American General confirmed on Friday that it had accepted a $23bn (£16.1bn) offer from AIG, worth $46 a share.
AIG made its unsolicited offer for American General in early April, nearly a month after Prudential made an all-share offer of $26.5bn (£18.6bn) to purchase American General.
However, the value of the offer was quickly reduced to just over $20bn (£14.4bn) when investors sent Prudential's shares plummeting - which opened the door for the AIG bid.
On the day before Prudential pulled out, its offer was worth about $44 per share.
Pru seeks other targets
Prudential said it was "disappointed" by the collapse of the deal but still committed to US expansion.
However, a spokesman stressed the company would not be forced into a "knee-jerk reaction."
"We will continue to grow our US business organically.
We will not be bounced into a knee-jerk reaction."
He said there was never any question of Prudential increasing its offer for American General.
"We had a merger agreement in place," he added.
Takeover target
A merger with American General would have solved strategic problems for Prudential, according to analysts.
Firstly, it would have boosted the scale of Prudential's interests in the US.
The company currently owns Jackson National Life, a small insurer that has its work cut out competing in the massive US insurance industry.
More importantly, American General would have contributed some of its profits to invest in Prudential's fast-growing Asian business.
Markets relieved
Investors reacted with relief to the collapse of the American General deal, which has been on the cards for some weeks.
Prudential shares were up 11p to 855p at 0940GMT.
James Pearce, an insurance analyst at Bear Stearns, said: "I think most people expected AIG to win although people were beginning to get a bit nervous about the time it was taking for AIG to table a formal offer."
The $600m break fee from American General is expected to be used to fund organic growth in Asia and to improve shareholders' dividend.
Most analysts believe Prudential has emerged from the abortive deal relatively unscathed.
But it in the long-term, they say, the British insurer will have to seek further acquisitions to increase its presence in the US market.
One analyst, who did not want to be named, said: "The company have been saying that on a five-year view Jackson needs a partner but on a one year view they can manage quite well.
"I think, to be fair, the stock market has been fairly relaxed about Jackson's trading position until the company went around telling shareholders that it needed a partner."
Credibility intact?
David Harbage, a fund manager with Barclays Stockbrokers, also believes the Prudential's chief executive Jonathan Bloomer will not be damaged by the collapse of the merger.
"The markets believed the Pru was paying too much for American General.
"But the fact that AIG has come to the same conclusion means that the Pru's credibility remains intact."
He added: "The Pru can recover from this, but ultimately, if it doesn't make a move it could become a takeover target itself."
He added: "He (Mr Bloomer) has very much pinned his colour to the mast.
"They pulled out a lot of rhetoric about why they should do the AmGen deal.
"While I don't think many believed them, at the same time, if some of what they say is true then they do need to do something."