International Banking * Excluding volatility, profit on sale of businesses and the settlement of overdraft claims. Also excludes Central Group Items.
Our activities are organised into three businesses: UK Retail Banking, Insurance and Investments and Wholesale and International Banking. Their respective contributions are outlined below.
• Strong liquidity and funding position maintained throughout the recent global financial markets turbulence.
Corporate responsibility Lloyds TSB has a strong commitment to improving the quality of life of people in the communities where we work and I am proud of our achievements in this area.
Our employees also support a wide range of community programmes, volunteering their time and energy to local causes and initiatives. I am particularly proud of the work we have done to support the Group’s 2007 charity partner, Barnardo’s, where to date almost £1 million has been raised, with fund raising initiatives continuing into 2008.
Outlook As we look forward to 2008, we face the prospect of slowing global economic activity and all the associated challenges that this brings. Despite this our strategy remains unchanged. The progress made over the last four years means that we have a strong capital position from which we can continue to grow the business. We believe that our excellent customer proposition, based on high levels of service quality and committed customer relationships, leaves us well positioned to continue to grow our returns to shareholders through 2008 and in future years.
More Britons count on us for their current accounts 6 Lloyds TSB Group Annual Report and Accounts 2007
2007 was another good year for Lloyds TSB. We delivered strong results, despite the more challenging operating environment that we saw in the second half of the year. Our business performance, excluding the impact of the market dislocation, continued its strong momentum as our relationship-based strategy serves us well. We believe this momentum will carry through to 2008, given we have a high quality, sustainable earnings stream, driven by the deep relationships we have with our customers, coupled with the significant growth potential we have both within our own franchise and in the UK market as a whole. As a result, we remain confident as to the Group’s future outlook.
Over the last few years, the successful execution of our strategy has delivered increasing levels of customer recruitment and enhanced sales volumes, and in 2007 we saw further progress on these leading indicators of future profit.
“We have a high quality, sustainable earnings stream, driven by the deep relationships we have with our customers.”
Giving businesses what they need to grow 8 Lloyds TSB Group Annual Report and Accounts 2007
Significant growth potential The UK market represents the second largest economic profit pool for financial services, with high levels of household financial wealth. It enjoys the lowest level of unemployment in the G7 economies and despite a likely slow down in 2008, we are projecting good medium-term economic performance and strong long-term savings growth.
This has been a year of significant progress across the Group and let me express my thanks to all our staff for their wonderful contribution to our success. Relationship businesses thrive on great staff that understand customers and work towards meeting their needs. In this last year, the performance of our staff has been terrific.
Our strategy Our strategy remains to grow the business through developing long term customer relationships and building our customer franchise. All our businesses are focused on extending the reach and depth of our customer relationships, enhancing product capabilities to build competitive advantage, and improving processing efficiency whilst working capital harder. This will enable us to achieve our vision of being the best financial services organisation in the United Kingdom.
The focus on developing our relationships with personal, commercial and corporate customers, whilst developing innovative products that meet the needs of existing customers and attract new customers, is a key driver for income and business growth. Ensuring we become more efficient in everything we do will help ensure our costs are managed effectively whilst also enabling us to invest in the business to drive further growth. Resource allocation is also increasingly important and significant focus is given to allocating capital to where it will have the most positive impact on our businesses.
In 2007 the Group delivered a strong performance against the backdrop of significant turbulence in global financial markets. Statutory profit attributable to equity shareholders increased by £486 million, or 17 per cent, to £3,289 million and earnings per share increased by 17 per cent to 58.3p. Economic profit increased by 21 per cent to £2,238 million, and the post-tax return on equity improved from 26.6 per cent to 28.2 per cent. Profit before tax fell by 6 per cent to £4,000 million, largely as a result of significant adverse policyholder interests volatility.
Like many other financial institutions, the Group has been affected by the recent market dislocation; however, the relationship focus of our strategy has meant that the impact on the Group’s profit before tax was limited to £280 million in 2007 (£188 million reduction in income; £92 million increase in impairment).
Excellent cost management The Group continues to invest in improving processing efficiency, resulting in continued tight control over costs. During 2007, operating expenses increased by only 1 per cent to £5,491 million. Over the last 12 months, staff numbers have fallen by 4,552 (7 per cent) to 58,078, largely as a result of the disposal of Lloyds TSB Registrars and Dutton-Forshaw and further efficiency improvements in back-office processing centres. These improvements in operational effectiveness have resulted in a further reduction in the Group cost:income ratio from 50.8 per cent to 49.0 per cent.
Along with a number of other UK banks, during the year the Group has received a number of customer claims for the repayment of overdraft fees. On 27 July 2007, several banks, together with the Office of Fair Trading, asked the High Court of England and Wales to clarify the legal position regarding personal current account fees. The 2007 results include a charge of £76 million relating to the settlement of claims during the year, together with related costs.
Taxation charge The Group’s tax charge for 2007 was £679 million, which was an effective rate of 17.0 per cent (2006: 31.6 per cent). The effective tax rate is below the standard UK corporation tax rate as a result of the gains on disposals being either exempt from tax or covered by capital losses arising in earlier years, a deferred income tax credit following the reduction in the corporation tax rate announced in the 2007 Finance Act, and credits arising on policyholder interests. Under IFRS, the income statement includes a corresponding charge for policyholder interests within the Group’s profit before tax. Excluding these items the Group’s effective rate of tax was 28.3 per cent.
Pension schemes related credit – – – 128 128 – 128 * Excluding volatility, profit on sale of businesses, the settlement of overdraft claims in 2007 and the pension schemes related credit in 2006.
UK Retail Banking Our business UK Retail Banking provides a wide range of banking and financial services through our diversified, proprietary distribution network and highly recognised and well-regarded brands (Lloyds TSB, Cheltenham & Gloucester and Scottish Widows) to some 16 million personal customers through over 2,000 branches across the UK. We are the UK’s largest personal current account bank with over 12 million current account customers, have the largest number of internet banking customers in the UK and operate 11 call centres, all in the UK, taking 70 million calls per year. Lloyds TSB has been voted the most trusted bank in Britain for seven years running.
Our strategy UK Retail Banking’s strategic priorities are to grow revenue from its existing customer base; expand its customer franchise; and continuously improve productivity and efficiency.
The adverse mix effect of strong growth in finer margin mortgages and flat wider margin unsecured personal lending led to an overall reduction in the division’s net interest margin. Product margins on a year-on-year basis fell slightly reflecting competitive pressures in the mortgage business in the first half of 2007 which more than offset an increase in retail savings margins. Towards the end of the year, new business margins in the mortgage business started to improve and this supported a stabilisation in the UK Retail Banking net interest margin in the second half of the year, compared to the first half.
Gross new mortgage lending for the Group totalled £29.4 billion (2006: £27.6 billion). Mortgage balances outstanding increased by 7 per cent to £102.7 billion and net new lending totalled £6.7 billion, resulting in a market share of net new lending of approximately 6.2 per cent.
In June 2007, the Group launched the Lloyds TSB Airmiles Duo account, a new, innovative and exclusive credit card that offers a ‘two in one’ easy to manage account, with one PIN, one statement and two cards, an American Express and a MasterCard on which customers can earn Airmiles. The demand for this new product has been extremely strong, and over 700,000 cards have been issued to a generally more transactional, high quality, customer segment. As a result, Lloyds TSB was the UK market leader in new credit card issuance during 2007, and now has the largest and fastest growing loyalty credit card programme in the UK.
Improving productivity and efficiency We have continued to make significant progress in reducing levels of administration and processing work carried out in branches and, as a result, we have increased the number of dedicated customer facing branch network staff by some 4,000 over the last 2 years. Over the same period, branch network staff time spent on back office administration work has reduced from approximately 35 per cent to around 5 per cent. This has enabled us to increase our focus on meeting our customers’ needs and has supported the substantially improved branch network sales productivity and service efforts. These improvements have led to the retail banking cost:income ratio, excluding the impact of the settlement of overdraft claims, improving to 45.7 per cent, from 47.0 per cent last year.
Insurance and Investments Our business Insurance and Investments offers life assurance, pensions and investment products, general insurance and fund management services.
Insurance and Investments results Excluding volatility and profit on disposal of businesses 2007 2006 £m £m
• Good income growth and excellent cost control. Income, net of insurance claims and adjusting for the impact of surplus capital repatriation, increased by 7 per cent. Operating expenses decreased by 2 per cent.
• Robust capital position. Scottish Widows continues to deliver improving capital efficiency and self-financing growth, and a further £1.9 billion of capital was repatriated to the Group during 2007.
During 2007, Scottish Widows has continued to make strong progress in each of its key business priorities: to maximise bancassurance success; to profitably grow IFA sales; to improve service and operational efficiency; and to optimise capital management.
Optimising capital management Scottish Widows has maintained its strong focus on improving capital management. During 2007 Scottish Widows continued to deliver a more capital efficient product profile and improved internal rates of return. The post-tax return on embedded value, on an EEV basis, increased to 9.9 per cent, from 9.3 per cent last year. During 2007, £1.9 billion of capital was repatriated to the Group, giving a total capital repatriation of over £3.6 billion since the beginning of 2005.
“During 2007, Scottish Widows has continued to make strong progress in each of its key business priorities.”
Present value of new business premiums (PVNBP) 2007 2006 £m £m
Overall the post-tax return on embedded value increased to 9.9 per cent from 9.3 per cent. Scottish Widows maintained a strong new business margin of 3.1 per cent. Individual new business product margins remained broadly stable. The overall new business margin fell by 50 basis points however, as a result of an adverse impact from a higher risk-free discount rate and changes in other economic assumptions applied to new business and the shift in product mix resulting from the insourcing of a new branch network creditor insurance and protection product. This product generates a lower new business margin, but delivers good levels of value for the Group.
Movements in funds under management The following table highlights the movement in retail and institutional funds under management.
Shareholders’ Value of in-force net assets business Total £m £m £m
Summary income statement on an EEV basis 2007 2006 £m £m
The risk-free rate assumed in valuing in-force business is 10 basis points over the 15 year gilt yield. In valuing financial options and guarantees the risk-free rate is derived from gilt yields plus 10 basis points, in line with Scottish Widows’ FSA realistic balance sheet assumptions. The table below shows the range of resulting yields and other key assumptions.
Risk-free rate (financial options and guarantees) 4.28 to 4.81 3.91 to 5.41
For OEIC business, the lapse assumption is based on recent experience which has been collected over a period that has coincided with favourable investment conditions. Management have used a best estimate of the long-term lapse assumption which is higher than indicated by this experience. In management’s view, the approach and lapse assumption are both reasonable.
Sensitivity analysis The table below shows the sensitivity of the EEV and the new business profit before tax to movements in some of the key assumptions. The impact of a change in the assumption has only been shown in one direction other than for risk free rate. Where the impact has been shown only in one direction it can be assumed to be reasonably symmetrical.
10 per cent reduction in market values of equity assets2 (178) n/a 10 per cent reduction in market values of property assets3 (32) n/a 10 per cent reduction in expenses4 96 31 10 per cent reduction in lapses5 88 19 5 per cent reduction in annuitant mortality6 (64) (5)
5 per cent reduction in mortality and morbidity (excluding annuitants)7 22 3 100 basis points increase in equity and property returns8 nil nil 10 basis points increase in credit spreads9 (46) (6)
7 This sensitivity shows the impact of reducing mortality rates on non-annuity business to 95 per cent of the expected rate.
The business continues to invest in the development of its Corporate Partnership distribution arrangements and the performance of the Pearl business acquired in 2006 has exceeded our initial expectations.
Making Wholesale and International Banking a great place for our customers to bank is our number one priority. As a relationship bank, we place our customers at the forefront of our vision and we strive, with passion, to meet their needs. The way by which we manage our customer relationships is the vital ingredient in what differentiates us from our competition.
• Continued strong franchise growth in Commercial Banking, with an 8 per cent growth in income and a 13 per cent growth in profit before tax. Lloyds TSB has retained its leading position as the bank of choice for start-up businesses.
• Strong risk management and good asset quality, despite a rise of £264 million in impairment losses, largely as a result of the £92 million impact of market dislocation, a £28 million provision reflecting the impact of the 2007 Finance Act on the division’s leasing business, and a lower level of corporate releases and recoveries during the year.
In Wholesale and International Banking, the Group has continued to make significant progress in its strategy to develop the Group’s strong corporate and small to medium business customer franchises and, in doing so, become the best UK mid-market focused wholesale bank. The division has continued to make substantial progress in its relationship banking businesses. In Commercial Banking, strong growth in business volumes, further customer franchise improvements and good progress in improving operational efficiency have resulted in continued strong profit growth. In Corporate Markets, further good progress has been made in developing our relationship banking franchise supported by a strong cross-selling performance.
In Corporate Markets, profit before tax fell by 17 per cent, however, excluding the impact of market dislocation and the 2007 Finance Act, profit before tax increased by 13 per cent. On this basis, income increased by 18 per cent, supported by continued high levels of cross-selling income, strong growth in corporate lending and a higher level of income from venture capital investments. The strong growth in lending was supported by an increase of £4.7 billion in Group lending to property companies, to £17.6 billion. Two-thirds of this lending portfolio is commercial property lending supporting our existing customer franchise and reflects a well-spread nationwide portfolio. We adopt conservative credit criteria and the indexed loan-to-value of the portfolio is approximately 62 per cent. One third of the portfolio is residential lending, over half of which is to local authority backed public housing.
The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly disabled and disadvantaged, to play a fuller role in society. The Foundations receive 1 per cent of the Lloyds TSB Group’s pre-tax profit after adjusting for gains and losses on the disposal of businesses and pre-tax minority interests, averaged over three years, instead of a dividend on their shareholdings. In 2007, £37 million was accrued for payment to registered charities.
The use of fair values in financial reporting is now more widespread and there is a better understanding of their effects; consequently, in line with evolving best practice, the Group no longer considers it appropriate to disclose banking volatility separately. Divisions will continue to transfer, through the Group’s internal transfer pricing arrangements, to Group Corporate Treasury (included in Central Group Items) the movements in the market value of hedging derivatives where the impact is not locally managed.
Performance management The Group uses a balanced scorecard to measure and manage employee performance. The scorecard takes into account the needs of customers, employees and shareholders and measures individual performance against a range of factors, including financial success, contribution to the long term growth of the business, customer service, risk management and personal development.
University for Lloyds TSB The University for Lloyds TSB, (UfLTSB), one of the largest corporate universities in Europe, delivers learning programmes through a range of media. This includes on-line knowledge modules and face to face workshops to support skills development. In 2007 the website, which acts as a primary portal for learning across the Group, received over 3 million visits and hosted almost 300,000 on line assessments.
Work environment Lloyds TSB Group is committed to making sure the work place is maintained to the highest standards of health, safety and fire protection. Our objective is to provide great facilities and a safe environment for everyone, employees and customers alike, in all of our business locations.
Flexible working is increasingly important in the competitive workplace and we have created a balanced environment where we offer a multitude of flexible working practices including: • reduced hours; • variable hours; • job sharing; • compressed hours; • term-time working; • tele-working.
We believe that by treating our employees as adults and placing value on their contribution and delivery rather than working hours will create a high commitment high performance organisation.
Lloyds TSB also has a whistle blowing policy setting out the procedure by which people can raise, in confidence, any matters of concern. A whistle blowing line enables employees to raise any concerns and for such matters to be independently investigated.
Over the last few years we have been working to increase the number of women and ethnic minority employees in management and senior management positions across the organisation. At the end of 2007, there were four women on our group executive committee, one of the highest numbers for a FTSE 100 company, and 22 per cent of our senior managers were women.
Managing corporate responsibility The board reviews overall corporate responsibility performance annually and the chairman receives a quarterly progress report. Individual issues are subject to board discussion throughout the year. Our corporate responsibility steering group is chaired by the deputy group chief executive and comprises senior executives from all business divisions and relevant group functions. The steering group meets quarterly to recommend strategy and provide direction.
Our customers We want to build a great organisation, which is recognised for operating to high standards and is built on strong customer franchises. Our ultimate goal is to become Britain’s most recommended bank. We have put in place the essential building blocks; providing excellent customer service from well-trained staff; appropriate products that meet real needs; treating customers fairly at all times; and following ethical business practices to build a sustainable, profitable business.
Lloyds TSB welcomes and fully supports the Financial Services Authority’s initiatives to increase Financial Capability in the UK. We have seconded a Senior Executive to develop, launch and manage the financial capability in the workplace workstream of the FSA Strategy. Since launching 18 months ago, the team have provided educational material and training to over 1.2 million employees throughout the UK, and are well on track to reach the target of 4 million, by 2011. Feedback from all parties has been very encouraging and is improving these employees’ financial capability.
Customer satisfaction We measure our customers’ satisfaction with the service they receive via monthly surveys and use the results to calculate our CARE Index which is based on customer understanding, accessibility, responsibility and expertise. We seek to address customer complaints as quickly as prudent while ensuring appropriate standards of investigation and communication are maintained.
In a poll of finance directors across the UK, Lloyds TSB Corporate was voted ‘Bank of the Year’ for the third year running at the Real Finance/CBI FDs’ Excellence Awards, in recognition of our quality of service and understanding of our customers’ businesses. Lloyds TSB was also voted the Reader’s Digest most trusted bank or building society for the seventh successive year in 2007.
Our community Continuing to grow a successful business is the best way for Lloyds TSB to create value for all its stakeholders and contribute to the wider economy. We are a major employer with nearly 70,000 employees. In 2007, salaries, national insurance, pension contributions and other staff costs totalled over £2.90 billion. £0.86 billion of corporation tax was paid to governments and £1.96 billion was distributed to shareholders in the form of dividends.
Through their shares in the Lloyds TSB Group, the Lloyds TSB Foundations together receive one per cent of the Group’s pre-tax profits, averaged over three years, in lieu of their shareholder dividend. In 2007 we gave £37 million to support their work and a further £37 million will be donated in 2008 bringing our total contributions since the Lloyds TSB merger to over £360 million, making Lloyds TSB one of the largest charitable donors in the UK.
The Foundations recognise that their success as community and local funders depends on maintaining a presence in and actively engaging with communities. The England and Wales Foundation, for example, remains one of the few grant-makers with a significant regional presence and its regional structure enables the Foundation to respond directly and effectively to local needs.
Employee volunteering and fundraising In addition to the Foundations’ support for local community causes, thousands of our employees volunteer to help in their communities, raise funds for the Group’s Charity of the Year or make direct donations to charity using the UK’s Give As You Earn system. In 2007, the Foundations provided matched funding for over 33,000 hours of time volunteered by Lloyds TSB employees in the community and also matched over £768,000 funds raised by employees for charities.
No payments for late settlement £2.20 billion 28.78 days £2.29 billion 29.72 days £2.16 billion 27.01 days £2.20 billion 28.02 days
We have established a carbon reduction committee (reporting to the corporate responsibility steering group) to measure, monitor and manage progress against the target. Environmental impacts associated with major projects are calculated and that has helped us to identify a number of property and IT related projects that will begin to deliver significant CO2 reductions from 2008. Over time, many of these will also deliver significant cost savings.
Risk as a strategic differentiator The Group seeks to optimise performance by allowing divisions and business units to operate within capital and risk parameters and the Group’s policy framework. They must do so in a way which is consistent with realising the Group’s strategy and meets agreed business performance targets. The Group’s approach to risk management seeks to ensure the business remains accountable for risk whilst also ensuring there is effective independent oversight.
During 2007, we have continued to focus on enhancing our capabilities in providing both qualitative and quantitative data to the board on risks associated with strategic objectives and facilitating more informed and effective decision making. The Group‘s ability to take risks which are well understood, consistent with our strategy and plans and appropriately remunerated, is a key driver of shareholder return.
Risk governance structures The Group maintains a risk governance structure that strengthens risk evaluation and management, whilst also positioning the Group to manage the changing regulatory environment in an efficient and effective manner.
The group executive committee, assisted by the group business risk committee and the group asset and liability committee, supports the group chief executive in ensuring the effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, whilst also reviewing the Group’s aggregate risk exposures and concentrations of risk. The group executive committee’s duties are described in greater detail on page 62. The group executive committee members are also members of the group business risk committee which is chaired by the group chief executive. The group asset and liability committee, which is chaired by the deputy group chief executive, includes members of the group executive committee as well as the heads of products and markets and group market risk. The group business risk committee is supported by the following: – Compliance and Operational Risk Committee
Group Risk 1st line of Defence Business Management 2nd line of Defence Group and Divisional Oversight Functions 3rd line of Defence Group Audit
This approach seeks to provide the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also facilitates effective communication on these matters across the Group.
Risk management framework The Group uses an enterprise-wide risk management framework for the identification, assessment, measurement and management of risk, designed to meet its customers’ needs. It seeks to maximise value for shareholders over time by aligning risk management with the corporate strategy, assessing the impact of emerging risks from legislation, new technologies or the market, and developing risk tolerances and mitigating strategies. The framework strengthens the Group’s ability to identify and assess risks; aggregate group wide risks and define the corporate risk appetite; develop solutions for reducing or transferring risk, where appropriate; and exploit risks to gain competitive advantage, thereby seeking to increase shareholder value. The principal elements of the risk management framework are shown below: The risk management framework above comprises 10 interdependent activities which map to the components of the internal control-integrated framework issued by the Committee of Sponsoring Organisations of the Treadway Commission (COSO).
Group, divisions and business units ensure that there is a process for risk identification of the exposure to each risk type.
A key component of the risk management framework is the policy framework and accountabilities. The main policy levels are identified below: • Principles – high level principles for the six primary risk drivers
• High level group policy – policy for the main risk types aligned to the risk drivers
• Detailed group policy – detailed policy that applies across the Group
• Divisional policy – local policy that specifically applies to a division
• Business unit policy – local policy that specifically applies to a business unit
Proportionate control activity strategy is put in place to design mitigating controls, to transfer risk where appropriate and to ensure executives are content with the residual level of risk accepted.
The impact of risks and issues (including financial, reputational and regulatory capital) are determined through effective risk measurement including modelling and stress testing.
The current dislocation in global capital markets has been the most severe examination of the banking system’s capacity to absorb sudden significant changes in the funding and liquidity environment in recent history and individual institutions have faced varying degrees of stress. Should the Group be unable to continue to source a sustainable funding profile which can absorb these sudden shocks, it could impact its ability to fund its financial obligations or could result in securing them at an excessive cost. Throughout the market dislocation, the Group has maintained a strong liquidity position based on its significant retail and corporate deposit base.
A common approach is applied across the Group to assess the creation of shareholder value. This is measured by economic profit (the profit attributable to shareholders, less a notional charge for the equity invested in the business). The focus on economic profit allows the Group to compare the returns being made on capital employed in each business on a consistent basis.
In terms of loans and advances, credit risk arises both from amounts lent and commitments to extend credit to a customer as required. These commitments can take the form of loans and overdrafts, or credit instruments such as guarantees and standby, documentary and commercial letters of credit. With respect to commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail commitments to extend credit can be cancelled and the credit-worthiness of customers is monitored continually. In addition, most wholesale commitments to extend credit are contingent upon customers maintaining specific credit standards.
The Group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of counterparty. For its retail lending, exposure at default and loss given default models are also in use. All rating models, which are authorised by executive management, comply with the Group’s standard methodology. They have been developed internally and use statistical analysis, combined, where appropriate, with external data and/or credit officer judgement. Each rating model is subject to a rigorous validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible.
• Stress testing and scenario analysis: The credit portfolio is also subjected to stress-testing and scenario analysis, to simulate outcomes and calculate their associated impact. Events are modelled at a group wide level, at divisional and business unit level and by portfolio, for example, for a specific industry sector.
It is Group policy that collateral should always be realistically valued by an appropriately qualified source, independent of the customer, at the time of borrowing. Collateral is reviewed on a regular basis in accordance with business unit credit policy, which will vary according to the type of lending and collateral involved. In order to minimise the credit loss, the Group may seek additional collateral from the counterparty as soon as impairment indicators are noticed for the relevant individual loans and advances.
The Group also undertakes asset sales, securitisations and credit derivative-based transactions as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.
Market risk in the Group’s retail portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets and liabilities. Interest rate risk arises from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets.
The Group’s insurance activities also expose it to market risk, encompassing interest rate, exchange rate, property and equity risk: • The management of with-profits funds leads to assets and liabilities that are mismatched with the aim of generating a higher rate of return on assets to meet policyholders’ expectations.
Measurement The primary market risk measure used within the Group is the Value at Risk (VaR) methodology, which incorporates the volatility of relevant market prices and the correlation of their movements. This is used for determining the Group’s overall market risk appetite and for the high level allocation of risk appetite across the Group. Although an important measure of risk, VaR has limitations as a result of its use of historical data, assumed distribution, holding periods and frequency of calculation. The use of confidence levels does not convey any information about potential loss when the confidence level is exceeded. VaR can also be less well suited to non-linear positions, for example options. The Group recognises these limitations and supplements its use with a variety of other techniques. These reflect the nature of the business activity, and include interest rate repricing gaps, open exchange positions and sensitivity analysis. Stress testing and scenario analysis are also used in certain portfolios and at group level, to simulate extreme conditions to supplement these core measures.
The Group also agrees strategies for the overall mix of pension assets with the pension scheme trustees.
Insurance risk Definition The risk of reductions in earnings and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity of insured/underwritten events and to fluctuations in the timing and amount of claim settlements. This includes fluctuations in profits due to customer behaviour.
The risk of reductions in earnings and/or value, through financial or reputational loss, from failing to comply with the laws, regulations or codes applicable.
The risk of loss, both financial and reputational, from the inherent design, management or distribution of products, or from the failure to meet or exceed customer expectations, competitor offerings or regulatory requirements.
Risk appetite Operational risk appetite is defined as the quantum and composition of operational risk identified in the Group and the direction in which the Group wishes to manage it.
For legal and regulatory risk the Group has minimal risk appetite and seeks to operate to high ethical standards. The Group encourages and maintains an appropriately balanced legal and regulatory compliance culture and promotes policies and procedures to enable businesses and their staff to operate in accordance with the laws, regulations and voluntary codes which impact on the Group and its activities.
Exposures The main sources of operational risk within the Group relate to uncertainties created by the changing business, in particular the legal and regulatory environment in which financial firms operate both in the UK and overseas. As a result the most significant operational risk exposures are legal and regulatory.
• Evaluation of the non-financial exposures (e.g. reputational risk) for each of the risks to which the business area is exposed.
Capital risk is defined as the risk that the group has insufficient capital to provide a stable resource to absorb any losses or that the capital structure is inefficient.
Longer term funding is used to manage the Group’s strategic liquidity profile which is determined by the Group’s balance sheet structure. Longer term is defined as an original maturity of more than one year.
For information, a comparison of Basel I to Basel II equivalents, on the Group’s key ratios as at 31 December 2007 is shown below: Basel I Basel II 31 December 31 December £m £m
Life assurance businesses The principal subsidiary involved in the Group’s life assurance operations is Scottish Widows plc (‘Scottish Widows’), which holds the only large With Profit Fund managed by the Lloyds TSB Group. Throughout 2006 and up until the third quarter of 2007, the Group also owned Abbey Life Assurance Company Limited (which had been closed to new business since March 2000) but this business was sold at the end of September 2007.
Each life assurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FSA; the basis of calculating the regulatory capital requirement is given below. Except for Scottish Widows, the regulatory capital requirement is a combination of amounts held in respect of actuarial reserves, sums at risk and maintenance expenses (the Long-Term Insurance Capital Requirement) and amounts required to cover various stress tests. The regulatory capital requirement is deducted from the available capital resources to give ‘statutory excess capital’.
For Scottish Widows, no amount is required to cover the impact of stress tests on the actuarial reserves. However, a further test is required in respect of the With Profit Fund, which compares the level of ‘realistic excess capital’ to the ‘statutory excess capital’ of the With Profit Fund. In circumstances where the ‘realistic excess capital’ position is less than ‘statutory excess capital’, the Company is required to hold additional capital to cover the shortfall, but only to the extent it exceeds the value, calculated in a prescribed way, of internal transfers from the With Profit Fund. Any additional capital requirement under this test is referred to as the With-Profits Insurance Capital Component. The ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the With Profit Fund with a further deduction to cover various stress tests.
Further Support Account: The Further Support Account is an extra tier of capital support for the with-profits policies in existence at the date of demutualisation. The Scheme requires that assets can only be transferred from the Non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the Support Account and Further Support Account. Unlike the Support Account test, the economic value used for this test includes both admissible assets and the present value of future profits of business written in the Non-Participating Fund or by any subsidiaries of that fund. The balance of the Further Support Account is expected to reduce to nil by the year 2030. At 31 December 2007, the estimated net economic value of the Non-Participating Fund and its subsidiaries for the purposes of this test was £4,028 million (31 December 2006: £3,962 million) and the estimated combined value of the Support Account and Further Support Account was £2,834 million (31 December 2006: £2,873 million).
Other restrictions in the Non-Participating Fund: In addition to the policies which existed at the date of demutualisation, the With Profit Fund includes policies which have been written since that date. As a result of statements made to policyholders that investment policy will usually be the same for both types of business, there is an implicit requirement to hold additional regulatory assets in respect of the business written after demutualisation. The estimated amount required to provide such support at 31 December 2007 is £193 million (31 December 2006: £216 million). Scottish Widows has obtained from the FSA permission to include the value of this support in assessing the realistic value of assets available to the With Profit Fund. There is a further test requiring that no amounts can be transferred from the Non-Participating Fund of Scottish Widows unless there are sufficient assets within the Long Term Fund to meet both policyholders’ reasonable expectations in light of liabilities in force at a year end and the new business expected to be written over the following year.
With Profit Participating Long Term Shareholder Fund Fund Fund Fund Total £m £m £m £m £m
During 2007, dividends of £1,860 million were paid. These were partly financed by the sale of Abbey Life Assurance Company Limited.
Scottish Widows plc With Profit Fund (in accordance Other long- Total life with FRS 27) term funds business £m £m £m
Options and guarantees The Group has sold insurance products that contain options and guarantees, both within the With Profit Fund and in other funds.
• Investment volatility. The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2007, the 10 year equity-implied at-the-money assumption was set at 25.5 per cent (31 December 2006: 20 per cent). The assumption for property volatility was 15 per cent (31 December 2006: 15 per cent). The volatility of interest rates has been calibrated to the implied volatility of swaptions which was broadly 11 per cent (31 December 2006: 13 per cent).
The financial information set out in the table below has been derived from the annual report and accounts of Lloyds TSB Group plc for each of the past five years. 2005 was the first year in which the annual report and accounts were prepared under International Financial Reporting Standards (IFRS). 2004 and earlier years had been prepared under UK Generally Accepted Accounting Principles (UK GAAP) and earlier years had been adjusted for subsequent changes in accounting policy and presentation. To bridge the change in framework, 2004 figures have been presented under both IFRS and UK GAAP. Under IFRS, accounting standards dealing with financial instruments (IAS 32 and IAS 39) and insurance (IFRS 4 and FRS 27) were applied only from 1 January 2005. To aid comparison, IFRS balance sheet data is presented as at 1 January 2005 rather than 31 December 2004; the 2004 IFRS income statement data is not comparable to the data for 2005 and 2006. The financial statements for each of the years presented have been audited by PricewaterhouseCoopers LLP, independent auditors.
Total dividend for the year1 2,026 1,927 1,915 1,914 1,914 1,911 31 December 31 December 31 December 1 January 31 December 31 December
Post-tax return on average risk-weighted assets 2.03 1.89 1.81 1.99 2.01 2.63 31 December 31 December 31 December 1 January 31 December 31 December
Joined the board in 2003. Joined Procter and Gamble in 1967 and held a number of senior and general management appointments in Europe, South America and North America, before retiring in 2001. A non-executive director of Cadbury Schweppes, GfK AG and Telekom Austria. Aged 65.
* Member of the audit committee ** Chairman of the audit committee ◆◆ Member of the nomination committee ◆◆ Chairman of the nomination committee
Terri A Dial Group Executive Director, UK Retail Banking Joined the board in 2005. Served with Wells Fargo in the USA from 1973 to 2001 where she held a number of senior and general management appointments before becoming president and chief executive officer of Wells Fargo Bank in 1998. Chairs the retail committee of the British Bankers’ Association. A non-executive director of the LookSmart Corporation and a member of the advisory board of the Judge Business School of Cambridge and the London Skills and Employment Board. Aged 58.
G Truett Tate Group Executive Director, Wholesale and International Banking Joined the group in 2003 as managing director, corporate banking before being appointed to the board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was president and chief executive officer of eCharge Corporation from 1999 to 2001 and co-founder and vice chairman of the board of Chase Cost Management Inc from 1996 to 2003. A non-executive director of BritishAmerican Business Inc. A member of the fund-raising board of the National Society for the Prevention of Cruelty to Children. Aged 57.
Helen A Weir CBE Group Finance Director Joined the board in 2004. Group finance director of Kingfisher from 2000 to 2004. Previously finance director of B&Q from 1997, having joined that company in 1995, and held a senior position at McKinsey & Co from 1990 to 1995. Began her career at Unilever in 1983. A non-executive director of Royal Mail Holdings. A member of the Said Business School Advisory Board and a former member of the Accounting Standards Board. Aged 45.
An interim dividend of 11.2p per ordinary share was paid on 3 October 2007 and a final dividend of 24.7p per ordinary share will be paid on 7 May 2008. These dividends will absorb £2,026 million.
Employees The Lloyds TSB Group is committed to providing employment practices and policies which recognise the diversity of our workforce and ensure equality for employees regardless of sex, race, disability, age, sexual orientation or religious belief.
As the Company owed no amounts to trade creditors at 31 December 2007, the number of days required to be shown in this report, to comply with the provisions of the Companies Act 1985, is nil.
The chairman, the group chief executive and the group finance director also have meetings with representatives of major shareholders and the senior independent director also attends some of these meetings. In addition, all directors are invited to attend investment analysts’ and stockbrokers’ briefings on the financial results.
The chairman’s committee, comprising the chairman, the group chief executive and the deputy group chief executive, meets to assist the chairman in preparing for board meetings.
The group executive committee, comprising the group chief executive, the deputy group chief executive, the group executive directors, the chief risk director, the group human resources director and the director of group IT and operations, meets to assist the group chief executive in performing his duties. Specifically, the committee considers the development and implementation of strategy, operational plans, policies and budgets; the monitoring of operating and financial performance; the assessment and control of risk; the prioritisation and allocation of resources; and the monitoring of competitive forces in each area of operation. The committee, assisted by its sub-committees, the group business risk and group asset and liability committees, also supports the group chief executive in endeavouring to ensure the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, and in reviewing the Group’s aggregate risk exposures and concentrations of risk.
The committee exercises specific powers delegated to it by the board from time to time. To comply with the Group’s articles of association, only committee members who are also directors of the company participate in the exercising of any powers delegated by the board.
Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have prepared the consolidated and parent company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. The financial statements are required by law to give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss of the Group for that period. The directors consider that in preparing the financial statements on pages 77 to 156 the Company and the Group have used appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider applicable have been followed.
Going concern The directors are satisfied that the Company and Lloyds TSB Group have adequate resources to continue to operate for the foreseeable future and are financially sound. For this reason they continue to adopt the going concern basis in preparing the accounts.
2 Left the board on 30 September 2007. 3 Left the board on 9 May 2007.
Statement from Wolfgang Berndt I am delighted to introduce the report of the board in relation to remuneration policy and practice.
The committee met on four occasions during 2007 and, in addition to its regular business, attention was given to: • reviewing the appropriateness of comparator groups used for the purpose of benchmarking overall levels of reward opportunity
• examining the linkage between performance and remuneration elsewhere in the business, with a particular focus on annual bonus schemes which apply to areas of the Group operating in highly specialised pay markets
The remuneration committee unanimously recommends that you vote to approve the remuneration report at the 2008 AGM.
Directors’ remuneration report 64 Lloyds TSB Group Annual Report and Accounts 2007
Advisers to the committee Towers Perrin, New Bridge Street Consultants and Kepler Associates were engaged by the committee to advise on matters relating to executive remuneration. Over the course of 2007 Towers Perrin also provided market remuneration data as well as other remuneration consulting services to the Group.
Mr Daniels, Mr Fairey, Mrs Risley (Group Human Resources Director from 23 May 2007) and Mr Farley (Reward & Employment Policy Director) provided guidance to the committee (other than for their own remuneration).
Independent non-executive directors’ fees The fees of the independent non-executive directors are agreed by the board within a total amount determined by the shareholders. Directors may also receive fees, agreed by the board, for membership of board committees. The fees are designed to recognise the various responsibilities of a non-executive director’s role and to attract individuals with relevant skills, knowledge and experience. The fees are neither performance related nor pensionable and are comparable with those paid by other companies. The annual fees from 1 January 2008 are listed below with the figures applicable since the previous review in January 2007 in brackets.
Annual incentive scheme The annual incentive scheme for executive directors is designed to reflect specific goals linked to the performance of the business.
Some of the key non-financial achievements include an increase in the Group customer CARE Index and we again won the award for Britain’s most trusted bank (for the seventh year in succession) and the CBI Corporate Bank of the year award (for the third year running). We have seen a strengthening of our risk framework, which has served us well in the current environment. We have also seen a further improvement in our Employee Engagement Index, which on a comparative basis places us above the financial services norm and in line with the high performing company score. TSR performance, particularly when tracked against our comparator group, also continues to improve.
• Profit before tax from Insurance and Investments increased by 9 per cent. Strong progress was made in increasing bancassurance sales and the profit before tax from Scottish Widows Investment Partnership increased by 52 per cent, reflecting higher margins and an improved mix of business. The increased weather related claims, largely relating to the severe flooding in the UK, contributed to a 47 per cent reduction in profit before tax in the General Insurance business.
Other share plans The executive directors and the chairman are also eligible to participate in the Group’s ‘sharesave’ scheme and the Group’s ‘shareplan’. These are ‘all-employee’ share schemes and performance conditions do not apply.
Service agreements The Group’s policy is for executive directors to have service agreements with notice periods of no more than one year. All current executive directors are entitled to receive 12 months’ notice from the Group, but would be required to give 6 months’ notice if they wished to leave. Executive directors normally retire at age 60. However, following the implementation of The Employment Equality (Age) Regulations 2006, they may now choose to delay their retirement until age 65.
During 2007, Mr Fairey, Ms Dial and Mrs Weir received fees of £22,333, $38,000 and £42,500 respectively, which were retained by them, for serving as non-executive directors of other companies. In addition Mrs Weir received and retained £7,500 for serving as a member of the Accounting Standards Board in 2007.
Directors’ remuneration report Audited information 70 Lloyds TSB Group Annual Report and Accounts 2007
Defined contribution scheme members Mr Tate is a member of a defined contribution scheme. During the year to 31 December 2007, the employer has made contributions to the defined contribution scheme in respect of him totalling £120,000.
Directors’ remuneration report 72 Lloyds TSB Group Annual Report and Accounts 2007 * The changes in beneficial interests between 31 December 2007 and 21 February 2008 related to ‘partnership’ and ‘matching’ shares acquired under the Lloyds TSB Group shareplan.
February 2003 – August 2004 That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international financial services companies including Lloyds TSB) must be at least ninth, when 14 per cent of the option will be exercisable. If the Company is ranked first in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met.
Lloyds TSB performance share plan Under the plan, executive directors were required to defer 50 per cent of their bonus awards in 2005 and 2006 into shares in the Company, known as bonus shares. The number of bonus shares awarded was calculated after the deduction of income tax and national insurance from the deferred element of the bonus. The bonus shares are held on behalf of the executive for a period of three years before release.
At the end of 2007 Lloyds TSB Group was ranked 5th after the three year performance period for the performance shares awarded in 2005.
Directors’ remuneration report Audited information 74 Lloyds TSB Group Annual Report and Accounts 2007
May 2006 For 50 per cent of the award (the ‘EPS Award’) – the percentage increase in earnings per share of the Group (on a compound annualised basis) over the relevant period must be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the retail price index over the same period. If it is less than 3 per cent per annum the EPS Award will lapse. If the increase is more than 3 but less than 6 per cent per annum then the proportion of shares released will be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2006 and ends on 31 December 2008.
For the other 50 per cent of the award (the ‘TSR Award’) – the performance condition was as described for May 2006 with the relevant performance period commencing on 8 March 2007 (the date of Award) and ending on
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report and the consolidated financial statements in accordance with applicable law and International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union are set out in the statement of directors’ responsibilities on page 63.
Trading and other liabilities at fair value through profit or loss 29 3,206 1,184
Movement in cash flow hedges, net of tax – 1 – 1 – 1
Repayment of capital to minority shareholders – – – – (151) (151)
Effects of exchange rate changes on cash and cash equivalents 82 (148)
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts.
The following IFRS pronouncements relevant to the Group have been adopted in these consolidated financial statements: (i) IFRS 7 ‘Financial Instruments: Disclosures’. This standard, which was effective from 1 January 2007, requires more detailed qualitative and quantitative disclosures about exposure to risks arising from the Group’s financial instruments. As a disclosure standard, the application of this new standard has not had any impact on amounts recognised in the financial statements. The IFRS 7 disclosures are set out in these financial statements and in the business review on pages 36 to 51. IFRS 7 supersedes IAS 30 ‘Disclosures in the Financial Statements of Banks and Similar Financial Institutions’ and the disclosure requirements previously contained in IAS 32 ‘Financial Instruments: Presentation’.
(ii) Amendment to IAS 1 ‘Presentation of Financial Statements – Capital Disclosures’. This standard, which was effective from 1 January 2007, requires additional disclosures of the objectives, policies and processes for managing capital, quantitative data about what the Group regards as capital, and compliance with capital requirements. These disclosures are set out in the business review on pages 48 to 56.
(b) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable net assets and contingent liabilities of the acquired entity at the date of acquisition. Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written down immediately through the income statement and is not subsequently reversed. At the date of disposal of a Group undertaking, the carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal except where it has been written off directly to reserves in the past.
Revenue recognition policies specific to life assurance and general insurance business are detailed below (see r).
Notes to the group accounts 82 Lloyds TSB Group Annual Report and Accounts 2007
Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. Such assets and liabilities are carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.
Financial assets and liabilities are designated as at fair value through profit or loss on acquisition: • When doing so results in more relevant information because either: – it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on them on a different basis; or
(h) Derivative financial instruments and hedge accounting All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and options pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative.
Changes in the fair value of any derivative instrument that is not part of a hedging relationship are recognised immediately in the income statement.
The criteria that the Group uses to determine that there is objective evidence of an impairment loss may include: • Delinquency in contractual payments of principal and/or interest; • Indications that the borrower or group of borrowers is experiencing significant financial difficulty; • Restructuring of debt to reduce the burden on the borrower; • Breach of loan covenants or conditions; and
• Leasehold improvements: shorter of 10 years or the remaining period of the lease
The Group evaluates non-lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then accounted for separately.
(q) Taxation Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
Notes to the group accounts 86 Lloyds TSB Group Annual Report and Accounts 2007
– insurance or participating investment contracts in the Group’s With Profit Fund
Deposits and withdrawals are accounted for directly in the balance sheet as adjustments to the liability.
(4) Reinsurance Contracts entered into by the Group with reinsurers under which the Group is compensated for losses on one or more contracts issued by the Group and that meet the classification requirements for insurance contracts are classified as reinsurance contracts held. Insurance contracts entered into by the Group under which the contract holder is another insurer (inwards reinsurance) are included with insurance contracts.
(1) Functional and presentation currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (‘the functional currency’). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.
(2) Transactions and balances Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when deferred in equity as qualifying cash flow or net investment hedges. Non-monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was determined. Translation differences on equities and similar non-monetary items measured at fair value are recognised in profit or loss, except for differences on available-for-sale non-monetary financial assets such as equity shares, which are included in the fair value reserve in equity unless the asset is a hedged item in a fair value hedge.
On consolidation, exchange differences arising from the translation of the net investment in foreign entities are taken to shareholders’ equity. When a foreign operation is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale.
Impairment of available-for-sale financial assets In determining whether an impairment loss has been incurred in respect of an available-for-sale financial asset, the Group performs an objective review of the current financial circumstances and future prospects of the issuer and considers whether there has been a significant or prolonged decline in the fair value of that asset below its cost. This consideration requires management judgement. Among factors considered by the Group is whether the decline in fair value is a result of a change in the quality of the asset or a downward movement in the market as a whole. An assessment is performed of the expected future cash flows expected to be realised from the asset, taking into account, where appropriate, the quality of underlying security and credit protection available. The movement in available-for-sale financial assets is shown in note 20. The reduction in the fair value of available-for-sale financial assets during the year was £483 million (2006: £10 million). Impairment losses in respect of available-for-sale financial assets transferred from reserves to the income statement totalled £70 million (2006: £nil).
The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Assumptions are made regarding the expected lifetime of scheme members based upon recent experience, however given the rate of advance in medical science and increasing levels of obesity, it is uncertain whether they will ultimately reflect actual experience. An increase of one year in the expected lifetime of scheme members would increase the overall deficit by approximately £400 million and the annual cost by approximately £30 million; a reduction of one year would reduce the overall deficit by approximately £400 million and the annual cost by approximately £40 million.
Goodwill At 31 December 2007 the Group carried goodwill on its balance sheet totalling £2,358 million (2006: £2,377 million), substantially all of which relates to acquisitions made a number of years ago.
While management believes that the liability carried at year end is adequate, the application of statistical techniques requires significant judgement. An increase of 10 per cent in the cost of claims would result in the recognition of an additional loss of approximately £20 million. Similarly, an increase of 10 per cent in the ultimate number of such claims would lead to an additional loss of approximately £20 million; some relief would arise from reinsurance contracts held.
Notes to the group accounts 90 Lloyds TSB Group Annual Report and Accounts 2007
Total income, net of insurance claims 5,580 275 936 1,211 4,291 (376) – 10,706
Total income, net of insurance claims 5,263 418 1,603 2,021 4,212 (392) – 11,104
Other segment items: As the activities of the Group are predominantly carried out in the UK, no geographical analysis is presented.
Notes to the group accounts 92 Lloyds TSB Group Annual Report and Accounts 2007
Certain fees payable by the Group’s asset finance business have been reclassified to interest income as part of the effective yield of the related lending; there is no impact upon profit before tax. Comparative figures have been restated accordingly.
Total net income arising on assets held at fair value through profit or loss 3,118 5,256
Life insurance gross claims can also be analysed as follows: A non-life insurance claims development table is included in note 31.
During the year ended 31 December 2007, operating expenses include a charge of £76 million (2006: £nil) relating to the settlement of customer claims for the repayment of overdraft fees, together with related costs.
Total fees payable to the Company’s auditors by the Group 14.6 17.0
During the year, the auditors also earned fees payable by entities outside the consolidated Lloyds TSB Group in respect of the following: £m £m
Acquisition due diligence and other work performed in respect of potential venture capital investments 0.6 1.0
The businesses sold in 2007 did not represent separate material lines of business and consequently they have not been treated as discontinued operations.
The Group, as a proxy for policyholders in the UK, is required to record taxes on investment income, gains and losses each year. Accordingly, the tax attributable to UK life insurance policyholder earnings is included in income tax expense. The tax credit attributable to policyholders was £243 million (2006: £222 million expense), including a prior year tax charge of £5 million (2006: tax charge of £12 million).
Tax charge thereon at UK corporation tax rate of 30% 1,200 1,274
The weighted average number of anti-dilutive share options and awards excluded from the calculation of diluted earnings per share was 3 million at
The maximum exposure to credit risk at 31 December 2007 of the loans and advances to banks and customers designated at fair value through profit or loss was £404 million (31 December 2006: £451 million); the Group does not hold any credit derivatives or other instruments in mitigation of this risk. There was no significant movement in the fair value of these loans attributable to changes in credit risk; this is determined by reference to the publicly available credit ratings of the instruments involved.
Later than 1 year and not later than 5 years 1,004 1,232
At 31 December 2007 £15,265 million (2006: £13,779 million) of available-for-sale financial assets had a contractual residual maturity of greater than one year.
All assets have been individually assessed for impairment. The criteria used to determine whether an impairment loss has been incurred are disclosed in note 1 (j). Included in available-for-sale assets at 31 December 2007 are debt securities individually determined to be impaired whose gross amount before impairment allowances was £75 million and in respect of which no collateral was held.
Amortisation of premiums and discounts 36 – 36 Changes in fair value (note 41) (483) – (483) Impairment transferred from reserves (note 41) 70 (70) – Disposal of businesses (19) – (19)
In addition, the following amounts have been recognised in the income statement: 2007 2006 £m £m
The recoverable amount of Asset Finance has also been based on a value in use calculation using cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 12 per cent (gross of tax). The discount rate has been set at a premium over the Group’s weighted average cost of capital to take into account the specific risk profile of the Asset Finance business. The cash flows for each of the businesses of Asset Finance beyond the five-year period are extrapolated using steady growth rates, in each case not exceeding 4 per cent nor the long-term average growth rates for the markets in which the respective businesses of Asset Finance participate.
25 Tangible fixed assets Operating Total tangible Premises Equipment lease assets fixed assets £m £m £m £m
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2007 and 2006 no contingent rentals in respect of operating leases were recognised in the income statement.
At 31 December 2007 £25 million (2006: £2,760 million) of deposits from banks had a contractual residual maturity of greater than one year.
Included in customer accounts were deposits of £777 million (2006: £462 million) held as collateral, principally in relation to derivative contracts. The fair value of those deposits approximates the carrying amount.
The movement in life insurance contract liabilities over the year can be analysed as follows: Gross Reinsurance* Net £m £m £m
Process for determining key assumptions The process for determining the key assumptions for insurance contracts and participating investment contracts is set out below.
Non-Profit Fund liabilities Generally, assumptions used to value Non-Profit Fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement of Non-Profit Fund liabilities are: • Interest rates
Gross non-life insurance contract liabilities are analysed by line of business as follows: 2007 2006 £m £m
1 This sensitivity shows the impact on the value of in-force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk-free rate by 25 basis points.
2 This sensitivity shows the impact of a flat 5 per cent addition to the expected rate.
4 This sensitivity shows the impact of a 10 basis point increase in corporate bond yields and the corresponding reduction in market values. Government bond yields and the risk-free rate are assumed to be unchanged.
Non-life insurance all risks – gross £m £m £m £m £m £m
Estimate of ultimate claims costs: At end of accident year 234 227 211 208 317 1,197
Liability recognised in the balance sheet 4 4 10 20 153 191
overnance Financial Statem ents Shareholder Inform ation 32 Liabilities arising from non-participating investment contracts The movement in liabilities arising from non-participating investment contracts may be analysed as follows: Gross Reinsurance* Net £m £m £m
Other post-retirement benefit schemes 111 100 * Reinsurance balances receivable are reported within other assets (note 26).
Changes in the fair value of scheme assets 2007 2006 £m £m
Rate of increase for pensions in payment and deferred pensions 3.10 2.70
The expected return on scheme assets in 2008 will be calculated using the following assumptions: 2008 %
During the year ended 31 December 2007 the charge to the income statement in respect of these schemes was £63 million (2006: £56 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
Future transfers from Scottish Widows plc’s long-term business funds to its Shareholder Fund will be subject to a shareholder tax charge. Under IAS 12, no provision is required to be made to the extent that the timing of such transfers is under Scottish Widows plc’s control. Accordingly, deferred tax liabilities of £90 million (2006: £110 million) have not been recognised.
Provisions for contingent liabilities and commitments Provisions are held in cases where the Group is irrevocably committed to provide additional funds, but where there is doubt as to the potential borrower’s ability to meet its repayment obligations.
Preferred securities 6.90% Perpetual Capital Securities (US$1,000 million) d, g 471 483
Subordinated Floating Rate Notes 2020 (e100 million) e 73 67 5.75% Subordinated Step-up Notes 2025 callable 2020 (£350 million) 305 328
e) These notes bear interest at rates fixed periodically in advance based on London Interbank rates.
f) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until any deferred payments have been made. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares.
Ordinary shares The holders of ordinary shares (excluding the limited voting ordinary shares), who held 98.60 per cent of the total share capital as at 31 December 2007, are entitled to receive the Company’s report and accounts, attend, speak and vote at general meetings and appoint proxies to exercise voting rights. Holders of ordinary shares (excluding the limited voting ordinary shares) may also receive a dividend (subject to the provisions of the Company’s articles of association) and on a winding up may share in the assets of the Company.
Issued and fully paid preference shares Throughout 2006 and 2007, the Company has had in issue 400 6 per cent non-cumulative redeemable preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a fixed rate non-cumulative preferential dividend at a rate of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company. The holders of the 6 per cent non-cumulative redeemable preference shares held less than 0.1 per cent of the total share capital as at 31 December 2007. In accordance with IFRS, these shares are reported within liabilities.
The Bank of New York Nominees have waived the right to all dividends on the Lloyds TSB Group plc shares that they hold (holding at 31 December 2007: 10 shares, at 31 December 2006: 10 shares).
Performance conditions for executive options For options granted up to March 2001
Options granted to senior executives other than executive directors are not so highly leveraged and, as a result, different performance multipliers are applied to their options. For the majority of executives, options are granted with the performance condition but no performance multiplier.
overnance Financial Statem ents Shareholder Inform ation 44 Share based payments continued
The weighted average share price at the time that the options were exercised during 2007 was 574.39 pence (2006: 552.29 pence). The weighted average remaining contractual life of options outstanding at the end of the year was 6.2 years (2006: 6.8 years).
The fair value of the matching element of the performance shares awarded during 2006 was £1.92.
The fair value calculations at 31 December 2007 are based on the following assumptions: Other option Other share SAYE schemes plans
Free shares An award of shares may be made annually to employees based on a percentage of each employee’s salary in the preceding year up to maximum of £3,000. The percentage is normally announced concurrently with the Group’s annual results and the price of the shares awarded is announced at the time of award. The shares awarded are held in trust for a mandatory period of three years on the employee’s behalf. The award is subject to a non-market based condition: if an employee leaves the Group within this three year period for other than a ‘good’ reason, all of the shares awarded will be forfeited (for awards made up to April 2005, only a portion of the shares would be forfeited: 75 per cent within one year of the award, 50 per cent within two years and 25 per cent within three years).
The number of shares awarded relating to free shares in 2007 was 6,784,201 (2006: 7,725,195), with an average fair value of £5.82 (2006: £5.28), based on the market price at the date of award.
The number of shares awarded relating to matching shares in 2007 was 2,073,018 (2006: 2,036,423), with an average fair value of £5.49 (2006: £5.40), based on market prices at the date of award.
Legal proceedings During the ordinary course of business the Group is subject to threatened or actual legal proceedings. All such material cases are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed properly to assess the merits of the case. No provisions are held against such cases; however the Group does not currently expect the final outcome of these cases to have a material adverse effect on its financial position.
Debt securities in issue – – – – – 54,118 – 54,118
Liabilities arising from non-participating investment contracts – – – – – – 24,370 24,370
Trading and other financial assets at fair value through profit or loss 26,165 29,568
Available-for-sale debt securities, treasury and other bills, and trading and other financial assets at fair value through profit or loss – the credit quality of the Group’s available-for-sale debt securities, treasury and other bills, and the majority of the Group’s trading and other financial assets at fair value through profit or loss held is set out below. An analysis of trading and other financial assets at fair value through profit or loss is included in note 15 and a similar analysis for available-for-sale financial assets is included in note 20. The Group’s non-participating investment contracts are all unit-linked. Movements in the fair values of trading and other financial assets at fair value through profit or loss which back those investment contracts, including movements arising from credit risk, are borne by the contract holders.
2 See note 46 – Contingent liabilities and commitments for further information.
overnance Financial Statem ents Shareholder Inform ation 47 Financial risk management continued
Loans and advances Loans and advances designatedLoans and advances to customers at fair value Loans and
Neither past due nor impaired 99,828 29,850 73,475 203,153 1,189 34,845 Past due but not impaired 2,153 966 639 3,758 – – Impaired – no provision required 415 100 293 808 – –
Allowance for impairment losses (note 19) (42) (1,918) (233) (2,193) – (1)
Loans and advances which are neither past due nor impaired Loans and advances designatedLoans and advances to customers at fair value Loans and
Loans and advances which are past due but not impaired Loans and advances designatedLoans and advances to customers at fair value Loans and
Other assets held at fair value through profit or loss: Bank and building society certificates of deposit 42 548 53 – – 168 811
Total held at fair value through profit or loss 11,726 3,685 4,591 2,749 402 1,823 24,976
Total held as trading assets 842 1,905 1,902 270 24 429 5,372
Other assets held at fair value through profit or loss: Other public sector securities 13 – 6 – – 25 44
Bank and building society certificates of deposit 16 345 47 – – 165 573
Corporate and other debt securities 5,870 1,598 2,915 1,597 153 1,037 13,170
Bank and building society certificates of deposit 6 1,229 356 24 – – 1,615
Corporate and other debt securities 1,971 976 698 – – 1,172 4,817
Treasury bills and other bills 46 1,705 – – 15 – 1,766
Total held as available-for-sale assets 12,748 4,003 1,081 30 20 1,281 19,163
The following tables set out the amounts and residual maturities of Lloyds TSB Group’s off balance sheet contingent liabilities and commitments.
Available-for-sale financial assets Listed securities are valued at current bid prices. Unlisted securities and other financial assets are valued based on discounted cash flows, market prices of similar instruments and other appropriate valuation techniques.
49 Consolidated cash flow statement (a) Change in operating assets 2007 2006 £m £m
Included within cash and cash equivalents at 31 December 2007 is £7,426 million (2006: £9,054 million) held within the Group’s life funds, which is not immediately available for use in the business.
(f ) Acquisition of group undertakings and businesses 2007 2006 £m £m
Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 8 4
The amendment requires some puttable financial instruments (being those which give the holder the right to put the instrument back to the issuer for cash or another financial asset) and some financial instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation to be classified as equity.
Revises the overall requirements for the presentation of financial statements, guidance for their structure and minimum content requirements. The revised standard requires the presentation of all non-owner changes in equity within a statement of comprehensive income.
Clarifies the application of IFRS 2 Share-based Payment to certain share-based payment arrangements involving own equity instruments and arrangements involving equity instruments of a parent entity.
To the members of Lloyds TSB Group plc We have audited the parent company financial statements of Lloyds TSB Group plc for the year ended 31 December 2007 which comprise the balance sheet, the statement of changes in equity, the cash flow statement and the related notes. These parent company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the directors’ remuneration report on pages 64 to 75 that is described as having been audited.
We have reported separately on the consolidated financial statements of Lloyds TSB Group plc for the year ended 31 December 2007.
Sir Victor Blank J Eric Daniels Helen A Weir Chairman Group Chief Executive Group Finance Director
overnance Financial Statem ents Shareholder Inform ation for the year ended 31 December 2007 £ million £ million
The accounting policies of the parent company are the same as those of the Group which are set out in note 1 to the consolidated financial statements, except that it has no policy in respect of consolidation and investments in subsidiaries are carried at historical cost, less any provisions for impairment.
† Further information regarding the fixed/floating rate non-cumulative callable preference shares can be found in note 39 to the consolidated financial statements.
Measurement basis of financial assets and liabilities The accounting policies in note 1 to the consolidated financial statements describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet heading.
10 Approval of the financial statements and other information The parent company financial statements were approved by the directors of Lloyds TSB Group plc on 21 February 2008.
Auditors Report on the consolidated financial statements 76 Report on the parent company financial statements 148 Fees 96
Directors Attendance at board and committee meetings 63 Biographies 58 Directors’ report 60 Emoluments 70 Interests 72 Remuneration policy 65 Service agreements 69
Governance Compliance with the combined code 61 Risk governance structures 36 The board and its committees 61
Held at fair value through profit or loss Accounting policy 83 Notes to the group accounts 100, 110
Taxation Accounting policy 86 Critical accounting estimates and judgements 90 Analysis of charge for the year 98 Deferred tax 119
Analysis of shareholders at 31 December 2007 Shareholders Number of ordinary shares
At the date of this report, notifications had been received that Legal & General Investment Management Limited had a direct interest of 4.11% and Barclays PLC and The Capital Group Companies, Inc had interests of 3.84% and 4.86% respectively, in the issued share capital with rights to vote in all circumstances at general meetings. No other notification has been received that anyone has an interest of 3% or more in the issued share capital.
The Company provides a facility for investing in Lloyds TSB shares through an ISA. For details contact: Retail Investor Operations, Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA. Telephone 0871 384 2244.
• obtaining details of the dividend reinvestment plan which enables you to use your cash dividends to buy Lloyds TSB shares in the market