced that it would review Prudential's dividend policy. Since then the Board has determined a dividend policy which reflects operating cashflows, and the strategy to invest in the business for long-term growth. The Board believes

4



that the dividends for 2004 reflect an appropriate balance between the cash generated by the Group, the ability to finance growth, maintain financial flexibility and the development of modified statutory basis profits over the medium to long-term. The Board believes that the current level of dividend is one from which it will be possible to grow the dividend.


Exchange Rate Information

        Prudential publishes its consolidated financial statements in pounds sterling. References in this document to "US dollars", "US$", "$" or "¢" are to US currency, references to "pounds sterling", "£", "pounds", "pence" or "p" are to UK currency (there are 100 pence to each pound) and references to "euro" or "€" are to the European single currency. The following table sets forth for each year the average of the noon buying rates on the last business day of each month of that year, as certified for customs purposes by the Federal Reserve Bank of New York, for pounds sterling expressed in US dollars per pound sterling for each of the five most recent fiscal years. Prudential has not used these rates to prepare its consolidated financial statements.

Year ended December 31,

  Average rate
2000   1.51
2001   1.44
2002   1.51
2003   1.65
2004   1.84

        The following table sets forth the high and low noon buying rates for pounds sterling expressed in US dollars per pound sterling for each of the previous six months:

 
  High
  Low
December 2004   1.95   1.91
January 2005   1.91   1.86
February 2005   1.92   1.86
March 2005   1.93   1.87
April 2005   1.92   1.87
May 2005   1.90   1.82

        On June 23, 2005, the noon buying rate was £1.00 = $1.82.

5



RISK FACTORS

        A number of factors (risk factors) affect Prudential's operating results, financial condition and trading price. In common with other industry participants, the profitability of the Group's businesses depends on a mix of factors including mortality and morbidity trends, policy surrender rates, investment performance, and administration and acquisition expense.

        The risk factors mentioned below should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. The information given is as of the date of this report, is not updated, and any forward-looking statements are made subject to the reservations specified below under "Forward-Looking Statements".

Prudential's businesses are inherently subject to market fluctuations and general economic conditions.

        Prudential's businesses are inherently subject to market fluctuations and general economic conditions. In the UK, this is because a significant part of Prudential's shareholders' profit is related to bonuses for policyholders declared on its with-profits products, which are broadly based on historic and current rates of return on equity, real estate and fixed income securities, as well as Prudential's expectations of future investment returns.

        In the US, fluctuations in prevailing interest rates can affect results from Jackson National Life which is predominantly a spread-based business with the majority of its assets invested in fixed income securities. In particular, fixed annuities and stable value products in Jackson National Life expose the Group to the risk that changes in interest rates which are not fully reflected in the interest rates credited to customers will reduce spread. The spread is the difference between the amounts that Jackson National Life is required to pay under the contracts, and the rate of return it is able to earn on its general account investments to support the obligations under the contract. Declines in spread from these products or other spread businesses that Jackson National Life conducts could have a material impact on its businesses or results of operations.

        For some non unit-linked investment products, in particular those written in some of the Group's Asian operations, it may not be possible to hold assets which will provide cash flows to exactly match those relating to policyholder liabilities. This is particularly true in those countries where bond markets are not developed and in certain markets such as Taiwan, Korea and Japan where regulated surrender values are set with reference to the interest rate environment prevailing at the time of policy issue. This is due to the duration and uncertainty of the liability cash flows and the lack of sufficient assets of a suitable duration. This results in a residual asset/liability mismatch risk which can be managed but not eliminated.

        In all markets in which Prudential operates, its businesses are susceptible to general economic conditions and changes in investment returns which may also change the level of demand for Prudential's products. Past uncertain trends in international economic and investment climates which have adversely affected Prudential's business and profitability could be repeated. This adverse effect would be felt principally through reduced returns and credit defaults (in fixed interest corporate bonds or unsecured lending), and may continue to affect the business unless conditions improve. In addition, falling investment returns could impair Prudential's operational capability, including its ability to write significant volumes of new business.

        See Item 4, "Information on the Company—Business of Prudential—Investments" for a description of Prudential's invested assets, investment strategies and investment yields. See also Item 5, "Operating and Financial Review and Prospects—Factors Affecting Results of Operations—General Economic and Market Conditions".

6



Prudential is subject to the risk of exchange rate fluctuations owing to the geographical diversity of its businesses.

        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 and shareholders' funds is not separately managed other than hedging activity in respect of the US dollar and US dollar related components of the Financial Groups Directive surplus capital. This currency exposure could impact on the Group's gearing ratios (defined as debt over debt plus shareholder funds). The impact of gains or losses on currency translations is recorded as a component of shareholders' funds within the consolidated statement of total recognized gains and losses.

        Of core structural borrowings at December 31, 2004 of £2,797 million, £898 million was denominated in US dollars, partially to hedge the currency exposure arising from Prudential's investment in its US operations. The impact of gains or losses on currency translation is recorded as a component of shareholders' funds within the consolidated statement of total recognized gains and losses. This loss primarily arises upon translation into pounds sterling of the investments in Prudential's US and Asian operations, but reflects the offset of exchange gains of £64 million on the carrying value of the US dollar denominated borrowings, reflecting movements in the US dollar to pounds sterling exchange rate during 2004. See Item 11, "Quantitative and Qualitative Disclosures about Market Risk".

Prudential conducts its businesses subject to regulation and associated regulatory risks, including the effects of changes in the laws, regulations, policies and interpretations in the markets in which it operates.

        Changes in government policy, legislation or regulatory interpretation applying to companies in the financial services and insurance industries in any of the markets in which Prudential operates, which in some circumstances may be applied retrospectively, may adversely affect Prudential's product range, distribution channels, capital requirements and, consequently, reported results and financing requirements. For instance, these changes include possible changes in the regulatory framework for pension arrangements and policies, the regulation of selling practices and solvency requirements or tax law or interpretation. In the UK the Financial Services Authority's ("FSA") depolarization reforms and the rules relating to stakeholder products could have a significant effect on the types of products sold by Prudential, how its products are priced, distributed and sold and on shareholders' return.

        Similar changes in regulation in other jurisdictions could also have an impact elsewhere in the Group.

        The EU Insurance Groups Directive, which was implemented in the UK in 2001, together with the FGD, which became effective from January 1, 2005, 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 implementation of these directives leads to Prudential being required to maintain a somewhat higher amount of capital as calculated at the Group level than necessary in respect of some of its businesses. The FGD parent company solvency requirements have to be complied with continuously starting January 1, 2005, with the result that Prudential needs to maintain an appropriate amount of capital at the parent company level to accommodate, for example, short-term movements in global foreign exchange rates to the extent not hedged, interest rates, deterioration in the credit quality of the Group's bond portfolios and equity markets. In addition, changes in the local regulatory regimes of designated territories could affect the calculation of the Group's solvency position.

7



        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.

        Various jurisdictions in which Prudential operates have created investor compensation schemes that require mandatory contributions from market participants in some instances in the event of a failure of another market participant. As a major participant in the majority of its chosen markets, circumstances could arise where Prudential, along with other companies, may be required to make such contributions. See "Item 5—Operating and Financial Review and Prospects".

        See Item 5, "Operating and Financial Review and Prospects—Factors Affecting Results of Operations—Government Policy and Legislation" and Item 4, "Information on the Company—Supervision and Regulation of Prudential".

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.

        The resolution of several issues affecting the financial services industry could have a negative impact on Prudential's reported results or on its relations with current and potential customers. These could be a review of business sold in the past under previously 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 such as the requirement in the UK to provide redress to certain past purchasers of pension and mortgage endowment policies and regulatory reviews on products sold and industry practices, including in respect of businesses it has closed.

        In the US, federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund, variable annuity and insurance product industries including the broker-dealer system. As a result of publicity relating to widespread perceptions of industry abuses, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms.

        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 unfavorable 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 the UK, the 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 that 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. Further, heightened competition for talented and skilled employees with local experience, particularly in Asia, may limit the Group's potential to grow its business as quickly as planned.

        Within the UK, Prudential's principal competitors in the life market include many of the major stock and mutual retail financial services companies including, in particular, Aviva, Legal & General, HBOS and Standard Life. In 2004 Prudential had a 58% market share of group additional voluntary contributions, 28% of the individual annuity market and in the fourth quarter had a 39% share of the with-profits bond market sold through IFAs.

        Jackson National Life's competitors in the US include major stock and mutual insurance companies, mutual fund organizations, banks and other financial services companies. Jackson National Life's principal life insurance company competitors in the US include AIG, Allstate Financial, Allianz Life of North America, AXA Financial Inc, Hartford Life Inc., ING, John Hancock, Lincoln National Corporation and Met

8



Life. At December 31, 2004 in the United States Jackson National Life was the fourteenth-largest life insurance company in terms of General Account assets, the sixth-largest provider of individual fixed annuities in terms of sales and the fifteenth largest provider of variable annuities in terms of sales.

        Within Asia, the Group's main regional competitors are international financial companies, including AIG, Allianz, ING and Manulife. In 2004, Prudential Corporation Asia was the leading European-based life insurer in Asia in terms of market coverage and number of top 5 markets, with operations in 12 Asian countries.

        Prudential believes competition will intensify across all regions in response to consumer demand, technological advances, the impact of consolidation, regulatory actions and other factors. Prudential's ability to generate an appropriate return depends significantly upon its capacity to anticipate and respond appropriately to these competitive pressures. See Item 4, "Information on the Company—Business of Prudential—Competition".

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 meet its contractual obligations.

        On December 20, 2002, Moody's downgraded the financial strength rating of the Prudential Assurance Company Limited's ("Prudential Assurance" or "PAC") long-term fund from Aaa (on review for possible downgrade) to Aa1 (stable outlook). On January 29, 2003, Standard & Poor's downgraded the financial strength rating of PAC'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- (stable outlook) by Fitch Ratings. The rating from Moody's represents their third highest category out of 9, the rating from Standard & Poor's represents the second highest category out of 8 and the rating from Fitch Ratings represents the second highest category out of 12. Prudential's short-term debt is rated as P-1 by Moody's and A1+ by Standard & Poor's. These ratings represent the highest rating category out of 4 and out of 6 categories for each rating agency, respectively.

Adverse experience in the operational risks inherent in Prudential's business could have a negative impact on its results of operations.

        Operational risks are present in all of Prudential's business, 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 outsources several operations, including 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

9



has not experienced or identified any operational risks in its systems or processes during 2004 or subsequently which have caused, or are expected to cause, a significant negative impact on its results of operations.

Adverse experience against the assumptions used in pricing products and reporting business results could significantly affect Prudential's results of operations.

        Prudential needs to make assumptions about a number of factors including those enumerated in the first paragraph of the discussion of Risk Factors in determining the pricing of its products and for reporting the results of its long-term business operations.

        For example, the assumption that Prudential makes about future expected levels of mortality is particularly relevant for its UK annuity business. In exchange for a premium equal to the capital value of their accumulated pension fund, pension annuity policyholders receive a guaranteed payment, usually monthly, for as long as they are alive. As part of its pension annuity pricing and reserving policy, Prudential assumes that current rates of mortality continuously improve over time. Annuity mortality assumptions were revised in 2003 to assume future improvements in mortality for males and females at levels projected on the Continuous Mortality Investigations medium cohort table as published by the Institute and Faculty of Actuaries. If mortality improvement rates significantly exceed the improvement assumed, Prudential's results of operations could be adversely affected.

        A further example is the assumption that Prudential makes about future expected levels of the rates of early termination of products by its customers (persistency). This is particularly relevant to its lines of business other than its UK annuity business. Prudential's persistency assumptions reflect recent past experience for each relevant line of business. Any expected deterioration in future persistency is also reflected in the assumption. If actual levels of future persistency are significantly lower than assumed (that is, policy termination rates are significantly higher than assumed), Prudential's results of operations could be adversely affected.

As a holding company, Prudential is dependent upon its subsidiaries to cover operating expenses and dividend payments.

        Prudential's insurance and investment management operations are generally conducted through direct and indirect subsidiaries. As a holding company, Prudential's principal sources of funds are dividends from subsidiaries, shareholder backed funds, the shareholder transfer from Prudential's long-term funds and any amounts that may be raised through the issuance of debt and commercial paper.

        Certain of the subsidiaries have regulatory restrictions that can limit the payment of dividends, which in some circumstances could limit the Group's ability to pay dividends to shareholders.

Prudential operates in a number of markets through joint ventures and other arrangements with third parties. These arrangements involve certain risks that Prudential does not face with respect to its consolidated subsidiaries.

        Prudential operates, and in certain markets is required by local regulation to operate, through joint ventures. Prudential's ability to exercise management control over its joint venture operations and its investment in them depends on the terms of the joint venture agreements, in particular, the allocation of control among, and continued co-operation between, the joint venture participants and may be adversely affected by new or existing regulations in the markets in which its joint ventures operate. Prudential may also face financial or other exposure in the event that any of its joint venture partners fails to meet its obligations under the joint venture or encounters financial difficulty. In addition, a significant proportion of the Group's product distribution is carried out through arrangements with third parties not controlled by Prudential and is dependent upon continuation of these relationships. A temporary or permanent disruption to these distribution arrangements could affect Prudential's results of operations.

10



FORWARD-LOOKING STATEMENTS

        This annual report 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, economic and business conditions in the countries in which Prudential operates, 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, together with other factors discussed in "Risk Factors". 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.

        In particular, the following are forward-looking in nature:

        Prudential may also make or disclose written and/or oral forward-looking statements in reports filed or furnished to the US Securities and Exchange Commission, Prudential's annual report and accounts to shareholders, proxy statements, offering circulars, registration statements and prospectuses, press releases and other written materials and in oral statements made by directors, officers or employees of Prudential to third parties, including financial analysts. Prudential undertakes no obligation to update any of the forward-looking statements contained in this annual report or any other forward-looking statements it may make.

11



Item 4. Information on the Company

BUSINESS OF PRUDENTIAL

Overview

        Prudential is a leading international financial services group, providing retail financial services and fund management in the markets in which it operates: the United Kingdom, the United States, Asia and continental Europe. At December 31, 2004, Prudential was one of the 25 largest public companies in the United Kingdom in terms of market capitalization on the London Stock Exchange. Prudential is not affiliated with Prudential Financial, Inc. or its subsidiary, The Prudential Insurance Company of America.

        Prudential has been writing life insurance in the United Kingdom for over 150 years and has had the largest long-term fund in the United Kingdom for over a century. Prudential began writing property and casualty insurance in 1915, and expanded its business into British Commonwealth countries, including Singapore and Malaysia, in the 1920s and 1930s. In 1986, Prudential acquired Jackson National Life Insurance Company, a US insurance company writing life and fixed annuity business. A group strategy review in the early 1990s identified significant opportunities for Prudential in the Asian life sector and Prudential Corporation Asia was established in 1994 to develop a material and profitable Asian business. In 1998, Prudential launched Egg, now a leading e-commerce retail financial services provider, and in 1999, Prudential acquired M&G, a leading UK fund manager. In June 2000, Prudential completed its listing on the New York Stock Exchange and completed an initial public offering of Egg plc on the London Stock Exchange. In January 2002, Prudential completed the transfer of its personal lines property and casualty insurance business to Winterthur Insurance and the Churchill Group, its UK subsidiary, for consideration of £353 million.

        In the United Kingdom, Prudential offers a range of retail financial products and services, including long-term insurance and asset accumulation and retirement income products (life insurance, pensions and pension annuities), retail investment and unit trust products, fund management services and banking products. Prudential primarily distributes these products through independent financial advisers, referred to as IFAs, bank branches, and direct marketing, by telephone, mail and the internet.

        At December 31, 2004, in the United Kingdom, Prudential was:


        In the United States, Prudential offers a range of products through Jackson National Life Insurance Company ("JNL"), including fixed, fixed-indexed and variable annuities, life insurance, guaranteed investment contracts and funding agreements. Equity-Indexed Annuities are now referred to as Fixed-Index Annuities, a term that JNL believes more accurately describes the product design and its benefits and features. Prudential distributes these products through independent insurance agents, securities

12


broker-dealers, registered investment advisors and banks, credit unions and other financial institutions. At December 31, 2004, in the United States, Jackson National Life was:


(1)
Source: National Underwriter Insurance Data Services from Highline Data

(2)
Source: LIMRA

(3)
Source: VARDS

        Prudential Corporation Asia is the leading European-based life insurer in Asia in terms of market coverage and number of top 5 markets, with operations in 12 Asian countries. Prudential Corporation Asia offers a mix of life insurance with accident and health options, selected personal lines property and casualty insurance and mutual funds with the product range tailored to suit the individual country markets. Its insurance products are distributed mainly through an agency sales-force and complementary bancassurance agreements while the majority of mutual funds are sold through banks and brokers. Its life operations in China and India are through joint ventures in which it holds 50% and 26%, respectively. In addition, in India, Prudential holds 55% of a fund management joint venture with ICICI and in Hong Kong it has a 36% stake in a joint venture with Bank of China International for MPF and mutual funds.

        At December 31, 2004 Prudential Corporation Asia had:

13


        Prudential's operating profit under UK GAAP on the modified statutory basis before amortization of goodwill and tax for the periods indicated is set forth in the table below.

 
  Year Ended
December 31,

 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
UK and Europe Insurance Operations   305   256   372  
M&G   136   83   71  
Egg (continuing operations)   43   55   27  
   
 
 
 
  Total UK and Europe operations   484   394   470  
US operations (continuing operations)   182   140   131  
Asian operations   130   71   62  
Group activities   (193 ) (181 ) (189 )
   
 
 
 
  Total continuing operations   603   424   474  
Discontinued operations:              
  Egg France   (37 ) (89 ) (47 )
  US banking operations   17   22   22  
   
 
 
 
Total operating profit before amortization of goodwill and tax(1)   583   357   449  
   
 
 
 

(1)
In determining operating profit (based on a long-term investment returns before amortization of goodwill and tax), the Group has used the expected long-term investment return and excluded amortization of goodwill and exceptional items. The directors believe that such presentation better reflects the Group's underlying performance on a statutory basis of measurement.


Strategy

Shareholder Focus

        Prudential's strong mix of business around the world positions it well to benefit from the growth in customer demand for asset accumulation and income in retirement. Prudential believes that its international reach and diversity of earnings will continue to give it a significant advantage.

        Prudential's commitment to its shareholders is to maximize the value over the time of their investment. Prudential does this by investing for the long-term to develop and bring out the best in its people and its business to produce superior products and services, and hence superior financial returns.

        Prudential's aim is to develop lasting relationships with its customers and policyholders, through products and services that offer value for money and security. Prudential seeks to continually enhance its reputation, built over 150 years, for integrity and for acting responsibly within society.

Building the Platform

        In recent years, the global retail financial services industry has undergone significant change. Changes in underlying demographics, government attitudes, regulatory requirements, technology and customer demands are all driving fundamental change in the industry. Prudential is committed to delivering superior returns to its shareholders and has therefore reconfigured its business to compete more effectively in this changing environment.

        Over the past six years, Prudential has transformed itself from a business with a narrow product range and limited distribution channels focus into a multi-channel business with a broad product range and a clear retail financial services focus. At the same time, Prudential has withdrawn from those operations or markets that did not meet its target returns or that did not offer the opportunities to achieve critical mass in the desired timeframe.

14



        Prudential has significantly restructured its operations in both the United Kingdom and the United States over the last few years to improve its customer focus and management accountability, and to broaden its product range and distribution reach.

        In the United Kingdom, Prudential restructured its long-term savings business into a single integrated business combining Prudential's UK businesses with that of Scottish Amicable, which was acquired in 1997, to form Prudential UK Insurance Operations. The simplified organizational structure was effective from January 1, 2002. This has resulted in improved operational effectiveness through removal of duplication, greater customer focus and reduced operating costs. Meanwhile, Egg added banking products to Prudential's product range and has a market leading on-line position in providing banking and insurance products. The acquisition of M&G in 1999 has enhanced Prudential's retail, institutional and internal fund management capability.

        In the United States, Prudential has significantly diversified its product range and distribution strategy. Prudential has launched and developed its own equity-based, index-linked and stable value product ranges complementing its fixed annuity products, successfully entered the broker-dealer market and significantly grown its presence in the bank channel.

        In Asia, building on a solid base of established operations in Singapore, Hong Kong and Malaysia, Prudential has followed since 1994 a clear, value creating strategy of entering new markets, building and diversifying distribution and launching innovative products through targeting profitable market segments.

        The cost of development initiatives has adversely impacted, and will continue to adversely impact, short-term earnings, but Prudential believes these investments are building long-term shareholder value.

        This value is clearly demonstrated by the scale and mix of Prudential's new business sales. In 2004, new business inflows exceeded £36 billion with over half coming from mutual fund sales, and 67% coming from outside the United Kingdom.

        This transformation has created a strong platform to pursue strategic initiatives for future growth and shareholder value creation.

Growing the Business

        Prudential is conscious that the retail financial services industry continues to evolve, and it expects to continue to adapt its business to maintain a strong advantage over its competitors while delivering returns to shareholders. Prudential's goal is to pursue its key strategic themes of maintaining focus on its customers, investing in technology to improve further customer access and service, driving down costs and driving growth in new and expanding markets.

        The strength of Prudential's businesses and positive developments in a number of its markets represent an opportunity to enhance its market position and generate improved returns for its shareholders. A strong financial position at a Group level provides increased financial flexibility and allow Prudential to capitalize on these opportunities as they arise. In response to these developments the Board decided in October 2004 to launch a 1 for 6 rights offering. The majority of the net proceeds of Prudential's rights offering (£1,021 million) will be used to provide capital to support Prudential's growth plans for the UK life business and to fund a potential opportunity to increase its ownership from 26% to 49% of its joint venture life insurance business with ICICI in India. The remainder of the proceeds will be used to ensure that Prudential continues to meet the parent company solvency test under the EU Financial Groups Directive ("FGD") that became effective from January 1, 2005. The proceeds of the rights offering have initially been invested centrally within the Group in fixed interest securities.

15



Driving Growth

        Within its existing major markets of the United Kingdom, the United States and Asia, Prudential believes fundamental shifts in demographics and in the manner of pension provision will create significant opportunities for future profitable growth. At the same time as pursuing growth in its existing markets, Prudential continues to seek new markets in which it believes it can create value for its shareholders.

        In February 2002, M&G announced the launch of M&G International, focused initially on the distribution of M&G branded mutual funds to retail investors in Germany, Austria and Italy. In 2004, gross fund inflows increased fourfold to €611 million (£433 million), compared with 2003.

        In early 2002, Prudential reviewed the strategy for its Prudential and Scottish Amicable branded long-term business within continental Europe. The review concluded that an organic growth strategy based on investment in the German and French markets would be too slow and expensive to create value in these markets and would require significant acquisitions to create scale. Further, the analysis indicated that the returns achievable from any available acquisition would be too low to justify the investment of capital. As a consequence, in November 2002, Prudential agreed to sell its German long-term business to Canada Life for £82 million. This sale was completed in January 2003. In December 2003, Prudential agreed the sale of Prudential Europe Management Services Limited, its European administration company to Capita Life and Pensions Services Ireland Limited for £16 million. As part of this transaction a ten year third-party administration contract was put in place between the Prudential and Capita Life and Pensions Ireland Limited to ensure continuity of administration services to the company.

        Prudential believes that Asia offers significant long-term growth opportunities and its strategy is designed to create material and sustainable value in Asia by focusing on three dimensions: entering countries with opportunities to leverage its strengths, building and diversifying distribution and providing innovative customer-focused products. In India, Prudential's joint venture with ICICI continues to be the leading private sector player. In 2004, the Indian government announced its intention to allow increased foreign ownership in Indian companies, and Prudential remains interested in increasing its stake in the joint venture. However, the relevant legislation has not yet been put before the Indian Parliament. At present Prudential is not looking to expand the number of countries in Asia in which it operates. Prudential will however continue to diversify both channels and products within existing territories and increase its coverage within countries where it is already operating.

        In May 2002, Egg acquired 100% of Zebank, a French direct financial services company for £22.8 million in cash. During 2003 the decision was taken that the development of the business in France required a level of investment greater than that Egg was prepared to take on a standalone basis. Egg therefore began negotiations with potential partners that may have led to a joint venture or similar transaction. However, no suitable business partner was identified subsequently. On July 13, 2004, Egg announced its withdrawal from the French market to focus on its successful UK business. The exit from France was completed in Q1 2005 and the total closure costs are expected to be within the provision (£113 million) established in July 2004.

        The discussions with potential partners in relation to Egg's French business led to expressions of interest in Egg from a number of potential purchasers and as a result Prudential announced on January 14, 2004 that it was in preliminary discussions regarding a possible transaction with respect to its 79% shareholding in Egg. Following an extensive process, Prudential announced on August 3, 2004 that it was no longer in discussions with respect to its shareholding in Egg. Prudential intends to protect and build on its value of its investment while Egg remains part of the Group.

        During 2004 and the first quarter of 2005, Prudential UK was appointed to work with major independent financial advisor groups ("IFAs") such as Sesame, Millfield, Tenet and Burns Anderson on

16



the design of their respective multi-tie propositions. It has also been appointed to the regulated multi-tie panels for Millfield, Burns Anderson, THINC Destini and Barclays.

        The UK insurance market is starting to recover from three years of decline. During this period, Prudential transformed its UK insurance business from a direct-sales operation, selling with-profits products, into a company that sells mainly shareholder-backed products through a range of channels, including independent financial advisers, business to business and partnership agreements with other companies. Prudential also improved its efficiency and broadened its product range. Over the next few years, Prudential sees new opportunities arising from the creation of multi-ties, and has won places on many of the multi-tie panels announced to date. Prudential expects these agreements to begin to have an effect on its performance in 2005, and to make an increasing contribution thereafter.

        In October 2004 Prudential launched PruHealth, a UK healthcare product that links health and fitness to the cost of medical insurance. As PruHealth is not a life insurance product, its premium income is not reported as new business sales; for the first quarter of 2005, the gross written premiums were £1 million. Support for PruHealth is strong in the IFA channel and its rate of growth is accelerating. The product has been developed through a joint venture with Discovery of South Africa.

        In November 2004, Prudential and its Chinese joint venture partner CITIC were granted a life insurance license for Shanghai in addition to the existing life insurance licenses for Guangzhou, Beijing and Suzhou where operations commenced in 2000, 2003 and 2004, respectively. In the first quarter of 2005, Prudential and its joint venture partner CITIC were granted three more life insurance licenses for Dongguan, Foshan and Wuhan and in May 2005 announced that it had been awarded another license for Zhongshan. CITIC Prudential's new branches are expected to open for business in the second half of 2005. Prudential is now the only European life insurance joint venture with licenses for eight Chinese cities.

        In November 2004, Prudential announced the purchase of Life Insurance Company of Georgia for £142 million. This acquisition will double the number of JNL's in-force life and annuity policies, add scale to its operating platform and expand its distribution capability. This will enable JNL to grow its life business at a higher return and faster rate than can be achieved organically. JNL anticipates the capital provided will be returned over a period of about 5 years. The planning for the integration of the business is on track and full integration is anticipated within 12 months of closing the transaction. The purchase was completed on May 18, 2005.

        In October 2004, JNL completed the sale of Jackson Federal Bank ("JFB") to Union Bank of California for £166 million. JFB's principal area of business was banking and commercial real estate lending, which no longer aligned with JNL's strategy. Accordingly, the results of operations for Jackson Federal Bank are reported as discontinued operations in the accompanying financial statements.

        Prudential continues to consider opportunities to acquire businesses to further the strategy of growing its business, particularly in new and expanding markets. Prudential may finance these acquisitions with bank borrowings, debt or equity issuances or a combination of such financings.

Focusing on Customers

        Prudential's goal is to deliver products that its customers want to buy, through the distribution channels they wish to use. Prudential is continually exploring opportunities to expand its distribution reach and broaden its product offering.

        In the United Kingdom, Prudential has complementary businesses and market-leading positions in key product areas, enabling it to deliver sustained growth in the low margin environment in which it now operates. The businesses comprising Prudential's UK Insurance Operations have undergone enormous strategic transformations in recent years, bringing together several operating units under the powerful Prudential brand and improving service to over seven million customers. In 2002, Prudential's

17



UK Insurance Operations announced the development of an outsourced customer service operation in Mumbai, India. In May 2003, the Mumbai customer service center opened and at the end of 2004 employed over 880 people. Measures to improve customer service continued in 2004 with a number of initiatives to simplify communication channels with both customers and intermediaries.

        M&G is Prudential's UK and European fund management business and had over £126 billion of funds under management as of December 31, 2004, of which £98 billion related to Prudential's long-term business funds. 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. Based on May 2005 data from the Investment Management Association, M&G ranks as the fourth largest asset manager in the UK.

        Egg has 3.1 million customers who are defined as "marketable" based on their activity levels. Moving forward, Egg will focus on growing lending balances and fee income through a mix of both acquisition and cross sales rather than by customer acquisition as the key growth metric.

        In the United States, Prudential, through Jackson National Life, is one of the few providers to have a significant market position across the range of fixed, variable and fixed-indexed annuity products. It also offers life and institutional products. Jackson National Life has expanded its distribution channels to include independent agents, broker-dealers, banks, registered investment advisors and other financial institutions. Through the recent acquisition of Life Insurance Company of Georgia, JNL will double its number of in-force life and annuity policies, add scale to its operating platform and expand its distribution capability. This will enable JNL to grow its life business at a higher return and faster rate than achievable organically.

        In Asia, Prudential has a reputation for developing customer-focused and innovative savings and insurance products. It leverages UK and US product expertise and works with Asian regulators to bring new products to market, achieving particular success with unit-linked products. While Prudential believes it can best manage customer service quality in Asia through ownership of distribution channels, it also gives customers the choice to access its products through complementary bancassurance arrangements.

Summary

        Prudential's strategic initiatives over the past few years have significantly changed the shape and focus of the group and have built a platform for further growth and value generation. Prudential believes that by continuing to implement its strategy of product innovation for the benefit of its customers, improve efficiency and develop new distribution channels, it will maximize value for its shareholders over the long term.


Company Address and Agent

        Prudential plc is a public limited company organized under the laws of England and Wales. Our registered office is Laurence Pountney Hill, London EC4R 0HH, England (telephone: +44 20 7220 7588). Our agent in the United States is Jackson National Life Insurance Company, located at 1 Corporate Way, Lansing, Michigan 48951, United States of America.

18




Significant Subsidiaries

        The table below sets forth Prudential's significant subsidiaries.

Name of Company

  Percentage
Owned(1)

  Country of
Incorporation

The Prudential Assurance Company Limited   100%   England and Wales
Prudential Annuities Limited(2)   100%   England and Wales
Prudential Retirement Income Limited(2)   100%   Scotland
M&G Investment Management Limited(2)   100%   England and Wales
Egg Banking plc(2)(3)   79%   England and Wales
Jackson National Life Insurance Company(2)   100%   United States
Prudential Assurance Company Singapore (Pte) Limited(2)   100%   Singapore
PCA Life Assurance Company Limited   99%   Taiwan

(1)
Percentage of equity owned by Prudential directly or indirectly. The percentage of voting power held is the same as the percentage owned. Each subsidiary has one class of ordinary shares and operates mainly in its country of incorporation, except for Prudential Retirement Income Limited which operates mainly in England and Wales.

(2)
Owned by a subsidiary of Prudential.

(3)
Egg Banking plc is a subsidiary of Egg plc, a listed subsidiary of Prudential. The ordinary shares of Egg plc, of which there is only one class, are 79% owned by Prudential and 21% owned by shareholders external to the Prudential group.

19



UK and Europe Business

Introduction

        Prudential's UK business is structured into business units, each focusing on its respective target customer markets. Prudential's UK business units are UK and Europe Insurance Operations, M&G and Egg.

        The following discussion describes:

        In 2004, Prudential's UK and Europe business generated operating profit from continuing operations before amortization of goodwill and tax of £484 million and total UK and Europe new business insurance premiums of £6,538 million and investment flows of £5,845 million. As of December 31, 2004, M&G had over £126 billion funds under management and Egg had customer deposits of £6,336 million and a credit card book of £3,578 million.

UK Retail Financial Services Market Overview

        The United Kingdom is one of the world's largest life insurance markets in terms of premiums and is one of the largest retail banking markets. In recent years, the UK insurance and banking markets have changed significantly and are continuing to evolve as a result of changes in regulation and government policy, demographics, technological development and consumer awareness and attitudes. Retail financial services providers are adapting to these changes to meet consumer needs by broadening the range of products that they offer and the means by which those products are distributed to, and accessed by, customers.

        The historical divisions between insurance, banking and other financial products are being eroded. It is increasingly common for providers to offer a range of pension products, life products and services, property and casualty insurance, banking products and retail investment products and services. Consumers are increasingly being offered access to these products through direct marketing and over the internet, as well as through the traditional company salesforce, IFAs, and bank branch distribution channels. However, for more complicated products, detailed "fact finds" are often required and consequently face-to-face advice is still preferred.

        Independent financial advisors continue to be the principle channel for the distribution of life and pension products for insurers in the UK. This channel is undergoing significant change with the introduction by the Financial Services Authority ("FSA") of new "depolarization" rules leading to the establishment of multi-tie panels. Over the next few years, Prudential UK expects that a significant proportion of IFAs, which previously operated as whole-of-market providers, will move to a panel approach whereby they will distribute the product range of a select number of life companies.

        Depolarization is also expected to have an effect on the UK bank distribution market as some banks move to offer their customers products from a panel of different providers rather then from a single product provider.

        Competition among retail financial service companies is focused on product range, distribution reach, brand, investment performance and the specific benefits offered by products, charges and financial strength.

20



        Prudential believes the prospects for the UK life insurance industry are improving and that it is well positioned to take advantage of the opportunities presented. In accordance with this, a proportion of Prudential's rights offering proceeds is to be used to support Prudential's growth plans in the UK. During 2005, Prudential UK and Europe sales are expected to grow by 10%, given the expectation of market growth of 5%.

UK Products and Profitability

        In common with other UK long-term insurance companies, Prudential's products are structured as either with-profits (participating) products, or non-participating products including annuities in payment and unit-linked products. Depending upon the structure, the level of shareholders' interest in the value of policies and the related profit or loss varies.

        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 PAC's long-term fund. The return to shareholders on virtually all 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% of the distribution from the main with-profits fund as bonus additions to their policies and shareholders receive 10% as a statutory transfer.

        In 2004, profits distributed from Prudential's primary with-profits fund amounted to £1,986 million, of which £1,788 million (90%) was added to policies as bonuses, and £198 million (10%) was available for distribution to shareholders and will be paid as a dividend in 2005.

        The profits from almost all Prudential's new non-participating business written since July 1, 2004 accrue solely to shareholders. Such business is written in the non-profit sub-fund within PAC's long-term fund, or in various shareholder owned direct or indirect subsidiaries, the most significant of which is Prudential Retirement Income Limited ("PRIL"). There is a substantial volume of in-force non-participating business in PAC's with-profits fund and that fund's wholly owned subsidiary Prudential Annuities Limited ("PAL"); profits from this business accrue to the with-profits fund. The vast majority of external non-profit annuity business is now written in PRIL and, with effect from July 1, 2004, immediate annuities arising from vesting deferred annuity policies were reinsured to PRIL.

Products

        The traditional life insurance product offered by UK life insurance companies was a long-term savings product with a life insurance component. The life insurance element conferred tax advantages that distinguished the traditional life insurance products offered in the United Kingdom from the savings products offered by banks, building societies and unit trust companies. The gradual reduction of these tax advantages and increasing sales of single premium life products have resulted in the distinction between life insurance and other long-term savings products becoming less important. Pension products remain tax-advantaged within certain limits.

        Prudential expects demand for private personal pension and savings products to increase over the medium to long term, in part reflecting a change in the UK government's approach to social security that has encouraged long-term savings through tax advantages, but also in reaction to the growing realization that state-provided pensions are unlikely to provide sufficient retirement income. An ageing population is focusing on asset-accumulation and other retirement products to supplement their state benefits, while younger generations are focusing on pension and long-term savings products as well as health and income protection cover.

21



        During the late 1980s, the UK government began encouraging individuals to invest in equities, with particular emphasis on UK equities. The UK government's privatization program and the introduction in 1988 of tax-advantaged Personal Equity Plans, referred to as PEPs, considerably widened the UK equity investor base. The current UK government replaced PEPs in April 1999 with Individual Savings Accounts, referred to as ISAs, a tax-advantaged product that offers equity, insurance and deposit investment options. ISAs will continue until 2010 based on government pronouncements.

        The UK government introduced "stakeholder pensions" in April 2001 with the intention of creating a pension for individuals who were earning enough to be able to afford to make a contribution towards a pension but were not currently doing so. This initiative built on previous changes, such as the introduction of personal pensions in 1988.

        Until the late 1990s, the UK's regulation of savings has largely focused on the sales process, rather than on the product design. With the advent of "stakeholder' pensions, the government made a tentative step into product regulation—a pension product can only use the name "Stakeholder' if it meets certain conditions, concerning charges, access and terms. However, the sales regulation for these pensions was just as onerous as for non-stakeholder pensions, with all sales requiring a full fact find of the customer to check suitability.

        Following the Sandler Review, which was reported in 2002, HM Treasury and the Department of Work and Pensions have been developing regulatory constraints for a new set of "Stakeholder' products based on simplicity, charge caps, and safety (by controlling investment risk). These new stakeholder products will include a cash deposit account, a medium-term savings vehicle, a pension (a revised version of the existing stakeholder pension), and a Child Trust Fund (to which the government will contribute for every new-born child in the UK). It is proposed that this suite of products will operate within a lighter-touch regulatory sales and advice regime. The advice is based on standard questions which are designed to determine whether a savings or investment product from a stakeholder range is suitable for a customer. It is aimed at minimizing potential customer detriment. See "—Supervision and Regulation of Prudential—UK Supervision and Regulation—Application of 2000 Act Regulatory Regime to Prudential—Regulation of Insurance Business".

        The product requirements, and the lighter touch sales approach, have now been determined and took effect from April 2005. The extent of the industry's participation in the new stakeholder regime is likely to depend very heavily on the balance of charges available and costs associated with the new sales approach.

        Historically, the majority of the life and pensions business written in the United Kingdom was with-profits business. However, in response to regulatory scrutiny and subsequent changes in the regulatory environment and customer requirements, with-profits products are being increasingly supplemented by simpler unit-linked products. For a detailed description of Prudential's with-profits products and policies, "—Shareholders' Interests in Prudential's Long-term Insurance Business—With-profits Products".

Distribution

Direct to Consumer

        The direct to consumer distribution channel is primarily charged with increasing revenue from existing Prudential customers and by seeking new customers. Direct to Consumer includes the telephone and Internet and focuses on annuities, protection and health products.

Business to Business

        The business to business distribution channel focuses on the maximization of the value of the existing book of corporate pension schemes and winning new schemes. This channel targets Prudential's

22



strong base of corporate pensions through workplace marketing. Prudential UK Insurance Operations corporate pension products are marketed through consulting actuaries, benefits advisers and its company employer and employee relationship management teams. Consulting actuaries and benefits advisers are IFAs, but are not generally the same as the retail IFAs being targeted via the intermediary channel discussed below. In addition, Prudential markets bulk annuities to trustees of Defined Benefit schemes via employee benefit consultants.

        Within the Corporate Pensions sector the adviser market is heavily dominated by a small number of Employee Benefit Consultants ("EBCs") who control the majority of the 250 plus lives sectors. Prudential targets its proposition at medium to large sized employers, distributed via the major EBC's on a nil commission basis. Prudential has a well developed and comprehensive worksite communication proposition that is effectively deployed within both our new and existing clients to educate and inform members as well as increasing the take up within the arrangements. Prudential is the provider to 20% of FTSE 350 companies, managing more than 4,000 pension schemes.

Intermediaries

        The intermediary channel focuses on the distribution of products to individual customers via retail IFAs. This channel was restructured during 2004 in response to the new regulatory regime effective from December 2004. A new infrastructure was created to customize the levels of support required. A new divisional structure was implemented that matches field-based account managers with high value customer segments. Lower value segments are serviced by telephone-based account managers. The new organization structure positions the Intermediaries business to extract maximum value from the opportunities the new regulatory regime presents.

Corporate Partnerships

        The corporate partnerships channel focuses on developing strong relationships with banks, retail brands and other distributors. Corporate partnerships also seeks to help our distribution partners in their distribution and product development strategies. In October 2002, Prudential's UK Insurance Operations announced an agreement with Abbey National to distribute the Prudence Bond in the United Kingdom. This agreement was discontinued in 2004. In January 2003, Zurich Financial Services signed a five-year distribution agreement for Zurich Advice Network to offer customers a Prudential annuity post depolarization and improved annuity rates pre-depolarization and in 2004 Pearl Assurance and Prudential signed an agreement whereby Prudential provides annuities to Pearl's vesting personal pension customers. Prudential has also signed a number of deals with banks to provide life insurance. The partnership with Lloyds TSB is one of the largest of these. In December 2004, Prudential reached agreement with Royal London to reassure Scottish Life's approximately 60,000 in-force annuities, representing in excess of £1 billion of funds under management.

        Retail financial services and products are distributed face-to-face, through branches, tied agents, company salesforces and IFAs, or directly by mail, telephone and over the internet. Tied agents are exclusive agents who represent only one insurer and must offer customers the products most suitable to their needs, but only from the range of products offered by that insurer. In recent years the high costs of company salesforces and tied agency networks, combined with customers perceiving a lack of choice, have meant that salesforces and tied agents have lost significant market share to IFAs, with the result that many insurers, including Prudential, have chosen to close these tied agents and direct salesforce networks.

        Increasingly, consumers require wider access to financial products than agents can provide. IFAs, banks, direct marketing and, to a lesser extent, e-commerce distribution are gaining market share at the expense of traditional company salesforces. Direct and e-commerce distribution methods are generally lower-cost than other methods but have not been conducive to providing financial advice to the

23



consumer to date. Accordingly, products distributed directly are generally more straightforward and have lower, often fee-based, charges.

        IFAs are required by the UK polarization laws to provide the best advice to customers, considering all of the products available in the market and the customer's particular circumstances, and are legally responsible for their own advice. In contrast, company salesforces may only sell the products of the company of which they are employed, but must nevertheless provide the best advice in light of the customer's particular circumstances. A company has legal responsibility for the advice its salesforce provides and the conduct of its tied agents.

        The FSA announced a relaxation of the polarization rules in March 2001 with respect to stakeholder pension schemes and direct offer financial promotions for packaged products (which include life policies other than pure protection policies, pensions, regulated collective investment schemes and investment trust savings schemes). As a result of these changes, tied sales forces and appointed representatives of product provider firms are now free to market stakeholder pensions manufactured by any other company.

        The FSA following a consultation process, published new rules at the end of 2004 implementing new "depolarization' rules. Advisers now have the choice of being "single tied' as before, or multi tied advising on the products of a limited range of providers, or IFA where they offer products from the "whole of market' as now, but they also have to offer a "fee alternative'. Prudnetial's view is a significant number of existing IFAs will choose to adopt a "multi tie' selecting a limited number of large brands.

        In preparation for this change, Prudential has worked with major IFA groups to design and build multi-tie propositions and, as of March 31, 2005, Prudential has been appointed to work with Sesame, Millfield, Tenet and Burns-Anderson on the design of their respective multi-tie propositions. It has also been appointed to the regulated multi-tie panels including, Millfield, Thinc Destini, Barclays and Burns-Anderson.

UK Business Units

UK and Europe Insurance Operations

        In 2004, operating profit before goodwill, amortization and tax from Prudential's long-term UK and Europe Insurance Operations was £305 million. This represented 63% of the total £484 million operating profit before amortization of goodwill and taxation recorded by Prudential in the United Kingdom and Europe from long-term and other operations. See Item 5, "—Operating and Financial Review and Prospects—Analysis by Geographic Region—UK and Europe Operating Results". The UK insurance operation's profit accounts for over 98% of the combined UK and Europe Insurance Operation's profit. Therefore this section primarily focuses on the UK Insurance Operation.

UK Insurance Operations

Products

        Prudential offers a wide range of products, which traditionally have been marketed under the "Prudential" and "Scottish Amicable" brands. From January 2003, however, products have only been sold under the Prudential brand. See Item 5, "—Operating and Financial Review and Prospects—Analysis by Geographic Region—UK and Europe Insurance Operations—UK Restructurings". The products distributed include long-term products consisting of:

24


        Until December 2001, Prudential also offered personal lines property and casualty insurance through its UK Insurance Operations. However it transferred this business in January 2002 to Winterthur Insurance and the Churchill Group, (Winterthur's UK subsidiary) which is now owned by Royal Bank of Scotland. Since April 1, 2002, all new Prudential branded personal lines property and casualty insurance business has been written in Churchill's name. See "—Transfer of Property & Casualty Business to Winterthur".

        In October 2004 Prudential launched PruHealth, a UK healthcare product that links health and fitness to the cost of medical insurance. As PruHealth is not a life insurance product, its premium income is not reported as new business sales; for the first quarter of 2005, the gross written premiums were £1 million. Support for PruHealth is strong in the IFA channel and its rate of growth is accelerating. The product has been developed through our joint venture with Discovery of South Africa.

Long-term Products

        Prudential's long-term products in the United Kingdom consist of life insurance, pension products and pensions annuities. The following table shows Prudential's UK Insurance Operations new business insurance and investment premiums by product line for the periods indicated. New business premiums include deposits for policies with limited or no life contingencies.

 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Life insurance            
  With-profits   246   532   1,875
  Unit-linked   1,565   617   396
   
 
 
    Total life insurance   1,811   1,149   2,271
Pensions            
  With-profits individual   28   35   57
  Unit-linked individual   60   59   88
  Department of Work and Pensions rebates   354   383   305
  Corporate*   432   368   397
   
 
 
    Total pensions   874   845   847
Pension annuities and other retirement products            
  Fixed   3,482   1,855   2,055
  Retail Price Index   204   133   293
  With-profits   76   59   117
   
 
 
    Total pension annuities   3,762   2,047   2,465
   
 
 
Total new business premiums   6,447   4,041   5,583
   
 
 

*
Note: certain investment mandates previously reported as UK Corporate Pension business are now reported as M&G institutional investment flows. This gives rise to a restatement of 2003 UK sales of £320 million (£688 million to £368 million) and restatement of 2002 UK sales of £158 million (£555 million to £397 million).

        New business premiums in 2004 were £6,447 million, up 59% and 16% respectively on 2003 and 2002. This increase principally reflects a growth in sales of Unit-Linked investments of 144% and Pension Annuities of 84%. The 84% growth in Pension Annuities was mainly driven by growth in both individual and bulk annuities and also a reassurance deal for £1,108m with Royal London (see Corporate Partnerships section).

25


Life Insurance Products

        Prudential's UK life insurance products are predominantly medium to long-term savings products with life cover attached, and also include pure protection (term) products. The main savings products Prudential offers are investment bonds.

Savings Products—Investment Bonds

        Prudential offers customers a choice through a range of investment funds to meet different risk and reward objectives. Prudential launched the Flexible Investment Plan ("FIP") in November 2003. Through this plan, our customers have the option to invest in the Prudence Bond (With-Profits) along with a range of unit linked bonds. Advisers can build an individual portfolio and asset allocation model to accurately match a client's risk / reward profile. FIP also gives financial advisers the opportunity to choose from different external fund management groups and the flexibility to make changes to portfolio and asset allocation over time.

        The Prudence Bond, a single premium, unitized with-profits policy with no fixed term, is one of the United Kingdom's leading investment bond products in terms of with-profits market share. Prudential launched the Prospect Bond, another single premium with-profits bond, in October 2003. The Prospect Bond gives investors the opportunity to move out of under-performing funds elsewhere in the market, and into the Prudential With-Profits Fund. In September 2004, Prudential launched the next generation with-profits investment bond, entitled PruFund. A complement for Prudence Bond, it is designed to provide increased transparency and smoothed investment returns to the customer. In 2004, total new business premiums attributable to the PruFund, Prudence Bond, Prospect Bond and the Prudential Investment Bond, were in excess of £246 million. Sales of Prudential's offshore bonds, the International Prudence Bond and International Prudential Portfolio Bond, were £273 million in 2004.

        These with-profits products aim to provide capital growth over the medium to long-term, and access to a range of investment sectors without the costs and risks associated with direct investment into these sectors. Capital growth for the policyholder on with-profits bonds apart from PruFund is achieved by the addition of reversionary or regular bonuses, which are credited to the bond on a daily basis from investment returns achieved within Prudential Assurance's long-term with-profits fund, off-set by charges and expenses incurred in the fund. A final bonus may also be added when the bond is surrendered. PruFund delivers growth through a published expected growth rate, updated quarterly, and a transparent formulaic smoothing mechanism. In contrast the capital return on unit-linked bonds directly reflects the movement in the value of the assets underlying those funds. When funds invested in Prudential Assurance's long-term with-profits fund are either fully or partially withdrawn, Prudential may apply a market value adjustment to the amount paid out.

Life Protection

        Prudential underwrites life protection for companies providing loans to their customers. Sales in 2004 were £795 million mostly generated through partnership agreements with Lloyds TSB and Alliance and Leicester.

Pension Products

        Prudential provides both individual and corporate pension products. In 2004, new business premiums totaled £88 million for individual pensions and £432 million for corporate pensions. Pension products are tax-advantaged long-term savings products that comply with rules established by the UK Inland Revenue and are designed to supplement state-provided pensions. These rules require that, upon retirement, maturity benefits are used to purchase pension annuities by policyholder election at retirement or at least by the age of 75, although they do permit a portion to be taken as a tax-free lump sum. Prior to retirement, these products typically have minimal mortality risk to Prudential and are

26



primarily considered investment products. An exception is where a guaranteed annuity option has been offered on the product, with an element of risk to Prudential both in underlying mortality and investment assumptions.

        Prudential ceased marketing Guaranteed Annuity Options ("GAOs") in 1987, but for a minority of corporate pension schemes GAOs still apply for new members. Current liabilities for this type of business make up less than 1% of the with-profits sub-fund.

        Many of the pension products Prudential offers are with-profits products or offer the option to have all or part of the contributions allocated to a with-profits fund. Where funds invested in the with-profits fund are withdrawn prior to the pension date specified by the policyholder, Prudential may apply a market value adjustment to the amount paid out. The remaining pension products are non-participating products, which include unit-linked products.

Individual Pensions

        Prudential's individual pension range offers unit-linked and unitized with-profits products.

        In 2001, Prudential introduced products that meet the criteria of the UK government's stakeholder pension program. The stakeholder pension is intended for individuals earning enough to be able to afford to make contributions to a pension but who are not currently doing so. The introduction of stakeholder pensions has had implications for, among other things, how Prudential designs, administers, charges for and distributes pension products. The most significant requirements involve capped charges and a low minimum contribution which must be accepted by the provider. The government has capped charges at 1% of the policyholder account balance per annum for stakeholder pensions, which is significantly below the charges on personal pension products previously offered by the UK pensions industry.

Department of Work and Pensions Rebates ("DWP Rebate")

        Prudential also provides individual personal pension products through the DWP Rebate arrangement. Under this arrangement, individuals may elect to contract out of the UK's State Second Pension (referred to as SP2) which was previously known as State Earnings Related Pension Scheme, administered by the UK Department of Work and Pensions. If an individual elects to contract out, then he or she will designate a pensions provider, such as Prudential. Premiums on products sold in this manner are paid through "rebates" from the Department of Work and Pensions, which represent the amount that would be otherwise paid into SP2. Rebate amounts are invested to provide benefits to the individual. Premiums from Department of Work and Pensions rebates are typically reported in the first quarter of each year. In 2004, Prudential recorded total premiums of £354 million from Department of Work and Pensions rebates.

Corporate Pensions

        There are two categories of corporate pension products: defined benefit and defined contribution. Prudential has an established defined benefit plan client base that ranges from small unlisted companies to some of the largest companies in the United Kingdom. In addition, Prudential offers defined contribution products including additional voluntary contribution plans (current UK regulations require that all companies that offer an occupational pension plan must also offer a group additional voluntary contribution plan to their employees). Additional voluntary contribution plans enable employees to make additional pension contributions, either regularly or as a lump sum, to supplement their occupational pension plans.

        Defined benefit plans and products continue to dominate the corporate pensions market in terms of funds under management. In recent years, however, most new plans established have been defined

27



contribution products. In addition, there is an increasing trend among companies to close the plans to new members or to convert existing schemes from defined benefit to defined contribution in order to stabilize or reduce potential pension liabilities.

        Prudential offers group unit-linked policies and with-profits policies to the corporate pensions market. Prudential's defined contribution products are Additional Voluntary Contribution plans, Group Money Purchase Plans, Group Personal Pension plans, Group Stakeholder Pension plans and Executive Pension plans.

        Prudential also has a Company Pension Transfer Plan (or Bulk S32), designed to accept benefits from both defined benefit and defined contribution pension schemes which are winding-up (cease to exist or being replaced by a new type of scheme).

Pension Annuities and other retirement products

        Prudential offers individual conventional immediate annuities that are either fixed or retail price-indexed (referred to as RPI), where annuity payments are guaranteed from the outset, or with-profits annuities, where annuity payments are variable. A total of £2,180 million of individual conventional annuities were sold in 2004. Of this total, £1,055 million were sold to existing Prudential customers with maturing pension policies. The other £1,125 million were sold to new customers, typically individuals with a pension maturing with another provider who chose Prudential to provide their annuity. Prudential also offers bulk annuities, whereby it manages the assets and accepts the liabilities, of a company pension scheme or life fund, usually when it is being wound up by the employer. Due to the nature of the product, the volume of Prudential's bulk annuity sales is unpredictable as it depends on the decision of scheme trustees. In 2004, Prudential sold £1,582 million of bulk annuities, of which £1,108 million related to an agreement with Royal London in which Prudential reached an agreement to reassure Scottish Life's approximately 60,000 in-force annuities.

        Prudential's immediate annuity products provide guaranteed income for a specified time, usually the life of the policyholder, in exchange for a lump-sum capital payment. No surrender value is available under any of these products. The primary risks to Prudential from immediate annuity products, therefore, are mortality improvements and credit risk.

Conventional Annuities

        Prudential's conventional annuities include level (non-increasing), fixed increase and retail price index ("RPI") annuities. Prudential's fixed-increase annuities incorporate automatic increases in annuity payments by fixed amounts over the policyholder's life. The RPI annuities provide for a regular annuity payment to which an additional amount is added periodically based on the increase in the UK Retail Prices Index. In 2004, sales of RPI annuities were £204 million (including £109 million of bulk annuities). In 2004, sales of level and fixed-increase annuities amounted to £3,482 million (including £1,583 million of bulk annuities and £31 million of Flexible Retirement Income Account ("FRIA") products).

With-profits Annuities

        Prudential is one of only a few companies in the United Kingdom writing with-profits annuities. In 2004, Prudential wrote £76 million of this business including £7 million of FRIA sales. Prudential's with-profits annuities combine the income features of annuity products with the investment smoothing features of with-profits products and enable policyholders to obtain equity-type returns over time. Policyholders select an "anticipated bonus" from the specific range Prudential offers for the particular product. The value of the annuity payment each year depends upon the anticipated bonus rate selected by the policyholder when the product is purchased and the bonuses Prudential declares each year during the term of the product. If bonus rates fall below the anticipated rate, then the annuity income falls.

28



Flexible Retirement Income Account

        FRIA offers customers a flexible retirement solution and consists of two separate products. The Flexible Income Draw-down Plan ("FIDP") offers wide investment choice, income flexibility and options on death, including the repayment of the remaining fund as a lump sum. Under the current rules for approval of pension schemes, customers can use this draw-down product to provide retirement income up to age 75. These rules require customers to purchase annuities with any remaining pension funds at age 75. The Flexible Lifetime Annuity ("FLA") offers similar investment choice and income flexibility to FIDP but no lump sum death benefits. Prudential sold £31 million of the FRIA products in 2004.

Home Equity Release Plan

        In 2004, through a partnership with Northern Rock Plc, Prudential offered a lifetime mortgage product to customers aged 60 and over who wished to access the equity in the value of their home. Under the partnership agreement, £11 million of Prudential branded lifetime mortgages were sold in 2004. In May 2005, Prudential announced that its partnership agreement with Northern Rock would come to an end in 2005 and Prudential will further develop lifetime mortgages on its own. These loans are typically used to supplement income in retirement. No capital repayments or interest payments are required during the customer's lifetime under the lifetime mortgage.

Transfer of Property and Casualty Business to Winterthur

        In November 2001, Prudential agreed to transfer its personal lines property and casualty insurance operations to Winterthur and the Churchill Group, its UK subsidiary. On December 31, 2001, the insurance liabilities were almost wholly reassured to Winterthur Insurance. The related cash transfer for this reinsurance was offset in January 2002 against the sales proceeds of this business. The sale was completed on January 4, 2002 for a consideration of £353 million. After allowing for the costs of the sale and other related items, the profit on sale recorded in the 2002 results was £355 million before tax. Profits from this business have been classified as discontinued operations throughout this report.

        As part of the arrangements for the handover of the operations, new personal lines property and casualty insurance business for the three months to April 1, 2002, was written by Prudential with full reinsurance to Winterthur. Since April 1, 2002, all new Prudential branded personal lines property and casualty insurance business has been written in Churchill's name.

Other Closed Businesses

        Prior to 1993, Prudential wrote a wide range of commercial lines property and casualty insurance business, which it sold through brokers and its company salesforce. Prudential also had a London Market operation and specialist marine and aviation insurance operations. Prudential withdrew from all of these areas and, consequently, these businesses are now in run-off. The total claims provisions established for these closed businesses amounted to £104 million, comprising net claims provisions of £87 million and a closure provision of £17 million, at December 31, 2004. Prudential believes these provisions are prudent and does not currently anticipate that it will need to make any further provisions in respect of these closed businesses.

        In 2004, PAC proposed a solvent scheme of arrangement to certain of its creditors pursuant to section 425 of the Companies Act 1985 (the "PAC Scheme") in respect of certain books of business covering marine insurance and reinsurance ("Scheme Business") underwritten by various underwriting pools managed by St Helen's Trust Limited in which PAC was a participant. The Scheme Business also included non-marine insurance and reinsurance underwritten by PAC. The PAC Scheme was approved by the requisite majority of its Scheme Creditors (as defined in the PAC Scheme) on June 24, 2004 and was sanctioned by the High Court of England and Wales on July 9, 2004. The sanctioning order of the High Court was lodged that day with the Registrar of Companies, thereby rendering the PAC Scheme effective on July 9, 2004.

29



        On September 9, 2004, the US Bankruptcy Court granted PAC ancillary relief under section 304 of the US Bankruptcy Code preventing Scheme Creditors from taking any action against PAC in respect of Scheme Business otherwise than in accordance with the terms of the PAC Scheme.

        The PAC Scheme required Scheme Creditors to submit all claims in respect of Scheme Business by 12 noon, London time, on October 7, 2004. Since that time, PAC and Omni Whittington Insurance Services Limited in its capacity as Scheme Manager, have been working with those Scheme Creditors who submitted claims by October 7, 2004 to seek to agree the value of those claims. Approximately 80% of claims submitted by Scheme Creditors under the PAC Scheme have now either been settled, repudiated or the subject of formal settlement offers.

        It should be noted that the PAC Scheme does not apply to United Kingdom statutory classes of insurance including employers' liability coverage and PAC continues to administer new claims in this category.

European Business

        In early 2002, Prudential re-evaluated its strategy for the Prudential and Scottish Amicable-branded long-term business within continental Europe. The review concluded that an organic strategy based on investment in the German and French markets would be too slow and expensive to create value and would require significant acquisitions to create scale. Further, the analysis indicated that the returns achievable from any available acquisition would be too low to justify the investment of capital. This resulted in divestment from France and Germany and, where possible, the outsourcing of administrative functions.

        Prudential sells offshore products via its Dublin based subsidiary Prudential International Assurance. The major products being the International Prudence Bond (which offers a with-profits option) and the International Prudence Portfolio Bond (unit-linked). These are sold via the Intermediary channel described above and in mainland Europe through master distributor intermediary network relationships, including Master Finance in Belgium, ProTrust in Liechtenstein and Austria, Andrew Peat in the Netherlands. Total premiums sold through these partners in 2004 was £91 million.

Sale of German Business to Canada Life

        In November 2002, Prudential agreed to sell its in-force German life business to Canada Life for £82 million. The sale was completed on January 1, 2003. New business policies continued to be underwritten by Prudential International Assurance plc ("PIA") and all in-force business and new business was reassured to Canada Life, and Canada Life retroceded (onwardly reassured) the with-profits business to PAC. A full portfolio transfer was completed following High Court approval on 14 August 2003. The reassurance agreement from PIA to Canada Life was automatically cancelled as a result of the portfolio transfer. The with-profits retrocession agreement was also cancelled, and replaced by a new direct reassurance agreement from Canada Life to PAC.

Closure of French Branch

        In June 2003, Prudential announced its intention to cease writing new business in France and from January 1, 2004 Prudential ceased selling the Prudential Europe Vie product in France. It will continue to administer existing policies.

Sale of Prudential Europe Management Services

        In December 2003, Prudential announced the sale of Prudential Europe Management Services Limited to Capita Life and Pensions Services Ireland Limited for £16 million. As part of the transaction a

30



ten year third-party administration contract was put in place between Prudential and Capita Life and Pensions Services Ireland Limited to ensure continuity of administration services to the company.

        PIA was excluded from the scope of this transfer and remains a Prudential owned company focused on supporting the development of international offshore and cross-border business. PIA's role is to provide an opportunity for "offshore' sales for UK Intermediaries ("UKI") together with sales into continental Europe on a "Freedom of Services" basis (enabling PIA to sell in European countries without establishing a local office) using Master Distributors distribution, which is similar to an IFA network in the UK. The increase in sales in 2004, from both UKI and Master Distributors, provides a platform for further development in 2005.

M&G

        M&G is Prudential's fund management business in the United Kingdom and continental Europe and comprises retail, institutional and internal fund management activities. In 2004, M&G's profit accounted for £136 million of Prudential's 2004 UK operating profit before amortization of goodwill and taxation of £447 million. The table below shows the breakdown in profits between M&G's underlying profits and performance fees over the period indicated.

 
  Period ended December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Underlying Profits   110   70   49
Performance Related Fees   6   8   20
Carried Interest   20   5   2
   
 
 
  Total   136   83   71
   
 
 

        M&G delivered strong underlying profits of £110 million in 2004, a 57% increase on the previous year, reflecting the strengths of M&G's diversified business, disciplined cost management and the success it has had in developing new sources of revenue. In addition, there were also £7 million of one-off provision releases in 2004, the majority of which was due to the satisfactory resolution of a fee negotiation. Between 2002 and 2004, M&G's underlying profit has more than doubled even though the average of the FTSE All Share index in 2004 was at similar levels to 2002.

        Over three years Prudential UK's main with-profits fund, which is principally managed by M&G, has generated annual returns 0.7% higher than its strategic benchmark and 2% higher than its competitor benchmark. Total performance fees in 2004 were £26 million, including £6 million of performance related fees for the management of the Prudential Assurance Company long-term and annuity funds which continued to beat their strategic and competitor benchmarks during the year. M&G also received £20 million which relates to the disposal of some of the investments by PPM Ventures that are not expected to recur.

        Gross fund inflows into M&G's retail products were a record £2 billion in 2004, a 61% increase on 2003 as M&G maintained its fixed income sales and continued to increase fund flows into equity funds on the back of its strong fund performance. Net fund inflows for 2004 were £417 million. This enabled M&G to consolidate its position as one of the top three retail fund managers in the United Kingdom, measured in terms of total funds under management (source: Investment Management Association).

        In its institutional businesses, M&G continued to reap the benefits of its position as a leading innovator in fixed income and private finance, with gross fund inflows increasing by 50% to £3.9 billion during 2004. Net fund inflows were £1.6 billion. The successful strategy of developing new external business lines with attractive margins, using expertise developed for internal funds, generated increased revenue streams, especially in the area of non-correlated assets such as leveraged loans. M&G's private

31



finance business successfully completed two more Collateralized Debt Obligations ("CDOs") during the year, bringing the total number of CDOs launched since 2001 to six.

        M&G's property division, Prudential Property Investment Managers ("PruPIM"), which invests primarily on behalf of the Prudential Assurance Company, significantly increased its funds under management during 2004 and expanded its product offering into the retail marketplace with the launch of the M&G Property Fund alongside its growing unit-linked funds. PruPIM is one of the largest institutional property fund managers in the UK with over £14.8 billion invested in the property market.

        The following table shows funds managed by M&G at the dates indicated.

 
  At December 31,
 
  2004
  2003
  2002
 
  (In £ Billions)

Retail fund management   11   10   9
Institutional fund management   17   14   12
Internal fund management   98   87   79
   
 
 
  Total   126   111   100
   
 
 

Retail Fund Management

        M&G's retail fund management business comprises management and distribution of retail investment products. In its most important market, the United Kingdom, distribution is increasingly through various types of intermediary though it also sells directly to customers. M&G is also expanding its distribution into certain European markets (via M&G International) and some Asian markets.

Institutional Fund Management

        M&G's institutional business is focused on fixed income and pooled pension mandates. Clients are typically large institutional investors, primarily pension funds and insurance companies. In addition to traditional institutional fund management activities, M&G has also expanded its activities in more specialist areas, primarily through its Private Finance and Prudential Finance business units. Private Finance provides fund management services in project finance and securitized debt and Prudential Finance manages the Group's banking relationships, core debt issuance and commercial paper programs and provides capital market solutions for Prudential group companies. M&G also carries out securities lending on behalf of its clients.

Internal Fund Management

        M&G's internal fund management activities are based in the United Kingdom. Total internal funds under management at December 31, 2004 were £98 billion. Internal funds are invested by M&G in equities, fixed income securities, property and private equity.

        Where Prudential chooses to invest internal funds in the United States or Asia, this is done through PPM America in the United States and Prudential Asset Management in Asia. See "—US Business—PPM America" and "—Asian Business—Funds Management" for descriptions of PPM America and Prudential Asset Management, respectively.

Egg

        Egg offers banking products and intermediated services. It was launched in October 1998 with the goal of attracting a new segment of customers and developing a new direct distribution channel. The Egg brand has consistently targeted consumers who like to manage their own financial affairs, seek consistently good value and simple products and prefer the flexibility offered by remote access.

32



Following its unprecedented success in attracting new customers in the first six months, Egg began accepting new applications for deposit accounts exclusively through the internet in April 1999 and since then its business model has remained internet-led, supported by the telephone. By the end of 2004 Egg had 3.1 million customers that are defined as "marketable' based on their activity levels with the majority of these acquired into its highly successful credit card product. These customers are typically aged between 25 and 45, are ABC1 in terms of their social demographics (according to the definition set by the Central Statistical Office of the UK based on occupation) and earn above average salaries.

        Egg's operating profit from continuing operations in 2004 was £43 million, compared with £55 million in 2003.

        Egg UK delivered an operating profit of £74 million in 2004, compared with a £73 million in 2003. Income arising in the UK of £497 million grew by 18 per cent on 2003, with net interest income and non-interest income increasing over 2003 by 9 per cent and 34 per cent respectively. Unsecured lending balances grew by £1.4 billion during 2004, taking total balances to £6.2 billion as at the end of 2004.

        Consistent with the intention to focus on its successful UK business, Egg has sold its investment business to Fidelity Funds Network incurring a £3 million restructuring charge. This will release approximately £20 million of capital back to its core banking business in 2005. At the year end Egg had also put Funds Direct, its investment wrap platform business, up for sale and provided for a £17 million impairment charge against the full carrying value of the underlying assets. During 2004, Egg also incurred £6 million of costs in relation to the process whereby Prudential was considering proposals for its shareholding in Egg. These mainly comprised of loyalty and retention bonus for Egg's staff and other legal and advisory fees. Prudential announced on August 3, 2004 that it was no longer in discussions with respect to its shareholding in Egg.

        The operating loss of the discontinued French operation was £37 million, reflecting the results up to the date of the announcement of Egg's intention to withdraw from the market in July 2004. A provision of £113 million was made for the estimated exit costs. The main components of this provision are cumulative loss on disposal on the lending, savings and brokerage businesses (£39 million), future operating losses (£32 million) and redundancy costs under the agreed social plan (£25 million). £96 million of the exit costs provision had been utilized by the year end.

        Egg's total operating profit before amortization of goodwill and tax in 2004 was £6 million, compared to a loss of £34 million in 2003. This reflects the higher operating loss recorded in France in 2003 (£89 million). Taking into account the French exit cost provision, total loss of Egg in 2004 was £107 million, compared to £34 million in 2003.

        The following table shows the total product balances for both Egg and Prudential branded products at the dates indicated.

Products

 
  At December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Customer savings   6,336   6,452   8,016
Mortgage loans   1,693   1,995   2,360
Credit card receivables   3,578   3,131   2,338
Personal loans   2,619   1,785   973

        Egg's own-branded banking product portfolio includes credit cards, savings accounts, mortgages and personal loans. Egg Card, the UK's first credit card designed for the internet, was launched in September 1999. Egg achieved a market share of 6% of outstanding UK credit card balances at December 31, 2004 and the balance outstanding on credit cards stood at £3,578 million. At

33



December 31, 2004, Egg's branded savings in the UK totaled in £6,215 million and Egg's own-branded mortgage balances stood at £1,102 million and its personal loan balances stood at £2,618 million.

        Egg also offers motor, travel, home and contents and life assurance, with each product type underwritten by different insurers and Egg receiving a sales commission. Egg sold approximately 120,000 policies in 2004.

        Egg also markets Prudential branded products. These product balances, included in the above table, were £591 million of mortgage loans, savings of £121 million and £1 million of personal loans at December 31, 2004.

        Prudential believes that Egg has gained a significant advantage in the provision of internet-based financial services by being among the first to the market with the services and products it offers. Egg has developed into an on-line marketplace, enabling clients to obtain products and services ranging from core banking products and related financial services to intermediated financial and non-financial products and services.

Acquisitions and Disposals

Egg France:

        In May 2002, Egg acquired 100% of Zebank, a French direct financial services company, for £22.8 million in cash (€36 million). The fair value of Zebank's net assets on May 22, 2002, the date the transaction was completed, was £20.3 million (€32 million).

        On November 1, 2002, Egg launched its first retail financial services product in France, an international VISA card, "la Carte Egg". The start-up costs in preparing for launch and building the brand led to a loss of £47 million in the period from acquisition to December 31, 2002. At December 31, 2003 Egg France had 130,000 customers, with 66,000 credit cards in issue and a credit card balance outstanding of £120 million.

        During 2003 the decision was taken that the development of the business in France required a level of investment greater than what Egg was prepared to take on a standalone basis. Egg therefore began negotiations with potential partners that may have led to a joint venture or similar transaction. However, no suitable business partner was identified. On July 13, 2004, Egg announced its withdrawal from the French market to focus on its successful UK business. The exit from France was complete in Q1 2005 and the total closure costs are expected to be within the provision (£113 million) established in July 2004.

Funds Direct:

        In January 2002, Egg announced that it had acquired Funds Direct, an investment wrap platform business, for £2.9 million. The fair value of the net assets acquired on the date of acquisition was £0.9 million. Following the decision to focus on its core UK business, Egg put Funds Direct up for sale and booked a £17 million impairment charge against the full carrying value of the underlying assets in 2004.

Investment Business:

        Egg announced in October 2004 an agreement with Fidelity whereby from Q1 2005, Egg will host Fidelity's Funds Network on its website as its exclusive investment platform. As part of this agreement, Egg also sold its funds supermarket business which had assets under management of around £170 million to Fidelity Funds Network. The transaction resulted in restructuring costs of £3 million in 2004.

34


Reinsurance

        In view of the size and spread of Prudential Assurance's long-term insurance fund, there is little need for reinsurance to protect this business. Some limited reinsurance is maintained and treaties relating to critical illness, permanent health insurance and term insurance are in place.

Reserves

        In the United Kingdom, a long-term insurance company's reserve and other requirements are determined by its Board, with advice from its Actuarial Function Holder, subject to minimum reserve requirements. These minimum reserve requirements are established by the rules of the Integrated Prudential Sourcebook for Insurers and have been interpreted by mandatory professional guidance notes.

        The reserves are published in annual returns to the UK supervisory authority. In practice, similar provisions are included in the life insurance company's statutory accounts with limited adjustments. Whether an employee of, or consultant to, an insurance company, an Actuarial Function Holder must give due regard to the fair treatment of policyholders in making recommendations to a company's board of directors. Mandatory professional guidance notes require an Actuarial Function Holder to report directly to the UK supervisory authority any serious concerns regarding a company's ability to treat its customers fairly.

        Prudential's reserving for with-profits products as required by UK regulation, takes into account annual bonuses/annual interest credited to policyholders because these are "attached" to the policies and are guaranteed. The reserve also includes an element in respect of final bonuses including a reserve for claims expected in the period for which final bonuses have been declared.

        Prudential reserves for unit-linked products on the basis of the value of the unit fund and additional reserves are held for expenses and mortality where this is required by the contract design.

        As well as the reserves, the company's assets must also cover other capital requirements set out in the Integrated Prudential Sourcebook. These comprise a resilience capital requirement, which makes prudent allowance for potential future adverse movements in investment values; a with-profits insurance capital component, which is a measure of the difference in the surplus assets on regulatory and realistic bases; and the long-term insurance capital requirement, which must be held by all European Union insurance companies. See "Financial Strength of Prudential Assurance's Long-term Fund" for further information on solvency.

Financial Strength of Prudential Assurance's Long-term Fund

        A common measure of financial strength in the United Kingdom for long-term insurance business is the free asset ratio. The free asset ratio is the ratio of assets less liabilities to liabilities, and is expressed as a percentage of liabilities. On a comparable basis with 2003, the free asset (or previous regulatory Form 9) ratio of the Prudential Assurance Company (PAC) long-term fund was approximately 14.8% at the end of 2004, compared with 10.5% at December 31, 2003.

        The valuation has been prepared, in our opinion, on a conservative basis in accordance with the current 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. Certain reinsurance 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, were converted into a contingent loan during 2004.

        The fund is very strong with an inherited estate measured on an essentially deterministic valuation basis of more than £6.5 billion compared with approximately £6 billion at the end of 2003. On a realistic

35



basis, with liabilities recorded on a market consistent basis, the free assets are valued at around £5.4 billion before a deduction for the risk capital margin.

        The PAC long-term fund is rated AA+ by Standard & Poor's and Aa1 by Moody's. The ratings from Standard & Poor's, Moody's and Fitch for Prudential Assurance's long-term fund represent the second highest ratings out of 8, 9 and 16 in their respective rating categories.

        The table below shows the change in the investment mix of Prudential's main with-profits fund:

 
  At December 31,
 
  2004
%

  2003
%

  2002
%

UK equities   33   33   32
International equities   15   15   13
Fixed income securities   29   31   33
Cash and other asset classes   5   4   4
Property   18   17   18
   
 
 
Total   100   100   100
   
 
 

        For the UK main with-profits fund 86% of fixed income securities are investment grade with 23% rated AA or above. For Prudential Annuities Limited 98% of the fixed income securities are investment grade with 46% rated AA or above. For Prudential Retirement Income Limited 98% of total assets are investment grade with 57% rated AA or above.

        The investment return on the Prudential main with-profits fund was 13.4% in the year to December 31, 2004 compared with the rise in the FTSE All Share (Total Return) Index of 12.8% over the same period. Over the last ten years the with-profits fund has consistently generated positive compound fund returns with 3, 5 and 10 year compound returns of 6.7% per annum, 3.8% per annum and 10.3% per annum, respectively. These returns demonstrate the benefits of the fund's strategic asset allocation and long-term outperformance. During 2004 there was no change to the strategic asset allocation of the fund. There has been no significant reduction in the level of the fund's equity holdings during the year or subsequently.

Realistic Financial Strength Reporting

        As noted in the 2003 Form 20-F, the FSA's view at that time was that the regulations for determining with-profits reserves on a statutory basis, while prudent, did not robustly relate the degree of prudence to the actual risks faced. A specific issue was that the degree of prudence increased as market values declined. The result was that companies could have come under pressure to sell equities to meet the solvency regulations, even though this might not have been in the best long-term interests of policyholders.

        In order to address these issues, the FSA published its Integrated Prudential Sourcebook, which included regulations for a more "realistic" valuation basis, which applied from December 31, 2004.

        Prudential supported the FSA's objective of moving to a more realistic basis of solvency reporting. In due course, this will make companies' financial health more transparent to policyholders, IFAs and regulators alike, and enable more informed choices to be made by policyholders. The PAC long-term With-Profits Sub-Fund is very strong with the inherited estate (free assets) measured on a realistic basis, valued at £5.4 billion at the end of 2004 before deducting for the risk capital margin.

36



Shareholders' Interests in Prudential's Long-term Insurance Business

        In common with other UK long-term insurance companies, Prudential's products are structured as either with-profits products or non-participating (including unit-linked) products. For statutory and management purposes, Prudential Assurance's long-term fund consists of a number of sub-funds in which shareholders and policyholders have varying interests.

With-profits Products

        With-profits products provide an equity-type return to policyholders through bonuses that are "smoothed". There are two types of bonuses: "annual" and "final". Annual bonuses, often referred to as reversionary bonuses, are declared once a year and, once credited, are guaranteed in accordance with the terms of the particular product. Unlike annual bonuses, final bonuses are only guaranteed until the next bonus declaration. Final bonuses are only credited on a product's maturity or surrender or on the death of the policyholder. Final bonuses can represent a substantial portion of the ultimate return to policyholders.

        With-profits policies are supported by a with-profits fund. Prudential's primary with-profits fund is part of Prudential Assurance's long-term fund. With-profits products provide benefits that are generally either the value of the premiums paid, less charges and fees and with the addition of declared bonuses, or the guaranteed death benefit with the addition of declared bonuses. Smoothing of investment returns is an important feature of with-profits products. It is designed to reduce the impact of fluctuations in investment return from year to year and is accomplished predominantly through the level of final bonuses declared.

        The return to Prudential's shareholders in respect of with-profits business Prudential writes is an amount equal to up to one-ninth of the value of the bonuses Prudential credits or declares to policyholders in that year. Prudential has a large block of in-force with-profits business with varying maturity dates that generates a relatively stable stream of shareholder profits from year to year.

        Prudential Assurance's board of directors, with the advice of its Actuarial Function Holder and its With-Profits Actuary determines the amount of annual and final bonuses to be declared each year on each group of contracts.

        When determining policy payouts, including final bonuses, Prudential follows an actuarial practice of considering "asset shares" for specimen policies. Asset shares broadly reflect the value of premiums paid in respect of a policy accumulated at the investment return on the assets Prudential notionally attributes to the policy. In calculating asset shares, Prudential takes into account the following items:

        However, Prudential does not take into account the surplus assets of the long-term fund, or their investment return, in calculating asset shares. Asset shares are used in the determination of final bonuses together with treating customers fairly, the need to smooth claim values and payments from year to year and competitive considerations.

        Prudential is required by UK law and regulation to consider the fair treatment of its customers in setting bonus levels. The concept of treating customers fairly is established by statute but is not defined.

37



In practice, it provides one of the guiding principles for decision-making in respect of with-profits products.

        The overall return to policyholders is an important competitive measure for attracting new business. The ability to declare competitive bonuses depends, in part, on the financial strength of Prudential Assurance's long-term fund, enabling it to maintain high levels of investment in equities and real estate, if it wishes to do so. Equities and real estate have historically over the long-term provided a return in excess of fixed interest securities.

        In 2004, Prudential declared a total bonus of £1,986 million from Prudential Assurance's primary with-profits fund, of which £1,788 million was added to with-profits policies and £198 million was available for distribution to shareholders. This includes annual bonus rates of 3.25% for the Prudence Bond and 3.25% for personal pensions. In 2003, Prudential declared total bonuses of £2,093 million from Prudential Assurance's primary with-profits fund, of which £1,884 million was added to with-profits policies and £209 million was distributed to shareholders. This included annual bonus rates of 3.25% for the Prudence Bond and 3.25% for personal pensions. In 2002, Prudential declared total bonuses of £2,724 million, of which £2,451 million was added to with-profits policies and £273 million was distributed to shareholders. This included annual bonus rates of 3.25% for the Prudence Bond and 3.5% for personal pensions.

        The closed Scottish Amicable Insurance Fund (referred to as "SAIF") declared total bonuses in 2004 of £379 million, compared to £379 million in 2003 and £601 million in 2002. Shareholders have no interest in profits from the SAIF fund, although they are entitled to the investment management fees paid by this business. For greater detail on the SAIF fund, see "—The SAIF Sub-fund and Accounts" below.

        The FSA and HM Treasury are currently conducting independent reviews of with-profits business in the United Kingdom. See "—Supervision and Regulation of Prudential—UK Supervision and Regulation".

Surplus Assets in Prudential Assurance's Long-term With-profits Fund

        The long-term fund contains the amount that PAC 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' accumulated asset shares plus any additional payments that may be required by way of smoothing or to meet guarantees. The balance of the assets of the with-profits sub-fund is called the "inherited estate" and represents the major part of the working capital of Prudential's long-term fund which enables PAC to support with-profits business by:

        The size of the inherited estate fluctuates from year to year depending on the investment return and the extent to which it has been required to meet smoothing costs, guarantees and other events.

        Prudential 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 FSA the principles that would apply to any re-attribution of the inherited estate. No conclusions have been reached. Furthermore, Prudential 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

38



inherited estate to policyholders and shareholders. Prudential estimates that at December 31, 2004, the value of the inherited estate was more than £6.5 billion compared to around £6 billion at the end of 2003.

        The costs associated with the mis-selling review of Prudential's with-profits personal pensions have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders' pay-out values have been unaffected by personal pension mis-selling.

Depletion of Surplus Assets and Shareholders' Contingencies

        As a proprietary insurance company, Prudential Assurance is liable to meet its obligations to policyholders even if the assets of the long-term funds are insufficient to do so. The assets, in excess of amounts expected to be paid for future terminal bonuses and related shareholder transfers (the excess assets) in the long-term funds, represented by the Fund for Future Appropriations could be materially depleted over time by, for example, a significant or sustained equity market downturn, costs of significant fundamental strategic change or a material increase in mis-selling provisions. In the unlikely circumstance that the depletion of the excess assets within the long-term fund was such that the Group's ability to treat its customers fairly was adversely affected, it might become necessary to restrict the annual distribution to shareholders or to contribute shareholders' funds to the long-term funds to provide financial support.

        In 1998, Prudential stated that deducting personal pensions mis-selling costs from the inherited estate of the With-Profits 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 assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing. The mis-selling review was completed on June 30, 2002 and consequently the assurance has not applied to new business issued since January 1, 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and single premium top-ups, transfers and switches to existing arrangements. The assurance will continue to apply to any policy in force as at December 31, 2003, both for premiums paid before January 1, 2004 and for subsequent regular premiums (including future fixed, retail price index or salary related increases and Department for Work and Pensions rebates).

        The maximum amount of capital support available under the terms of the assurance for policies in-force at December 31, 2003 will reduce over time as Prudential pays claims on the policies covered by it.

        The bonus and investment policy for each type of with-profits policy is the same irrespective of whether or not the assurance applies. Hence removal of the assurance for new business has had no impact on policyholder returns and this is expected to continue for the foreseeable future.

The SAIF Sub-fund and Accounts

        The SAIF sub-fund is a ring-fenced sub-fund of Prudential Assurance's long-term fund and was formed following the acquisition of the mutual Scottish Amicable Life Assurance Society in 1997. No new business may be written in SAIF, although regular premiums are still being paid on policies in-force at the time of the acquisition and "top-ups" are permitted on these policies.

        This fund is solely for the benefit of those Scottish Amicable Life Assurance Society policyholders whose policies were transferred to SAIF. Shareholders have no interest in the profits of this fund, although they are entitled to the investment management fees paid on this business. The brand name

39



and rights to profit on new business were transferred to a new Prudential subsidiary, Scottish Amicable Life plc, which operated for the benefit of shareholders.

        At the time of the acquisition, Prudential Assurance's long-term fund made payments of £276 million to the SAIF sub-fund for the unit-linked life business and non-participating life business and the future profits from unitized with-profits life business. Prudential Assurance also agreed to set up a memorandum account of £1.3 billion that is considered in determining SAIF's investment policy. The SAIF sub-fund pays an annual charge to the other part of Prudential Assurance's long-term fund in respect of this memorandum account.

        Prudential Assurance's long-term fund made a further payment of £185 million to qualifying Scottish Amicable Life Assurance Society policyholders for the use of the Scottish Amicable brand and future expense synergies. This payment will be recovered by the long-term fund by means of a combination of a service agreement and a license fee agreement with Craigforth Services Limited now renamed Prudential UK Services Limited, a shareholder-owned service company set up at the time of the acquisition.

        In addition to the payments described above, shareholders paid £415 million to qualifying Scottish Amicable Life Assurance Society policyholders, representing goodwill, and £70 million for certain Scottish Amicable Life Assurance Society strategic investments.

        With the exception of certain guaranteed annuity products—referred to below,—the majority of SAIF with-profits policies do not guarantee minimum rates of return to policyholders. 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 December 31, 2004, the excess of SAIF assets over guaranteed benefits was £1,836 million. 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.

Non-participating Business

        The majority of Prudential-branded non-participating business is written in Prudential Assurance's long-term fund or by subsidiaries owned by the fund. Prudential's principal non-participating business is Prudential Annuities Limited (referred to as PAL), which is wholly owned by PAC's with-profits fund. The profits on this business are attributable to the fund and not to shareholders, although indirectly shareholders get one ninth of additional amounts paid to policyholders through the declaration of bonuses. In 2001, Prudential started to write new bulk annuity and individual external annuity business through Prudential Retirement Income Limited (referred to as PRIL), from which the profits are attributed solely to shareholders.

        The unit-linked business written by Prudential Assurance and Prudential International Assurance is written with capital provided by shareholders. At December 31, 2002 all of the Scottish Amicable Life plc business transferred to Prudential Assurance's long term fund. In 2003, ex-Scottish Amicable internal vestings (annuity sales arising from maturing in-force pension books) were transferred from PAL to the Prudential Assurance Company shareholders' fund. All profit from these businesses accrue to the shareholders.

Guaranteed Annuities

        Prudential Assurance sold guaranteed annuity products in the UK and held a provision of £49 million at December 31, 2004 within the main with-profits fund to honor guarantees on these products. The Group's main exposure to guaranteed annuities in the UK is through the SAIF and a

40



provision of £648 million was held in SAIF at December 31, 2004 to honor the guarantees. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund, this provision has no impact on shareholders. See "—Shareholders' Interests in Prudential's Long-Term Insurance Business—The SAIF Sub-fund and Accounts".

Compliance

        From December 1, 2001, the FSA took formal responsibility for the regulation and supervision of all Prudential's authorized UK insurance, investment and banking businesses under the Financial Services and Markets Act 2000 (the "2000 Act"), described in greater detail under "—Supervision and Regulation of Prudential—UK Supervision and Regulation".

        Within Prudential's UK businesses, matters arise from time to time as a result of inspection visits or other regulatory activity, which need to be discussed or resolved with the regulators. At any one time, there are a number of these issues and Prudential ensures that programs of corrective activity are discussed and agreed with the regulator, that such programs are properly planned, managed and resourced (using external resources as necessary), that, where appropriate, policyholders who have been disadvantaged are properly compensated and that progress is reported to the regulators on a regular basis. The issues currently affecting Prudential are set out below. Some of these are industry-wide.

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 program 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.

        The Group's main exposure to mortgage endowment products is in respect of policies issued by Scottish Amicable Life plc ("SAL") and policies issued by Scottish Amicable Life Assurance Society ("SALAS") and transferred into the SAIF. The FSA issued a report in March 2001 raising concerns regarding the conduct of sales of these products by tied agents of SAL and in March 2003 it fined SAL £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 SAL for cases that may require redress. At December 31, 2004, the provision was £7m. A provision of £47 million was set up in SAIF at December 31, 2004. As SAIF is a separate sub-fund of the Prudential Assurance long-term business fund, this provision 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 October 2001.

        Compensation of £16 million in respect of mis-sold endowment products was paid in 2004 by Prudential Assurance's main with-profits fund and a further provision of £61 million was established in the fund at December 31, 2004. This provision has no impact on the Group's profit before tax.

Pension Mis-selling

        In 1988, the UK government introduced new pensions legislation intended to encourage more individuals to make their own arrangements for their pensions. During the period from April 1988 to June 1994, many individuals were advised by insurance companies', Independent Financial Advisers and other intermediaries to not join, to transfer from or to opt out of their occupational pension schemes in favor of private pension products introduced under the UK Income and Corporation Taxes Act 1988. The

41



UK insurance regulator (previously the Personal Investment Authority, now the FSA subsequently determined that many individuals were incorrectly advised and would have been better off not purchasing the private pension products sold to them. Industry participants are responsible for compensating the persons to whom private pensions were mis-sold. As a result, the FSA required that all UK life insurance companies review their potential cases of pension mis-selling and pay compensation to policyholders where necessary and, as a consequence, record a provision for the estimated costs. Prudential met the FSA's requirement of issuing offers to all cases by June 30, 2002.

        Provisions in respect of the costs associated with the review have been included in the change in the long-term technical provision in Prudential's profit and loss account. Within the long-term technical provisions, the transfer from the FFA has been determined accordingly. See Item 5 "Operating and Financial Review and Prospects—Analysis by Geographic Region—United Kingdom—Fund for Future Appropriations" for more information on the FFA. Prudential established an initial provision in 1994 that was increased to £1,700 million by January 1, 2000. Subsequent movements in the pension mis-selling provision, including internal and external legal and administrative costs, have been as follows:

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Balance at January 1   530   730   1,065  
Changes to actuarial assumptions and method of calculation   (32 ) (131 ) (50 )
Discount accretion   22   21   53  
Redress to policyholders   (26 ) (56 ) (292 )
Payments of administrative expenses   (7 ) (34 ) (46 )
   
 
 
 
Balance at December 31   487   530   730  
   
 
 
 

        During 2004, the provision for pension mis-selling decreased by £43 million as well as decreasing by £200 million and £335 million during 2003 and 2002, respectively. The reasons for this movement are highlighted below.

        In 2004, 2003 and 2002, the provision was decreased by £32 million, £131 million and £50 million, respectively, to reflect changes in the method of calculation resulting from new requirements issued by the UK regulator and changes in the interest rate and mortality assumptions used.

        The pension mis-selling provision represents the discounted value of future expected payments and including benefit payments and all internal and external legal and administrative costs of adjudicating, processing and settling those claims. To the extent that amounts have not been paid, the provision increases each year reflecting the shorter period of the discount. The increase in the provision relating to the accretion of the discount amounted to £22 million in 2004, £21 million in 2003 and £53 million in 2002.

        The directors believe that, based on current information, the provision, together with future investment return on the assets backing the provision, will be adequate to cover the costs of pension mis-selling as well as the costs and expenses of the Group's pension review unit established to identify and settle such cases. Such provision represents the best estimate of probable costs and expenses. However, there can be no assurance that the current provision level will not need to be increased.

        The costs associated with the pension mis-selling review have been met from the inherited estate. Accordingly, these costs have not been charged to the asset shares used in the determination of policyholder bonus rates. Hence policyholders' pay-out values have been unaffected by pension mis-selling.

        In 1998, Prudential stated that deducting mis-selling costs from the inherited estate would not impact its bonus or investment policy and it gave an assurance that if this unlikely event were to occur,

42



it would make available support to the fund from shareholder resources for as long as the situation continued, so as to ensure that policyholders were not disadvantaged. The assurance was designed to protect both existing policyholders at the date it was announced, and policyholders who subsequently purchased policies while the pension mis-selling review was continuing.

        This review was completed on June 30, 2002, and consequently the assurance has not applied to new business since January 1, 2004. New business in this context consists of new policies, new members to existing pension schemes plus regular and single premium top-ups, transfers and switches to existing arrangements. The assurance will continue to apply to any policy in force at December 31, 2003, both for premiums paid before January 1, 2004, and for subsequent regular premiums (including future fixed, retail price index or salary related increases and Department of Work and Pensions rebate business). The maximum amount of capital support available under the terms of the assurance will reduce over time as claims are paid on the policies covered by it.

        The bonus and investment policy for each type of with-profits policy is the same irrespective of whether or not the assurance applies. Hence removal of the assurance for new business has had no impact on policyholder returns and this is expected to continue for the foreseeable future.

Free Standing Additional Voluntary Contribution Business

        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.

        The review required companies to identify relevant investors and to contact them with an offer to review their individual cases. The Group met the deadline set by the FSA to issue offers to all cases by December 31, 2002. As a result of the review, the Group held a provision of £2 million at December 31, 2004 and continues to monitor the situation.


US Business

        Prudential conducts its US insurance operations through Jackson National Life Insurance Company and its subsidiaries, including Curian Capital LLC, a registered investment advisor. The US operations also include PPM America, Prudential's US internal and institutional fund manager, and Prudential's US broker-dealer operations (National Planning Corporation, SII Investments, Inc., IFC Holdings, Inc. and Investment Centers of America, Inc.). At December 31, 2004, Prudential's US operations had approximately 1.6 million policies and contracts in effect and PPM America managed approximately US$71 billion (£37 billion) of assets. In 2004, operating profit (based on long-term investment returns) from continuing operations before amortization of goodwill and tax was £182 million.

US Market Overview

        The United States is the world's largest life insurance market in terms of premiums. Many of the factors that have affected the UK life insurance market in recent years, such as an ageing population, have also affected the US market. Uncertainties surrounding the adequacy of public and private pensions benefits are increasing the incentive to fund a secure retirement privately, and the demand for income products is also expected to increase as the baby boomer generation and its parents age.

        Despite favorable demographics, the US insurance industry faces a number of challenges, both from within and outside the industry. The life insurance business is projected to grow slowly and competition

43



is fierce. While the growth prospects for the annuity industry are more favorable, there are many players fighting for market share. Likewise, there is competition for retirement savings from other financial services providers, in particular, mutual fund companies and banks.

        There has been increasing convergence among US retail financial services providers as regulatory barriers have begun to erode and competition in the US life insurance industry has increased. Overcapacity in the industry generally has also contributed to more competitive pricing and greater consolidation, presenting opportunities to companies with financial strength and below industry-average cost structures.

        The US investment markets experienced two years of unusually poor returns in 2001 and 2002, with equity markets suffering significant declines and bond defaults reaching record levels. Like its competitors, Jackson National Life was affected by these market forces. The market in 2003 was also affected by weak growth in the economy at the start of the year and declining interest rates. However, there was dramatic growth in the second half of 2003 and the first annual, positive stock index gains in three years. However, in 2004 interest rates remained low and equity markets were relatively flat in the first nine months of the year, recovering somewhat in the fourth quarter of 2004.

Products

        The demographic factors described above, as well as the increased reliance on defined contribution plans (such as 401(k) plans) have resulted in a shift in the financial services market. This shift has been away from risk protection products, such as traditional life insurance, to tax-deferred savings (or asset accumulation) products, such as fixed and variable annuities. These products tend to be spread or fee-based and have accounted for a significant portion of the growth in the US insurance industry in recent years.

        When life insurance and annuity products initially became popular in the United States, they were interest-rate based and provided a minimum guaranteed rate of return. However, declining interest rates eroded the after-tax benefits of these products. Meanwhile, during the 1990s there was significant growth in equity markets. As a result, equity-based and equity-linked products, with and without guarantees, became increasingly important product offerings. Reflecting this shift, industry sales of individual variable annuity products grew from $29 billion in 1992 to $128 billion in 2000, a compound annual growth rate of 20.7%. During the same period, industry individual variable annuity assets grew from $212 billion to $971 billion, a compound annual growth rate of 20.9%.

        The mutual fund industry also benefited from the shift to equity-based products. The strong equity markets in the late 1990s fueled growth in assets under management, both through investment returns and increased contributions from the retail sector. In particular, fund managers with strong brands and investment performance provided strong competition for individuals' retirement savings.

        The above trends reversed in 2001 when, for the first time in twelve years, industry-wide variable annuity sales did not increase. In 2002, annuity providers continued to face the challenges of the previous year. By year-end 2002, the S&P 500 and NASDAQ Composite Indices had declined from their year 2000 peaks by 40% and 67%, respectively. In these volatile equity markets, annuity sales have benefited from a flight to safety. In 2002, total industry individual annuity sales increased by 20% to $223 billion, with the bulk of the increase coming from a continuing surge in fixed annuity sales. Nevertheless, variable annuity sales managed some increase in 2002, with significant amounts going to fixed account options.

        In 2003 and 2004, total industry individual variable annuity sales have been driven by sales of principal guaranteed benefits and living benefits, and by contract holders shifting from fixed options and fixed income funds into equities as these markets improved. This resulted in an increase in total industry individual variable annuity sales of 11% and 3% in 2003 and 2004, respectively. In 2003, total industry

44



individual fixed annuity sales fell by 15% reflecting declining interest rates, tightening spreads and declining margins, whilst in 2004 they increased by 1% as a result of interest rate increases during the year and customers' expectations of further increases.

Distribution

        Traditionally, insurance companies distributed their products through career or independent agencies. The career agencies typically received office space, training and administrative support from the sponsoring insurance company in return for directing a significant portion of their business to them. Independent agencies may receive some support from a specific insurance company, but are typically not required to specifically sell their products. The independent agencies have the ability to sell products from any insurance company.

        In contrast, broker-dealers are licensed to sell products regulated by the Securities and Exchange Commission, such as variable annuities. Broker-dealers maintain "panels" of preferred providers for each type of product. Broker-dealers are often organized into firms and networks typically depending on size and function. These consist of large broker-dealers specializing in security sales and underwriting, regional broker-dealers who sell securities and perform some underwriting functions, and independent broker-dealers who primarily specialize in financial planning activities. Many insurance companies now own financial planner broker-dealers.

        The regional broker-dealer channel focuses on firms with captive agents in a specific region of the United States. Distribution is through branch offices with an average of 10 to 15 brokers per office.

        Historically, regulatory barriers prohibited banks from developing and selling their own insurance products. Banks therefore generally developed favorable supplier relationships with insurance companies and distributed their products through bank branches. These barriers to entry have begun to diminish, and companies are developing the bancassurance model in the US market.

        Direct distribution is relatively mature in the United States. Consumers are accustomed to purchasing less complex retail financial products remotely, both by telephone and via the internet. The mutual fund providers have led this expansion within the retail financial services industry, setting the standard for cost structure and service.

        The registered investment advisor market began as a service offered to very high-net worth investment clients, focusing on platforms rather than specific products, and providing institutional-quality management, custom portfolios, and tax services. The industry has evolved to offer personalized investment advice, very high quality money management, good returns, and reasonable costs to a broader range of clients.

Jackson National Life

        Jackson National Life is a leading provider of long-term savings and retirement products to retail and institutional customers throughout the United States. Jackson National Life offers variable annuities, fixed-indexed annuities, individual fixed annuities, life insurance and institutional products. By developing and offering a wide variety of products, Jackson National Life believes that it has positioned itself to compete effectively in various stock market and interest rate environments. Jackson National Life markets its retail products through various distribution channels, including independent agents, broker-dealer firms (including financial planners), regional broker-dealers, banks and the registered investment advisor channel.

        The interest-sensitive fixed annuities, fixed-indexed annuities, immediate annuities and life insurance products are sold through independent agents, broker-dealers and banks. For variable annuity products, which can only be sold through broker-dealers licensed by the US National Association of Securities Dealers, Jackson National Life has selling agreements with such firms and is continuing to focus on its

45



own broker-dealer distribution channel. Its group pension department sells institutional products. In early 2003, Jackson National Life commenced operating in the registered investment advisor channel, with the launch of Curian Capital, LLC.

Products

        The following table shows total new business premiums in the United States by product line and distribution channel for the periods indicated, and policyholder reserves by product line. Total new business premiums include deposits for investment contracts with limited or no life contingencies.

 
  Year Ended
December 31,

   
 
  Policyholder
Reserves At
December 31,
2004

 
  2004
  2003
  2002
 
  (In £ Millions)

By Product                
Annuities                
  Fixed annuities                
    Interest-sensitive   1,087   1,279   2,647   11,137
    Fixed-indexed   429   255   254   1,748
    Immediate   43   96   61   622
  Variable annuities   1,981   1,937   1,363   7,208
   
 
 
 
      Total   3,540   3,567   4,325   20,715
   
 
 
 
Life insurance   28   13   22   2,652
   
 
 
 
Institutional products                
  GICs and funding agreements   180   183   292   988
  Medium term note funding agreements   672   303   1,118   2,862
   
 
 
 
      Total   852   486   1,410   3,850
   
 
 
 
Total   4,420   4,066   5,757   27,217
   
 
 
 
By Distribution Channel                
Independent agents   647   846   1,443    
Bank   1,089   1,007   1,568    
Broker-dealer   1,832   1,728   1,336    
Group pension department   852   485   1,410    
   
 
 
   
    4,420   4,066   5,757    
   
 
 
   

        In 2004, interest-sensitive fixed annuities accounted for 25% of total new business premiums and 41% of policyholder reserves of the US operations. Interest-sensitive fixed annuities are primarily deferred annuity products that are used for retirement planning and for providing income in retirement. They permit tax-deferred accumulation of funds and flexible payout options.

        The policyholder of an interest-sensitive fixed annuity pays Jackson National Life a premium which is credited to the policyholder's account. Periodically, interest is credited to the policyholder's account and in some cases administrative charges are deducted from the policyholder's account. Jackson National Life makes benefit payments at a future date as specified in the policy based on the value of the policyholder's account at that date.

46



        The policy provides that at Jackson National Life's discretion it may reset the interest rate, subject to a guaranteed minimum. The minimum guarantee varies from 1.50% to 5.50%, depending on the date of issue, with 77% of the fund at 3.0% or less at December 31, 2004. In addition, Jackson National Life also offers multi-year guaranteed products.

        When the annuity matures, Jackson National Life either pays the amount in the policyholder's account to the policyholder or begins making payments to the policyholder in accordance with the policyholder's instructions. Fixed annuity policies provide for surrender charges to be assessed on surrenders generally for the first seven to nine years of the policy.

        Approximately 22% of the interest-sensitive fixed annuities Jackson National Life wrote in 2004 provide for an adjustment, referred to as a market value adjustment, on surrenders in the surrender period of the policy. This formula based adjustment approximates the change in value that assets supporting the product would realize as interest rates move up or down. This adjustment can be positive or negative. The minimum guaranteed rate is not affected by this adjustment.

        Jackson National Life bears the investment and surrender risk on interest-sensitive fixed annuities, and its profits come from the spread between the yield on investments and the interest credited to policyholders (net of any surrender charges or market value adjustment) less initial and recurring expenses.

        Equity-Indexed Annuities are now referred to as Fixed-Indexed Annuities, a term that more accurately describes the product design and its benefits and features.

        Jackson National Life ranked ninth in the sale of fixed-indexed annuities in the United States in 2004. Fixed-indexed annuities accounted for 10% of total new business premiums in 2004 and 6% of policyholder reserves of US operations. Fixed-indexed annuities vary in structure, but generally are deferred annuities that enable policyholders to obtain a portion of a fixed-linked return but provide a guaranteed minimum return.

        Jackson National Life hedges the equity return risk on fixed-indexed products by purchasing futures and options on the relevant index. The cost of these hedges is taken into account in setting index participation rates. Recent volatility in the equity markets combined with lower bond yields has increased the cost of these hedges. In response, Jackson National Life has reduced its index participation rates on new business and developed new products with index participation rates that are less sensitive to changes in these variables.

        Jackson National Life bears the investment and surrender risk on fixed-indexed annuities. Profit arises from the difference between the premiums received plus the associated investment income, and the combined cost of expenses (general expenses, costs of purchasing fixed interest securities and options) and the policyholder's benefit (subject to the minimum guarantee).

        In 2004, immediate annuities accounted for 1% of total new business premiums and 2% of policyholder reserves of US operations. Immediate annuities guarantee a series of payments beginning within a year of purchase and continuing over either a fixed period of years and/or the life of the policyholder. If the term is for the life of the policyholder, then Jackson National Life's primary risk is mortality risk. This product is generally used to provide a guaranteed amount of income for policyholders and is used both in planning for retirement and in retirement itself. The implicit interest rate on these products is based on the market conditions that exist at the time the policy is issued and is guaranteed for the term of the annuity.

47


        Jackson National Life began offering variable annuity products in 1995. In 2004, variable annuities accounted for 45% of total new business premiums and 26% of policyholder reserves of US operations. Variable annuities are deferred annuities that have the same tax advantages and payout options as interest-sensitive and fixed-indexed annuities. They also are used for retirement planning and to provide income in retirement.

        The primary differences between variable annuities and interest-sensitive and fixed-indexed annuities are investment risk and return. If a policyholder chooses a variable annuity, the rate of return will depend upon the performance of the underlying fund portfolio. The policyholder bears the investment risk except for fixed account options, where Jackson National Life guarantees a minimum fixed rate of return. In most cases, variable annuities also offer various types of elective benefits. Enhanced death benefits guarantee that on death the policyholder receives a minimum value regardless of past market performance. These guaranteed death benefits might be expressed as the return of original premium, the highest past anniversary value of the policy, or as the original premium accumulated at a fixed rate of interest. Certain of the variable annuities also offer a guaranteed minimum income benefit, which provides for a minimum floor level of benefits upon annuitization, and a guaranteed minimum withdrawal benefit which provides a guaranteed return of principal invested, by allowing for periodic withdrawals of no more than a specified percentage of the initial premium each year, regardless of the value of the investments under the contract. Jackson National Life charges a fee for these elective benefits.

        Jackson National Life credits premiums on variable annuities to a separate account or to the fixed account, depending on the policyholders' elections. The policyholders determine how the premiums will be allocated by choosing to allocate all or a portion of their accounts either to a variety of variable sub-accounts, with a choice of investment managers, or to guaranteed fixed-rate options. The rate of election of the fixed account option within variable annuities in 2004 of 29% compares with 48% in 2003. The value of the portion of the separate account allocated to variable sub-accounts fluctuates with the underlying investment. Jackson National Asset Management, LLC (a subsidiary of Jackson National Life) earns fee income as the investment adviser for the underlying funds and has retained the services of a number of other investment advisers to act as sub-advisers to Jackson National Asset Management, LLC. Additionally, Jackson National Life Distributors, Inc. (a subsidiary of Jackson National Life) earns a 12b-1 fee for distributing the funds.

        The non-fixed account portion of variable annuity products is backed by specific assets that are held in a separate account. The assets in this separate account are "segregated" pursuant to state insurance law and do not form part of the assets in the US general account, which backs the remainder of the insurance business in the United States. Amounts held in the separate account are not chargeable with liabilities arising out of any other business Jackson National Life may conduct. All of the income, gains or losses from these assets less specified management charges are credited to or against this portion of the policies and not any other policies that Jackson National Life may issue.

        Jackson National Life earns fee income on the underlying separate account investment, earns profits from the spread between what it earns on investments backing the fixed rate accounts and the interest credited, and earns fee income for the additional elective benefits in the contract.

Life Insurance

        Reflecting the competitive life insurance market place and the overall trend towards asset accumulation products, Jackson National Life's life insurance products accounted for less than 1% of the total new business premiums and 10% of policyholder reserves of US operations in 2004. The products offered include term life insurance, interest-sensitive life insurance and variable universal life insurance. Each of these types of insurance policies can be modified using several options and riders to provide

48



particular benefits, including waiver of premium, accidental death benefit and supplemental term insurance.

Institutional Products

        Institutional products consist of guaranteed investment contracts ("GICs"), funding agreements and medium term note funding agreements. In 2004, institutional products accounted for 19% of total new business premiums and 15% of policyholder reserves of US operations. Jackson National Life began marketing GICs to institutional investors in December 1995. The GICs are marketed by its group pension department to defined contribution pension and profit-sharing retirement plans. Funding agreements are marketed to institutional investors, including corporate cash accounts and securities lending funds, as well as money market funds. Sales of institutional products increased in 2004 as JNL was able to take advantage of attractive issuance opportunities. Three types of institutional products are offered:

Traditional Guaranteed Investment Contracts

        Under a traditional GIC, the policyholder makes a lump sum deposit. Interest is paid on the deposited funds, usually on a quarterly basis. The interest rate paid is fixed and is established when the contract is issued.

        Traditional GICs have a specified term, usually two to three years, and typically provide for phased payouts. Jackson National Life tailors the scheduled payouts to meet the liquidity needs of the particular retirement plan. If deposited funds are withdrawn earlier, an adjustment is made that approximates a market value adjustment.

        Jackson National Life sells GICs to retirement plans, in particular 401(k) plans. The traditional GIC market is extremely competitive. This is due in part to competition from synthetic GICs.

Funding Agreements

        Under a funding agreement, the policyholder either makes a lump-sum deposit or makes specified periodic deposits. Jackson National Life agrees to pay a rate of interest, which may be fixed but which is usually a floating short-term interest rate linked to an external index. Interest is paid quarterly to the policyholder. The average term for the funding agreements is one to two years. At the end of the specified term, policyholders may re-deposit the principal in another funding agreement. Jackson National Life makes its profit on the spread between the yield on its investment and the interest rate credited to policyholders.

        Typically, brokerage accounts and money market mutual funds are required to invest a portion of their funds in cash or cash equivalents to ensure sufficient liquidity to meet their customers' requirements. The funding agreements permit termination by the policyholder on 7 to 90 days notice, and thus qualify as cash equivalents for the clients' purposes. Funding agreements terminable by the policyholder with less than 90 days notice account for less than 2% of Jackson National Life's total policyholder reserves.

Medium Term Note Funding Agreements

        Jackson National Life has also established European and global medium-term note programs that access new markets for Prudential. The notes offered may be denominated in any currency. Notes are

49



issued to institutional investors by a special purpose vehicle and are secured by funding agreements issued by Jackson National Life.

Distribution and Marketing

        Jackson National Life distributes products in all 50 states of the United States and in the District of Columbia, although not all products are available in all states. Operations in the State of New York are through a New York insurance subsidiary.

        Jackson National Life has focused on independent distribution systems and has avoided the fixed costs associated with recruiting, training and maintaining employee agents. It supports its network of independent agents and brokers with education and training programs. A substantial portion of the costs associated with generating new business are not fixed costs but vary directly with the level of business produced. As a result, industry figures show that the costs are low relative to other US insurers.

        Jackson National Life offers internet-based support to its broker-dealers. It continues to expand its internet-based services, increasing amounts of information available for both customers and agents.

Independent Agents

        The insurance and fixed annuity products are distributed through independent agents located throughout the United States. These 28,000 licensed insurance agents or brokers, who also may represent other companies, are supported by four regional marketing offices. Jackson National Life generally deals directly with writing agents and brokers thereby eliminating intermediaries, such as general agents. This distribution channel, called "Deal Direct", has enabled it to generate significant volumes of business on a low, variable cost basis. Jackson National Life is responsible for providing agents with product information and sales materials.

Broker-Dealers

        Jackson National Life Distributors, Inc., a broker-dealer, is the primary wholesale distribution channel for the variable annuity products. Jackson National Life Distributors also sells fixed-indexed annuities and fixed annuities. An internal network of wholesalers supports this distribution channel. These wholesalers meet directly with broker-dealers and financial planners and are supported by an extensive home office sales staff. There are more than 700 active selling agreements with regional and independent broker-dealer organizations throughout the United States. These selling agreements provide Jackson National Life with access to more than 33,000 registered representatives.

        In January 2002, Jackson National Life opened a new wholesale distribution channel servicing the regional broker-dealer distribution channel. Jackson National Life is well suited to provide the type of customized sales attention required for this channel, with the emphasis being on providing dedicated, specialized sales support, continuing education and tailored marketing solutions.

        Jackson National Life is responsible for training its broker-dealers, providing them with product information and sales materials and monitoring their activities from a regulatory compliance perspective.

Banks, Credit Unions and Other Financial Institutions

        Jackson National Life's Institutional Marketing Group distributes its annuity products through banks, credit unions and other financial institutions and through third-party marketing organizations that serve these institutions. Jackson National Life is a leading provider of annuities offered through banks and credit unions and can access over 21,000 financial institution representatives through existing relationships with banks and credit unions. Jackson National Life has established distribution relationships with medium-sized regional banks, which it believes are unlikely to develop their own insurance product capability.

50



Independent Broker-Dealers

        JNL's retail distribution is managed by its independent broker-dealer network, National Planning Holdings ("NPH"), which is made up of four firms, National Planning Corporation, SII Investments, Inc., INVEST Financial Corporation and Investment Centers of America, Inc. Jackson National Life's broker-dealer group has contracts with more than 2,400 registered representatives.

Registered Investment Advisor

        Commencing operation in early 2003, Curian Capital, LLC (Jackson National Life's registered investment advisor channel) provides innovative fee-based separately managed accounts and investment products to advisors through a sophisticated technology platform.

        The registered investment advisor industry began as a service offered to very high-net worth investment clients, focusing on platforms rather than specific products, and providing institutional-quality management, custom portfolios, and tax services. The industry has evolved to offer personalized investment advice, very high quality money management, good returns, and reasonable costs to a broader range of clients.

Group Pension Department

        Jackson National Life markets its institutional products through its group pension department. It has direct contacts with banks, municipalities, asset management firms and direct plan sponsors. Institutional products are distributed and marketed through intermediaries to these groups.

Factors Affecting Pricing of Products and Asset Liability Management

        Jackson National Life prices products based on assumptions about future mortality, investment yields, expenses and persistency. Pricing is influenced by competition and by its objectives for return on capital. Although Jackson National Life includes a profit margin in the price of its products, the variation between the assumptions and actual experience can result in the products being more or less profitable than it was assumed they would be. This variation can be significant.

        Jackson National Life designs its interest-sensitive products and conducts its investment operations to match closely the duration of the assets in its investment portfolio with the annuity, whole life, universal life and guaranteed investment contract product obligations. Jackson National Life seeks to achieve a target spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed-rate securities and in options and futures to match the equity-related returns under its fixed-indexed products.

        Jackson National Life segregates its investment portfolio for certain investment management purposes and as part of its overall investment strategy into four portfolios: fixed annuities without market value adjustment, fixed annuities with market value adjustment, fixed-indexed annuities and institutional liabilities. The portfolios backing fixed annuities with and without market value adjustments and the fixed-indexed annuities have similar characteristics and differ primarily in duration. The portfolio backing the institutional liabilities has its own mix of investments that meet more limited duration tolerances. Consequently, the institutional portfolio is managed to permit less interest rate sensitivity and has limited exposure to mortgage-backed securities. At December 31, 2004, 2% of the institutional portfolio was invested in residential mortgage-backed securities.

        The fixed-rate products may incorporate surrender charges, market value adjustments, two-tiered interest rate structures or other limitations relating to when policies can be surrendered for cash, in order to encourage persistency. At December 31, 2004, approximately 72% of Jackson National Life's fixed annuity reserves had surrender penalties or other withdrawal restrictions, down from 74% in 2003.

51



Substantially all of the institutional portfolio had withdrawal restrictions or market value adjustment provisions.

Underwriting

        The decision to underwrite a particular life policy depends upon the assessment of the risk to Jackson National Life represented by the proposed policy. The risk selection process is performed by the underwriters who evaluate policy applications on the basis of information provided by the applicant and other sources. Specific medical tests may be used to evaluate policy applications based on the size of the policy, the age of the applicant and other factors.

        Jackson National Life's underwriting rules and procedures are designed to produce mortality results consistent with the assumptions used in product pricing while providing for competitive risk selection.

Reserves

        Jackson National Life uses reserves established on a US GAAP basis as the basis for consolidation into Prudential's UK GAAP accounts.

        For the fixed, fixed-indexed and variable annuity contracts and institutional products, the reserve is the policyholder's account value. For the immediate annuities, reserves are determined as the present value of future policy benefits. Mortality assumptions are based on the 1983a Individual Annuitant Mortality Table and the Annuity 2000 Mortality Table for newer issues. Interest rate assumptions currently range from 2.0% to 8.0%.

        For the traditional term life contracts, reserves for future policy benefits are determined using the net level premium method and assumptions as to mortality, interest, policy persistency and expenses. Mortality assumptions are generally from 50% to 90% of the 1975-1980 Basic Select and Ultimate tables, depending on underwriting classification and policy duration. Interest rate assumptions range from 4.0% to 8.0%. Persistency and expense assumptions are based on Jackson National Life's experience.

        For the interest-sensitive and single premium life contracts, reserves approximate the policyholder's account value.

Reinsurance

        Jackson National Life reinsures portions of the coverage provided by its life insurance products with other insurance companies under agreements of indemnity reinsurance. Reinsurance assumed from other companies is not material.

        Indemnity reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk for the life insurer. Indemnity reinsurance does not discharge the original insurer's primary liability to the insured. Jackson National Life's reinsured business is ceded to numerous reinsurers and the amount of business ceded to any one reinsurer is not material.

        Jackson National Life limits the amount of risk it retains on new policies. Currently, the maximum risk that is retained on new policies is $1.5 million on last survivor life business. Jackson National Life is not a party to any risk reinsurance arrangement with any reinsurer pursuant to which the amount of reserves on reinsurance ceded to such reinsurer equals more than 1% of total policy reserves.

        Beginning in late 1995, Jackson National Life entered into reinsurance agreements to cede 80% of its new level premium term life insurance business written in the United States to take advantage of competitive pricing in the reinsurance markets. Beginning January 1, 1999, it began to cede 90% of new writings of level premium term products. Jackson National Life intends to continue to cede a significant

52



proportion of new term life insurance business for as long as pricing in the reinsurance markets remains favorable.

        Effective December 31, 2002, Jackson National Life ceded the guaranteed minimum death benefit coverage associated with variable annuities to an affiliate, Prudential Atlantic Reinsurance Company, Dublin, Ireland.

        Jackson National Life cedes the guaranteed minimum income benefit on variable annuities to an unaffiliated reinsurer.

Policy Administration

        Jackson National Life provides a high level of administrative support for both new and existing policyholders. Jackson National Life's ability to implement new products quickly and provide customer service is supported by integrated computer systems that propose, issue and administer complex life-insurance and annuity contracts. Jackson National Life continues to develop its life insurance administration and underwriting systems and its fixed and variable annuity administration systems to enhance the service capabilities for both new and existing policies.

PPM America

        PPM America is Prudential's US fund management operation, with offices in Chicago and New York. Its primary focus is to manage funds for Jackson National Life and therefore the majority of funds under management are fixed interest in nature. PPM America has also launched a number of institutional high yield and special investment vehicles to leverage their fund management capabilities into new areas. PPM America also serves as investment advisor for certain mutual funds, several private investment funds and structured finance vehicles and the US equity and fixed income portion of portfolios of certain affiliates within Prudential.

Jackson Federal Bank

        Prudential further diversified its business in the United States through the purchase in 1998 of a federally chartered savings association, First Federal Savings and Loan Association of San Bernardino, which was called Jackson Federal Bank ("JFB"). In February 2000, Jackson National Life announced the acquisition of three Fidelity Federal Branches and in September 2000, Jackson National Life acquired Highland Bancorp Incorporated, the holding company for Highland Federal Bank, for $110 million. Highland Federal Bank and the three Fidelity Federal Branches were merged with and renamed as Jackson Federal Bank. At the date of sale, Jackson Federal Bank's assets totaled $1.5 billion (£0.8 billion) and deposit accounts totaled $1.1 billion (£0.6 billion).

        In October 2004, JNL completed the sale of JFB to Union Bank of California for £166 million. JFB's principal area of business was banking and commercial real estate lending. With the sale of JFB, JNL was able to redeploy a portion of the capital to acquire Life Insurance Company of Georgia, which is more closely aligned with JNL's core strategy of providing long-term savings and retirement vehicles to our customers. Accordingly, the results of operations for Jackson Federal Bank are reported as discontinued operations in the accompanying financial statements.


Asian Business

        The Asian economies' consistently high economic growth rates and favorable demographics, together with the trend to allow greater access to foreign financial services players makes these markets very attractive. However, success is not guaranteed; there are many regulatory, cultural, competitive and organizational challenges which favor companies such as Prudential who have a long history and clear commitment to Asia, a successful track record and an operating model enabling us to 'think internationally and act locally'.

53



        Over the last ten years, building on its long-standing commitment to the region, Prudential has followed a proven strategy of expanding geographically, diversifying its distribution, launching innovative, customer focused products and partnering with leading local institutions. Today, Prudential has operations in 12 countries and is Europe's leading life insurer in Asia in terms of market coverage and number of top 5 market positions. It has an agency force of 136,000 that generates around 75% of new business with the remainder of new business coming from a variety of distribution partnerships, including a number of leading banks. The Prudential's logo is well-known throughout the region and has similar recognition levels to other leading international financial services institutions.

        This breadth and depth of operations across the region gives Prudential diversity backed up by collective scale that is a real competitive advantage as it can leverage expertise and experience in some countries and apply this elsewhere as appropriate. It is also able to take a longer-term view on the development of the region as a whole. Prudential Corporation Asia's consistently impressive product profit margins illustrate not just the overall attractiveness of the Asian markets, but more specifically our success in maximizing long-term value creation while effectively managing risk.

        With over five million life insurance customers, Prudential Corporation Asia now has the scale to benefit from more standardization and integration of processes and the introduction of common systems platforms. In 2004, the first step towards a more integrated back office was made with the launch of a regional processing center, Prudential Services Asia, based in Malaysia's high tech business park Cyberjaya.

        The impact of Prudential Corporation Asia's focus on capital efficiency and its increasing scale can be seen as it is expected to become a net contributor of cash to the Group in 2006, whilst continuing to fund high growth rates.

Development of Prudential's Asian Business

        Prudential's Asian operations are managed by its Hong Kong-based regional head office. Prudential's operations in Asia date from 1923, when it opened a branch office in India, which served the Indian sub-continent and several Middle Eastern countries with historic ties to the United Kingdom. In 1924, Prudential opened a branch office in Malaysia. Prudential expanded into Singapore in 1931 and opened a branch office in Hong Kong in 1964. In 1956, Prudential's Indian operations were nationalized and, in 1984, the Malaysian government required Prudential to sell a majority interest in its Malaysian operations to a local company. A majority share of the Malaysian operations was then reacquired in 1998. A group strategy review in the early 1990s identified significant opportunities for Prudential in the Asian life sector and Prudential Corporation Asia was established in 1994 to develop a material and profitable Asian business.

        During 1995 and 1996, Prudential Corporation Asia entered Thailand and Indonesia through acquisitions and launched a new operation in the Philippines. These were followed by re-entry into India with a joint venture mutual fund operation in 1998 (55% ownership), the acquisition of a Taiwanese life insurance operation and the launch of a new life insurance operation in Vietnam in 1999. In 2000, Prudential acquired a mutual fund business in Taiwan, launched new life insurance operations in China (50% ownership) and India (26% ownership) and established a joint venture in Hong Kong for the Mandatory Provident Fund ("MPF") and mutual funds (36% ownership).

        Prudential Corporation Asia continued its geographic expansion in 2001 with acquisitions of small, but financially and operationally sound life companies in Japan and South Korea. Also in 2001, Prudential Corporation Asia acquired Allstate's small operations in Indonesia and the Philippines. In June 2002, Prudential Corporation Asia acquired ING's small life operation in the Philippines and in October 2002 acquired Good Morning ITMC, a mid-sized South Korean mutual fund operation.

        The Japanese life market remains very challenging and in 2003 Prudential scaled back its operations to focus on higher value distribution channels and more profitable products. While the operation is now

54



somewhat more efficient with lower expense levels and has made some progress with establishing new distribution channels, it will take some time to deliver material volumes and become a positive contributor to Prudential Corporation Asia's overall results.

        Prudential Corporation Asia has also launched mutual fund operations in Japan, Singapore and Malaysia and has had its composite insurance licenses in Singapore and Malaysia reactivated.

        In India, our joint venture with ICICI continues to be the leading private sector player. In 2004, the Indian government announced its intention to allow increased foreign ownership in Indian companies, and Prudential remains interested in increasing our stake in the joint venture. However, the relevant legislation has not yet been put before the Indian Parliament.

        In March 2003, Prudential and its joint venture partner CITIC were granted its second life insurance license for Beijing in addition to the license for Guanghzou where operations commenced in 2000. In March 2004, Prudential and CITIC received their third and fourth life insurance licenses in China for Suzhou and Shanghai, respectively.

        As of December 31, 2004, CITIC Prudential had opened operations in three cities in China. As of March 31, 2005 it was granted additional licenses for cities in Guangdong province (Donggaun and Foshan), Hubei province (Wuhan) and approval to provide Group policies alongside the core individual life products. In May 2005 CITIC Prudential announced that it had been awarded another license for Zhongshan. Prudential is now the only European life insurance joint venture with licenses for eight Chinese cities. It is expected that this rapid development will continue as geographic licensing restrictions ease further.

        Prudential believes the key ingredients for the long-term Asian growth model are firmly in place: high population densities, high personal savings rates, improving education levels, increasingly entrepreneurial environment, rapid urbanization and deregulation. Prudential continues to support the long-term growth prospects of Prudential Corporation Asia in Asia.

        Prudential Corporation Asia's strategic themes are to:


Distribution

        Throughout Asia, agency continues to be the primary distribution channel. At the end of the year Prudential Corporation Asia had 136,000 tied agents, up from 112,000 in 2003. These agents, who are largely self-employed, sell insurance products exclusively for Prudential Corporation Asia. Management teams ensure that quality training, best practice agency management and high quality customer service are consistently provided.

        Prudential Corporation Asia continues to develop complementary distribution channels through a variety of distribution partnerships, with a number of leading banks. Alternative distribution, other than

55



agency-based, which includes bancassurance and direct distribution, produced 24% of total insurance sales in 2004, up from 22% in 2003.

Products

        Prudential Corporation Asia offers a range of products including life insurance with some accident and health options, personal lines property and casualty insurance and also mutual funds.

Life Insurance

        The life insurance products offered by Prudential Corporation Asia include a range of with-profits and non-participating term, whole life, endowment and unit-linked policies. Prudential Corporation Asia also offers health, disability, critical illness and accident coverage to supplement its core life products.

        Prudential Corporation Asia has a strong focus on capital-efficient product innovation and packages products to meet specific customer needs. In 1992, Prudential Corporation Asia was the first company to launch unit-linked products in Singapore and subsequently has leveraged this expertise with great success across the region. In 2004, Prudential Corporation Asia continued with unit-linked product launches in Philippines and Korea.

Funds Management

        In addition to the life products described above, Prudential offers mutual fund investment products in India, Taiwan, Japan, Singapore, Malaysia, Hong Kong and Korea, allowing customers to participate in debt, equity and money market investments. The Company earns a fee based on assets under management.

        In Hong Kong, Prudential Corporation Asia has a successful joint venture with Bank of China International ("BOCI") for the Mandatory Provident Fund ("MPF") and also unit trusts. As from December 1, 2000, employees, employers and the self-employed in Hong Kong became obliged to make contributions to the MPF. The plans that comprise the MPF are defined contribution pension plans with immediate vesting, preservation until retirement (or some other event specified by legislation) and full portability. Individuals are required to make monthly mandatory contributions of 5% of salary and employers make contributions equal to 5% of the employee's salary to the individual's accounts in the Fund. Both employee and employer contributions are subject to a maximum amount, currently HK$1,000 per month, the equivalent of £65 per month. Additional voluntary contributions are possible.

        Prudential Asset Management ("PAM") (formerly PPM Asia) is Prudential Corporation Asia's fund management division responsible for managing Prudential Corporation Asia's life and third party institutional funds including the Prudential group's investments in the Asia-Pacific region. PAM has offices in Singapore, Hong Kong and Tokyo.

        At December 31, 2004, Prudential Corporation Asia was managing £22.6 billion of funds, comprising Asian life insurance funds of £8.4 billion, £5.7 billion of non-Asian funds which predominately relate to the UK, Prudential Corporation Asia retail mutual funds and third party institutional funds of £8.5 billion and Prudential Corporation Asia's 36% of Bank of China International- Prudential Corporation Asia joint venture pension related funds, including MPF, of £0.2 billion.

Products and Profitability

Life Insurance Products

        Unit-linked products combine savings with protection and the cash value of the policy depends on the value of the underlying unitized 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. Non-participating products offer savings with protection

56



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, disability, critical illness and accident coverage. A&H products are commonly offered as supplements to main life policies but can also be sold separately.

Life Product Profitability

        The profits from participating policies are shared between the policyholder and insurer (typically in a 90:10 ratio) in the same way as with-profits business in the UK. Under unit-linked products the profits that arise from managing the policy, its investments and the insurance risk accrue entirely to shareholders, with investment gains accruing to the policyholder within the underlying unitized fund. The profits from non-participating products consist of any surplus remaining after paying the defined policy benefits. All the profits from A&H products accrue to shareholders.

        Unit-linked products tend to have higher profit than traditional non-linked products as expenses and charges are better matched and solvency capital requirements are lower. At the end of 2004 Prudential Corporation Asia offered unit-linked products in 10 of the 12 countries in Asia in which it operates.

Mutual Fund Products

        Prudential Corporation Asia's mutual fund range includes debt, equity, balanced and money market funds. Prudential Corporation Asia makes transaction charges (initial and surrender depending on the type of fund and the length of the investment) and also makes a service charge based on assets under management. The charges vary by country and fund with money market style funds generally having the lowest charges and equity funds the highest.

New Business Premiums

        In 2004, total sales of insurance products were £1,172 million, up 19% from 2003 (£989 million). Of this amount, regular premium insurance sales were up 1% to £510 million and single premium insurance sales increased from £482 million in 2003 to £662 million.

        The following table shows Prudential's Asian life insurance new business premiums by territory for the periods indicated. In this table "Other Countries" includes, Thailand, The Philippines and Vietnam.

 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Singapore   246   238   325
Hong Kong   333   272   224
Malaysia   68   70   74
Taiwan   231   160   159
Japan   24   44   48
Korea   96   49   10
China   25   18   13
Indonesia   66   58   30
India (Group's 26% interest in joint venture with ICICI)   38   20   10
Other countries   45   60   51
   
 
 
  Total   1,172   989   944
   
 
 

        In addition, for the year ended December 31, 2004, Prudential Corporation Asia's mutual funds had funds under management of £7.6 billion, up from £6.4 billion in 2003, following net sales of £1.2 billion during the year, down slightly from £1.5 billion in 2003. The £7.6 billion of funds under management at the end of 2004 primarily comprised of, India £2.1 billion, Taiwan £1.8 billion and Korea £1.4 billion.

57



Investments

General

        The overall financial strength of the Prudential group and the results, both current and future, of the insurance business are in part dependent upon the quality and performance of the various investment portfolios in the United Kingdom, the United States, Asia and in continental Europe.

Prudential's Total Investments

        The following table shows Prudential's insurance and non-insurance investments at December 31, 2004. In addition, at December 31, 2004 Prudential had £33 billion of external retail mutual funds under management. The "Other" column includes central funds, a short-term fixed income securities reinvestment program and funds in respect of other non-insurance operations. Assets held to cover linked liabilities relate to unit-linked and variable annuity products. In this table, investments are valued as set out in Note 3 of the notes to Prudential's consolidated financial statements.

 
  At December 31, 2004
 
  Insurance
  Banking
   
 
  United
Kingdom

  Europe
  United Kingdom
and
Europe

  United
States

  Asia
  Other
  Sub-total
  United
Kingdom

  Total
 
  (In £ Millions)

Debt and other fixed income securities   41,769   100   41,869   19,612   3,791   1,478   66,750   3,120   69,870
Equity securities   35,834   443   36,277   130   2,002   17   38,426     38,426
Loans and other   6,237   203   6,440   4,058   691   897   12,086   8,577   20,663
   
 
 
 
 
 
 
 
 
    Total   83,840   746   84,586   23,800   6,484   2,392   117,262   11,697   128,959
   
 
 
 
 
 
 
 
 
Real-estate                                    
  Investment   12,104     12,104   38   38   1   12,181     12,181
  Company-occupied   110     110   37   36   3   186   15   201
   
 
 
 
 
 
 
 
 
    Total real-estate   12,214     12,214   75   74   4   12,367   15   12,382
   
 
 
 
 
 
 
 
 
      Sub-total   96,054   746   96,800   23,875   6,558   2,396   129,629   11,712   141,341
Participating interests           20   6   26     26
   
 
 
 
 
 
 
 
 
      Total investments   96,054   746   96,800   23,875   6,578   2,402   129,655   11,712   141,367
Assets held to cover unit-linked liabilities   16,132   593   16,725   5,392   1,713     23,830     23,830
   
 
 
 
 
 
 
 
 
      Total   112,186   1,339   113,525   29,267   8,291   2,402   153,485   11,712   165,197
   
 
 
 
 
 
 
 
 

58


Prudential's Investment Yields

        The following table shows the income from the investments of Prudential's continuing operations by asset category for the periods indicated. This table does not include investment income from unit-linked and variable annuity products, or from banking investments. Yields have been calculated using the average of opening and closing balances for the appropriate asset.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  Yield
  Amount
  Yield
  Amount
  Yield
  Amount
 
 
  (In £ Millions, Except Percentages)

 
Debt and other fixed income securities                          
  Net investment income   6.0   3,938   6.4 % 4,109   6.7 % 4,126  
  Net realized investment gains (losses)   (0.0 )% (9 ) 0.6 % 375   (0.9 )% (531 )
  Net unrealized investment gains (losses)   1.2 % 786   0.1 % 44   1.1 % 651  
  Ending assets       66,750       64,591       63,200  
Equity investments                          
  Net investment income   3.6 % 1,329   3.2 % 1,050   3.0 % 1,053  
  Net realized investment gains   3.5 % 1,271   0.5 % 154   1.5 % 520  
  Net unrealized investment gains (losses)   6.9 % 2,526   17.2 % 5,566   (27.9 )% (9,907 )
  Ending assets       38,426       34,877       30,007  
Loans and other                          
  Net investment income   11.6 % 1,272   9.7 % 1,012   9.7 % 986  
  Net realized investment gains (losses)   0.3 % 32   0.0 % 5   (0.0 )% (3 )
  Net unrealized investment gains (losses)   1.1 % 125   0.4 % 37   0.8 % 80  
  Ending assets       12,086       9,751       11,092  
Real estate                          
  Net investment income   6.8 % 799   8.0 % 867   7.4 % 789  
  Net realized investment gains   2.3 % 269   2.2 % 235   1.9 % 200  
  Net unrealized investment gains (losses)   8.6 % 1,009   3.0 % 321   0.2 % 21  
  Ending assets       12,367       10,965       10,766  
Total (excluding unit-linked and cash)                          
  Net investment income   5.9 % 7,338   6.0 % 7,038   5.9 % 6,954  
  Net realized investment gains   1.3 % 1,563   0.7 % 769   0.2 % 186  
  Net unrealized investment gains (losses)   3.6 % 4,446   5.1 % 5,968   (7.8 )% (9,155 )
  Ending assets       129,629       120,184       115,065  

Prudential's Insurance Investment Strategy and Objectives

        Prudential's insurance investments support a range of businesses operating in many geographic areas. Each of the operations formulates a strategy, based on the nature of its underlying liabilities, its level of capital and its local regulatory requirements. Where the nature of underlying liabilities, level of capital and local regulatory requirements permit, Prudential tends to invest its assets predominantly in equities and real estate that have, over longer periods, provided superior returns to fixed interest assets.

Management of Insurance Funds

        Except for a small amount of unit-linked business and variable annuity business, amounting to approximately 6% of Prudential's own funds under management at December 31, 2004, Prudential manages its insurance funds principally through its fund management businesses, M&G in the United Kingdom, together with PPM America in the United States and Prudential Asset Management (formerly PPM Asia) in Singapore, Hong Kong and Japan.

59



        In each of the operations, local management analyzes the liabilities and determines asset allocation, benchmarks and permitted deviations from these benchmarks appropriate for its operation. These benchmarks and permitted deviations are agreed with internal fund managers, who are responsible for implementing the specific investment strategy through their local fund management operations.

Investments Relating to UK Insurance Business

Strategy

        In the United Kingdom, Prudential tailors its investment strategy for long-term business, other than unit-linked business, to match the type of product a portfolio supports. The primary distinction is between with-profits portfolios and non-participating portfolios, which include the majority of annuity portfolios. Generally, the objective is to maximize returns while maintaining investment quality and asset security and adhering to the appropriate government regulations.

        With-profits contracts are long-term contracts with minimal guaranteed amounts, the nature of which permits Prudential to invest primarily in equities and real estate. Accordingly, the with-profits fund investment strategy emphasizes a well-diversified equity portfolio (containing some international equities), real estate (predominantly in the United Kingdom), UK and international fixed income securities and cash.

        For Prudential's UK pensions annuities business and other non-participating business the objective is to maximize profits while ensuring stability by closely matching the cashflows of assets and liabilities. To achieve this matching, the strategy is to invest in fixed income securities of appropriate maturity dates.

        For Prudential's unit-linked business, the primary objective is to maximize investment returns subject to following an investment policy consistent with the representations Prudential has made to its unit-linked product policyholders.

60



Investments

        The following table shows the investments relating to Prudential's UK insurance business, other than its unit-linked business, at December 31, 2004. In this table, investments are shown at market value. The with-profits fund also includes two other businesses, SAIF and Prudential Annuities Limited. The investments in respect of SAIF are shown separately. The investments in respect of Prudential Annuities Limited are included within the Annuities column. The "Other" column includes investments relating to solvency capital of unit-linked funds and investments relating to non-life long-term business.

 
  At December 31, 2004
 
 
  With-
Profits

  Annuities
  SAIF
  Other
  Total
  Total %
 
 
  (In £ Millions, Except Percentages)

 
Equity securities                          
United Kingdom                          
  Listed   20,517     3,841     24,358      
  Unlisted   153     32     185      
   
 
 
 
 
     
  Total United Kingdom   20,670     3,873     24,543   25.6 %
   
 
 
 
 
     
International                          
  United States   1,390     276     1,666      
  Europe (excluding the United Kingdom)   2,968     546     3,514      
  Japan   1,170     211     1,381      
  Pacific (excluding Japan)   3,121     551   14   3,686      
  Other   905     139     1,044      
   
 
 
 
 
     
  Total international   9,554     1,723   14   11,291   11.8 %
   
 
 
 
 
 
 
    Total equity securities   30,224     5,596   14   35,834   37.3 %
   
 
 
 
 
     
Debt and other fixed income securities                          
  UK government   355   2,558   309   191   3,413      
  US government   33       48   81      
  Other   17,392   14,754   5,137   992   38,275      
   
 
 
 
 
     
    Total fixed income securities   17,780   17,312   5,446   1,231   41,769   43.5 %
   
 
 
 
 
     
Real estate                          
  Investment property   9,932   453   1,719     12,104      
  Company-occupied property   110         110      
   
 
 
 
 
     
    Total real estate   10,042   453   1,719     12,214   12.7 %
   
 
 
 
 
     
Loans and other                          
  Loans   70   251   139   5   465      
  Deposits   4,336   355   611   470   5,772      
   
 
 
 
 
     
    Total loans and other   4,406   606   750   475   6,237   6.5 %
   
 
 
 
 
 
 
    Total   62,452   18,371   13,511   1,720   96,054   100.0 %
   
 
 
 
 
 
 

61


Equity Securities

        Prudential's UK insurance operations, excluding unit-linked business, had £35,834 million invested in equities at December 31, 2004. Most of these equities support Prudential Assurance's with-profits fund and the SAIF fund, both of which are managed using the same general investment strategy. The following table shows the geographic spread of this equity portfolio by market value in accordance with the policies described in Note 3 of the notes to the consolidated financial statements.

 
  At December 31, 2004
 
  Market Value
  %
 
  (In £ Millions, Except Percentages)

United Kingdom   24,543   68.5
United States   1,666   4.6
Europe (excluding United Kingdom)   3,514   9.8
Japan   1,381   3.9
Pacific (excluding Japan)   3,686   10.3
Other   1,044   2.9
   
 
  Total   35,834   100.0
   
 

        The UK equity holdings are well diversified and broadly mirror the FTSE All-Share share index. Prudential holds equities in 568 UK companies. At December 31, 2004, the ten largest holdings in UK equities amounted to £10,826 million, accounting for 44.1% of the total UK equity holdings of £24,543 million supporting the UK insurance operations. The following table shows the market value of the ten largest holdings in UK equities at December 31, 2004.

 
  At December 31, 2004
 
  Market Value
  %
 
  (In £ Millions, Except Percentages)

B.P.   1,884   7.7
Vodafone Group   1,635   6.7
HSBC Holdings   1,493   6.1
GlaxoSmithKline   1,435   5.8
The Royal Bank of Scotland Group   1,057   4.3
Barclays   917   3.7
Shell Transport and Trading   808   3.3
Astra Zeneca   558   2.3
Diageo   523   2.1
Lloyds TSB Group   516   2.1
   
 
  Total   10,826   44.1
   
 

        99.8% of all industry sectors are represented in Prudential's equity portfolio. At December 31, 2004, within the £24,543 million in UK equities supporting the UK insurance operations, Prudential had £17,192 million, or 70.0% of the holdings invested in ten industries. The following table shows the

62



primary industry concentrations based on market value of the portfolio of UK equities relating to the UK insurance business at December 31, 2004.

 
  At December 31, 2004
 
  Market Value
  %
 
  (In £ Millions, Except Percentages)

Banks   5,004   20.4
Oil and Gas   3,024   12.3
Telecommunication Services   2,354   9.6
Pharmaceuticals and Biotech   2,107   8.6
Media and Entertainment   889   3.6
Construction and Building Materials   843   3.4
Mining   825   3.4
General Retailers   725   3.0
Beverages   724   2.9
Leisure and Hotels   697   2.8
   
 
  Total   17,192   70.0
   
 

Debt and Other Fixed Income Securities

        At December 31, 2004, 84.2% of Prudential's fixed income securities supporting the UK insurance operations were issued by corporations, 8.2% were issued or guaranteed by the UK government, 0.2% were issued or guaranteed by the US government and 4.8% were issued or guaranteed by other overseas governments. These guarantees relate only to payment and, accordingly, do not provide protection against fluctuations in market price that may occur during the term of the fixed income securities. The remaining 2.6% of Prudential's fixed income securities supporting the UK insurance operations consists mainly of local UK government issues.

        The following table shows the market value of the fixed income securities portfolio by maturity at December 31, 2004, in accordance with the policies described in Note 3 of the notes to the consolidated financial statements.

 
  At December 31, 2004
 
  Market Value
  %
 
  (In £ Millions, Except Percentages)

Securities maturing:        
  Within one year   482   1.2
  Over one year and up to five years   4,925   11.8
  Over five years and up to ten years   8,997   21.5
  Over ten years and up to fifteen years   5,096   12.2
  Over fifteen years   22,269   53.3
   
 
    Total   41,769   100.0
   
 

        Approximately 60.9% of the fixed income securities portfolio was rated by Standard & Poor's at December 31, 2004, of which 20.3% was rated AAA, 5.8% was rated between AA+ and AA-, 18.0% was rated between A+ and A-, 12.5% was rated between BBB+ and BBB- and 4.3% was rated below BBB-. A further 14.0% of this portfolio was rated by Moody's at December 31, 2004, of which approximately 4.8% was rated Aaa, 1.9% was rated between Aa1 and Aa3, 3.8% was rated between A1 and A3, 2.1% was rated between Baa1 and Baa3 and 1.4% was rated below Baa3.

63



Real Estate

        At December 31, 2004, Prudential's UK insurance operations had £12,214 million of investments in real estate in the United Kingdom. The following table shows the real estate portfolio by type of investment. The real estate investments are shown at market value in accordance with the policies described in Note 3 of the notes to the consolidated financial statements.

 
  At December 31, 2004
 
  Market Value
  %
 
  (In £ Millions, Except Percentages)

Office buildings   3,824   31.3
Shopping centers/commercial   5,550   45.4
Retail warehouses/industrial   2,576   21.1
Development   74   0.6
Other   190   1.6
   
 
  Total   12,214   100.0
   
 

        51.3% of the UK real estate investments are located in London and Southeast England (Buckinghamshire, Berkshire, East and West Sussex, Hampshire, Isle of Wight, Kent, Oxfordshire and Surrey) with 46.6% located throughout the rest of the United Kingdom and the remaining 2.1% located overseas.

Loans and Other

        At December 31, 2004, the loans and other portfolio of the UK insurance operations amounted to £6,237 million. The following table shows the loans and other portfolio by value at December 31, 2004.

 
  At December 31,
2004

 
  (In £ Millions)

Loans collateralized by mortgages   330
Loans to policyholders collateralized by insurance policies   54
Other loans   81
Deposits with credit institutions   4,769
Other   1,003
   
  Total   6,237
   

Investments Relating to Prudential's US Insurance Business

Strategy

        The investment strategy of the US Operations, for business other than the variable annuity business, is to maintain a diversified and largely investment grade debt and fixed income securities portfolio that maintains a desired investment spread between the yield on the portfolio assets and the rate credited on policyholder liabilities. Interest rate scenario testing is continually used to monitor the effect of changes in interest yields on cash flows, the present value of future profits and interest rate spreads.

        The investment portfolio of the US Operations consists primarily of fixed income securities, although the portfolio also contains investments in mortgage loans, policy loans, common and preferred stocks, cash and short-term investments and miscellaneous other investments.

64



Investments

        The following table summarizes the total insurance investments of the US Operations, other than the separate account investments supporting the variable annuity business, at December 31, 2004.

 
  December 31, 2004
 
  Non-Institutional
  Institutional
  Total
  Total %
 
  (In £ Millions, Except Percentages)

Debt and other fixed income securities                
  Corporate securities and commercial loans   12,640   2,627   15,267   64.0
  Residential mortgage-backed securities   1,868   82   1,950   8.2
  Commercial mortgage-backed securities   961   262   1,223   5.1
  Other   846   326   1,172   4.9
   
 
 
 
    Total debt and other fixed income securities   16,315   3,297   19,612   82.2
   
 
 
 
Loans and other   3,457   601   4,058   17.0
Equity securities   124   6   130   0.5
   
 
 
 
    Total   19,896   3,904   23,800   99.7
Real estate   75     75   0.3
   
 
 
 
    Total   19,971   3,904   23,875   100.0
   
 
 
 

        Debt and other fixed income securities are shown at amortized cost, with the exception of certain securities held by the US fund management operation, which are shown at fair value of £182 million. Loans and other are shown at outstanding loan balance or amortized cost except for investments in limited partnership interests which are shown at the Company's share of partnership equity. Equity securities are shown at fair value. Real estate is shown at depreciated cost. Interests in associate undertakings are carried at Jackson National Life's proportionate share of net assets. The fair value of unlisted securities is estimated by Jackson National Life, using independent pricing services or analytically determined values.

Debt and Other Fixed Income Securities

        At December 31, 2004, the US Operations had £15,267 million of corporate securities and commercial loans, representing 64.0% of US insurance total investments. Of the £15,267 million, £12,703 million consisted of fixed income securities that are publicly traded or trade under Rule 144A of the Securities Act of 1933 ("Rule 144A") and £2,564 million consisted of investments in non-Rule 144A privately placed fixed income securities.

        For statutory reporting in the United States, debt securities are classified into six quality categories specified by the Securities Valuation Office of the National Association of Insurance Commissioners ("NAIC"). The categories range from Class 1 (the highest) to Class 6 (the lowest). Performing securities are designated Classes 1-5. Securities in or near default are designated Class 6. Securities designated as Class 3, 4, 5 and 6 are non-investment grade securities. Generally, securities rated AAA to A by nationally recognized statistical ratings organizations are Class 1, BBB in Class 2, BB in Class 3 and B and below in Classes 4 through 6. If a designation is not currently available from the NAIC, Jackson National Life's investment advisor, PPM America, provided the designation for the purposes of the disclosure contained herein.

65



        The following table shows the credit quality of the portfolio of publicly traded and Rule 144A fixed income securities at December 31, 2004.

 
  At December 31, 2004
 
  Book Value
  % of Total
 
  (In £ Millions, Except Percentages)

NAIC Designation        
  1   4,781   37.6
  2   6,678   52.6
  3   951   7.5
  4   271   2.1
  5   21   0.2
  6   1   0.0
   
 
    Total   12,703   100.0
   
 

        The following table shows the credit quality of the non-Rule 144A private placement portfolio at December 31, 2004.

 
  At December 31, 2004
 
  Book Value
  % of Total
 
  (In £ Millions, Except Percentages)

NAIC Designation        
  1   980   38.2
  2   1,210   47.2
  3   274   10.7
  4   85   3.3
  5   5   0.2
  6   10   0.4
   
 
    Total   2,564   100.0
   
 

        At December 31, 2004, the US insurance Operations had £1,950 million of residential mortgage-backed securities, representing 8.2% of US insurance total investments. Although this percentage is higher than the average US insurance company, Jackson National Life believes these securities provide additional yield and liquidity. At December 31, 2004, 96.9% of the US insurance Operations' residential mortgage-backed securities were rated AAA or the equivalent by a nationally recognized statistical ratings organization (these include Standard & Poor's, Moody's and Fitch) and 99.8% were rated NAIC 1.

        The primary investment risk associated with residential mortgage-backed securities is that a change in the interest rate environment could cause payment of the underlying obligations to be made more slowly or more quickly than was anticipated at the time of their purchase. If interest rates decline, then this risk is called "pre-payment risk" and the underlying obligations will generally be repaid more quickly when the yields on reinvestment alternatives are lower. Alternatively, if interest rates rise, the risk is called "extension risk" and the underlying obligations will generally be repaid more slowly when reinvestment alternatives are higher. Residential mortgage-backed securities offer additional yield to compensate for these risks. The US Operations can manage pre-payment risk, in part, by reducing crediting rates on its products.

66


        At December 31, 2004, the US Operations had £1,223 million of commercial mortgage-backed securities, representing 5.1% of US insurance total investments, invested in commercial mortgage-backed securities. 99.0% of this total was rated by a nationally recognized statistical ratings organization (these include Standard & Poor's, Moody's and Fitch) and 98.3% was rated investment grade. Due to the structures of the underlying commercial mortgages, these securities do not present the same pre-payment or extension risk as residential mortgage-backed securities.

        At December 31, 2004, the US Operations had £1,172 million of other fixed income securities, representing 4.9% of US insurance total investments.

Loans and Other

        Loans and other totaled £4,058 million, representing 17.0% of US insurance total investments at December 31, 2004. Of the £4,058 million, £2,786 million consisted of loans and £1,272 million consisted of other financial investments.

        Loans represented 11.7% of US insurance total investments at December 31, 2004. £2,412 million related to commercial mortgage loans and £374 million to policy loans.

        Commercial mortgage loans represented 10.1% of US insurance total investments at December 31, 2004. This total included 489 first mortgage loans with an average loan balance of approximately £5.0 million, collateralized by properties located in the United States and Canada. The vast majority of the US Operations' commercial mortgage loan investments have been directly originated in the last eight years.

        Jackson National Life has addressed the risk of these investments by building a portfolio that is diverse both in geographic distribution and property type, emphasizing four main institutional property types: multi-family residential, retail, suburban office and warehouse/distribution facilities.

        As of December 31, 2004, approximately 21.6% of the portfolio was industrial, 25.5% multi-family residential, 22.1% suburban office, 20.4% retail, 9.9% hotel and 0.5% other. Approximately 12.7% of the portfolio is collateralized by properties in California and 12.4% of the portfolio is collateralized by properties in Texas, with no other state representing more than 7% of the total origination.

        Commercial mortgages generally involve more credit risk than residential mortgages due to several factors, including larger loan size, general and local economic conditions, local real estate conditions and the credit quality of the underlying tenants for the properties. Jackson National Life's investment policy and strict underwriting standards are designed to reduce these risks while maintaining attractive yields. In contrast to residential mortgage loans, commercial mortgage loans have minimal or no pre-payment and extension risk.

        Policy loans represented 1.6% of US insurance total investments at December 31, 2004. Policy loans are fully secured by individual life insurance policies or annuity policies and are contractual arrangements made under the policy.

67


Other

        Other financial investments, representing 5.3% of US insurance total investments at December 31, 2004, were made up of £721 million of cash and short-term investments, £400 million of limited partnership interests and £151 million of other miscellaneous investments.

        The largest investment in the limited partnerships category is a £166 million interest in the PPM America Private Equity Fund. The remainder of this category consists of diversified investments in 146 other partnerships managed by independent money managers that generally invest in various equity and fixed income loans and securities.

Equity Securities

        Equity securities supporting US insurance operations totaled £130 million at December 31, 2004 representing 0.5% of US insurance total investments, and consisted of £95 million of common stocks including associates and £35 million of preferred stocks.

Common Stocks

        The £95 million of investments in common stocks included £65 million of investments in mutual funds and £30 million of other investments in common stocks at December 31, 2004.

Preferred Stocks

        The £35 million of investments in preferred stocks included £21 million of private equity preferred stocks at December 31, 2004.

Real Estate

        At December 31, 2004, the US Operations had £75 million of investments in real estate, £37 million of which is real estate Jackson National Life occupies.

Investments Relating to Asian Insurance Business

        Prudential's Asian operations' investments, other than investments in respect of unit-linked business, largely support the business of its Singapore, Hong Kong, Malaysia, Japan and Taiwan operations.

        The following table shows Prudential Asia's investments, other than investments from unit-linked business, at December 31, 2004. In this table, investments are valued in accordance with the policies described in Note 3 of the notes to the consolidated financial statements.

 
  At December 31, 2004
 
  Market Value
  % of Total
 
  (In £ Millions, Except Percentages)

Debt and other fixed income securities   3,791   57.7
Equity securities   2,002   30.4
Loans and other   691   10.5
Real estate   74   1.1
Participating interests   20   0.3
   
 
  Total   6,578   100.0
   
 

        Prudential manages interest rate risk in Asia by matching liabilities with fixed interest assets of the same duration to the extent possible. Asian fixed interest markets however generally have a relatively short bond issue term, which makes complete matching challenging. A large proportion of the Hong

68



Kong liabilities are denominated in US dollars and Prudential holds US fixed interest securities to back these liabilities.

Debt and Other Fixed Income Securities

        The following table shows consolidated investment categorization of the debt and fixed income security investments of Prudential Asia's long-term insurance fund, other than investments from unit-linked business, at December 31, 2004.

 
  At December 31, 2004
 
  Market Value
  % of Total
 
  (In £ Millions, Except Percentages)

Debt and other fixed income securities:        
Government Bonds   2,021   53.3
Quasi Government Bonds   125   3.3
Investment grade Corporate Bonds   1,454   38.4
Non-Investment grade Corporate Bonds   27   0.7
Un-rated bonds   164   4.3
   
 
  Total   3,791   100.0
   
 

Equity Securities

        The following table shows a geographic analysis of equity security investments of Prudential Asia's long-term insurance fund, other than investments from unit-linked business, at December 31, 2004.

 
  At December 31, 2004
 
  Market Value
  % of Total
 
  (In £ Millions, Except Percentages)

Singapore   929   46.4
Hong Kong   886   44.3
Malaysia   88   4.4
Japan   49   2.4
Taiwan   44   2.2
Other   6   0.3
   
 
  Total   2,002   100.0
   
 

Loans and Other

        Loans and other include policy loans, mortgage loans, deposits with credit institutions, unit trust investments and derivatives, including forwards, futures, options and swaps.

Investments Relating to Banking Business

        At December 31, 2004, Prudential had total banking investments of £11,712 million. The following table summarizes the investment portfolios relating to the UK banking business. In this table,

69



investments are valued on the same basis as in Note 3 of the notes to Prudential's consolidated financial statements.

 
  At December 31, 2004
 
  Market Value
  Total %
 
  (In £ Millions, Except Percentages)

Debt and other fixed income securities   3,120   26.6
Loans and other   8,577   73.2
Real estate   15   0.2
   
 
  Total   11,712   100.0
   
 

        Of the £11,712 million of investments, £1,269 million was in respect of certificates of deposit maturing in less than three months.

        The following table shows UK banking business loans by type and repayment period at December 31, 2004.

 
  At December 31, 2004
 
  Due in One
Year or Less

  Due in Over One
Year and Up to
Five Years

  Due in Over
Five Years

  Provision for bad
and doubtful debts

  Total
 
  (In £ Millions)

Overdrafts   2       (1 ) 1
Unsecured personal loans   35   1,386   1,197   (131 ) 2,487
Credit card receivables   3,578       (117 ) 3,461
Residential mortgages   7   98   1,589   (1 ) 1,693
Loans to banks   616         616
   
 
 
 
 
  Total   4,238   1,484   2,786   (250 ) 8,258
   
 
 
 
 

        The following table shows UK banking business loans by type and interest rate at December 31, 2004.

 
  At December 31, 2004
 
  Fixed
Rate

  Variable
Rate

  Provision for bad
and doubtful debts

  Total
 
   
  (In £ Millions)

   
Overdrafts     2   (1 ) 1
Unsecured personal loans   2,618     (131 ) 2,487
Credit card receivables     3,578   (117 ) 3,461
Residential mortgages   27   1,667   (1 ) 1,693
Loans to banks   270   346     616
   
 
 
 
  Total   2,915   5,593   (250 ) 8,258
   
 
 
 


Description of Property

        Prudential's UK based businesses occupy approximately 30 properties in the United Kingdom, Europe and Mumbai. These properties are primarily offices with some ancillary storage/warehouse facilities. Prudential's headquarters are located in London. Of the remainder, the most significant are offices in London, Reading, Chelmsford, Dudley and Derby in England, Stirling in Scotland and Belfast in Northern Ireland. The property in Stirling and two properties in Reading and Derby are held on a freehold basis. The properties in Stirling and in Reading are leased by the business from Prudential

70



Assurance's long-term fund. The rest of Prudential's UK and Mumbai properties are held on long-term leaseholds. The leasehold properties range in size from 1,800 to 270,000 square feet. Overall, the occupied property portfolio totals approximately 1,300,000 square feet.

        In addition to these properties, the Prudential group owns the freehold of a sports facility in Reading for the benefit of staff.

        The Prudential group also holds approximately 80 other leasehold properties in the United Kingdom. This surplus accommodation consists primarily of small offices spread geographically across the United Kingdom and totals approximately 364,000 square feet.

        In the United States, Prudential owns Jackson National Life's executive and principal administrative office located in Michigan. Prudential also leases premises in Michigan, Colorado, California, Illinois, New York, New Jersey, Georgia, Florida, Wisconsin, Kansas, Massachusetts, Connecticut, New Hampshire and North Dakota for certain of its operations. Prudential holds 38 operating leases with respect to office space, throughout the United States. In the United States, Prudential owns and leases a total of approximately 730,000 square feet of property.

        In Asia, Prudential owns or leases properties principally in Hong Kong, Singapore, Malaysia, Indonesia, Thailand, the Philippines, China, Taiwan, Japan, Vietnam, India and Korea. Within these countries, Prudential holds 59 offices on a freehold basis, 8 offices on a leasehold basis and 543 operating leases in respect of office space, totaling approximately 5,300,000 square feet of property. In addition, Prudential is planning to lease approximately 425,000 square feet of additional property in 2005 to support expansion plans throughout the region.

        Prudential believes that its facilities are adequate for its present needs in all material respects.

        Prudential had tangible assets, principally computer equipment, furniture and fixtures of £155 million, £184 million and £196 million at December 31, 2004, 2003 and 2002, respectively.


Competition

General

        There are significant participants in each of the financial service markets in which Prudential operates. Its competitors include both mutual and stock financial companies. In addition, regulatory and other developments in many of Prudential's markets have obscured traditional financial service industry lines and opened the market to new competitors and increased competition. Some new entrants are taking advantage of the low barriers to entry afforded by internet distribution, especially in the area of retail banking. In some of Prudential's markets, other companies may have greater financial resources, allowing them to benefit from economies of scale, and may have stronger brands than Prudential does in that market.

        The principal competitive factors affecting the sale of Prudential's products in its chosen markets are:

71


        An important competitive factor is the ratings Prudential receives in some of its target markets, most notably in the United States, from recognized rating organizations. The intermediaries with whom Prudential works, including IFAs, agents, brokers, wholesalers and financial institutions consider ratings as one factor in determining from which provider to purchase financial products. Prudential Assurance's long-term fund is currently rated AA+ (stable outlook) by Standard & Poor's, Aa1 (stable outlook) by Moody's and AA– (stable outlook) by Fitch Ratings. The ratings from Standard & Poor's, Moody's and Fitch Ratings represent the second highest ratings out of 8, 9 and 12 in their respective rating categories. Jackson National Life is rated AA (negative outlook) by Standard & Poor's, AA (stable outlook) by Fitch Ratings and A1 (stable outlook) by Moody's. The ratings from Standard & Poor's and Fitch Ratings represent the second highest rating category out of 9 and 12 categories respectively and the ratings from Moody's represent the third highest rating category out of 9 categories.

        Prudential offers different products in its different markets of the United Kingdom, the United States and Asia and, accordingly, faces different competitors and different types of competition in these markets. In all of the markets in which Prudential operates its products are not unique and, accordingly, it faces competition from market participants who manufacture a varying range of similar and identical products.

United Kingdom

        Prudential's principal competitors include many of the major stock and mutual retail financial services and fund management companies operating in the United Kingdom. These companies include Aviva, Legal & General, Standard Life, Friends Provident, Lloyds TSB, HBOS, Aegon, AXA, Zurich Financial Services, Fidelity, Invesco, Jupiter, Threadneedle and Schroders. Prudential competes with other providers of financial products to be included on IFA panels of preferred providers.

        In the United Kingdom, the level of bonuses on Prudential's with-profits products is an important competitive measure for attracting new business through IFAs. The ability to declare competitive bonuses depends, in part, on a company's financial strength, which enables it to adopt an investment approach with a higher weighting in equities and real estate and allows it to smooth the fluctuations in investment performance upon which bonuses are based. Bonus rates on Prudential's with-profits policies are broadly in line with those of its major competitors.

United States

        Jackson National Life's competitors in the United States include major stock and mutual insurance companies, mutual fund organizations, banks and other financial services companies. National banks, in particular, may become more significant competitors in the future for insurers who sell annuities, as a result of recent legislation, court decisions and regulatory actions. Jackson National Life's principal life insurance company competitors in the United States include AXA Financial Inc., Lincoln National Corporation, Transamerica Corporation, Nationwide Financial Services, Inc., SunAmerica, Inc. and Hartford Life, Inc.

        Jackson National Life does not have a career agency salesforce in the United States and, consequently, competes for distributors such as banks, broker-dealers and wholesalers. Jackson National Life also competes with other providers of financial products to be placed at the top of independent agents' lists of sources.

72



Asia

        Competition in the Asian markets in which Prudential operates is mainly focused on distribution, with particular emphasis on the size and competency of the agency salesforce. Within Asia, Prudential is second to AIG in terms of penetration and overall life market share across the region. While there are large local participants in individual markets, for example, Great Eastern Life in Singapore and Malaysia, Nippon Life in Japan, Cathay Life in Taiwan, and LIC in India, none of these has pan-regional businesses. Regional players are typically of North American or European origin.

        In addition, Prudential compete with the above as well as smaller competitors for talented and skilled employees with local experience, which are in particular demand in Asia. See Item 3 "Key Information—Risk Factors"

        In the regional mutual fund market in terms of market presence and position, Prudential ranks alongside leading international participants such as Schroders and Fidelity.


Intellectual Property

        Prudential does not operate in the United States under the Prudential name and there have been long-standing arrangements between it and Prudential Financial, Inc. and its subsidiary, the Prudential Insurance Company of America, relating to their respective uses of the Prudential name. Prudential and Prudential Financial, Inc. recently entered into a new trade mark co-existence agreement.


Legal Proceedings

Jackson National Life

        JNL is involved in litigation arising in the ordinary course of business. It is the opinion of management that the ultimate disposition of such litigation will not have a material adverse affect on JNL's financial condition or results of operations. JNL has been named in civil litigation proceedings, which appear to be substantially similar to other class action litigation brought against many life insurers alleging misconduct in the sale and administration of insurance products. JNL generally accrues for legal contingencies once the contingency is deemed to be probable and estimable. Accordingly, at December 31, 2004 and 2003, JNL had recorded accruals totaling $20.8 million and $13.5 million, respectively.

Prudential Corporation Asia

        On April 23, 2004 the Jakarta Commercial Court accepted a bankruptcy petition filed against PT Prudential Life Assurance ("PT Prudential"). The case arose as a result of PT Prudential terminating a consultancy contract for agency salesforce management, following legal advice. As a result, the consultant made a claim for approximately US$40 million and filed a bankruptcy petition in the Jakarta Commercial Court. The Court held that PT Prudential owed the consultant approximately US$165,000 and, despite the business being solvent, put PT Prudential into bankruptcy. In June 2004, the Supreme Court of Indonesia overturned the bankruptcy decision of the Jakarta Commercial Court. An amendment to the Indonesian bankruptcy law has subsequently been enacted and as result only the Ministry of Finance can now file of bankruptcy petition against an insurance company.

Prudential Group

        Prudential and its subsidiaries are involved in other litigation arising in the normal course of business. While an adverse ruling in any individual case may not in itself be material to Prudential, if applied across all similar cases, the potential liabilities may be more significant. Although the outcome of such matters cannot be predicted with certainty, management believes that the ultimate outcome of

73



such litigation will not have a material adverse effect on the group's financial condition, results of operations or cash flows.


Sources

        Throughout this annual report, Prudential describes the position and ranking of its overall business and individual business units in various industry and geographic markets. The sources for such descriptions come from a variety of conventional sources generally accepted as relevant business indicators by members of the financial services industry. These sources include information available from the Association of British Insurers, the UK Department of Trade and Industry, Association of Unit Trusts and Investment Funds, Neilsen Net Ratings, Moody's, Standard & Poor's, Fitch, UBS Warburg, Life Insurance Marketing and Research Association, the Variable Annuity Research Data Service, referred to as VARDS, LIMRA International, Townsend and Schupp, The Advantage Group, the Life Insurance Association of Singapore, the Hong Kong Federation of Insurers, Life Insurance Association of Malaysia, Life Insurance Association of Taiwan and the Taiwanese Securities Investment Trust Consulting Association.

74



SUPERVISION AND REGULATION OF PRUDENTIAL

        Prudential's principal insurance, investment and banking operations are in the United Kingdom, the United States and Asia. Accordingly, it is subject to applicable United Kingdom, United States and Asian insurance, banking and other financial services regulation which is discussed below.


UK Supervision and Regulation

The Financial Services and Markets Act 2000

        Prudential's insurance, investment and banking businesses in the United Kingdom are regulated by the Financial Services Authority (the "FSA"), the statutory regulator granted powers under the 2000 Act. In addition, those businesses are subject to various United Kingdom laws governing the terms and the sale of products (for example, the Consumer Credit Act 1974 in relation to the banking business) some of which require the relevant Prudential entity to be licensed or registered.

Risk-Based Regulation

        The FSA employs a risk-based regulatory approach under the 2000 Act pursuant to which each regulated firm's risk is assessed on a common model. This covers the firm's control environment and business and customer risk profiles, together with an assessment of the potential impact on consumer protection and market stability of financial or compliance failure of that firm. The FSA aims to create a single set of prudential requirements organized according to risk category with sections containing rules and guidance on credit, market, operational and insurance risks, as well as capital adequacy and consolidated supervision.

        A key feature of the risk-based regime is the introduction of a single Integrated Prudential Sourcebook to replace the separate "Interim Prudential Sourcebooks" that currently regulate businesses in different regulated sectors. While the FSA initially envisaged that the Integrated Prudential Sourcebook would be fully implemented on January 1, 2004, developments and delays in the agreement of international legislation (such as the new Basel capital accord) have led to a phased introduction of its provisions. However, since the regulation of insurance has not been affected by many of these delays, the FSA proceeded with the early introduction of substantially all of the new prudential regime for insurance firms in its original target year of 2004.

Overview of 2000 Act Regulatory Regime

Single Regulator

        The FSA is the single regulator for all authorized persons with respect to regulated activities in the financial services sector. In this regard, the FSA is authorized to make rules and issue guidance and codes in relation to a wide sphere of activity encompassing the governance of the conduct of business by, and the prudential supervision of, authorized persons.

Permission to carry on "Regulated Activities"

        Under the 2000 Act, no person may carry on or purport to carry on a regulated activity in the United Kingdom unless he is an authorized person or is an exempt person. A firm which is granted permission by the FSA to carry on regulated activities becomes an authorized person for the purposes of the 2000 Act. "Regulated activities" are prescribed in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 and include banking activities, insurance activities and certain other activities, such as dealing in investments as principal or agent, and the establishment, operation and winding up of stakeholder pension schemes, as described below.

75



Authorization Procedure

        When considering an application for authorization by a firm, the FSA may delineate the scope of, and include such restrictions on, the grant of permission as it deems appropriate. In granting or varying the terms of a firm's permissions, the FSA must ensure that the firm meets certain threshold conditions, which, among other things, require the firm to have adequate resources for the carrying on of its business, and to be a fit and proper person, having regard to all the circumstances.

        Once authorized, and in addition to continuing to meet the threshold conditions to authorization, firms are obliged to comply with the FSA Principles for Business, which are high level principles for conducting financial services business in the United Kingdom. These include the maintenance of adequate systems and controls, treating customers fairly and communicating with customers in a manner that is clear, fair and not misleading.

        Moreover, the 2000 Act obliges firms to secure the FSA's prior approval of the appointment of individuals performing certain important functions within a firm or on its behalf with respect to the carrying on of regulated activities (approved persons).

Application of 2000 Act Regulatory Regime to Prudential

        Each of Prudential's principal UK insurance, investment and banking businesses is subject to regulation and supervision by the FSA in the carrying on of its regulated activities. The following discussion considers, in turn, the main features of the 2000 Act regime applicable to Prudential's insurance, investment and banking businesses in the United Kingdom.

Regulation Applicable to Prudential's Insurance, Investment and Banking Businesses

Supervision of Management and Change of Control of Authorized Firms

        The FSA closely supervises the management of authorized firms through the approved persons regime, under which any appointment of persons who hold positions of significant influence within an authorized firm must be pre-approved by the FSA.

        The FSA also regulates the acquisition of control over authorised firms. Under the 2000 Act, any person proposing to acquire control of an authorised firm must first obtain the consent of the FSA. In considering whether to grant or withhold its approval to the acquisition of control, the FSA must be satisfied both that the acquirer is a fit and proper person to have control over the authorized firm, and that the interests of consumers would not be threatened by his acquiring control.

        Control over a UK authorised firm ("A") is acquired if the acquirer holds 10% or more of the shares in A or a parent undertaking of A ("P"); is able to exercise significant influence over the management of A or P by virtue of his shareholding in that company; is entitled to exercise, or control the exercise, of 10% or more of the voting power of A or P; or is able to exercise significant influence over the management of A or P by virtue of his voting power in that company. Increases in "control', once they reach thresholds of 20%, 33% and 50% of the shares or voting power of an authorized firm or one of its controllers, also require the consent of the FSA.

        In order to determine whether a person or a group of persons is a "controller" for the purposes of the 2000 Act, the holdings (shares or voting rights) of the person and his "associates", if any, are aggregated.

Intervention and Enforcement

        The FSA has extensive powers to investigate and intervene in the affairs of an authorized firm. The 2000 Act imposes on the FSA statutory obligations to monitor compliance with the requirements

76



imposed by, and to enforce the provisions of, the 2000 Act, related secondary legislation and the rules made thereunder.

        The FSA's enforcement powers, which may be exercised against both authorized firms and approved persons, include public censure, imposing unlimited fines and, in serious cases, the revocation or variation of permission to carry on regulated activities or of an approved person's approved status. In addition, the FSA may vary or revoke an authorized firm's permission if it is desirable to protect the interests of consumers or potential consumers, or if the firm has not engaged in regulated activity for 12 months, or if it is failing to meet the threshold conditions for authorisation. The FSA has further powers to obtain injunctions against authorized persons and to impose or seek restitution orders where persons have suffered loss. Once the FSA has made a decision to take enforcement action against an authorized or approved person (other than in the case of an application to the court for an injunction or restitution order), the person affected may refer the matter to the Financial Services and Markets Tribunal. Breaches of certain FSA rules by an authorized firm may also give a private person who suffers loss as a result of the breach a right of action against the authorized firm for damages.

        In addition to its ability to apply sanctions for market abuse, the FSA has the power to prosecute criminal offences arising under the 2000 Act and insider dealing under Part V of the Criminal Justice Act 1993 and breaches of money laundering regulations. The FSA's stated policy is to pursue criminal prosecution in all appropriate cases.

        The FSA, although not a creditor, may seek administration orders under the Insolvency Act 1986 (as amended), present a petition for the winding-up of an authorized person or have standing to be heard in the voluntary winding-up of an authorized person. It should be noted that insurers carrying on long-term insurance business cannot voluntarily be wound up without the consent of the FSA.

FSA Conduct of Business Rules

        The FSA's Conduct of Business Rules apply to every authorized firm carrying on regulated activities and regulate the day-to-day conduct of business standards to be observed by authorized persons in carrying on regulated activities.

        Recent amendments in the FSA's Conduct of Business Rules have brought about changes in the structure of the markets in which packaged products (such as life insurance policies with an investment element) are sold within the UK and the mechanics of the sales process.

        Under the previous regime, the FSA's policy of 'polarisation' effectively required those intermediaries who advised on packaged products either to be independent and advise on products from across the market, or to represent one company only, and sell only its products. The removal of this restriction has allowed firms to sell not only their own products, but those of other providers as well, without limit on the number of providers whose products can be sold.

        Those firms which advise customers on packaged products are now required to provide advice based on a particular range of products, details of which range will need to be decided in advance by the firm, and disclosed to the customer as part of the pre-sales process through FSA prescribed documentation. In order to be able to hold itself out as "independent", a firm needs to offer customers the chance to pay for its services on a fee (rather than commission) basis as well as advising on products across the whole market.

        The amendments to the FSA's Conduct of Business Rules to reflect the process of "depolarisation" included provisions restricting the terms on which product providers can take up direct or indirect holdings in, or provide credit to, intermediaries offering advice on packaged products (which do not apply in between firms in the same immediate group). Furthermore, the FSA's Conduct of Business Rules were amended to include rules governing the extent to which product providers can provide

77



intermediaries with indirect benefits, in order to avoid the development of conflicts of interest (which rules, again, are disapplied for firms in the same immediate group).

Financial Promotion

        The FSA's Conduct of Business Rules govern the circumstances and manner in which authorized firms may communicate and approve "financial promotions", which are communications in the course of business that constitute invitations or inducements to engage in investment activity.

The Financial Ombudsman Service

        The Financial Ombudsman Service is intended to provide speedy, informal and cost effective dispute resolution of complaints made against authorized firms by individuals and small-business customers. The Ombudsman is empowered to order firms to pay fair compensation for loss and damage and may order a firm to take such steps as it determines to be just and appropriate to remedy a complaint. Authorised firms must have appropriate complaints handling procedures.

        In a recent decision (which may be appealed), the High Court of England and Wales has ruled that the Financial Ombudsman may depart from principles of English law when deciding levels of compensation in order to achieve a result which is fair and reasonable in his opinion.

The Financial Services Compensation Scheme

        The 2000 Act provides for the establishment of a compensation scheme intended to compensate individuals and small businesses for claims against an authorized firm where the authorized firm is unable or unlikely to be able to meet those claims (generally, when it is insolvent or has gone out of business). The scheme is divided into three sub-schemes of banking, insurance and investment business, reflecting the different kinds of business undertaken by authorized firms. The scheme is funded by contributions from industry participants referable to the particular sub-schemes so as to minimize cross-subsidy between authorized persons whose businesses are not similar. Prudential estimates its reserve for future fund assessments for its UK business to be insignificant, and, believes the reserves in place are adequate for all payments for known insolvencies. In the event of a failure of a market participant, Prudential could be required to make contributions to compensate investors.

Regulation of Insurance Business

        Effecting and carrying out contracts of insurance as principal are regulated activities for the purposes of the 2000 Act, and the carrying on of such regulated activities is referred to as insurance business. Some of Prudential's subsidiaries, including The Prudential Assurance Company Limited, Prudential Annuities Limited, Prudential Retirement Income Limited, Prudential Pensions Limited, Prudential Holborn Life Limited and Prudential (AN) Limited carry on insurance business in the United Kingdom with the permission of the FSA and are supervised by the FSA under the 2000 Act.

Developments in Prudential Regulation

        The FSA's rules on the prudential regulation of insurance business are principally contained in those sections of the FSA's Integrated Prudential Sourcebook which prescribe rules and guidance for authorized persons carrying on insurance business. Under rules in the Integrated Prudential Sourcebook, an insurance company is restricted from carrying on any commercial business other than insurance business and activities directly arising from that business. The FSA Interim Prudential Sourcebook for Insurers (the "Interim Prudential Sourcebook") continues to govern some matters such as the reporting requirements.

78



Capital requirements of the Integrated Prudential Sourcebook

        The FSA made the majority of the rules which govern the prudential regulation of insurers in 2004 and these rules are now in force as part of the Integrated Prudential Sourcebook. Overall, the requirements of the Integrated Prudential Sourcebook are intended to align the capital adequacy requirements for insurance businesses more closely with those of banking and investment firms and building societies, for example, by addressing tiers of capital, rather than looking at net admissible assets.

        The Integrated Prudential Sourcebook also introduced an Individual Capital Assessment framework for life and non-life insurers. The Individual Capital Assessment requires all insurers to assess for themselves the amount of capital needed to back their business. If the FSA views the result of this assessment as insufficient, it may draw up its own Individual Capital Guidance for a firm, which can be imposed as a requirement on the scope of the authorized firm's permission.

Long-term Assets and Liabilities

        Long-term business assets and liabilities—those assets and liabilities relating to, broadly, life and health insurance policies—must be segregated from the assets and liabilities attributable to non-life insurance business or to shareholders. Separate accounting and other records must be maintained and a separate fund must be established to hold all receipts of long-term business.

        The extent to which long-term fund assets may be used for purposes other than long-term business is restricted by the rules in the Integrated Prudential Sourcebook and Interim Prudential Sourcebook. Only the "established surplus"—the excess of assets over liabilities in the long-term fund, as determined by an actuarial investigation—may be transferred so as to be available for other purposes. Restrictions also apply to the payment of dividends by the insurance company, as described below. The rules in the Integrated Prudential Sourcebook require, in addition to the capital requirements referred to below, the maintenance of sufficient assets in the separate long-term insurance fund to cover the actuarially determined value of the insurance liabilities.

Capital Requirements

        The Integrated Prudential Sourcebook requires that insurance companies maintain assets sufficient to meet the relevant capital requirement at all times in respect of both any long-term insurance and general insurance undertaken by the insurance company, the calculation of which requirement in any particular case being dependent on the type and amount of insurance business a company writes. The method of calculation of the capital requirement is set out in the Integrated Prudential Sourcebook and the level of an insurer's capital resources is also determined in accordance with the rules set out in the Integrated Prudential Sourcebook. Failure to maintain the required capital resources requirement is one of the grounds on which wide powers of intervention conferred upon FSA may be exercised.

        Under the Integrated Prudential Sourcebook, an authorized person carrying on insurance business must hold capital resources equal at least to the Minimum Capital Requirement (the "MCR"). Insurers with with-profits liabilities of more than £500 million must hold capital equal to the higher of MCR and the Enhanced Capital Requirement (the "ECR"). The ECR is intended to provide a more risk responsive and "realistic" measure of a with-profits insurer's capital requirements, whereas the MCR is broadly speaking equivalent to the previous required minimum margin under the Interim Prudential Sourcebook and satisfies the minimum EU standards.

79



        Determination of the ECR involves the comparison of two separate measurements of the firm's financial resources requirements, which the FSA refers to as the "twin peaks" approach. The two separate peaks are:

          (i)  the requirement comprised by the mathematical reserves plus the sum of the "Long Term Insurance Capital Requirement" (the "LTICR") and the resilience capital requirement, together known as the "regulatory peak"; and

         (ii)  a calculation of the "realistic" present value of the insurer's expected future contractual liabilities together with projected "fair" discretionary bonuses to policyholders, plus a risk capital margin, together known as the "realistic peak".

        The LTICR is made up of several components, but in general is equal to approximately 4 per cent. of the mathematical reserves, although the formula varies according to the type of business written. The resilience capital requirement is in respect of the potential effects of market risk. If the calculation of the realistic peak produces a requirement in excess of the regulatory peak, then the difference is known as the with-profits insurance capital component.

Actuarial functions

        The rules in the FSA's Supervision Manual require that every insurance company that carries on long-term business must appoint one or more an actuaries to perform the "actuarial function" in respect of all classes of its long-term insurance business and, if it has any with-profits business, the "with-profits actuary function' in respect of all classes of that with-profits business.

        The actuary performing the "actuarial function" must prepare an annual report for the company's directors quantifying the company's long-term liabilities attributable to the insurance company's long-term insurance business, determining the value of any excess over those liabilities of the assets representing the long-term insurance fund and where any rights of long-term policyholders to participate in profits relate to particular parts of such a fund, a valuation of any excess of assets over liabilities in respect of each of those parts.

        The actuary performing the "with-profits actuary function" must advise the firm's management, at the level of seniority that is reasonably appropriate, on key aspects of the discretion to be exercised affecting those classes of the with-profits business of the firm in respect of which he has been appointed. He must also, at least once a year, in respect of each financial year commencing on or after January 1, 2005, report to the firm's governing body on key aspects (including those aspects of the firm's application of its Principles and Practices of Financial Management on which the advice described has been given) of the discretion exercised in respect of the period covered by his report affecting those classes of with-profits business of the firm.

Distribution of Profits and With-profits Business

        The Interim Prudential Sourcebook provides that, once an allocation of surplus in a with-profits fund has been made to policyholders, no transfer of assets representing any part of a subsequent surplus can be made, to shareholders or otherwise, unless either the "relevant minimum" (as defined in the Interim Prudential Sourcebook) of the surplus has been allocated to policyholders or a statutory notification procedure has been followed. Calculation of the relevant minimum is based upon the percentage of the relevant surplus previously allocated to eligible policyholders.

        Under the Interim Prudential Sourcebook, an insurance company is prohibited from declaring dividends in circumstances where the value of the long-term insurance business assets is less than the amount of the long-term insurance business liabilities. While its parent is not subject to the same restriction, HM Treasury however is given power under the 2000 Act to make regulations preventing an insurance company's parent from doing anything to lessen the effectiveness of any "asset identification

80



rules" made by the FSA, which will include in this context rules requiring insurers to maintain the solvency of the long-term fund.

        There has been considerable public debate regarding the rights and legitimate expectations of with-profits policyholders to assets forming part of an insurance company's surplus, particularly where such assets do not derive from the payment of current policyholders' premiums but are rather "inherited" from previous generations of policyholders or from other entities.

        The FSA also mandated that firms carrying on with-profits business must:

        Since April 1, 2004, firms carrying on with-profits business have been required to produce PPFM and to make them publicly available. From the same date, firms have also been required to have in place the relevant governance arrangements and reporting procedures to with-profits policyholders.

Treating Customers Fairly

        Principle 6 of the FSA's Principles for Businesses requires firms to treat customers fairly. This requirement has existed for many years in parts of the regulatory system and is seen as key to the operation of an efficient retail market for financial services and is closely linked to maintaining consumer confidence. Until recently the meaning of the duty had not been further defined. However, after a series of consultations, in January 2005 the FSA published Policy Statement 05/01, which contained as set of specific rules on this area in relation to with-profits policyholders.

        These new rules address, among other things, the costs charged to a with-profits fund by the firm managing the fund; penalties and charges levied on policyholders who surrender their policies early, the need for funds to be managed with the objective of ensuring that maturity payouts fall within a target range set for the fund; and the provision of information to with-profits policyholders or potential policyholders in a format that they can more readily understand—through the introduction of "Consumer Friendly Principles and Practices of Financial Management" (CFPPFMs).

        In addition, life insurers writing with-profits business must provide information to with-profits policyholders within 28 working days of a decision to close a fund to new business or of the appointment of a policyholder advocate to protect the interest of policyholders should a firm decide to make a reattribution of its inherited estate.

        These changes are to be implemented as a whole on 30th June 2005 but with a transitional period of up to six months (up until 31st December, 2005) for authorized firms to implement requirements on pay-out target ranges and policy surrender values. The requirements for firms to product CFPPFMs will take effect on December 31, 2005.

81



Reporting Requirements

        Under the Interim Prudential Sourcebook, insurance companies must file with the FSA their audited annual accounts and balance sheets and life insurers annual reports from the actuary performing the actuarial function.

        The FSA began consultation in 2002 on the use of implicit items to form part of an insurer's capital resources, and has now produced rules and guidance in the Integrated Prudential Sourcebook to indicate that the FSA will not permit implicit items to be included in the calculation of a firm's capital resources, except where the firm in question has obtained a formal waiver of the rules under the 2000 Act. The guidance notes that certain implicit items are not eligible for inclusion beyond December 31, 2009.

Transfer of Insurance Business

        Before any transfer of insurance business may take place, the 2000 Act requires a scheme of transfer to be prepared and approved by the High Court.

Winding-Up Rules

        The general insolvency laws applicable to UK companies are modified in certain respects in relation to insurance companies. Since the introduction of the Financial Services and Markets Act 2000 (Administration Orders Relating to Insurers) Order 2002 (the "2002 Order"), which came into force in May 2002, insurance companies in the UK have become subject to the administration procedures contained in Part II of the Insolvency Act 1986 (which previously did not apply). These administration procedures have, however, also been slightly modified by the 2002 Order in relation to, for example, the power of an administrator to make any payments due to a creditor.

        Additionally, in the United Kingdom, all FSA authorized insurance companies, except for pure reinsurers, are subject to the Insurers (Reorganisation and Winding-up) Regulations 2004, which came into force in February 2004.

        These Regulations provide, among other things, that direct insurance claims will have priority over the claims of other unsecured creditors, including reinsurance creditors, on a winding-up by the court or a creditors' voluntary winding up of the insurance company. Furthermore, instead of making a winding-up order when an insurance company has been proved unable to pay its debts, a UK court may, under Section 377 of the 2000 Act, reduce the amount of one or more of the insurance company's contracts on terms and subject to conditions (if any) which the court considers fit. Where an insurance company is in financial difficulties but not in liquidation, the Financial Services Compensation Scheme may take measures for securing the transfer of all or part of the business to another insurance company.

        Section 376 of the 2000 Act provides further insolvency protection to policyholders of insurance companies effecting or carrying out contracts of long-term insurance. Unless the court orders otherwise, a liquidator must carry on the insurer's business so far as it consists of carrying out the insurer's contracts of long-term insurance with a view to it being transferred as a going concern to a person who may lawfully carry out those contracts. In carrying on the business, the liquidator may agree to the variation of any contracts of insurance in existence when the winding-up order is made, but must not effect any new contracts of insurance.

EU Directive on Group Supervision

        The European Union formally adopted Directive 98/78/EC on the supplementary supervision of insurance undertakings within a group (the "Insurance Groups Directive") in October 1998. The

82



Insurance Groups Directive required member states to introduce the following measures to strengthen supervision of insurance companies, which are part of a group:

        These requirements have been implemented in the UK by the Insurer's Interim Prudential Sourcebook and the Integrated Prudential Sourcebook.

        The parent undertaking solvency calculation under the rules that implement the requirements of the Insurance Group Directive is filed with the FSA and differs from the adjusted solo solvency margin test in that it is a currently only a calculation rather than a formal test. However, insurers will be required under the rules in the Integrated Prudential Sourcebook from December 31, 2006 to ensure that the group capital resources of the each undertaking included in the parent undertaking solvency calculation are equal to or exceed the group capital resources requirement for that undertaking.

EU Directive on Financial Conglomerates

        In November 2002, the European Union formally adopted Directive 2002/87/EC (the "Financial Groups Directive") on financial conglomerates, which are groups that include regulated entities which are active in the banking/investment services sectors and the insurance sector, and which meet certain criteria. The Financial Groups Directive, as implemented in the UK through the Integrated Prudential Sourcebook, came into force for those firms and groups affected (which for the time being includes Prudential) from financial years beginning on or after January 1, 2005. The aim of the Financial Groups Directive is to impose additional prudential requirements in respect of regulated entities within financial conglomerates including, to a certain extent, any mixed financial holding company. The additional supervision is organized at the level of the financial conglomerate and covers capital adequacy, risk concentration and intra-group transactions.

        The Insurance Groups Directive, which was implemented in the UK in 2001, together with the Financial Groups Directive, require European financial services groups, including Prudential, to maintain on a continuous basis net aggregate surplus capital in excess of solvency requirements at the Group level. The Financial Conglomerates Directive requires a continuous parent company solvency test which requires the aggregating of surplus capital held in the regulated subsidiaries, from which group borrowings are deducted, other than those subordinated debt issues which qualify as capital. The test is passed when this aggregate number is positive. A negative result at any point in time is a notifiable breach of UK regulatory requirements. Additionally, the FSA has indicated that it will require public disclosure of the Financial Groups Directive solvency position from December 31, 2005.

New EU Rules on Solvency Margins

        In addition to the solvency requirements of the Insurance Groups Directive and Financial Groups Directive, under rules amending the solvency margin requirements for life and non-life insurance

83



undertakings, which have been implemented in EU member states in 2004 (the FSA's new rules in this respect apply to firms from the beginning of their 2004 financial years), each UK insurer must maintain capital resources (shareholders' equity and quasi-equity) at a level that depends on the nature of the insurer's activity and that is calculated with reference to certain balance sheet and income statement items, subject to an absolute minimum (so-called minimum guaranteed fund) of €3 million (€2 million for some classes of non-life insurance). The rules are part of the European Commission's efforts to achieve a single European market for financial services. These rules were introduced by the Solvency I Directives (2002/12/EC and 2002/13/EC). They were fully implemented in the United Kingdom in January 1, 2005 and make up part of the FSA's Integrated Prudential Sourcebook. The rules also give regulators greater powers to intervene in the event of concerns regarding an insurance company's financial position.

        The European Commission continues to work on a more comprehensive review of solvency requirements for insurance undertakings, the so-called "Solvency II" project, which will be based on a three-pillar structure, comprised of capital requirements, supervisory review and public disclosure. Although the final form of the Directive is yet to established, and there can be no certainty of its impact on solvency requirements, it is expected that the new solvency rules will be based on two levels of regulatory capital requirements for insurers: a solvency capital requirement, which is expected to adopt a more risk-based approach along the lines introduced in the United Kingdom through the Integrated Prudential Sourcebook and will be aimed at reflecting and quantifying the exposure of the relevant insurance undertaking, and a minimum capital requirement, which will be computed in a less refined manner and which would act as trigger for supervisory intervention. However, the indications from the European Commission are that the Directive adoption process will not start before summer 2006, with a view to the Directive's formal adoption in October 2006.

Other EU Measures

        In May 2003, the European Union adopted Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision, which member states must implement into their national law by September 2005. This Directive is intended to permit employee pension schemes to be operated and managed on an EU-wide basis. The Directive contains certain prudential rules and "prudent person" investment requirements, which could be extended by member states to the occupational retirement schemes operated by life insurance companies. Finally, on April 21, 2004, the European Commission presented a proposal for a directive on the supervision of reinsurance undertakings. If adopted, the reinsurance directive would introduce a set of harmonized rules to allow pure reinsurance companies to operate across the European Union on the basis of their home-country license.

Regulation of Investment Business

        Certain of Prudential's subsidiaries are authorized by the FSA to carry on investment business. These entities are subject to regulation and supervision by the FSA and must comply with the FSA Conduct of Business Rules and all other applicable rules prescribed by the 2000 Act regime.

Regulation of stakeholder pension schemes

        The establishment, operation and winding-up of a stakeholder pension scheme are regulated activities, and rights under a stakeholder pension scheme are defined as "investments" for the purposes of the 2000 Act regime, so that dealing, arranging, managing, advising and providing custody activities in respect of rights relating to a stakeholder pension also constitute regulated activities.

84



Regulation of mortgage lending, sales and administration and general insurance mediation

        Mortgage lending, sales and administration as well as long-term care insurance became activities regulated under the 2000 Act on October 31, 2004, for which for which authorization by the FSA is now required. General insurance sales and administration became activities regulated under the 2000 Act on January 14, 2005, for which authorization by the FSA is now required.

Regulation of Banking Business

        The FSA has sole responsibility for banking supervision and regulation in the United Kingdom and has wide discretionary powers in relation to those banks it regulates. The FSA has wide investigatory and enforcement powers, including the power to require information and documents from banks, appoint investigators, apply to the court for injunctions in cases of breaches or likely breaches of rules, impose financial penalties, issue a public statement or censure and vary, cancel or withdraw authorization to carry on banking business.

Supervision

        In its role as supervisor of banks, the primary objective of the FSA is to fulfil its responsibilities under the 2000 Act regime relating to the safety and soundness of banks with the aim of strengthening, but not guaranteeing, the protection of depositors. The FSA has adopted a risk-based approach to bank supervision.

        The FSA requires Prudential to maintain a certain minimum capital adequacy ratio of total capital to risk-weighted assets and to report large exposures. The Interim Prudential Sourcebook for Banks, on a general level, requires banks operating in the United Kingdom to maintain adequate liquidity, taking into account the nature and scale of their business so that they are able to conduct business in a prudent manner and meet their obligations as they fall due. As part of its supervision, the FSA requires the banks subject to its supervision to provide it with information that the FSA may reasonably require to perform its functions under the 2000 Act regime.

Solvency Requirements

        The requirement to have adequate financial resources is one of the criteria for permission to accept deposits under the 2000 Act. A bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. In assessing a bank's capital adequacy, the FSA takes into account not only the level of a bank's own funds but also other matters such as concentration of the loan book (large exposures) and liquidity.

        The FSA applies capital adequacy rules and guidelines that accord with relevant EC Directives and which are based on the Basel Accord of 1988, which established a framework for measuring the capital adequacy of international banking organizations. These rules and guidelines implement the requirements of the Banking Consolidation Directive and the Capital Adequacy Directive, as amended, which require credit institutions and investment firms to provide capital for counterparty risk and market risk. The FSA's rules and guidelines impose on banks a requirement that they maintain a minimum level of capital to support on and off-balance sheet exposures, weighted according to broad categories of risk. Each bank is subject to the FSA's rules and guidelines and must maintain a required capital adequacy ratio of total capital to risk-weighted assets. This ratio is set by the FSA individually for each such bank, but the ratio is in no case less than 8%.

        The FSA introduced a new market risk regime as from October 1, 1998 for implementation of its policy based on the Basel Accord and the parallel EC Market Risk Directive, known as the "CAD Amending Directive". Both the 1996 Basel Amendment to the Basel Accord and the CAD Amending

85



Directive enable banks and investment firms to use internal value-at-risk models to calculate capital charges for market risks.

        Banks that have a trading book over a certain size are obliged to meet the trading book capital requirements of the CAD and the CAD Amending Directive in respect of the market-related and credit-related risks arising from their proprietary trading activities. This involves splitting their business between trading and banking books.

        Most UK banks are required to maintain, in non-interest-bearing accounts at the Bank of England, a cash balance, known as the cash ratio deposit, which is based on eligible liabilities, primarily pound sterling deposits less amounts on loan to other monetary institutions. Although these balances count towards the liquidity requirements for the real time gross settlement system introduced in the United Kingdom during 1996, they are generally regarded as non-operational and, accordingly, do not count towards overall liquidity requirements. The liquidity standard for sterling, which the UK government introduced in January 1996, requires the maintenance of sufficient holdings of liquid assets to cover potential cash outflows over the next five business days. This policy applies to UK-incorporated retail banks and group UK-based sterling operations.

        The Basel Committee on Banking Supervision published a new accord in June 2004 which will replace the Basel Accord of 1988. Basel II consists of three "pillars": minimum capital, a supervisory review of an institution's capital adequacy and internal assessment process and market discipline to strengthen disclosure. With respect to the first pillar, the new capital framework will not merely expand and develop the standardized rules set out in the 1988 Accord, but will allow banks to compute their capital charges for credit risk on the basis of their own internal ratings, subject to rigorous quantitative and qualitative criteria. It is expected that the new accord will be implemented by the end of 2006.

        In July 2004, the European Commission presented a proposal for a new capital requirements framework for banks and investment firms. The European Commission's paper implements, with modifications, the new Basel framework and similarly contains proposals for minimum capital requirements, supervisory review, and disclosure as an aid to market discipline.

        The FSA published in January 2005 Consultation Paper 05/03 on the implementation of the New Basel Capital Accord and the EC Capital Requirements Directive. The main proposals in the Consultation Paper are:

86



US Supervision and Regulation

General

        Prudential conducts its US insurance activities through Jackson National Life, a stock life insurance company licensed to transact its insurance business in, and subject to regulation and supervision by, the District of Columbia and 49 of the 50 states; Jackson National Life operates a subsidiary, Jackson National Life Insurance Company of New York, in the state of New York. The extent of such regulation varies, but most jurisdictions have laws and regulations governing the financial aspects of insurance companies, including standards of solvency, reserves, reinsurance and capital adequacy and the business conduct of insurance companies. In addition, statutes and regulations usually require the licensing of insurers and their agents and the approval of policy forms and related materials. These statutes and regulations in Jackson National Life's state of domicile, which is Michigan, also set out the permitted types and concentration of investments.

        Insurance regulatory authorities in each of the jurisdictions in which Jackson National Life does business require it to file detailed quarterly and annual financial statements, and these authorities have the right to examine its operations and accounts. In addition, Jackson National Life is generally subject to federal and state laws and regulations that affect the conduct of its business. New York and Michigan require their state insurance authorities to conduct an examination of an insurer under their jurisdiction at least once every five years. The New York insurance authorities conducted an examination of Jackson National Life of New York in 2003 for the exam period of January 1, 2000 through December 31, 2002 and the report included no material findings. Michigan insurance authorities completed a routine examination of Jackson National Life during the year 2001 for the period ending December 31, 2000 and the report included no material findings.

        Jackson National Life's ability to pay shareholder dividends is limited under Michigan insurance law. The Commissioner of the Michigan Office of Financial and Insurance Services (the "Michigan Insurance Commissioner") may limit, or not permit, the payment of, shareholder dividends if the Michigan Insurance Commissioner determines that an insurer's surplus, as regards policyholders, is not reasonable in relation to its outstanding liabilities and is not adequate to meet its financial needs as required by Michigan insurance law. Jackson National Life must report any shareholder dividends to the Michigan Insurance Commissioner before they can be paid. In the case of an extraordinary shareholder dividend or distribution, an insurer must give 30 days advance notice to the Michigan Insurance Commissioner and may not pay the dividend or distribution if the Michigan Insurance Commissioner disapproves within such 30-day period. For this purpose, an extraordinary dividend or distribution means any dividend or distribution of cash or other property whose fair market value together with that of other dividends or distributions that an insurer made within the preceding twelve months exceeds the greater of 10% of the insurer's surplus as regards policyholders as of December 31 of the immediately preceding year, or the net gain from operations of the insurer, not including realized capital gains, for the prior year. In 2002, 2003 and 2004, Jackson National Life paid shareholder dividends of $142.0 million, $85.2 million and $120.0 million, respectively.

        State regulators also require prior notice or regulatory approval of changes in control of an insurer or its holding company and of certain material transactions with affiliates. Under New York and Michigan insurance laws and regulations, no person, corporation or other entity may acquire control of an insurance company or a controlling interest in any parent company of an insurance company, unless that person, corporation or entity has obtained the prior approval of the regulator for the acquisition. For the purpose of each of New York and Michigan law, any person acquiring, directly or indirectly, 10% or more of the voting securities of an insurance company is presumed to have acquired "control" of the company. To obtain approval of any change in control, the proposed acquiror must file an application with the New York Superintendent of Insurance or the Michigan Insurance Commissioner, as appropriate. This application requires the proposed acquiror to disclose, among other information, its background, financial condition, the financial condition of its affiliates, the source and amount of funds by which it

87



will effect the acquisition, the criteria used in determining the nature and amount of consideration to be paid for the acquisition, proposed changes in the management and operations of the insurance company and other related matters.

Guaranty Associations and Similar Arrangements

        Each of the 50 states of the United States, the District of Columbia and the Commonwealth of Puerto Rico have laws requiring insurance companies doing business within their jurisdictions to participate in various types of guaranty associations or other similar arrangements. These associations and arrangements provide certain levels of protection to policyholders from losses under insurance policies issued by insurance companies that became impaired or insolvent. Typically, these associations levy assessments, up to prescribed limits, on member insurers on a basis that is related to the member insurer's proportionate share of the business in the relevant jurisdiction of all member insurers in the lines of business in which the impaired or insolvent insurer is engaged. Some jurisdictions permit member insurers to recover assessments that they paid through full or partial premium tax offsets, usually over a period of years. Prudential estimated its reserve for future guarantee fund assessments for Jackson National Life to be £9.8 million ($18.9 million) at December 31, 2004. Prudential believes this reserve to be adequate for all anticipated payments for known insolvencies.

Asset Valuation Reserve

        State regulators generally require that insurers establish an asset valuation reserve that consists of two components: a "default component" to provide for future credit-related losses on fixed income investments and an "equity component" to provide for losses on all types of equity investments. The asset valuation reserve establishes statutory reserves for fixed maturity securities, equity securities, mortgage loans, equity real estate and other invested assets. The reserve is designed to provide for all realized and unrealized gains and losses on such assets, other than those resulting from changes in interest rates. The level of reserves is based on both the type of investment and its rating. Contributions to the reserve may result in a slower growth in surplus or a reduction of Jackson National Life's unassigned surplus, which, in turn, may reduce funds available for shareholder distributions. The extent of the impact of the asset valuation reserve on Jackson National Life's statutory surplus depends in part on the future composition of the investment portfolio.

Interest Maintenance Reserve

        State regulators generally require that insurers establish an interest maintenance reserve to defer non-credit-related realized capital gains and losses, net of taxes, on fixed income investments (primarily bonds and mortgage loans) which are amortized into net income over the estimated remaining periods to maturity of the investments sold and to defer material gains or losses, net of taxes, resulting from market value adjustments on policies and contracts backed by assets carried at book value. The extent of the impact of the interest maintenance reserve on earnings and surplus depends on the amount of future interest-rate related realized capital gains and losses on fixed maturity investments and deferred gains or losses resulting from market value adjustments.

The National Association of Insurance Commissioners Ratios

        On the basis of statutory financial statements that insurers file with state insurance regulators, the National Association of Insurance Commissioners annually calculates twelve financial ratios to assist state regulators in monitoring the financial condition of insurance companies. A usual range of results for each ratio is used as a benchmark and departure from the usual range on four or more of the ratios can lead to inquiries from individual state insurance departments. In 2004, all of Jackson National Life's ratios fell within the usual range.

88



Policy and Contract Reserve Sufficiency Analysis

        Michigan insurance law requires Jackson National Life to conduct annually an analysis of the sufficiency of its life and annuity reserves. A qualified actuary must submit to the insurance department an opinion that states that the reserves, when considered in the light of the assets that an insurance company holds with respect to such reserves, make good and sufficient provision for the associated contractual obligations and related expenses of the insurance company. If a qualified actuary cannot provide such an opinion, then the insurance company must set up additional reserves by moving funds from unassigned surplus. The 2004 opinion has been submitted to the Michigan Office of Financial and Insurance Services without any qualifications.

Jackson National Life's Capital and Surplus

        Michigan insurance law requires Jackson National Life, as a domestic stock life insurance company, to maintain at least US$7,500,000 in unimpaired capital and surplus. In addition, insurance companies are required to have sufficient capital and surplus to be safe, reliable and entitled to public confidence.

        As a licensed insurer in the District of Columbia and every state but New York, where it operates through a subsidiary, Jackson National Life is subject to the supervision of the regulators of each such jurisdiction. In connection with the continual licensing of Jackson National Life, regulators have discretionary authority to limit or prohibit the new issuance of business to policyholders when, in their judgment, the regulators determine that such insurer is not maintaining minimum surplus or capital or if the further transaction of business will be hazardous to policyholders.

Risk-based Capital

        In 1992, the National Association of Insurance Commissioners approved risk-based capital standards for life insurance companies as well as a model act for state legislatures to enact. The model act requires that life insurance companies report on a formula-based, risk-based capital standard that they calculate by applying factors to various asset, premium and reserve items. The formula takes into account the risk characteristics of a company, including asset risk, insurance risk, interest rate risk and business risk. The National Association of Insurance Commissioners designed the formula as an early warning tool to identify potentially inadequately capitalized companies for purposes of initiating regulatory action. The National Association of Insurance Commissioners intended the formula as a regulatory tool only and did not intend it as a means to rank insurers generally. The model act imposes broad confidentiality requirements on those engaged in the insurance business (including insurers, agents, brokers and others) and on state insurance departments as to the use and publication of risk-based capital data.

        Any state adopting the model act gives the state insurance commissioner explicit regulatory authority to require various actions by, or take various actions against, insurance companies whose adjusted capital does not meet minimum risk-based capital standards. The Michigan Insurance Commissioner takes into account the National Association of Insurance Commissioners' risk-based capital standards to determine adequate compliance with Michigan insurance law. At December 31, 2004, Jackson National Life's total adjusted capital under the National Association of Insurance Commissioners' definition substantially exceeded Michigan standards.

Regulation of Investments

        Jackson National Life is subject to state laws and regulations that require diversification of its investment portfolio, limit the amount of investments in certain investment categories such as below investment grade fixed income securities, common stock, real estate and foreign securities and forbid certain other types of investments altogether. Jackson National Life's failure to comply with these laws and regulations would cause investments exceeding regulatory limitations to be treated by the Michigan Insurance Commissioner as non-admitted assets for purposes of measuring surplus and, in some instances, the Michigan Insurance Commissioner could require divestiture of non-qualifying investments.

89



USA Patriot Act

        The Patriot Act, enacted in 2001, includes numerous provisions designed to fight international money laundering and to block terrorist access to the US financial system. The US Treasury Department has issued a number of regulations implementing the Patriot Act that apply certain of its requirements to financial institutions such as Prudential's broker-dealer subsidiaries. Among other things, the regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. Jackson National Life does not expect the impact of the Patriot Act on its operations to be material, and has established policies and procedures to ensure compliance with the Patriot Act's provisions. The Treasury Department is expected to issue a number of additional regulations which will further clarify the Patriot Act's requirements, including with respect to insurance companies.

Securities Laws

        Jackson National Life, certain of its affiliates and certain policies and contracts that Jackson National Life offers are subject to various levels of regulation under the federal securities laws that the US Securities and Exchange Commission (the "SEC") administers.

        The primary intent of these laws and regulations is to protect investors in the securities markets and generally grant supervisory agencies broad administrative powers, including the power to limit or restrict the conduct of business for failure to comply with such laws and regulations. Jackson National Life may also be subject to similar laws and regulations in the states in which it provides investment advisory services, offers the products described above or conducts other securities-related activities.

        Jackson National Asset Management, LLC is registered with the SEC as an investment adviser pursuant to the Investment Advisors Act of 1940, as amended ("Investment Advisors Act of 1940"), and is also registered or notice filed in all applicable states. Jackson National Asset Management, LLC is registered as a transfer agent pursuant to the Securities Exchange Act of 1934, as amended ("Securities Exchange Act"). The investment companies (mutual funds) for which Jackson National Asset Management, LLC serves as an investment adviser are subject to SEC registration and regulation pursuant to the Securities Act of 1933, as amended ("Securities Act"), and the Investment Company Act of 1940, as amended ("Investment Company Act"). In addition, each variable annuity and variable life product sponsored by Jackson National Life, organized under an applicable separate account or unit investment trust, is subject to SEC registration and regulation pursuant to the Securities Act and the Investment Company Act, and applicable state insurance and securities laws.

        Curian Capital, LLC is registered with the SEC pursuant to the Investment Advisors Act of 1940 and is also registered or notice filed in all applicable states.

        BH Clearing, LLC is registered as a broker-dealer with the SEC pursuant to the Securities Exchange Act, and is registered as a broker-dealer in all applicable states. In addition, BH Clearing, LLC is in process of seeking membership in the National Association of Securities Dealers (the "NASD").

        Jackson National Life Distributors, Inc. is registered as a broker-dealer with the SEC pursuant to the Securities Exchange Act, and is registered as a broker-dealer in all applicable states. In addition, Jackson National Life Distributors, Inc. is a member firm of the NASD.

        Each of SII Investments, Inc., National Planning Corporation, Investment Centers of America, Inc., and IFC Holdings, Inc. (which does business under the name INVEST Financial Corporation), is a broker-dealer, investment adviser, and insurance agency (or affiliated with an insurance agency), licensed and qualified to transact business pursuant to its respective registration and/or membership with the SEC, the NASD, the Municipal Securities Rulemaking Board, applicable state securities and insurance authorities, and all other applicable jurisdictional authorities.

        Prudential also conducts US investment management activities through PPM America, Inc., which is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. PPM

90



America, Inc. serves as the investment adviser to Jackson National Life, certain mutual funds, several private investment funds and structured finance vehicles, and the US equity and fixed income portions of portfolios of certain UK affiliates of PPM America, Inc. The mutual funds for which PPM America, Inc. serves as investment adviser or sub-adviser are subject to regulation under the Securities Act and the Investment Company Act.

        PPM America, Inc. and certain of its subsidiaries are subject to various levels of regulation under the federal securities laws that the SEC administers as well as state securities laws.

        To the extent that PPM America, Inc. manages assets of employee benefit plans subject to the Employee Retirement Income Security Act of 1974 ("ERISA"), or the Internal Revenue Code, it may be subject to certain restrictions imposed by ERISA and taxes imposed by the Internal Revenue Code. Such restrictions are summarized in "—Employee Benefit Plan Compliance" in this section below. The Department of Labor and the Internal Revenue Service have interpretive and enforcement authority over the applicable provisions of ERISA and the Internal Revenue Code.

Employee Benefit Plan Compliance

        Jackson National Life issues certain types of general account stable value products, such as GICs and funding agreements, to employee benefit plans and to investment vehicles that pool the investments of such plans. Many of these plans are retirement plans that are subject to the fiduciary standards of ERISA and that are tax-qualified under the Internal Revenue Code. As such, Jackson National Life may be subject to certain restrictions imposed by ERISA and taxes imposed by the Internal Revenue Code. These restrictions include:

        In general, the Internal Revenue Code imposes taxes on persons involved in certain of the transactions described above.

        The Department of Labor and the Internal Revenue Service, have interpretive and enforcement authority over the applicable provisions of ERISA and the Internal Revenue Code.

        In the instance where an insurer issues a guaranteed benefit policy to a plan, ERISA provides that the insurer need not become a fiduciary with respect to the plan solely as a result of the issuance of the policy. Under Section 401 of ERISA, a guaranteed benefit policy means an insurance policy to the extent such policy provides for benefits the amount of which the insurer guarantees.

        In 1993, in John Hancock Mutual Life Insurance Company v. Harris Trust & Savings Bank, the US Supreme Court held that a portion of the funds held under a certain type of general account annuity contract did not constitute a "guaranteed benefit policy" within the meaning of ERISA, a holding which potentially exposes insurers with similar types of contracts to the application of ERISA's fiduciary and prohibited transaction provisions in connection with the management of assets in their general accounts.

        Although no assurances can be given, Jackson National Life believes that none of its contracts are of the type to which the holding in Harris Trust would be applicable. Moreover, the Department of Labor has issued PTE 95-06 which generally exempts external, unaffiliated investment transactions from ERISA's prohibited transaction provisions. If the Harris Trust holding is applied to its contracts, Jackson

91



National Life would be subject to ERISA's fiduciary and prohibited transaction provisions described above.

Financial Services Regulatory and Legislative Issues

        Proposals to change the laws and regulations governing the financial institutions industry are frequently introduced in the US Congress, in the state legislatures and before the various regulatory agencies. The likelihood and timing of any proposals or legislation and the impact they might have on Jackson National Life and its subsidiaries cannot be determined at this time.

        State legislatures and/or state insurance regulatory authorities frequently enact laws and/or regulations that significantly affect insurers supervised by such authorities. Although the US federal government does not directly regulate the insurance business, federal initiatives may also have an impact on the insurance industry.

        A major issue at the state level involves the Insurance Product Regulation Compact (the "Compact"), which has already been adopted by several states and has been introduced in a number of state legislatures. The Compact was developed by the National Association of Insurance Commissioners to serve as an agreement among member states to create a more streamlined system of insurance product regulation. A principal component of the Compact is the creation of a multi-state commission governed by participating states. It is contemplated that the commission would serve as a single point of filing for life insurance and annuity products, and would establish uniform, national standards for those products. The Compact is expected to become operational only if certain criteria (based on the number of states enacting the Compact or the premium volume for life insurance, annuities, disability income and long-term care insurance of states joining the Compact) are met.

        The US President has in the past proposed to increase the taxes levied against the insurance industry to increase the federal budget revenues. The industry has been very successful in resisting these proposals on the grounds that an increase in taxes on insurance companies or insurance policies would have a negative affect on US citizens saving for their retirement. The insurance industry is very vigilant in monitoring these proposals and taking action to oppose them, as well as to support proposals that would provide more favorable tax treatment for certain annuity products.

        The governor of Michigan has recently proposed to increase the state tax assessed on insurance companies' premiums. It is unclear at this time whether the tax increase, which is still under consideration by the Michigan state legislature, will be adopted as proposed.

        Proposed US federal legislation, the State Modernization and Regulatory Framework (the "SMART Act"), intended to streamline and modernize the state insurance regulatory framework has garnered some Congressional support. The SMART Act would require states to comply with uniform standards and resolve disputes, speed up the process of getting new products to the market and move toward a system of market-based rates, without creating a federal regulator to monitor compliance. A coalition of national insurance and banking organizations is also actively seeking introduction of US federal legislation that would allow insurance companies to obtain a federal charter as a regulatory alternative to a state charter. Prudential cannot predict whether any federal (or state) legislative initiative to change the nature or scope of the regulation of the insurance industry will be enacted into law.

        Federal and state regulators have focused on, and continue to devote substantial attention to, the mutual fund and variable annuity and insurance product industries including the broker-dealer system. As a result of publicity relating to widespread perceptions of industry abuses, including fraudulent and anticompetitive practices among insurance brokers and mutual funds, there have been numerous regulatory inquiries and proposals for legislative and regulatory reforms. In addition, the Attorney General of New York State and the New York State Insurance Department have recently launched an investigation into alleged fraud and bid rigging in the insurance industry and have compelled certain insurance companies to adopt reforms in their business practices. Jackson National Life has not, to our

92



knowledge, been a target in the ongoing probe. It is difficult to predict at this time whether changes resulting from industry investigations and/or new laws and regulations will affect our insurance or investment management businesses, and, if so, to what degree.


Asian Supervision and Regulation

        Prudential's businesses in Asia are subject to all relevant local regulatory and supervisory schemes. These laws and regulations vary from country to country, but the regulators typically grant (or revoke) licenses and therefore control the ability to operate a business.

        The industry regulations are usually widely drawn and will include provisions governing both financial matters and the way business is conducted in general. Examples include the registration of agents, the approval of products, asset allocation, minimum capital and the basis for calculating the company's solvency and reserves and the valuation of policyholder liabilities. Regulatory authorities may also regulate affiliations with other financial institutions, shareholder structures and the injection of capital and payment of dividends. Financial statements and other returns are filed with the regulators. The regulators may also conduct physical inspections of the operations from time to time.

        A number of Asian countries require insurance companies to participate in policyholder protection schemes (i.e., contribute to a fund to support policyholders in the event of an insurance company failing).

        To date Prudential Corporation Asia has had no regulatory issues giving rise to a material impact on its results.

        For Prudential Corporation Asia's more material operations the details of the regulatory regimes are as follows:

Hong Kong

        The Insurance Companies Ordinance ("ICO") empowers a Commissioner of Insurance to establish an office for the administration of the industry including approvals for a company to conduct insurance business.

        The Hong Kong branch of Prudential Assurance is authorized to carry on both long-term business and general business under a composite license.

Japan

        The Financial Services Agency of Japan ("JFSA") regulates insurance companies and other financial institutions. The Insurance Business Division of the JFSA specifically undertakes the supervision of insurance companies. The fundamental principles of insurance regulation are set out in the Insurance Business Law.

        PCA Life Japan is licensed by and registered with the JFSA as a life insurance company.

Korea

        The Ministry of Finance and Economy of Korea set the insurance law after consultation with the Financial Supervisory Commission ("FSC"). The FSC's responsibilities include regulation of the insurance industry but it delegates to the Financial Supervisory Services ("FSS") work such as supervision, examination and direct contact with insurance companies. The detailed rules under the supervisory regulation are prepared by FSS

        PCA Life Korea is licensed by and registered with the FSC as a life insurance company

93


Singapore

        The Monetary Authority of Singapore ("MAS") is responsible for insurance company regulation and supervision. In order to sell insurance in Singapore, companies need to be licensed by the MAS.

        Prudential Assurance Company Singapore is registered and licensed to manufacture and sell both life and general insurance business.

Taiwan

        The Taiwanese Ministry of Finance ("MOF") is responsible for approving a company's participation in insurance activities and for regulating and supervising authorized insurers.

        PCA Life Taiwan operation is licensed for life insurance business.

Malaysia

        In Malaysia, Bank Negara is the regulatory body responsible for supervising and regulating the conduct of financial services including insurance business.

        All insurance companies must be licensed with the Ministry of Finance. In addition, they are required to be a member of the Life Insurance Association of Malaysia and/or General Insurance Association of Malaysia.

        Prudential Assurance Malaysia Berhad has a license for both life and general insurance business.

China

        Historically, the People's Bank of China were responsible for the supervision of the insurance industry but in October 1998, a new authority, China Insurance Regulatory Commission ("CIRC") was formed.

        Consistent with WTO requirements, geographic restrictions on foreign players have been eased as of December 2004, however, entry into any new province still requires approval by CIRC. Within a province the China Insurance Regulatory Bureau (CRIB) manage all insurance regulatory matters on behalf of CIRC including foreign companies application for sales office licenses within the provinces where they are already operating.

India

        Insurance is subject to federal regulation in India. The primary legislation is the Insurance Act, 1938, and the Insurance Regulatory & Development Authority Act, 1999 ("IRDA").

        The IRDA's duties include issue of certificates of registration to insurance companies and it has a mandate to protect the interests of the policy holders

Indonesia

        The insurance industry is regulated by the Insurance Directorate of the Ministry of Finance.

        The anomaly in the country's bankruptcy rules that allowed insurance companies to declared bankrupt via the commercial courts rather than by the Ministry of Finance has recently be overturned.

Future Regulatory Development

        Prudential Corporation Asia expects the regulatory regimes in Asia to continue to develop, potentially driven by, for example, consumers requiring greater degrees of product transparency and more sophisticated advice. Regulators may introduce new legislation and hence there is a risk past sales may be assessed against new compliance requirements and investment conditions. Given the size of Prudential Corporation Asia's agency force, the introduction of more complex regulation may increase the risk of compliance issues in the future.

94



Item 5.    Operating and Financial Review and Prospects

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

        The following discussion and analysis should be read in conjunction with Prudential's consolidated financial statements and the related notes to Prudential's consolidated financial statements included elsewhere in this document. Prudential's consolidated financial statements have been prepared in accordance with UK GAAP, which differs in certain material respects from US GAAP. Information related to the nature and affect of such differences is presented in Notes 36 and 37 of the notes to the consolidated financial statement in this document. A summary of the critical accounting policies which have been applied to these statements is set forth in the section below entitled "—Factors Affecting Results of Operations—UK GAAP Critical Accounting Policies".

        The results discussed below are not necessarily indicative of the results to be expected in any future periods. This discussion contains forward-looking statements based on current expectations, which involve risks and uncertainties. Actual results and the timing of certain events may differ significantly from those projected in these forward-looking statements due to a number of factors, including those set forth in the section below entitled "—Factors Affecting Results of Operations", in Item 3, "Key Information—Risk Factors" and elsewhere in this document.


Introduction

        Prudential provides a broad range of financial products and services, primarily to the retail market. The period since 2002 has been one of significant change as Prudential has positioned itself to compete internationally in an increasingly challenging global marketplace.

        In 2002, Prudential's UK Insurance Operations announced plans to establish an offshore service center in India to improve customer contact service for the UK business and achieve additional cost savings. This initiative has incurred a restructuring charge of approximately £7 million with an estimated total impact on shareholders of £2 million, with the remaining £5 million borne by the PAC long-term fund. However, the charge is expected to be offset by gross cost savings from 2006 of approximately £16 million, of which approximately £4 million per annum is expected to be attributable to shareholders. See Item 5 "—Operating and Financial Review and Prospectus—Analysis by Geographic Region—UK and Europe Insurance Operations—UK Restructurings".

        In November 2002, Prudential agreed to sell its German life insurance business (the policies for which are underwritten through a Dublin-based life insurance company) to Canada Life for £82 million. The sale was completed on January 1, 2003. In December 2003, Prudential announced the sale of Prudential Europe Management Services Limited to Capita Life and Pensions Services Ireland Limited for £16 million. As part of this transaction, a ten year third-party administration contract was put in place between Prudential and Capita Life and Pensions Services Ireland Limited to ensure continuity of administration services See Item 4, "—Information on the Company—Business of Prudential—European Business—Sale of German Business to Canada Life" and "—Sale of Prudential Europe Management Services".

        At December 31, 2002 all of Scottish Amicable Life plc's business was transferred into Prudential Assurance's long-term fund.

        In November 2003, M&G completed the outsourcing of its retail administration to International Financial Services Limited. This will ensure M&G has leading edge IT systems to support its retail operation and deliver significant cost savings.

        During 2004 and the first quarter of 2005, Prudential UK was appointed to work with major IFA groups such as Sesame, Millfield, Tenet and Burns Anderson on the design of their respective multi-tie

95



propositions. It has also been appointed to the regulated multi-tie panels for Millfield, Burns Anderson, THINC Destini and Barclays.

        In October 2004, Prudential launched PruHealth, a UK healthcare product that links health and fitness to the cost of medical insurance. As PruHealth is not a life insurance product, its premium income is not reported as new business sales; for the first quarter of 2005, the gross written premiums were £1 million. Support for PruHealth is strong in the IFA channel and its rate of growth is accelerating. The product has been developed through a joint venture with Discovery of South Africa.

        In 2003, Prudential Corporation Asia was awarded its second life insurance business license for Beijing by the China Insurance Regulatory Commission and in August, Prudential announced the launch of its partnership in Beijing with CITIC, its joint venture partner in China. In November 2004, Prudential and CITIC were granted a life insurance license for Shanghai in addition to the existing life insurance licenses for Guangzhou, Beijing and Suzhou where operations commenced in 2000, 2003 and 2004, respectively. In the first quarter of 2005, Prudential CITIC were granted three more life insurance licenses for Dongguan, Foshan and Wuhan and in May 2005 announced that it had been awarded another license for Zhongshan. CITIC Prudential's new branches are expected to open for business in the second half of 2005. Prudential is now the only European life insurance joint venture with licenses for eight Chinese cities.

        In October 2004, JNL completed the sale of JFB to Union Bank of California for £166 million. JFB's principal area of business was banking and commercial real estate lending, which no longer aligned with JNL's strategy. Accordingly, the results of operations for JFB are reported as discontinued operations in the accompanying financial statements.

        In November 2004, Prudential announced the purchase of Life Insurance Company of Georgia for £142 million. This acquisition will double the number of JNL's in-force life and annuity policies, add scale to its operating platform and expand its distribution capability. This will enable JNL to grow its life business at a higher return and faster rate than can be achieved organically. JNL anticipates the capital provided will be returned over a period of about 5 years. The planning for the integration of the business is on track and full integration is anticipated within 12 months of closing the transaction. The purchase was completed on May 18, 2005.

        In October 2004, the Board decided to launch a 1 for 6 rights offering. The majority of the net proceeds of the rights offering (£1,021 million) will be used to provide capital to support Prudential's growth plans for the UK and to fund a potential opportunity to increase its ownership from 26% to 49% of its joint venture life insurance business with ICICI in India. The remainder of the proceeds will be used to ensure that Prudential continues to meet the parent company solvency test under the FGD that became effective from January 1, 2005. The proceeds of the rights offering have initially been invested centrally within Prudential in fixed interest securities.


Factors Affecting Results of Operations

        Prudential's results of operations are affected, to a greater or lesser degree, by a variety of factors, including demographics, general economic and market conditions, government policy and legislation and regulation, as discussed in greater detail below. See Item 3, "Key Information—Risk Factors" for more information on risks associated with these and other factors. In addition, changes to the composition of its businesses and the execution of its growth strategy may result in increased variation in profits from year to year.

General Economic and Market Conditions

        Since 2004, stock market prices have significantly recovered and interest rates have risen again. Despite these recent fluctuations, Prudential believes that the historical strength of the UK and US

96



equity markets, combined with demographic factors and governmental efforts to increase individual savings and self-provision for retirement, have resulted in increased consumer focus on savings and investment products.

        In Asia, Prudential believes the potential for strong economic growth remains and that it is in a strong position to benefit from the long-term growth potential throughout the region. In 2004 Asian economies performed exceptionally well, with strong GDP growth. The composition of demand and economic activity has been shifting recently towards being more domestically driven and Prudential expects this trend to continue, resulting in less dependence on Western economies. Short interest rates are expected to continue to rise slowly as central banks balance normalizing economic policy with containing pressure for currencies to appreciate. Long bond yields are expected to climb from current levels as economic activity broadens and domestic inflation rises. Equity investments will be supported by continued economic growth and the current valuation levels. Overall, it is expected that these factors will continue to encourage investors into long term savings products.

        Changes in interest rates and returns from equity, real estate and other investments as well as volatility in these items may affect Prudential's profitability. In the United Kingdom, where Prudential invests in debt and other fixed income securities, equity securities and real estate, shareholders' profits under UK GAAP are largely a function of the bonuses it declares on with-profits products. The most important influences on the bonus rates are the overall rate of return earned on investments and Prudential's expectation of future investment returns. See "—Analysis by Geographic Region—United Kingdom—Basis of Profits", "—With-profits Products" and "—Bonus Rates" below. Prudential's bonus policy and its impact on profitability is addressed in more detail in "UK GAAP Critical Accounting Policies" below.

        In the United States, fluctuations in prevailing interest rates, including changes in the difference between the levels of prevailing short-term and long-term rates, can affect results from Jackson National Life, which is predominantly a spread-based business with the majority of its assets invested in fixed income securities. Changes in interest rates, either upward or downward, can expose Jackson National Life to the risk of not earning anticipated spreads between the rate earned on investments and the rate credited on its policies. For example, if interest rates go up and/or competitors offer higher crediting rates, withdrawals on annuity contracts may increase as policyholders seek higher investment returns elsewhere. In response, Jackson National Life could (1) raise its crediting rates to stem withdrawals, decreasing its spread; (2) sell assets which may have depressed values in a high interest rate environment, creating realized investment losses; or (3) pay out existing cash which would otherwise have earned interest at the higher interest rates. Moreover, to the extent that Jackson National Life holds illiquid private placements and commercial mortgages, there is a risk that it will incur losses if it needs to sell those assets. Conversely, if interest rates decrease, withdrawals from annuity contracts may decrease relative to original expectations, creating more cash than expected to be invested at lower rates. Jackson National Life may have the ability to lower the rates it credits to policyholders as a result, but may be forced to maintain crediting rates for competitive reasons or because there exist minimum interest rate guarantees in certain contracts. In either case, the spread earned by Jackson National Life would be lowered.

        The profitability of Jackson National Life's spread-based businesses depends in large part on its ability to manage interest rate spreads, as well as the credit and other risks inherent in its investment portfolio. There can be no guarantee that these risks will be managed successfully. Prudential designs its US products and manages the investments supporting this business to reduce interest rate sensitivity. This has the effect of moderating the impact on Prudential's results of changes in prevailing interest rates. See Item 11, "Quantitative and Qualitative Disclosures about Market Risk" for a discussion of the management of Prudential's exposure to such market risk.

97



Government Policy and Legislation

        Changes in government policy or legislation applying to companies in the financial services and insurance industries in any of the jurisdictions in which Prudential operates, particularly in the United Kingdom, the United States and Asia, may adversely affect the result of its operations. These include possible changes in the tax treatment of financial products and services, government pension arrangements and policies, the regulation of selling practices and solvency standards. These changes may affect Prudential's existing and future business by, for example, causing customers to cancel existing policies, requiring Prudential to change its range of products and services, redesign its technology or other systems, retrain staff, pay increased tax or incur other costs.

Regulation

        In recent years, the insurance sectors in the markets in which Prudential operates have faced increased scrutiny. In 1997, Prudential was publicly criticized by its UK regulators for its treatment of pension mis-selling during the period from 1988 to 1994 and for failures to adequately monitor and train its salesforce. In 2001, a fine of £650,000 was levied by the Personal Investment Authority on Prudential, following an inspection in 1999 of Prudential's Phase 1 procedures, which revealed instances of delay in making payments of redress and of deficiencies in its record keeping. Pension mis-selling is discussed in more detail under Item 4, "Information on the Company—Business of Prudential—UK and Europe Business—Compliance—Pension Mis-selling". In March 2003, the FSA levied a fine of £750,000 on Prudential for the mis-selling of mortgage endowment policies by Scottish Amicable during the period from January 1999 to February 2001. Mortgage endowment mis-selling and regulatory actions taken by the FSA to address the issue are discussed in more detail under Item 4, "Information on the Company—Business of Prudential—UK and Europe Business—Compliance—Mortgage Endowment Products Review".

        Additional regulation, scrutiny and related costs have put pressure on the margins on new business. In the United States, Prudential has been the subject of regulatory sanctions and class actions. These class actions are discussed in more detail under Item 4, "Information on the Company—Business of Prudential—Legal Proceedings". Changes in pensions financial services and tax regulation could have an impact on Prudential's results. See Item 4, "Information on the Company—Supervision and Regulation of Prudential" for a summary of the current regulatory environment in which Prudential conducts its business.

Exchange Rates

        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 United States, Asia and Europe, which represent a significant proportion of total group income and expenses, generally write policies and invest in the same local currency, which although limiting the effect of exchange rate fluctuations on local operating results, can lead to fluctuations in Prudential's consolidated financial statements upon translation of results into pounds sterling.

UK GAAP Critical Accounting Policies

        Prudential's discussion and analysis of its financial condition and results of operations are based upon Prudential's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United Kingdom. Prudential's financial statements are prepared in accordance with the modified statutory basis ("MSB") of reporting of long-term business. This is in accordance with the revised Statement of Recommended Practice issued by the Association of British Insurers ("ABI") in November 2003. In broad terms, MSB profits for long-term business reflect

98



the aggregate of statutory transfers from with-profits funds and profits on a traditional deferral and matching approach for other long-term business.

        The preparation of these financial statements requires Prudential to make estimates and judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, Prudential evaluates its estimates, including those related to long-term business provisioning, the fair value of assets and the declaration of bonus rates. Prudential bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        Critical accounting policies are defined as those that are reflective of significant judgements and uncertainties, and potentially result in materially different results under different assumptions and conditions. Prudential believes that its critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies, see Note 3 of the notes to the consolidated financial statements and "US GAAP Analysis—US GAAP Critical Accounting Policies" below.

        The critical accounting policies in respect of the items discussed below are critical for the group's results in so far as they relate to the group's shareholder financed business, in particular for Jackson National Life.

Long-term Business Provision

        At December 31, 2004, the long-term business provision represented 60% of Prudential's total liabilities. These liabilities predominantly relate to with-profits and other protection type policies. These liabilities are estimated using actuarial methods based on assumptions relating to premiums, interest rates, investment returns, expenses, mortality and surrenders.

UK insurance operations

        The overwhelming majority of the liabilities for business in-force of UK insurance operations are held by Prudential Assurance Company and its subsidiaries Prudential Annuities Limited and Prudential Retirement Income Limited. The key features of the liabilities of these companies are as follows:

Conventional with-profits and other protection-type policies

        The future policyholder benefit provisions on conventional with-profits and other protection-type policies are calculated using the net premium method. The net premium is calculated such that it would be sufficient at the outset of the policy to provide only for the discounted value of the original guaranteed death and maturity benefits on the chosen assumptions. The provision is then calculated by subtracting the present value of future net premiums from the present value of future benefits (including vested bonuses) using a prudent discount rate.

        Under the net premium valuation method, vested bonuses are included in the cash flows assessed but future allocations of bonuses are not included explicitly, although are implicitly taken into account in the discount rate used, which is based on the return available on suitable investments. The detailed methodology for UK companies is included in regulations contained in the FSA rules. In particular, the returns available from equity and property assets are based on expected income and/or earnings and no allowance is made for potential future growth.

        The assumptions to which the estimation of the long-term business provision is particularly sensitive are the interest rate used to discount the provision and the assumed future mortality experience of policyholders. The net premium reserves are calculated using assumptions for interest, mortality,

99



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%. There have been no significant changes to key assumptions.

Pension Annuities

        The interest rates used in establishing policyholder benefit provisions for pension annuities in the course of payment are adjusted each year and ranged from 1.5% to 5.0% at December 31, 2004, 2.0% to 5.1% for 2003, and 2.4% to 5.4% for 2002. Mortality rates used in establishing policyholder benefit provisions are based on published mortality tables adjusted to reflect actual experience. For 2004, the only other noteworthy change of assumptions was with respect to mortality, where the shape of the set of assumptions was 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 no 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. Regular partial withdrawals are allowed for in the calculation.

        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 interest rate used to discount the provision, the assumed future per policy expenses and the assumed future mortality experience of policyholders.

        For PAC business, the provision is taken as the lower of:

        For the purpose of calculating the liability using the bonus reserve method, the assumed interest rates range from 2.5% to 5.0% at December 31, 2004, and from 3.0% to 5.0% at both December 31, 2003 and December 31, 2002, while future reversionary bonuses are assumed to fall immediately from current levels to zero. For unitized with-profits policies, the policyholder benefit provisions are based on the policyholder account balance. There have been no significant changes of assumptions for accumulating with-profit business.

        If actual experience differs from these assumptions, or the basis of preparation is altered (for example, as for UK unitized with-profits business in 2003), then the value of the liabilities would need to be adjusted. See Item 4, "Business of Prudential—UK and Europe Business—UK Business Units—UK

100



Insurance Operations—Life Insurance Products—Savings Products—Investment Bonds" for a discussion of Prudential's unitized with-profits business.

Jackson National Life

        The future policyholder benefit provisions for Jackson National Life's conventional protection-type policies are determined using the net level premium method, with an allowance for surrenders and claims expenses. Rates of interest used in establishing the policyholder benefit provisions range from 4.0% to 8.0%. Mortality assumptions range from 50% to 90% of the 1975-1980 Basic Select and Ultimate tables, depending on underwriting classification and policy duration. For investment-type products sold by Jackson National Life, the policyholder benefit provision included within technical provisions in the consolidated balance sheets is the policyholder account balance.

Asian Operations

        The future policyholder benefit provisions for Asian businesses are determined in accordance with methods prescribed by local GAAP adjusted to comply, where necessary, with UK GAAP. For the Hong Kong business, which is a branch of the Prudential Assurance Company, and the Singapore and Malaysian operations the valuation principles and sensitivities to changes of assumptions of conventional with-profits and other protection-type policies are similar to those described above for equivalent products written by the UK operations. For Hong Kong business the interest rate has reduced to 3.4% at December 31, 2004 from 3.6% at December 31, 2003 and from 3.75% at December 31, 2002 for traditional business and to between 2.5% and 2.9% at December 31, 2004 from 3.25% at December 31, 2003 and from 3.75% at December 31, 2002 for accumulating with-profits assurances. For Singapore and Malaysia there have been no significant changes of assumption. Interest rates of 3.5% to 4.0% in Singapore and 4.0% in Malaysia have been used in accordance with local regulations.

        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 1.4% to 7.0% at December 31, 2004 and from 1.5% to 6.5% at December 31, 2003. In Japan, they range from 0.9% to 1.3% at December 31, 2004 and from 0.9% to 1.6% at December 31, 2003.

Fair Value of Assets

        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 diminution in value, are carried at amortized 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 determined by the directors for unlisted securities. Where third party information is not available, the Group performs alternative valuation techniques, including discounted cash flow analysis, option-adjusted spread models, and enterprise valuation.

        Except to the extent of other than temporary impairments, movements in the fair value of Jackson National Life's bond portfolio do not impact shareholders' profits or funds as they are carried at amortized cost. Impairments in the carrying value of the individual bonds and other fixed income securities that are considered other than temporary are reflected as losses in profit or loss before tax.

101



Among the factors considered is whether the decline in fair value results from a change in the quality of the security itself, or from a downward movement in the market as a whole, and the likelihood of recovering the carrying value based on the current and short-term prospects of the issuer. Unrealized losses that are considered to be primarily the result of market conditions, such as increasing interest rates, unusual market volatility or industry-related events, and where the Group also believes there exists a reasonable expectation for recovery and, furthermore, has the intent and ability to hold the investment until maturity or the market recovers, are usually determined to be temporary.

Investment Returns

        Investment returns comprise investment income, realized gains and losses and changes in unrealized gains and losses, except for changes in unrealized gains and losses on debt securities held by Jackson National Life. These securities are carried in the balance sheet at amortized cost. For debt and other fixed income securities held by Jackson National Life, purchase premiums and discounts are amortized based on the underlying investments' call or maturity dates and this amortization is included in investment returns. Realized gains and losses, including writedowns on permanent diminutions, are recognized in income on the date of sale as determined on a specific identification basis for Jackson National Life and on an average cost basis elsewhere.

Deferred Acquisition Costs

        In common with other insurers, Prudential incurs significant costs in connection with acquiring new insurance business. These costs, which vary with and are primarily related to the production of new business, are capitalized and amortized against margins in future revenues on the related insurance policies. The recoverability of the asset is measured and the asset is deemed impaired if the projected future margins are less than the carrying value of the asset. Assumptions are made as to whether certain costs should be deferred or not and whether they will be offset by future margins on the policies. To the extent that the actual future margins differ from those anticipated, then an adjustment to the carrying value of the deferred acquisition cost asset will be necessary.

        The deferral and amortization of deferred acquisition costs is of most relevance to the Group's reported profits for shareholder financed long-term business operations, principally Jackson National Life in the United States. In 2004, the amortization of deferred acquisition costs were at expected levels. Equity market performance in 2003 improved expected profits on variable annuity lines and resulted in a £69 million ($112 million) lower amortization charge than 2002. In 2002, for Jackson National Life, poor equity market performance lowered future expected profits on the variable annuity line through lower fee income and an increased provision for future guaranteed minimum death benefit claims. As a result, the deferred acquisition cost asset associated with the variable annuities became impaired. No such deferred acquisition cost asset impairments were recorded in 2004 or 2003 due to improved equity market performance. However, further impairments or accelerated amortization of this deferred acquisition cost asset may result if future equity market returns are below assumed levels.

Deferred Tax

        Deferred tax assets and liabilities generally are recognized in accordance with the provisions of FRS 19, "Deferred tax". Prudential has chosen not to apply the option available under FRS 19 of recognizing such assets and liabilities on a discounted basis to reflect the time value of money. Except as set out in FRS 19, deferred tax is recognized in respect of timing differences that have originated but not reversed by the balance sheet date.

        Deferred tax assets are recognized to the extent that they are regarded as recoverable, that is to the extent that, on the basis of all available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying timing differences

102



can be deducted. The UK taxation regime applies separate rules to trading and capital profits and losses. The distinction between timing differences that arise from items of either a capital or trading nature may affect the recognition of deferred tax assets under FRS 19. Accordingly, for the 2004 results and balance sheet position at December 31, 2004, the possible tax benefit of approximately £430 million, which may arise from capital losses valued at approximately £1.7 billion, is sufficiently uncertain that it has not been recognized. In addition, a potential deferred tax asset of £114 million, which may arise from trading losses of approximately £408 million, is sufficiently uncertain that it has not been recognized. With regard to £100 million 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.

Derivative Financial Instruments

        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. 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 other derivative financial instruments, various methods of hedge accounting are used. These are fully described in Note 24 of the notes to the consolidated financial statements.

        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.

        Jackson National Life uses derivatives (primarily interest rate swaps) to hedge certain risks in conjunction with its asset/liability management program. However, Jackson National Life has elected not to incur the costs of restructuring its derivative contracts, segregating investment portfolios and adding the systems and personnel required to qualify for much stricter hedge accounting treatment.

Other Features of UK GAAP Accounting That Are of Particular Significance to an Understanding of Prudential's UK GAAP Results

        The other features that are of significance relate to the method of accounting for the assets and liabilities of the Group's with-profits funds. A summary of this basis of accounting is included in "—Analysis by Geographic Region—United Kingdom—Basis of Profits". Further details are described below.

        For with-profits business (including non-participating business of Prudential Annuities Limited which is owned by the PAC with-profits fund), adjustments to liabilities and any related tax effects are recognized in the profit and loss account. However, except for any impact on the annual declaration of bonuses, shareholder profits for with-profits business and shareholders' funds would not be affected by adjustments to liabilities. This is because UK GAAP profits for with-profits business solely reflect one-ninth of the cost of bonuses declared for the year. Adjustments to the UK GAAP basis long-term business provision for the PAC with-profits fund would normally reflect changes that have also been reflected in the annual regulatory returns submitted to the FSA. Except to the extent of any second order effects on other elements of the regulatory returns, such changes can be expected to have a consequent effect on the excess of assets over liabilities of the fund for purposes of solvency

103



calculations, and the related free asset ratio which is an indicator of the overall financial strength of the fund. Similar principles apply to the Group's Asian with-profits business.

Fund for Future Appropriations

        The fund for future appropriations ("FFA") represents the excess of assets over policyholder liabilities of the Group's with-profits funds. The annual excess or 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, or from, the fund for future appropriations through a charge or credit to the profit and loss account. The balance retained in the FFA for future appropriations represents cumulative retained earnings arising on the with-profits business that has not been allocated to policyholders or shareholders. The balance is determined after full provision for deferred tax on unrealized appreciation of investments.

        Changes to the level of the fund for future appropriations do not directly impact shareholders' results or funds. After allowing for differences in the basis of preparation of UK GAAP and UK regulatory returns, movements in the level of the fund for future appropriations are broadly indicative of movements in the excess of regulatory basis assets over liabilities of the fund. In turn, movements in this excess as a proportion of liabilities are indicative of changes in the financial strength of the fund. Differences in the basis of preparation of UK GAAP and UK regulatory returns arise principally from the treatment of certain regulatory basis liabilities, such as mismatching reserves (that are accounted for as reserves within the fund for future appropriations), recognition of deferred acquisition costs for UK GAAP, and asset valuation differences and admissibility deductions reflected in the regulatory returns.

Profits Recognition

        As outlined in "—Analysis by Geographic Region—United Kingdom—Basis of Profits" below, Prudential's results include an annual profit distribution to shareholders from long-term with-profits funds that represents an amount of up to one-ninth of the value of that year's bonus declarations to policyholders. The distribution corresponds directly to the post-tax modified statutory basis profit for with-profits business. The boards of directors of the subsidiary companies that have with-profits operations, using actuarial advice, determine the amount of annual and final bonuses to be declared each year on each group of contracts. More detail on Prudential's bonus policy is set out in "—Analysis by Geographic Region—United Kingdom—Basis of Profits".

Fair Value of Assets

        Changes in the fair value of assets of Prudential's long-term with-profits funds will primarily be reflected in the excess of assets over liabilities recorded under UK GAAP as the fund for future appropriations. Shareholders' profits from with-profits business and shareholders' funds are not directly impacted by movements in the fair values of the assets. However, current investment performance is a factor that is taken into account in the setting of the annual declaration of bonuses which, in turn, affects UK shareholder profits to the extent of one-ninth of the cost of bonus.

        Changes in the fair value of assets of unit-linked (separate account) funds are normally accompanied by a matching change in unit-linked business liabilities that is also recognized in the profit and loss account.

Investment Returns

        For with-profits business, investment returns together with other income and expenditure are recorded within the profit and loss account. However, the difference between net income of the fund and the cost of bonuses and related statutory transfers is reflected in an amount transferred to or from the fund for future appropriations within the profit and loss account. Except to the extent of current

104



investment returns being taken into account in the setting of bonus policy, the investment returns of with-profits fund in a particular year do not affect shareholder profits or with-profits funds.

Securities lending

        The Group is party to various securities lending agreements under which securities are loaned to third parties on a short-term basis. The loaned securities are not removed from the Group's consolidated balance sheet; rather, they are retained within the appropriate investment classification. The Group's policy is that collateral in excess of 100% of the fair value of securities loaned is required from all securities borrowers and reverse repurchase agreements and typically consists of cash, debt securities, equity securities or letters of credit.

105



International Financial Reporting Standards and Discretionary Changes

Background

        The European Union ("EU") requires that all listed European groups prepare their financial statements in accordance with EU approved International Financial Reporting Standards ("IFRS") from January 1, 2005. For Prudential, the IFRS basis of reporting will replace the current UK GAAP Modified Statutory Basis of reporting. In common with other major groups, Prudential has a well-developed programme to implement the necessary changes.

        The Group will report interim 2005 IFRS basis results in July. However, Prudential recognizes that the market will need time to become familiar with the changes and their impact on the presentation of the financial statements, therefore the Group published selected comparative full-year 2004 IFRS basis results on the basis of selected financial information on June 2, 2005. For the avoidance of doubt neither the information contained in the June 2, 2005 announcement nor the information contained in this document constitutes IFRS financial statements.

IASB and EU developments on technical requirements

        The International Accounting Standards Board ("IASB") has now, with some exceptions, completed its deliberations, and fully issued all of the standards to constitute the stable platform for 2005 reporting. New standards issued from April 1, 2005 are called IFRS whilst those issued prior to this date (including those amended subsequently under the IASB's improvement project) are referred to as International Accounting Standards ("IAS").

        Substantially all of these standards have been subjected to a process of review under EU auspices, recommended for approval by the EU's Accounting Regulatory Committee, and then formally approved.

        The IASB is continuing to consider the restrictions that should apply under IAS 39 "Financial Instruments: Recognition and Measurement" ("IAS 39") to companies' ability to record the fair value movements on assets and liabilities to the profit and loss account. The IASB's continued consideration of these issues reflects concern expressed by some European institutions at the current version of the standard.

Application of IFRS to Prudential and Effects of Other Accounting Changes

        The description that follows contains extracts and explanations based on the Group's recent publication of selected IFRS financial information announced on June 2, 2005. Due to the continuing work of the IASB and possible amendments to the interpretive guidance, the Group's accounting policies, and consequently the information presented, may change prior to the publication of the first IFRS results in July 2005 and/or the 2005 full year results to be published in mid March 2006.

        In recognition of the difficulties for the banking sector in retrospectively applying IAS 32 "Financial Instruments: Disclosure and Presentation" ("IAS 32") and IAS 39 on financial instruments, the IASB has permitted application of these standards from January 1, 2005. This is also permitted for IFRS 4 "Insurance Contracts" ("IFRS 4") on insurance contracts. For Prudential, application of IAS 32 to IAS 39 for its banking subsidiary, Egg plc, for 2004 would have given rise to results that are not representative of the approach it intends to apply for hedge accounting from January 1, 2005. The Group has therefore chosen to utilize the IFRS 1 option to adopt these standards from January 1, 2005. The selected IFRS financial information presented below has been prepared on this basis.

        In addition to changes necessitated by the adoption of IFRS, Prudential has chosen to make a discretionary change to the basis of determining long-term investment returns included in operating profits for fixed income securities. The purpose of this change is to reflect longer-term returns rather than a 5 year averaged credit experience currently used. The impact of this change is included in the

106



information presented below. The presentation of operating profit based on longer-term investment returns, although currently a 'GAAP measure' under UK GAAP, may be considered to be a 'non-GAAP measure' in future periods under IFRS. This may affect the way Prudential presents financial information in future reports.

        The application of IAS 32, IAS 39 and IFRS 4 to Prudential's insurance operations (particularly JNL), however, has a material impact on IFRS reported results. The Group recognizes the importance of providing information that is indicative of the basis of reporting to be applied for 2005 for these operations. Accordingly, a description of the estimated impact of applying IAS 32, IAS 39 and IFRS 4 has been included. In addition, the Group discloses below the transitional impact of applying these three standards to shareholders' equity as at January 1, 2005.

The summary impact of applying IFRS basis reporting (excluding IAS 32, IAS 39 and IFRS 4) and discretionary presentation changes for longer-term investment returns is as follows:

        The adoption of IFRS and the discretionary change to the presentation of investment returns for the Group's shareholder backed non-participating business give rise to the following summary impact on full year 2004 IFRS basis results.

IFRS Basis Results

Year ended December 31, 2004

  Previously
published
(UK GAAP)(1)

  Discretionary
change for
long-term
investment
returns(3)

  Required
change to
statutory IFRS

  Statutory
IFRS(2)

 
  £m

  £m

  £m

  £m

Operating profit based on longer-term investment returns, before amortization of goodwill and shareholder tax of continuing operations:                
  JNL   196   100     296
  Other operations   427   (9 ) (6 ) 412
   
 
 
 
  Total(3)   623   91   (6 ) 708
   
 
 
 
Representing:                
  IFRS basis results before discretionary change for longer-term investment returns               617
  Effect of discretionary change of policy for longer-term investment returns               91
  IFRS basis results after discretionary change for longer-term investment returns               708
               
Total profit, including actual investment return, before shareholders' tax*(4) of continuing operations   758     92   850
   
 
 
 
Shareholders' Equity (capital and reserves)                
  As at December 31, 2004   4,281     209   4,490
   
 
 
 

(1)
Figures shown for 'previously published' relate to continuing operations and exclude amounts attached to discontinued activities, including Egg's Funds Direct operations

(2)
References in the table above to 'Statutory IFRS' reflect the Group's adoption of all IFRS standards other than IAS 32, IAS 39 and IFRS 4, for the 2004 comparative results to be included in the Group's 2005 statutory basis financial statements, in so far as they affect the selected financial information. For the avoidance of doubt the statutory IFRS results do not represent the

107


(3)
References to operating profit, based on longer-term investment returns, before shareholders' tax, reflect the continuation of the Group's approach to providing an analysis of results that demonstrates underlying performance i.e. excluding short-term volatility in investment returns. Profits determined on this basis are provided as an additional analysis of the results to be included in the Group's income statement and reflect the long-standing convention previously advocated for UK insurers by the Statement of Recommended Practice issued by the Association of British Insurers.


In determining the statutory IFRS basis operating results based on longer-term investment returns, the basis of determining the longer-term investment returns has been refined. Previously for fixed income securities of JNL and other non-participating shareholder backed businesses of the Group, the basis for determining longer-term returns was estimated by recognizing realized gains and losses on a five-year averaged basis. For future reporting under IFRS and restated 2004 IFRS basis results this has been replaced with a combination of an annualized charge for long-term expected default experience and amortization of interest related realized gains and losses to the period when the sold securities would have otherwise matured.


The change more closely reflects the longer-term nature of the credit cycle and refines the impact of realisations that are unrelated to defaults and impairments. Prudential believes that the presentation of operating profits based on longer-term investment returns better reflects the Group's underlying performance.

(4)
References to operating profit and total profit before shareholder tax reflect the continued presentation as additional information of tax attributable to with-profits funds and unit linked policyholders as a charge deducted in the determination of pre-shareholder tax results. In determining the allocation of tax charges between those attributable to with-profits funds, unit-linked policyholders and shareholders, a methodology consistent with that previously appropriate under UK GAAP (modified statutory basis) reporting has been applied.

        Technically under IFRS, which does not recognize the distinction between taxes attributable to these different participants, total formal IFRS pre-tax profit is required to be recorded in the income statement before deduction of all taxes. In determining such pre-tax profits, transfers to and from unallocated surplus of with-profits funds are taken into account. These transfers are themselves a function of the tax borne by with-profits funds. The total profit before tax on an IFRS basis is not representative of profit before taxes attributable to shareholders.

        In order to provide pre-tax results that are relevant from a shareholder perspective, the Group has elected to provide additional analysis in its financial statements of the profits before shareholder tax, but after deduction of policyholder tax.

108


The impact on operating profit, based on longer-term investment returns, before shareholder tax (by business unit) of applying IFRS basis reporting (excluding IAS 32, IAS 39 and IFRS 4) and discretionary presentation changes for longer-term investment returns is as follows:

A summary of the changes to operating profit, based on longer-term investment returns, before shareholder tax for continuing operations is shown below:

 
  Previously
published*(1)

  Discretionary
change for
longer-term
investment
returns

  Required
change to
statutory IFRS

  Statutory
IFRS*(2)

 
 
  £m

  £m

  £m

  £m

 
UK and Europe operations                  
  Insurance operations   305   0   0   305  
  M&G (note a)   136   0   0   136  
  Egg (note b)   63   0   (2 ) 61  
   
 
 
 
 
  Total   504   0   (2 ) 502  
   
 
 
 
 
US operations                  
  JNL (note c)   196   100   0   296  
  Broker dealer and fund management   (14 ) 0   0   (14 )
   
 
 
 
 
  Total   182   100   0   282  
   
 
 
 
 
Asian operations (note d)                  
  Long-term business   126   (9 ) 0   117  
  Fund Management   19   0   0   19  
  Development Expenses   (15 ) 0   0   (15 )
   
 
 
 
 
  Total   130   (9 ) 0   121  
   
 
 
 
 
Other income and expenditure                  
  Interest payable on core structural borrowings   (154 ) 0   0   (154 )
  Other (note e)   (39 ) 0   (4 ) (43 )
   
 
 
 
 
  Total   (193 ) 0   (4 ) (197 )
   
 
 
 
 
Total continuing operations (note f)   623   91   (6 ) 708  
   
 
 
 
 
Representing:                  
  IFRS basis results before discretionary change for longer-term investment returns               617  
  Effect of discretionary change of policy for longer-term investment returns               91  
  IFRS basis results after discretionary change for longer-term investment returns               708  
               
 

*(1)
Figures shown for 'previously published' relate to continuing operations and exclude amounts attached to discontinued activities, including Egg's Funds Direct operations

*(2)
References in the table above to 'Statutory IFRS' reflect the Group's adoption of all IFRS standards other than IAS 32, IAS 39 and IFRS 4, for the 2004 comparative results to be included in the Group's 2005 statutory basis financial statements, in so far as they affect the selected financial information included in this summary. For the avoidance of doubt the statutory IFRS results do not represent the Company's statutory accounts, nor have they been extracted from statutory IFRS accounts. Figures in the statutory IFRS column also reflect the effect of Prudential's discretionary charge for longer-term investment returns.

109


Notes on changes to operating results, based on longer-term investment returns, of continuing operations:

(a)    M&G    

        For M&G, the zero change reflects the effect of applying IAS 19 "Employee Benefits" ("IAS 19") for the M&G pension scheme (£(1) million) offset by the altered measurement of acquisition costs and front-end charges for external investment management business (£1 million) under IAS 18 "Revenue" ("IAS 18").

(b)    Egg    

        Operating profit, as previously published, of £63 million is shown after adjusting for the losses of £20 million attaching to the now discontinued Funds Direct business.

        The statutory IFRS changes to the 2004 comparative results for Egg reflect only those adjustments arising from IFRS standards other than from IAS 32 and IAS 39. £(3) million of the change of £(2) million arises from the application of IFRS 2 to share based payment in respect of shares in Egg plc.

(c)    JNL    

        The discretionary change to reflect the altered basis of recognition of longer-term investment return is unrelated to the requirements of IFRS. The change primarily affects the operating result of JNL as follows:

Previously published basis:

  £m
 
Averaged losses on fixed income securities   (102 )

Statutory IFRS


 

£m


 
Longer-term default assumption   (47 )
Amortization of interest related realized gains and losses   45  
   
 
    (2 )
   
 

Net Change


 

£m


 
Gross change   110  
Change to related amortization of acquisition costs   (10 )
   
 
    100  
   
 

        The change of £100 million results from Prudential's decision to replace the prior methodology for estimating longer-term returns by recognizing realized gains and losses (including the exceptional default losses experienced in 2001 and 2002) with a default assumption that reflects longer-term expectations, based on historical precedent. The longer-term default provision has been calibrated on a basis consistent with published rating agency risk margin analyses and is reflective of the credit quality of individual investments held in the JNL portfolio.

        There are no significant changes to JNL's operating results for IFRS changes. The accounting basis applied previously to JNL's contracts aligns very closely to that required under IFRS.

(d)    Asian operations    

        With the exception of the altered basis of determining longer-term returns, there is no change to operating profit for Asian operations. Virtually all insurance contracts of the Group's Asian Operations

110



continue to be accounted for under UK GAAP as they are technically classified as insurance rather than investment contracts under IFRS 4.

(e)    Other income and expenditure    

        The change of £(4) million comprises:

 
  £m
 
Shareholders' share of pension costs not allocated to business operations   (3 )
In respect of share based payments   (1 )
   
 
    (4 )
   
 

(f)    Estimated impact if IAS 32, IAS 39 and IFRS 4 had been adopted at January 1, 2004 for the Group's insurance operations    

        If the IASB had not permitted the adoption of IAS 32, IAS 39, and IFRS 4 from January 1, 2005, it is estimated that operating profit for the period relating to the Group's insurance operations would have been £9 million lower. This reduction relates to the application of IAS 39 and IFRS 4 to unit-linked contracts that are classified as investment contracts under IFRS 4 within the Group's UK and Europe operations. The impact on operating profit of adopting IAS 32, IAS 39 and IFRS 4 at January 1, 2004 for the Group's non-insurance operations has not been identified. Further details on the impact of adopting these standards is provided below in the section describing the impact on transition.

111



The impact on total profit before shareholder tax, including actual investment returns (of continuing operations) of applying IFRS basis reporting (excluding IAS 32, IAS 39 and IFRS 4) is as follows:

A summary of changes to total profit before shareholder tax, including actual investment returns, of continuing operations is shown below:

 
  Previously
published
(UK GAAP)*(1)

  Discretionary
change for
longer-term
investment
returns

  Required
change to
statutory IFRS

  Statutory
IFRS*(2)

 
 
  £m

  £m

  £m

  £m

 
Operating profit, based on longer-term investment returns, before shareholder tax   623   91   (6 ) 708  
Representing:                  
  IFRS basis results before discretionary change for longer-term investment returns               617  
  Effect of discretionary change of policy for longer-term investment returns               91  
  IFRS basis results after discretionary change for longer-term investment returns               708  

Amortization of goodwill (note a)

 

(94

)


 

94

 


 

Short-term fluctuations in investment returns (note b)

 

229

 

(91

)

11

 

149

 

Shareholders' share of actuarial gains and losses on defined benefit pension schemes (note c)

 


 


 

(7

)

(7

)
   
 
 
 
 

Total profit including actual investment returns, before shareholder tax of continuing operations (note d)

 

758

 


 

92

 

850

 
   
 
 
 
 

*(1)
Figures shown for 'previously published' relate to continuing operations and exclude amounts attached to discontinued activities, including Egg's Funds Direct operations

*(2)
References in the table above to 'Statutory IFRS' reflect the Group's adoption of all IFRS standards other than IAS 32, IAS 39 and IFRS 4, for the 2004 comparative results to be included in the Group's 2005 statutory basis financial statements, in so far as they affect the selected financial information. For the avoidance of doubt the statutory IFRS results do not represent the Company's statutory accounts, nor have they been extracted from statutory IFRS accounts.

Notes on changes to total profit before shareholder tax of continuing operations

(a)    Amortization of goodwill    

        Subject to annual impairment testing, goodwill is not amortized under IFRS.

(b)    Short-term fluctuations in investment returns    

        The discretionary change of £(91) million reflects the revised basis of determining longer-term returns, as discussed previously. The £11 million change to statutory IFRS principally reflects the share of profits of property and venture fund investment subsidiaries, held by the PAC with-profits fund, that are attributable to minority interests.

112



(c)    Shareholders' share of actuarial gains and losses on defined benefit pension schemes    

        The actuarial gains and losses comprise the effect of short-term fluctuations in investment returns on scheme assets, and the effect of changes in actuarial assumptions, after deduction of the proportion absorbed by the PAC with-profit fund. Due to IFRS requirements, as they apply to the share of actuarial gains and losses absorbed by with-profit funds, the Group's policy is to record all actuarial gains and losses in the income statement.

(d)    Estimated impact if IAS 32, IAS 39 and IFRS 4 had been adopted at January 1, 2004 for the Group's insurance operations    

        If the IASB had not permitted the adoption of IAS 32, IAS 39, and IFRS 4 from January 1, 2005, total profit for the period relating to the Group's insurance operations would have been £135 million higher. The £135 million uplift comprises a reduction in operating profit of £9 million to £699 million (as previously described) and an increase of £144 million to £293 million in short-term fluctuations in investment returns resulting in a revised total profit of £985 million. The £144 million change to short term fluctuations arises from the market valuation of derivatives used for economic hedging purposes by JNL. The Group has not generally sought to hedge account for JNL's derivatives and as result value movements on these derivatives will be included in the income statement from January 1, 2005. The impact on total profit of adopting IAS 32, IAS 39 and IFRS 4 at January 1, 2004 for the Group's non-insurance operations has not been identified. Further details on the impact of adopting these standards is provided below in the section describing the impact on transition.

The impact on shareholders' equity of applying IFRS basis reporting (excluding IAS 32, IAS 39 and IFRS 4) is as follows:

        A summary of changes to shareholders' equity at December 31, 2004 is shown below:

 
   
  £m
 
Previously published under UK GAAP   4,281  

Changes to statutory IFRS

 

 

 
    Timing difference on recognition of accrued final dividend (note a)   253  
    Shareholders' share of deficits (net of tax) of UK defined benefit pension schemes (note b)   (115 )
    Goodwill (note c)   94  
    Other items (note d)   (23 )
        209  
       
 
Statutory IFRS basis shareholders' funds at December 31, 2004*   4,490  

*
References in the table above to 'Statutory IFRS' reflect the Group's adoption of all IFRS standards other than IAS 32, IAS 39 and IFRS 4, for the 2004 comparative results to be included in the Group's 2005 statutory basis financial statements, in so far as they affect the selected financial information. For the avoidance of doubt the statutory IFRS results do not represent the Company's statutory accounts, nor have they been extracted from statutory IFRS accounts.

Notes on changes to shareholders' equity (capital and reserves)

(a)    Timing difference on recognition of accrued final dividend    

        Under IFRS, dividends declared after the balance sheet date of the reporting period are recognized for accounting purposes in the period of declaration.

113



(b)    Shareholders' share of deficits (net of tax) of UK defined benefit pensions schemes    

        Under IAS 19 provision for pension scheme deficits is required on a basis similar to that previously shown in the 2004 Annual Report as memorandum disclosure under FRS 17. The deficits of the schemes reflect the difference between the market value of the assets of the schemes and projected liabilities for future cash flows discounted at an AA graded corporate bond rate. The total deficits have been apportioned, on a basis that reflects the activity of the members of the schemes, between the PAC with-profit fund and shareholders' funds. After deduction of attaching deferred tax the net effect is to reduce the unallocated surplus of the PAC with-profit fund at December 31, 2004 by £472 million. Shareholders' funds are reduced by £115 million.

(c)    Goodwill    

        The charge for goodwill reflects the fact, subject to annual impairment testing, that goodwill is not amortized from the date of adoption of IFRS.

(d)    Other items    

        Of the deduction of £23 million, £27 million relates to Prudential shares owned by unit trusts that are consolidated under IFRS. These shares are accounted for as Treasury shares and hence deducted from shareholders' equity rather than being recorded as assets.

The adjustment on transition to IAS 32, IAS 39 and IFRS 4 is as follows:

        On formal adoption of IAS 32, IAS 39 and IFRS 4 at January 1, 2005 for the Group's insurance and other operations, the Group's IFRS basis results will incorporate a transitional adjustment to shareholders' equity. The changes are as follows:

 
  Previously
published

  Statutory*
IFRS

 
 
  £m

  £m

 
Shareholders' equity attributable to holders of Prudential plc at December 31, 2004   4,281   4,490  
Transition adjustments:          
  Insurance operations (note a)   N/A   261  
   
 
 
    N/A   4,751  
  Banking and other non-insurance operations (note b)   N/A   (25 )
   
 
 
Shareholders' equity attributable to holders of Prudential plc at 1 January 2005   4,281   4,726  
   
 
 

*
References in the table above to 'Statutory IFRS' reflect the Group's adoption of all IFRS standards other than IAS 32, IAS 39 and IFRS 4, for the 2004 comparative results to be included in the Group's 2005 statutory basis financial statements, in so far as they affect the selected financial information. For the avoidance of doubt the statutory IFRS results do not represent the Company's statutory accounts, nor have they been extracted from statutory IFRS accounts.

(a)    Insurance operations    

        The transition adjustment for insurance operations shown above predominantly relates to the altered valuation bases of JNL's derivatives and fixed income securities.

        On application of IAS 39, movements in the fair value of financial instruments are recorded in either the income statement or directly to shareholder reserves in the balance sheet, depending upon the designation and the impact of hedge accounting rules. Derivative instruments are generally also carried at fair value with movements in value being recorded in the income statement. Hedge accounting,

114



whereby value movements on derivatives and hedged items are recorded together in the performance statements, is permissible only if certain hedge effectiveness criteria are met.

        Currently, under UK GAAP the fixed income securities of JNL are, unless impaired, accounted for at amortized cost with derivatives similarly treated. In applying IFRS the Group has decided to account for JNL's fixed income securities on an "available for sale" basis whereby the fixed income securities are accounted for at fair value with movements in that fair value being recorded in shareholders' reserves rather than the income statement. In this respect, the treatment is the same as applied by many US insurers under US GAAP. Value movements for JNL's derivatives will however be booked in the income statement as required by IAS 39.

        For derivative instruments of JNL, Prudential has carefully considered whether it is appropriate to undertake the necessary operational changes to apply hedge accounting in order to achieve matching of value movements in hedging instruments and hedged items in the performance statements. In reaching the decision not to do so a number of factors were particularly relevant. These are:

        In this regard, the issues surrounding IAS 39 application are very similar to those considered by other US life insurers when SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" was first applied for US GAAP reporting. Taking account of these considerations, Prudential has decided that, except for certain minor categories of derivatives, it is not sensible to seek to achieve hedge accounting under IAS 39 by completely re-configuring the structure of JNL's derivative book. As a result of this decision the total income statement result will be more volatile as the movements in value of JNL's derivatives will be reflected within it. This is despite the fact that JNL's derivative activity achieves a high level of economic hedge effectiveness.

        After partially offsetting 'shadow' accounting changes in the balance sheet and shareholder reserves for deferred acquisition costs and related deferred tax, the altered valuation basis gives rise to an increase in shareholders' equity of £273 million. The movement in this unrealized appreciation from period to period primarily reflects the impact of changes of market interest rates and risk premium. In future, IFRS shareholders' funds are likely to be more volatile for this feature.

        Partially offsetting the uplift on transition described above, a deduction of £12 million to shareholders' funds was made. This primarily relates to the application of IAS 39 and IFRS 4 to those unit-linked contracts in the Group's UK and Europe insurance operations that are classified as investment contracts under IFRS 4. Under the changed basis of classification:

115


        It should be emphasized that the IFRS changes to profit recognition for these contracts merely impact the timing of profit recognition. Cash flow in any particular period from these contracts, as they mature and regulatory basis surpluses emerge, will be unaffected, as is the aggregate profit for the contracts over their life. The impact of the changes on the result in any given period depends upon the level of deferred acquisition costs under previous (UK GAAP) and revised (IFRS) basis. In general under IFRS, it is expected that, with a growing book of unit-linked business, emergence of profit will be delayed.

        Guaranteed Investment Contracts ("GIC's") of Jackson National Life and a very small number of contracts in the Asian operations are also subject to measurement change under IAS 39. The current measurement approach for GIC's is though almost the same as the amortized cost approach being applied under IFRS. The changes to the Asia contracts are immaterial in their financial effect.

        On presentational effects, under IAS 39, premiums and claims on these UK unit-linked contracts, GIC's, and minor Asian contracts will be recorded as movements on contract liabilities in the balance sheet. Although profit does not alter for this change, the presentation in the Group's income statement is affected so that premium income and the charge for claims and surrenders are reduced. In this regard the change is similar conceptually to that required under deposit accounting as applied under US GAAP.

        It should be noted that the IFRS 4 rules are very different from those under US GAAP as to the category of policies that are classified as "investment contracts". Most of the Group's contracts that would be classified as investment contracts under US GAAP will continue to be accounted for under IFRS as either insurance contracts, or investment contracts with discretionary participating features, with the facility to continue to account under IFRS on a UK GAAP basis (the MSB method of reporting).

        For all other insurance contracts of UK and Europe operations the basis of measurement of assets and liabilities continues to be applied as under UK GAAP until the IASB introduces a comprehensive (Phase 2) standard.

        It should be noted however that, by the UK insurance industry's adoption of the requirements of FRS 27, UK GAAP for with-profit contracts of UK life funds will alter to reflect the FSA realistic reporting regime. The change essentially alters the basis of providing for future bonuses on, and valuing guarantee features of, with-profit contracts. In turn this affects the residual amount that has yet to be allocated between policyholders and shareholders (the Fund for Future Appropriations). The estimated impact on the 2004 year end position is shown on page 138. Profit recognition for this business on the UK GAAP and IFRS bases though will continue to reflect the company's 10% interest in the actuarially determined surplus for distribution.

(b)    Banking and non-insurance operations    

        The transition adjustment for banking and non-insurance operations of £(25) million relates to the Group's share of Egg's transitional adjustment and the difference between fair value and amortized cost in relation to certain derivatives held by the Group's non-insurance operations.

        On application of IAS 32 and IAS 39 Egg has designated its wholesale assets as Available-for-Sale, holding them at fair value with unrealized gains and losses reflected directly in equity. Liabilities are measured at amortized cost with no effect compared to UK GAAP, except where set-up fees had been previously expensed but will, under IFRS, be capitalized and amortized.

        Derivatives are the only products for which changes in fair value will affect the total result for the reporting period. However, for interest rate swaps that economically hedge fixed rate personal loans by matching them against the variable rate savings book, Egg will apply portfolio cash flow hedge accounting under IAS 39. Changes in the fair value of these hedges will be recorded directly in equity in the balance sheet and not the income statement.

116



Overview of Consolidated Results

Introduction

        Prudential has built strong positions in the United kingdom, the United States and Asia, three of the most attractive savings markets in the world. In 2004, each of its three regional insurance businesses delivered double-digit growth in sales and profits.

        Prudential achieved these results by adopting a disciplined approach to investment and growth, allocating capital to those businesses that deliver sustainable high returns. At the same time, Prudential managed its risks by maintaining a diversified portfolio of businesses across its chosen markets, principally in the UK, the US and Asia, including several mature cash generators, as well as attractive newer businesses which require investment.

        The following table shows Prudential's UK GAAP consolidated total profit on ordinary activities on the modified statutory basis for the periods indicated.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Operating profit (based on long-term investment returns) before amortization of goodwill and tax from continuing operations(1)              
    UK and Europe Operations   484   394   470  
    US Operations   182   140   131  
    Asian Operations   130   71   62  
    Other income and expenditure   (193 ) (181 ) (189 )
   
 
 
 
  Total continuing operations   603   424   474  
  Discontinued UK banking operation   (37 ) (89 ) (47 )
  Discontinued US banking operation   17   22   22  
   
 
 
 
Operating profit (based on long-term investment returns) before amortization of goodwill and tax   583   357   449  
Amortization of goodwill   (97 ) (98 ) (98 )
Short-term fluctuations in investment returns   229   91   (205 )
Profit on business disposals   48     355  
Egg France closure cost   (113 )    
   
 
 
 
Profit on ordinary activities before tax   650   350   501  
   
 
 
 
Tax on profit on ordinary activities              
  Tax on operating profit before amortization of goodwill   (177 ) (106 ) (120 )
  Tax on items excluded from operating profit before amortization of goodwill   (55 ) (38 ) 78  
   
 
 
 
Tax on profit on ordinary activities   (232 ) (144 ) (42 )
   
 
 
 
Profit on ordinary activities after tax before minority interests   418   206   459  
Minority interests   10   2   9  
   
 
 
 
Profit on ordinary activities after tax and minority interests   428   208   468  
   
 
 
 

(1)
For the purposes of this report, operating profit is based on long-term investment returns before amortization of goodwill and tax. See Note 5 of the notes to Prudential's consolidated financial statements for a description of the basis.

        The Group's reportable business segments are based on the organizational structure used by the directors for making operating and investment decisions and for assessing performance and are as follows: UK and Europe Insurance operations, M&G and Egg, which are all located in the UK (collectively "UK and Europe Operations"), US Operations and Asian Operations. The business segments are determined firstly by the territories in which the Group conducts business, which are the United Kingdom and Europe, the United States and Asia. UK and Europe Operations include long-term life

117



insurance business, banking and fund management activities. The US and Asian Operations mainly include life insurance business and fund management activities.

        In determining operating profit, the Group has used the expected long-term investment return and excluded amortisation of goodwill and tax. For additional information on this basis see Note 5 of the notes to Prudential's consolidated financial statements. The directors believe that such presentation better reflects the group's underlying performance on a statutory basis of measurement.

Group operating profit before amortization of goodwill and tax

        Group operating profit (based on long-term investment returns) before amortization of goodwill and tax in 2004 was £583 million compared to £357 million in 2003 and £449 million in 2002. The higher profit in 2004 compared to 2003 primarily reflects strong growth in insurance and fund management businesses. In 2003 the reduction from 2002 primarily reflects a £90 million reduction in PAC with-profits fund shareholder transfer. Below is a summary by operation of results.

        UK and Europe Operation's operating profit (based on long-term investment returns) before amortization of goodwill and tax comprises;

 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Continuing operations:              
UK and Europe Insurance Operations   305   256   372  
M&G   136   83   71  
Egg   43   55   27  
   
 
 
 
Total continuing operations   484   394   470  
   
 
 
 
Discontinued operations:              
Egg France   (37 ) (89 ) (47 )
   
 
 
 
UK and Europe operating profit (based on long-term investment returns) before amortization of goodwill and tax   447   305   423  
   
 
 
 

        UK and Europe Insurance Operations' operating profit (based on long-term investment returns) before amortization of goodwill and tax was £305 million in 2004, an increase of 19% on 2003. This included a fourfold increase in the profit of Prudential Retirement Income Limited ("PRIL") from £31 million to £124 million. This more than offset the £17 million reduction in the profit from the with-profits fund of The Prudential Assurance Company Limited ("Prudential Assurance" or "PAC"), which fell due to lower annual and terminal bonus rates announced in February 2004. In 2003, the £116 million reduction in the UK and Europe Insurance Operations' operating profit (based on long-term investment returns) before amortization of goodwill and tax includes a reduction of £90 million from the PAC with-profits fund due to lower annual and terminal bonus rates announced in 2003, partially offset by fees earned from higher funds under management and increased policy claims. Losses on shareholder-backed business increased by £26 million as a result of increased new business volumes that carry significant new business strain.

        M&G's operating profit before amortization of goodwill and tax was £136 million in 2004, a 64% increase on 2003. Underlying profit before performance fees was £110 million during 2004, a 57% increase on the previous year, reflecting the strengths of M&G's diversified business, disciplined cost management and the success it has had in developing new sources of revenue. There were also £7 million of one-off provision releases in 2004, the majority of which was due to the satisfactory resolution of a fee negotiation. Over the last two years, M&G's underlying profit has more than doubled even though the average of the FTSE All Share index in 2004 was at similar levels to 2002. In 2003, M&G's operating profit before amortization of goodwill and tax of £83 million was an increase of £

118



12 million on 2002. This reflected the benefit of diversified revenue streams, sharp focus on cost control and cost savings achieved through outsourcing its retail administration.

        Egg's operating profit before amortization of goodwill and tax amounted to £6 million in 2004, compared with a loss of £34 million and a loss of £20 million in 2003 and 2002 respectively. Egg's profit from continuing operations in 2004 was £43 million, compared with £55 million in 2003, reflecting an increase in profit from the UK business offset by a £17 million impairment charge on the underlying assets of its subsidiary, Funds Direct.

        The US Operations' operating profit (based on long-term investment returns) before amortization of goodwill and tax of £199 million in 2004 was 23% ahead of 2003. The increase primarily reflects higher spread income, record variable annuity fee income, a favorable £28 million legal settlement and a positive £8 million adjustment arising from the adoption of SOP 03-01 "Accounting and Reporting by Insurance Enterprises for Certain Non-traditional long duration contracts and for separate accounts". This adjustment relates to a change in the method of valuing certain liabilities. These are partially offset by increased Deferred Acquisition Costs ("DAC") amortization. The US Operations' operating profit (based on long-term investment returns) before amortization of goodwill and tax in 2003 was £162 million, compared to £153 million in 2002. The increase in profit primarily reflects lower amortization of DAC for variable annuity products and higher fee and other income, offset by higher market value adjustment payments and higher average bond losses. See Note 37 of the notes to Prudential's consolidated financial statements for further discussion.

        Prudential Corporation Asia's operating profit (based on long-term investment returns) before amortization of goodwill and tax was £130 million in 2004, an increase of £59 million over £71 million achieved in 2003. This reflects an increase in underlying profits of £47 million and a decrease in development expenses of £12 million. Profits from the more established operations in Singapore, Hong Kong and Malaysia were £110 million, an increase from the £91 million recorded in 2003, as these operations continue to mature. Prudential Corporation Asia's operating profit (based on long-term investment returns) before amortization of goodwill and tax in 2003 was £71 million compared to £62 million in 2002 reflecting growth in insurance and investment products and the continued development of distribution channels.

Profit on ordinary activities before tax

        Profit on ordinary activities before tax was £650 million in 2004 compared to £350 million in 2003. This mainly reflects growth in operating profit of £226 million and improvement in short-term fluctuations in investment returns from £91 million in 2003 to £229 million in 2004.

        In 2003, profit on ordinary activities before tax was £350 million compared to £501 million in 2002, which included £355 million relating to the disposal of the UK General Insurance business. The lower profit in 2003 was also driven by lower operating profit of £92 million offset by an improvement in short-term fluctuations in investment returns from a negative £205 million in 2002 to a positive £91 million in 2003.

Profit on ordinary activities after tax

        Profit on ordinary activities after tax before minority interests was £418 million in 2004 compared with £206 million in 2003 and £459 million in 2002. These movements reflect the movements in profit before tax in those years and effective tax rates of 36% in 2004, 41% in 2003 and 8% in 2002. The 36% effective tax rate in 2004 and 41% effective tax rate in 2003 reflect an effective operating profit tax charge of 30% in both years combined with the lack of tax relief on the amortization of goodwill charge and the impact of taxation on short-term fluctuations in investment returns. The overall low rate of tax in 2002 reflects the relief of tax payable on business disposals against capital losses available to Prudential.

119




Analysis by Geographic Region

        Prudential focuses on operating profit (based on long-term investment returns) before amortization of goodwill, tax and exceptional items by geographic region as the primary measure of current year performance. This excludes exceptional items, such as profits on business disposals, and includes the investment return for (i) the UK shareholders' funds and (ii) Jackson National Life using a long-term rate of return, rather than the actual return for the year, in accordance with UK GAAP and the Association of British Insurers' guidelines. The analysis and discussion below is based upon operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and tax. Due to the long-term nature of Prudential's business, its basis of presentation of operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and tax may not be comparable with other UK companies. See Note 5 of the notes to Prudential's consolidated financial statements for a description of this basis.

        For all of Prudential's long-term insurance businesses (United Kingdom and Europe, United States and Asia), operating profit is generated principally from its in-force book of business. Prudential's in-force book is business written in earlier years and on which it continues to declare bonuses or credit interest to policyholders and generate profit for shareholders. These books of in-force business have been built up over many years with the result that, for Prudential's long-term insurance business, sales in any one year do not have a significant impact on shareholders' profit in that year, but may have an impact in subsequent years.

United Kingdom

Basis of Profits

        In order to understand how Prudential's results are derived it is necessary to understand how profit emerges from its with-profits business.

        Prudential's results comprise an annual profit distribution to shareholders from its UK long-term with-profits fund, hereafter referred to as the with-profits fund, as well as profits from its other businesses. Prudential's primary UK GAAP financial statements are prepared under the modified statutory basis of reporting as required by UK law. For most of its operations, other than its UK long-term insurance businesses, the modified statutory basis matches items of income and related expenditure within the same accounting period. This is achieved through the deferral of acquisition costs and application of the accruals concept.

With-profits Products

        For Prudential's UK long-term insurance business, the primary annual contribution to shareholders' profit comes from its with-profits products. With-profits products are designed to provide policyholders with smoothed investment returns through a mix of annual and final bonuses. Shareholders' profit in respect of bonuses from with-profits products represents an amount of up to one-ninth of the value of that year's bonus declaration to policyholders. The smoothing inherent in the bonus declarations provides for relatively stable annual shareholders' profit from this business.

Bonus Rates

        The main factors that influence the determination of bonus rates are the return on the investments of the with-profits fund, the effect of inflation, taxation, the expenses of the fund chargeable to policyholders and the degree to which investment returns are smoothed. The overall rate of return earned on investments and the expectation of future investment returns are the most important influences on bonus rates. The assets backing the with-profits business are predominantly invested in equities and real estate. If the financial strength of the with-profits fund were adversely affected, then a higher proportion of fixed interest or similar assets might be held by the fund.

120



Fund For Future Appropriations

        The annual excesses of premiums and investment returns over claim payments, operating expenses and the change in benefit provisions within Prudential's with-profits fund that are not distributed in that year as bonuses and related shareholders' profit are transferred to the fund for future appropriations by a charge to the profit and loss account of the with-profits fund. Any shortfall in such amounts would result in a transfer from the fund for future appropriations by a credit to the profit and loss account of the long-term fund. Current year amounts in respect of premiums, investment returns, operating expenses and unusual charges or credits do not directly affect the distribution of profit to shareholders from the with-profits business in that year. Current year claims, which include final bonus payments, do have an effect on shareholders' profit through the shareholders' proportion of the value of those final bonuses.

Surplus Assets and Their Use

        The fund for future appropriations comprises amounts Prudential expects to pay to policyholders in the future, the related shareholder transfers and surplus assets. These surplus assets, which are described in more detail under Item 4, "Information on the Company—Business of Prudential—UK and Europe Business—Shareholders' Interests in Prudential's Long-term Insurance Business—Surplus Assets in Prudential Assurance's Long-term With-profits Fund", have accumulated over many years from a variety of sources and provide the with-profits fund with working capital. This working capital permits Prudential to invest a substantial portion of the assets of the with-profits fund in equity securities and real estate, smooth investment returns to with-profits policyholders, keep its products competitive, write new business without being constrained as to cash flows in the early policy years and demonstrate solvency.

        In addition, Prudential can use surplus assets to absorb the costs of significant events, such as fundamental strategic change in its long-term business and, with the consent of the UK regulator, the cost of its pension mis-selling, without affecting the level of distributions to policyholders and shareholders. The costs of fundamental strategic change may include investment in new technology, redundancy and restructuring costs, cost overruns on new business and the funding of other appropriate long-term insurance related activities, including acquisitions.

The "SAIF" and "PAL" Funds

        Prudential's with-profits fund also includes the Scottish Amicable Insurance Fund ("SAIF") and the wholly-owned subsidiary, Prudential Annuities Limited ("PAL"). All assets of the SAIF business are solely attributable to former policyholders of Scottish Amicable Life Assurance Society (predating the acquisition of Scottish Amicable by Prudential in October 1997). The SAIF with-profits fund is discussed in more detail under Item 4, "Information on the Company—Business of Prudential—UK and Europe Business—Shareholders' Interests in Prudential's Long-term Insurance Business—The SAIF Sub-fund and Accounts". Since PAL is a wholly owned subsidiary of the with-profits fund, profits from this business affect shareholders' profits only to the extent that they affect the annual with-profits bonus declaration and resultant transfer to shareholders.

121



UK and Europe Operating Results

        The following table shows operating profit (based on long-term investment returns) before amortization of goodwill and tax for the periods indicated.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Continuing operations:              
  UK and Europe Insurance Operations—long-term business   305   256   372  
  M&G   136   83   71  
  Egg   43   55   27  
   
 
 
 
  Total continuing operations   484   394   470  
   
 
 
 
Discontinued operations:              
  Egg France   (37 ) (89 ) (47 )
   
 
 
 
Operating profit (based on long-term investment returns) before amortization of goodwill and tax   447   305   423  
   
 
 
 

UK and Europe Insurance Operations

        Operating profit (based on long-term investment returns) before amortization of goodwill and tax totaled £305 million in 2004 compared to £256 million in 2003 and £372 million in 2002.

UK Insurance Operations

        The operating profit (based on long-term investment returns) before amortization of goodwill and tax excluding European Operations totaled £299 million in 2004 compared with £254 million in 2003 and £371 million in 2002. The increase on 2003 included a four-fold increase in Prudential Retirement Income Limited's profit from £31 million to £124 million reflecting very strong sales performance, including a substantial annuity transaction with Royal London. This more than offset the £17 million reduction in profit from the with-profits fund, which fell due to lower annual and terminal bonus rates announced in February 2004. See Item 4, "Information on the Company—Business of Prudential—UK and Europe Business—UK Business Units—UK Insurance Operations—Life Insurance Products—Savings Products—Investment Bonds" for information on the bonus structure of Prudential's with-profits products.

        In any single period, operating profit is primarily the shareholders' annual distribution, also known as the shareholder transfer, from the Prudential Assurance long-term with-profits fund which represents up to one-ninth of the value of bonuses declared in that year to policyholders, and consequently is not directly impacted by current year gross premiums, investment return or expenses.

        In 2004 Prudential declared total post-tax bonuses of £2.0 billion from the Prudential Assurance long-term with-profits fund, of which £1.8 billion was credited to the with-profits policies and £198 million was distributed to shareholders. In 2003 Prudential declared total post-tax bonuses of £2.1 billion from the Prudential Assurance long-term with-profits fund, of which £1.9 billion was credited to the with-profits policies and £209 million was distributed to shareholders. In 2002, Prudential declared total post-tax bonuses of £2.7 billion from the Prudential Assurance long-term with-profits fund, of which £2.45 billion was credited to the with-profits policies and £273 million was distributed to shareholders.

        All unit-linked and non with-profits business written by Prudential in the United Kingdom is funded by capital provided by shareholders. Accordingly, all profit from this business goes to shareholders. In 2004 this business generated pre-tax losses of £25 million compared to pre-tax losses of £38 million in 2003 and £12 million in 2002.

122



UK Restructurings

        Restructuring of the Prudential UK Insurance Operations continued in 2004, following the restructuring of its direct salesforce and customer services channels and the establishment of an Indian service center which were announced in 2001 and 2002 respectively.

        In 2002, Prudential announced plans to establish an offshore service center in India to improve customer contact service levels for its UK Insurance Operations customers and to achieve further cost savings to those announced in 2001. The new processing center has been established in Mumbai and became fully operational during 2004. The initiative is expected to generate gross cost savings from 2006 of approximately £16 million per annum, of which approximately £4 million per annum is expected to be attributable to shareholders. In 2001, Prudential announced the restructuring of the direct salesforce and customer service channels of its UK and Europe Insurance Operations.

        As part of the restructurings, Prudential plans to make some 4,300 jobs redundant, of which approximately 4,100 had been completed by December 31, 2004.

European Operations

        The operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and tax from Prudential's European Insurance operations represents profits from Prudential International Assurance Plc (previously Scottish Amicable Life International), an Irish company, which mainly markets long-term insurance products into Belgium, Austria and the United Kingdom.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Long-term business   6   2   9  
Development expenses       (8 )
   
 
 
 
Europe total   6   2   1  
   
 
 
 

        Operating profit (based on long-term investment returns) before amortization of goodwill and tax from Prudential's European operations was £6 million in 2004, compared to £2 million in 2003, and £1 million in 2002.

        In November 2002, Prudential agreed to sell its German long-term business to Canada Life for £82 million. The sale was completed on January 1, 2003. A full portfolio transfer occurred in August 2003. See Item 4, "Information on the Company—Business of Prudential—European Business—Sale of German Business to Canada Life". In June 2004, Prudential announced it was ceasing to write new business in France. See Item 4, "Business of Prudential—European Business—Closure of French Branch".

M&G

        M&G's operating profit before amortization of goodwill and tax was £136 million in 2004, a 64% increase on 2003. Underlying profit before performance fees was £110 million during 2004, a 57% increase on the previous year, reflecting the strengths of M&G's diversified business, disciplined cost management and the success it has had in developing new sources of revenue. There were also £7 million of one-off provision releases in 2004, the majority of which was due to the satisfactory resolution of a fee negotiation. Over the last two years, M&G's underlying profit has more than doubled even though the average of the FTSE All Share index in 2004 was at similar levels to 2002.

        Performance related fees in 2004 were £26 million, including £20 million which relates to the disposal of some of the investments by PPM Ventures that are not expected to recur. M&G also received £

123



6 million of performance fees for the management of the Prudential Assurance Company long-term and annuity funds which continued to beat their strategic and competitor benchmarks during the year.

        In 2003, M&G's operating profit before amortization of goodwill and tax increased by £12 million, from £71 million in 2002 to £83 million in 2003. This was 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% less over the year than 2002. Underlying profits increased from £49 million to £70 million, whilst performance fees fell from £22 million in 2002 to £13 million in 2003. Similar to the growth during 2004, the increase in the underlying profit from 2002 to 2003 reflected M&G's diversification of revenue streams and disciplined cost control. In 2003, the performance fees decreased from the £22 million achieved in 2002 which recognized the exceptional performance of 2000 in the rolling three-year calculation.

Egg

        The following table shows operating profit (loss) before tax, for the periods indicated.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
UK banking operations              
Continuing operations:              
  Operating income   497   420   326  
  Expenses   (423 ) (347 ) (291 )
   
 
 
 
UK banking operating profit   74   73   35  
International banking operations (excluding Egg France)     (4 ) (3 )
Share of operating losses from joint ventures and associated undertakings   (21 ) (4 ) (5 )
Transaction and restructuring costs   (10 ) (10 )  
   
 
 
 
Operating profit from continuing operations   43   55   27  
   
 
 
 
Discontinued operations:              
Egg France   (37 ) (89 ) (47 )
   
 
 
 
Operating profit (loss)   6   (34 ) (20 )
   
 
 
 

        Egg's core UK business generated a profit before tax in 2004 of £74 million, compared to a £73 million profit in 2003 and a profit of £35 million in 2002.

        The profit from the core UK business reflects operating income of £497 million, an 18% increase from £420 million in 2003, offset by expenses of £423 million, compared to expenses of £347 million in 2003. The UK banking operations' increase in operating income reflects net interest income of £287 million, 9% higher than in 2003, despite the keen competition for card balances and the margin squeeze caused by rising base rates during 2004. In addition, other operating income of £210 million increased by £53 million from 2003, reflecting record personal loan sales with resulting commission income on selling associated insurance up £32 million from 2003. The increase in expenses is largely due to a £55 million increase in bad debt provision that reflects the change in product mix following the continuing growth in the unsecured lending portfolio, the stage of the life cycle of the card and loan books and the increasing proportion of personal loans business.

        In 2003, the profit from the UK banking operations reflects operating income of £420 million, compared to £326 million in 2002, offset by expenses of £347 million, compared to expenses of £291 million in 2002. The UK banking operations' increase in operating income reflects net interest income of £263 million, 18% higher than in 2002, due to the growth in the retail asset book combined with maintenance of margin. In addition, other operating income of £157 million increased by £

124



54 million from 2002, principally reflecting fees and commissions earned from a larger credit card book and from selling personal loan payment protection insurance. The increase in expenses is largely due to a £43 million increase in the bad debt provision that reflects the 22% growth in the credit book and an increase in unsecured lending balances as a proportion of the total asset book. Unsecured lending which comprises credit card and personal loans, grew in 2003 by £1.49 billion, leading to a balance of £4.8 billion, of which credit card balances accounted for £3.0 billion (£2.3 billion in 2002).

        Share of operating losses from joint ventures and associated undertakings in 2004 was £21 million, compared to a loss of £4 million in 2003. This loss principally comprised a £17 million impairment charge against the full carrying value of the underlying assets of Funds Direct, Egg's investment wrap platform business. This followed Egg's decision to focus on its successful UK banking business and dispose its investment in Funds Direct.

        Egg's operating profit was £6 million in 2004, compared to a loss of £34 million in 2003. This principally reflected the lower operating loss recorded in its operations in France. Operating loss in France was £37 million up until July 13, 2004 when the decision to withdraw from the French market was announced and at that point in time a provision of £113 million was established to cover the estimated costs of exit. This provision is accounted for as a non-operating loss.

United States

        Prudential's US operations comprise its US insurance company, Jackson National Life, which includes Jackson National Life Insurance Company of New York, Curian Capital, LLC, PPM America, its US internal and institutional investment manager, and its US broker-dealer group, National Planning Holdings. Jackson Federal Bank, the US banking operation, was sold in October 2004.

Basis of Profits

        The profit on Jackson National Life's business predominantly arises from spread income from interest-sensitive products, such as fixed annuities, institutional products and fee income on variable annuities. For the purposes of UK reporting, deposits into these products are recorded as premiums, withdrawals and surrenders are included in benefits and claims and the resulting net movement is recorded under other reserve movements within benefits and claims. Benefits and claims also includes interest credited to policyholders in respect of deposit products and fees charged on these policies. While the presentation of these items differs between UK GAAP and US GAAP, there is no net impact on operating profit. The UK GAAP result for Jackson National Life is based on Jackson National Life's US GAAP results with an adjustment to exclude the requirements of FAS 133 "Accounting for Derivative Instruments and Hedging Activities" as amended by FAS 137, 138 and 149 ("FAS 133"), and for a different treatment of investment gains and losses.

125


United States Operating Results

        The following table shows operating profit (based on long-term investment returns) before amortization of goodwill and tax for the periods indicated.

 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Continuing operations:            
Jackson National Life   196   143   117
National Planning Holdings and Curian   (26 ) (20 )
PPM America   12   17   14
   
 
 
Total continuing operations   182   140   131
   
 
 
Discontinued operations:            
US banking operation   17   22   22
   
 
 
Operating profit (based on long-term investment returns) before amortization of goodwill and tax   199   162   153
   
 
 

        Operating profit (based on long-term investment returns) before amortization of goodwill and tax of £199 million in 2004 was 23% ahead of 2003. The increase primarily reflects higher spread income, record variable annuity fee income, a favorable £28 million legal settlement and a positive £8 million adjustment arising from the adoption of SOP 03-01 "Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long Duration Contracts and for Separate Accounts". This adjustment relates to a change in the method of valuing certain liabilities. These are partially offset by increased DAC amortization. The increased losses at National Planning Holdings and Curian relate solely to Curian as it continues to build scale. See Note 37 of the notes to Prudential's consolidated financial statements for further discussion.

        Variable Annuity DAC amortization is calculated using a long-term return assumption which is implemented through the use of a mean reversion methodology. If the mean reversion were to be eliminated as of December 31, 2004, the variable annuity DAC carrying value would be reduced by approximately £6 million.

        Operating profit (based on long-term investment returns) before amortization of goodwill, exceptional items and tax of £162 million in 2003 was 6% ahead of 2002. The increase primarily reflected lower DAC amortization 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 amortization 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. No such impairment write-off of variable annuity DAC was required in 2003.

        The provision for guaranteed minimum death benefits (referred to as "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 2004.

        The movement in the average exchange rates from $1.64/£1.00 to $1.83/£1.00 during 2004 had an adverse translational impact of £24 million on the United States operating profit (based on long-term investment returns) before amortization of goodwill and tax.

126



Asian Operations

        Profits from the long-term insurance business of the Asian operations currently contribute 22% to Group operating profit (based on long-term investment returns) before amortization of goodwill and tax. Prudential Corporation Asia head office costs are included in Other Income and Expenditure below.

        The Japanese life market remains very challenging and in 2003 Prudential scaled back its operations to focus on higher value distribution channels and more profitable products. While the operation is now somewhat more efficient with lower expense levels and has made some progress with establishing new distribution channels, it will take some time to deliver material volumes and become a positive contributor to Prudential Corporation Asia's overall results.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Long-term business   126   85   82  
Investment products   19   13   6  
Development expenses   (15 ) (27 ) (26 )
   
 
 
 
Operating profit (based on long-term investment returns) before amortization of goodwill and tax   130   71   62  
   
 
 
 

        Operating profit (based on long-term investment returns) before amortization of goodwill and tax was £130 million in 2004, an increase of £59 million over £71 million achieved in 2003. This reflects an increase in underlying profits of £47 million and a decrease in development expenses of £12 million. In 2003, operating profit (based on long-term investment returns) before amortization of goodwill and tax increased £9 million over 2002.

        Operating profit before development expenses, amortization of goodwill and tax was £145 million in 2004, an increase of £47 million over the £98 million in 2003. Profits from the more established operations in Singapore, Hong Kong and Malaysia were £110 million, an increase from the £91 million recorded in 2003, as these operations continue to mature. In 2003, Prudential Asia's operating profit before development expenses, amortization of goodwill and tax increased £10 million over the £88 million in 2002.

        This result is after significant investment in 2004, as Prudential builds high quality customer-focused distribution channels across the region. Further significant investment is planned for 2005.

        Development expenses (excluding Asia regional head office expenses) decreased from £27 million in 2003 to £15 million in 2004.

127



Other Income and Expenditure

        Other income and expenditure represents the investment return on centrally retained shareholder capital and funds, interest expense on group borrowings and central corporate expenditure.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Investment return and other income   44   29   3  
Interest payable on core structural borrowings of shareholder financed operations   (154 ) (143 ) (130 )
Corporate expenditure              
Group Head Office   (54 ) (43 ) (36 )
Asia Head Office   (29 ) (24 ) (26 )
   
 
 
 
Total other income and expenditure   (193 ) (181 ) (189 )
   
 
 
 

        Losses from other income and expenditure before amortization of goodwill and tax for Group activities increased to £193 million in 2004 from £181 million in 2003. This reflected an increase in investment return and other income offset by higher interest payable and head office costs. Head office costs (including Asia regional head office costs of £29 million) were £83 million, up £16 million on 2003. The increase mainly reflects the substantial work being undertaken for the implementation of International Financial Reporting Standards, Sarbanes-Oxley and other regulatory costs.

        Losses from other income and expenditure before amortization of goodwill and tax for Group activities decreased to £181 million in 2003 from £189 million in 2002. This was mainly due to a £26 million increase from 2002 in investment return and other income, primarily as a result of a non-recurrent £24 million write down of the Group's 15% holding in Life Assurance Holding Corporation Limited in 2002. This was partly offset by a £13 million increase in funding costs from £130 million in 2002 to £143 million in 2003 reflecting an increase in core debt.

128




Geographic Analysis by Nature of Income and Expense

        The following table shows Prudential's consolidated total operating profit based on long-term investment returns before amortization of goodwill and tax for the periods indicated, following which is a discussion of significant line items by geography. Certain minor reclassifications and presentational changes have been made to the amounts presented for prior periods to conform these periods to the current presentations but there is no overall effect on total operating profit.

 
  Year Ended December 31,
 
 
  2004
  2003
  2002
 
 
  (In £ Millions)

 
Long-term business:              
Gross premiums   16,355   13,781   16,669  
Reinsurance   (256 ) (290 ) (216 )
   
 
 
 
Earned premiums   16,099   13,491   16,453  
Investment return—continuing operations   13,792   14,918   (4,073 )
                               —discontinued operations   17   22   22  
Expenses   (1,985 ) (1,844 ) (1,805 )
Taxation within long-term business funds   (896 ) (824 ) 662  
Benefits and claims   (22,568 ) (20,413 ) (16,383 )
Transfer (to) from the fund for future appropriations   (4,025 ) (5,021 ) 5,520  
   
 
 
 
Shareholders' profit after tax before amortization of goodwill, minority interests and exceptional items   434   329   396  
Add back tax on shareholders' profit   195   150   171  
   
 
 
 
Shareholders' profit from long-term business   629   479   567  
Other operations:              
  Continuing operations:              
    UK fund management   136   83   71  
    US broker-dealer and fund management   (14 ) (3 ) 14  
    Asia fund management   19   13   6  
    UK banking   43   55   27  
    Other income and expenditure   (193 ) (181 ) (189 )
   
 
 
 
  Total other continuing operations   (9 ) (33 ) (71 )
  Discontinued operations:              
    UK banking operation   (37 ) (89 ) (47 )
   
 
 
 
Total operating profit (based on long-term investment returns) before amortization of goodwill and tax   583   357   449  
   
 
 
 

Gross Premiums

 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Long-term business:            
United Kingdom and Europe   9,186   7,264   8,675
United States   4,717   4,369   6,098
Asia   2,452   2,148   1,896
   
 
 
Total   16,355   13,781   16,669
   
 
 

129


        Gross premiums totaled £16,355 million in 2004 compared to £13,781 million in 2003. Gross premiums in 2004 include £9,186 million from Prudential's UK and European operations, an increase of 26% on 2003 primarily due to a substantial annuity transaction with Royal London which concluded in December 2004, £4,717 million from the US, an 8% increase due to higher variable annuity sales partially off set by lower fixed annuity sales and a 14% increase in Asia due to increased contributions from established operations.

        Gross premiums totaled £13,781 million in 2003 compared to £16,669 million in 2002. Gross premiums in 2003 include £7,264 million from Prudential's UK and European operations, a reduction of 16% on 2002 primarily due to lower with-profits bond sales and the closure of the German operation in January 2003 and £4,369 million from the US, a 28% reduction due to lower fixed annuity and institutional sales partially off-set by higher variable annuity sales, partly offset by a 13% increase in Asia.

United Kingdom and Europe

        Gross premiums increased by 26% in 2004 to £9,186 million from £7,264 million in 2003. In the UK gross premiums increased 27% in 2004, to £8,674 million compared to £6,850 million in 2003. The increase principally reflects the premiums of £1,108 million from a large annuity reinsurance treaty with Royal London.

        Gross premiums decreased 16% in 2003 to £7,264 million from £8,675 million in 2002. In the UK gross premiums decreased 19% in 2003, to £6,850 million compared to £8,435 million in 2002. The reduction principally reflects the decline in the single premium with-profits bond market in 2003.

United States

        Gross premiums in 2004 were £4,717 million, or 8% above 2003 levels of £4,369 million, due to higher sales of variable annuities, fixed-indexed annuities and institutional products, partially offset by lower fixed annuity sales.

        In 2004, JNL's retail sales of £3,568 million were slightly lower than the £3,580 million delivered in 2003. This was driven by record sales of variable annuities, which at £1,981 million were up 2% on 2003's record of £1,937 million offset by negative foreign exchange movements of £430 million. Fixed annuity sales in 2004 of £1,130 million were 18% below the prior year. 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 lower rate of election of the fixed account option within variable annuities for the full-year 2004 of 29% compared with 48% in 2003. 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 up 9% on 2003 to £4,420 million due to the slightly lower retail sales offset by a 75% increase in sales of institutional products to £852 million. Institutional sales are made opportunistically, based on capital availability and return expectation.

        Gross premiums in 2003 were £4,369 million, or 28% below 2002 levels of £6,098 million, due to lower sales of fixed annuities and institutional products, partially offset by higher variable annuity sales.

        In 2003, JNL's retail sales of £3,580 million represented its second best year, 18% lower than the record sales delivered in 2002. This was driven by record sales of variable annuities, which at £1,937 million were up 42% on 2002. While JNL was able to gain share in the fixed annuity marketplace, fixed annuity sales in 2003 of £1,375 million were 49% below the prior year. 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% compared with 58% in 2002, although this had

130



fallen below 30% 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 29% on 2002 to £4,066 million 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.

Asia

        Gross premiums increased by 14% to £2,452 million in 2004 compared to £2,148 million in 2003. This growth reflects Prudential's successful strategy of entering new markets, strengthening and diversifying distribution channels and launching customer-focused products.

        The increase in gross premiums in 2004 mainly reflects a 37% increase in single premium sales from £482 million in 2003 to £662 million in 2004. Single premium sales in 2004 were £199 million in Singapore (up 10%), £255 million in Hong Kong (up 35%), £88 million in Taiwan (up 214%), £17 million in Japan (up 89%), £38 million in Indonesia (up 41%), £36 million in Korea (up 89%), £9 million in China (up 29%) and £5 million in India (up 25%) in each case, compared to 2003.

        The increase in gross premiums of 13% in 2003 mainly reflects a 9% increase in new regular (continuing) premium insurance sales from £465 million in 2002 to £507 million in 2003, and an 18% increase in renewal premiums from £952 million to £1,159 million over the same period. Single premium insurance increased from £479 million to £482 million. New regular premium insurance sales in 2003 were £57 million in Singapore (up 24%), £83 million in Hong Kong (down 1%), £59 million in Malaysia (in line with 2002), £132 million in Taiwan (down 9%), £35 million in Japan (down 10%), £31 million in Indonesia (up 63%) and £30 million in Korea (up 200%) in each case, compared to 2002.

        Single premium sales in 2003 included £189 million in Hong Kong (up 35%), £181 million in Singapore (down 35%), £28 million in Taiwan (up 100%) and £27 million in Indonesia (up 145%).

Investment Returns

 
  Year Ended December 31,
 
 
  2004
  Restated
2003

  Restated
2002

 
 
  (In £ Millions)

 
Long-term business:              
Continuing operations:              
United Kingdom and Europe   12,028   13,030   (5,582 )
United States   1,120   1,188   1,393  
Asia(1)   644   700   116  
   
 
 
 
Total   13,792   14,918   (4,073 )
   
 
 
 

(1)
Investment returns for Asia shown above have been restated and represent investment returns from long-term business only. Investment products have been reclassified and are reported separately.

        The investment return for shareholder financed businesses, principally the operations in the United States, shown above represents long-term investment returns. For other businesses, investment returns represent income and realized and unrealized investment appreciation after deducting expenses.

        In 2004, investment returns from continuing operations fell from £14,918 million in 2003 to £13,792 million. This was due to a decrease of £1,002 million in the UK and European investment returns over the same period, reflecting a 13.4% positive return on PAC's long-term fund in 2004

131



compared to a return of 16.5% in 2003. Meanwhile, US investment returns fell from £1,188 million in 2003 to £1,120 million in 2004 and Asian investment returns fell from £700 million in 2003 to £644 million in 2004.

        In 2003, investment returns improved from negative £4,073 million in 2002 to a positive return of £14,918 million. This was due to an increase of £18,612 million in the UK and European investment returns over the same period, reflecting a 16.5% positive return on PAC's long-term fund in 2003 compared to a negative return of 8.1% in 2002. Meanwhile, US investment returns fell from £1,393 million in 2002 to £1,188 million in 2003, whilst Asian investment returns increased from £116 million in 2002 to £700 million in 2003.

United Kingdom and Europe

        Total investment returns decreased from £13,030 million in 2003 to £12,028 million in 2004. Investment income primarily represents the return on the assets supporting the Prudential Assurance long-term fund. At December 31, 2004 33% of these assets were invested in UK equities, 15% in overseas equities, 29% in fixed maturities, 18% in real estate, and 5% in cash and other assets. The investment return on the Prudential Assurance long-term with-profits fund was 13.4% in the year to December 31, 2004 compared with the rise in the FTSE 100 share index of 11.2% and the FTSE All-Share index of 12.8%.

        Total investment returns increased from negative £5,582 million in 2002 to positive £13,030 million in 2003. Investment income primarily represents the return on the assets supporting the Prudential Assurance long-term fund. At December 31, 2003, 33% of these assets were invested in UK equities, 15% in overseas equities, 31% in fixed maturities, 17% in real estate, and 4% in cash and other assets. The investment return on the Prudential Assurance long-term with-profits fund was 16.5% in the year to December 31, 2003 compared with the rise in the FTSE 100 share index of 17.9% and the FTSE All-Share index of 20.9%.

United States

        In accordance with Group accounting policy (See Note 3 to the notes of Prudential's consolidated financial statements) the investment return for continuing US operations represents long-term investment returns and is analyzed as below:

 
  Year Ended December 31,
 
  2004
  2003
  2002
 
  (In £ Millions)

Continuing operations: