Profit before tax increased by £294 million, or 9 per cent, to £3,726 million.
Post-tax return on average shareholders’ equity increased to 23.3 per cent, from 22.2 per cent.
and IFRS 4 ‘Insurance Contracts’ (including UK Financial Reporting Standard 27 ‘Life Assurance’), which have been implemented with effect from 1 January 2005, with the opening balance sheet at that date adjusted accordingly. Further information on the impact of implementing IFRS on comparative information was published in the Group’s ‘Transition to IFRS’ announcement on 27 May 2005.
In Insurance and Investments we are, after a number of challenging years, starting to make significant progress in distributing bancassurance products through the branch network, as well as building on our existing strength through independent financial advisers. We have achieved higher levels of new business profitability and have improved our market share of new business.
The risk environment remains satisfactory overall, although we have seen a deterioration in the unsecured consumer lending portfolios as a result of an increase in the number of customers facing repayment difficulties, which has been offset by a strong performance in the Corporate lending portfolios. Over time, we expect the consumer position to stabilise in an improving economy, and the trend in corporate impairments to move away from the unusually benign recent experience.
The Retail Bank is committed to achieving top performance in both effectiveness and efficiency. Effectiveness is the ability to recruit, develop and retain loyal customers who think of us first for their next financial services need. Efficiency is the ability to provide service and sales at a lower cost so that we can give our customers better value. We believe that in order to achieve our goal we must be customer rather than product centric.
IFA sales grew strongly with a 30 per cent improvement in weighted sales, underpinned by product and service improvements in pensions and investments. This improved performance led to an estimated market share of 6.8 per cent in 2005, compared to 5.9 per cent last year.
Corporate Markets has delivered another strong performance with a 31 per cent improvement in profits supported by a 27 per cent growth in income from the cross-sale of products. The results reflect our strategy of managing these businesses in an integrated manner in support of our customers’ success. We were pleased to receive external recognition of our efforts as we won a range of awards including the CBI Bank of the Year Award 2005. Across the businesses, our asset quality remains very strong with impairment losses declining year on year. We are continuing to invest within Corporate Markets, in terms of our relationship offers, our product range and our infrastructure, to ensure we can meet even more of our customers’ needs in a highly competitive market.
I would like to take this opportunity to record my appreciation for his major contribution to the Group over the past five and a half years. We are delighted that Sir Victor Blank will succeed him and we look forward to welcoming him to the Group shortly.
In Wholesale and International Banking we are growing our earnings by deepening relationships with our customers
We also use ‘mystery shopping’ programmes to test the levels of service in our branches, via the telephone and on the internet. We use the Six Sigma process improvement approach to measure how well we meet our customers’ requirements.
Through our corporate responsibility management system we identify social, ethical and environmental risks and opportunities. The comprehensive policies and processes for managing risks are described in detail on pages 24 to 34 of this report. We were one of the first UK banks to introduce an environmental risk assessment system for our corporate and business lending. This was described as a ‘race leader’ in an independent study into European banks’ assessment of environmental risks.
UK Retail Banking UK Retail Banking provides banking, financial services, mortgages and private banking to some 15 million personal customers through our multi-channel distribution capabilities.
Branches. Lloyds TSB Group provides wide-reaching geographic branch coverage in England, Scotland and Wales, with over 2,100 branches of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester as at the end of 2005.
Credit cards. Lloyds TSB Group provides a range of card-based products and services, including credit and debit cards and card transaction processing services for retailers. Lloyds TSB Group is a member of both the VISA and MasterCard payment systems and has access to the American Express payment system. The Group had a 12.4 per cent share of outstanding card balances at 31 December 2005.
Life assurance, pensions and investments. Scottish Widows is Lloyds TSB Group’s specialist provider of life assurance, pensions and investment products, which are distributed through Lloyds TSB Bank’s branch network, through independent financial advisers and directly via the telephone and the internet. The Scottish Widows brand is the main brand for new sales of Lloyds TSB Group’s life, pensions, open ended investment companies and other long-term savings products.
Corporate Banking manages the core customer franchise, providing a relationship-based financial and advisory service to the corporate marketplace through dedicated regional teams throughout the UK and key strategic locations abroad, including New York. Customers have access to our expertise and a broad range of financial solutions. Our relationship managers act as a conduit to partners in Corporate Markets and other parts of the Group.
Registrars. Lloyds TSB Registrars, part of the Corporate Bank, operates as receiving bank and registrar to some of the UK’s leading public limited companies. As market leader, it currently maintains the share register of more than 700 clients, including around 60 per cent of the FTSE 100, managing some 22 million shareholder accounts.
Business Banking. A growing business which has relationships with some 587,000 small businesses managed by business managers based in 500 locations throughout the UK. This has been reinforced by an additional 300 business managers moving back into branches. Lloyds TSB Group has a leading share of the new business start-up market, with some 100,000 new businesses opening an account with Lloyds TSB in 2005. The main activity of the Agricultural Mortgage Corporation is to provide long-term finance to the agricultural sector.
The Group has continued to shape its international network to support its UK operations.
Offshore banking. Lloyds TSB Group’s offshore banking operations comprise offices in the UK, the Channel Islands, the Isle of Man, Hong Kong, Singapore, Malaysia and overseas representative offices in the Middle East, Africa, Asia and the Americas. The business provides a wide range of retail banking, wealth management and expatriate services to local island residents, UK expatriates, foreign nationals and to other customers requiring offshore financial services.
International corporate banking. Serves the corporate and institutional market in Europe, the Middle East and Japan through offices in Belgium, the Netherlands, Spain, Dubai and Japan.
In 2005 statutory profit before tax was £3,820 million, an increase of £343 million, or 10 per cent (2004: £3,477 million). Profit attributable to equity shareholders increased by £101 million, or 4 per cent, to £2,493 million and earnings per share increased by 4 per cent to 44.6p. Economic profit increased by 12 per cent to £1,616 million.
Other income, net of insurance claims, on a comparable basis and excluding the strengthening of reserves for mortality, increased by £260 million, or 6 per cent, to £4,659 million. Fees and commissions receivable increased by 9 per cent to £3,315 million as a result of higher income from strong volume growth in current account fees and an increase in fees from large corporate business and asset based lending, as a result of growing customer transaction volumes.
Overall asset quality remains satisfactory. On a comparable basis, impairment losses on loans and advances increased by 21 per cent to £1,090 million. A substantial reduction in impairment losses in the corporate franchise was more than offset by higher retail impairments, resulting from a combination of volume related asset growth in personal loan and credit card lending, the absence of a provision release in the mortgage business which totalled £39 million in 2004 and more customers, with higher levels of indebtedness and therefore lower levels of recovery, experiencing repayment difficulties. As a result of tightening our credit underwriting criteria during 2005, the quality of new business written during 2005 is good. Our impairment charge expressed as a percentage of average lending increased to 0.66 per cent, compared to 0.61 per cent in 2004. On a statutory basis, impaired assets totalled £4,122 million, compared with £3,515 million at 1 January 2005, representing 2.3 per cent of total lending, up from 2.1 per cent at 1 January 2005, but unchanged from 30 June 2005.
The Group’s pension schemes accounting deficit totalled £2,910 million at the end of December 2005 (£2,037 million net of deferred tax). During 2005 the Group made additional voluntary contributions of £220 million to these schemes to be applied in reduction of the schemes’ deficit. The Group is currently in the process of finalising its triennial actuarial valuation of the schemes and, as part of this process, is also considering other methods of addressing the schemes’ deficit.
Profit before tax, before provisions for customer redress 1,681 1,739 Provisions for customer redress (150) (100)
Lloyds TSB remains a leader in the added value current account market, with over 4 million customers. Target customer current account recruitment increased by 28 per cent, compared with 2004.
Impairment losses on loans and advances increased by £229 million, or 34 per cent, to £905 million, reflecting a combination of volume related asset growth in personal loan and credit card lending, the absence of a mortgage provision release which in 2004 totalled £39 million, and the impact of more customers, with higher levels of indebtedness, experiencing repayment difficulties. The impairment charge as a percentage of average lending for personal loans and overdrafts increased to 4.76 per cent, from 4.20 per cent in 2004, while the charge in the credit card portfolio increased to 4.01 per cent, from 3.42 per cent in 2004. In the mortgage business the Group continued to experience a low level of losses and, as a result, the mortgage impairment charge was £13 million. Overall, the provisions charge as a percentage of average lending, on a comparable basis, was 0.92 per cent, compared to 0.75 per cent in 2004.
Cheltenham & Gloucester (C&G) continued to focus on prime lending market segments during 2005. The average indexed loan-to-value ratio on the C&G mortgage portfolio was 43 per cent (31 December 2004: 41 per cent), and the average loan-to-value ratio for C&G new mortgages and further advances written during 2005 was 64 per cent (2004: 62 per cent). At 31 December 2005, 95 per cent of C&G mortgage balances had an indexed loan-to-value ratio of less than 85 per cent (31 December 2004: 94 per cent) and only 0.6 per cent of balances had an indexed loan-to-value ratio in excess of 95 per cent (31 December 2004: 0.3 per cent).
• Significantly improved profit performance. Profit before tax, on a comparable basis and excluding customer redress provisions and a significant strengthening of reserves for mortality, increased by 15 per cent to £908 million.
• Excellent progress in increasing bancassurance sales, particularly in the second half of 2005 when sales grew by 23 per cent, compared with the second half of 2004.
• Improved profitability. New business contribution in Scottish Widows increased by 19 per cent. Life and pensions new business margin increased to 29.7 per cent.
• Strong capital position maintained. During 2005, Scottish Widows Group repatriated £1 billion surplus capital to the Group.
* Comparable basis, excluding customer redress provisions and the strengthening of reserves for mortality
Corporate Markets 958 732 Business Banking 206 153 Asset Finance 219 240 International Banking 133 120
• Good levels of franchise growth in Business Banking. 24 per cent growth in trading surplus, and 35 per cent growth in profit before tax.
• Improved post-tax return on risk-weighted assets from 1.41 per cent to 1.50 per cent.
Changes in market variables such as the performance of equity markets and the level of interest rates, which are beyond the control of management, can result in significant volatility in the profitability of the Group’s insurance businesses. As in previous years, in order to provide a clearer representation of the underlying performance of the life and pensions and general insurance businesses, the effect of these changes is separately analysed within insurance volatility. Following the implementation of the requirements of IFRS and FRS 27, insurance volatility is principally comprised of the elements described below.
In the UK and elsewhere, there is continuing political and regulatory scrutiny on banking and, in particular, retail banking. In the UK, the Office of Fair Trading (OFT) is carrying out several enquiries into certain fees charged to customers in connection with credit cards, and interchange fees charged by some card networks. In addition, the OFT is conducting a market study in relation to payment protection insurance and is reviewing undertakings given by some banks in 2002 regarding the supply of banking services to SMEs. It is not possible to assess whether these enquiries will have any cost or income impact on the Group until the outcome of these enquiries is known.
The board, assisted by its sub-committees, the risk oversight committee, the group executive committee and the audit committee approves the Group’s overall risk management framework. The board also reviews the Group’s aggregate risk exposures and concentrations of risk to seek to ensure that these are consistent with the board’s appetite for risk. The risk oversight responsibilities of the board, audit committee and risk oversight committee are shown in the corporate governance section on pages 43 and 44, and further key risk oversight roles are described on the next page.
During the year a new Control Self Assessment process has increased the focus of management at all levels on risk management and reinforced accountabilities. All business units, divisional risk offices and group functions have completed a Control Self Assessment, reviewing the effectiveness of their internal controls and putting in place enhancements where appropriate. Managing directors and group executive directors have certified the accuracy of their assessment.
A key component of the risk management framework is the policy framework. During the year this has been substantially revised to reinforce clarity of accountabilities, efficiency and effectiveness. The process of embedding will continue into 2006.
Divisional and business unit policy is only produced by exception and is not necessary unless there is a specific area for which a particular division or business unit requires a greater level of detail than is appropriate for group level policy. The governance arrangements for development of, and compliance with, group, divisional and business unit policy, and the associated accountabilities are clearly outlined. All staff are expected to be aware of the policies and procedures which apply to them and their work and to observe the relevant policies and procedures. Line management in each business area has primary responsibility for ensuring that group policies and the relevant local policies and procedures are known and observed by all staff within that area.
The Capital Requirements Directive will come into force for all European banks at the start of 2007, although the final rules to be applied in the UK will only be published in 2006. The rules have been, and will continue to be, subject to further consultation, and Lloyds TSB Group has been playing a full part with the regulatory authorities in attempting to shape them. The Group plans to adopt an Internal Ratings Based approach to credit risk and an Advanced Measurement Approach to operational risk. Accordingly, a considerable investment is being made in order to meet the standards required for these more advanced approaches. As well as meeting the compliance imperative, benefits to the Group will accrue through further enhancement of our risk management and capital allocation capabilities.
• internal factors (ie resource capability and availability, customer treatment, service level agreements, products and funding and the risk appetite of other risk categories).
Credit risk is managed according to baseline credit framework standards, against which all activity is assessed. This framework identifies the following key elements: governance, organisational framework, policies, people, processes and procedures, management information, and systems and technology.
Credit risk can arise from lending or investing or through off balance sheet activities such as guarantees or the undertaking of settlement or delivery risk. The primary off balance sheet instruments used by the Group are guarantees together with standby, documentary and commercial letters of credit.
In its principal retail portfolios, the Group uses statistically-based decisioning techniques (primarily credit scoring), although thresholds are set above which an individual credit assessment takes place. Divisional risk departments review scorecard effectiveness and approve changes, with material changes subject to Group Risk approval. Credit risk in non-retail portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward.
Credit risk may also arise through the existence of contracts for the provision of services or products to Lloyds TSB and this is also considered through individual credit assessments, where the risks of loss are material.
Counterparty limits. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. Regular reports on significant credit exposures are provided to the group executive committee and board.
Impairment process. The maintenance of adequate impairment allowances is considered a key issue from a credit control perspective. Impairment methodology is set out in credit policy and is subject to a rigorous governance process, including the preparation of a regular Impairment Review paper to executive management, consideration by dedicated business unit and divisional impairment review committees and the reporting to the group executive committee of material individual counterparty impairment charges.
Historically, credit risk appetite has been described through a series of policies, sector caps, country limits and the annual and planned bad debt charge. To supplement this, and provide a more forward looking view of credit risk, we have now embarked on the process of introducing more sophisticated metrics to define credit risk appetite, assisted by the introduction of more advanced rating systems across the Group to support Basel II developments. A number of different measures have been developed to describe the Group’s credit risk appetite, since no single measure is considered sufficient. These metrics will be used as the basis for setting appetite ranges, at business unit, division and aggregated group level.
• Foreign currency risk also arises from the Group’s investment in its overseas operations
The Group’s insurance activities also expose it to market risk, encompassing interest rate, exchange rate and equity risk.
• Unit-linked liabilities are matched with the same assets that are used to define the liability but future fee income is dependent upon the performance of these assets
The group asset and liability committee regularly reviews market risk exposure and makes recommendations to the group chief executive concerning overall market risk appetite and market risk policy.
• The investment strategy for other insurance liabilities is determined by the term and nature of the underlying liabilities and asset/liability matching positions are actively monitored. Actuarial tools are used to project and match the cash flows
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. 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 is also not well suited to options positions. 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 re-pricing 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.
It is estimated that a hypothetical immediate and sustained 100 basis point increase in interest rates on 1 January 2006 would decrease net interest income by £112.5 million for the 12 months to 31 December 2006, while a hypothetical immediate and sustained 100 basis point decrease in interest rates would increase net interest income by £104.7 million. An analysis by currency is shown below.
Options and guarantees are incorporated in new insurance products only after careful consideration of the risk management issues that they present. This occurs as part of the new product approval process (see ‘Product and service risk’ on page 27).
The risk of reductions in earnings and/or value, through financial or reputational loss, from inadequate or failed internal processes and systems, or from people related or external events.
The Group continues to develop and refine its approach to managing operational risk. A consistent operational risk management framework for the timely identification, measurement, monitoring and control of operational risk has been introduced across the Group. Further development of operational risk metrics is taking place to seek to ensure that current and potential future operational risk exposures are understood in terms of both risk and reward potential.
The risk of reductions in earnings and/or value, through financial or reputational loss, from poor corporate governance at group, divisional and business unit level. Corporate governance in this context embraces the structures, systems and processes that provide direction, control and accountability for the enterprise.
The Group’s business is regulated primarily by the UK Financial Services Authority (‘FSA’), the Banking Code Standards Board (BCSB) and the Office of Fair Trading (OFT) and additionally by local regulators in offshore and overseas jurisdictions. Each business has a nominated individual with ‘compliance oversight’ responsibility under FSA rules. The role of such individuals is to advise and assist management to ensure that each business has a control structure which creates awareness of the rules and regulations to which the Group is subject, and to monitor and report on adherence to these rules and regulations.
Service improvements are monitored by customer satisfaction surveys, as well as internal process evaluations. The results of the research are fed into the Group’s CARE Index, which measures ongoing performance against five principal objectives: customer understanding; accessibility; responsibility; expertise; and overall service quality improvement. This is tracked monthly and is a key indicator for the Group.
Business units and group functions have primary responsibility for identifying and managing fraud risk at a local level in consultation with the Group Financial Crime Unit. Additionally the group fraud strategy and policy committee is responsible for monitoring fraud risk as well as ensuring that fraud risks are effectively identified and assessed and that strategies for fraud prevention are effectively coordinated.
The Group’s approach to people management is to employ skilled, committed staff, working as a team for the benefit of customers and shareholders, who are given the opportunity to fulfil their potential; employ the highest ethical standards of behaviour and best practice management principles; and recruit on the basis of ability and competence.
Lloyds TSB Group plc is also able to raise funds by issuing loan capital or equity, although in practice Lloyds TSB Group plc has never issued equity for this purpose and the majority of Lloyds TSB Group’s loan capital has been issued by Lloyds TSB Bank. As at 31 December 2005, Lloyds TSB Group plc had £1,502 million of subordinated debt in issuance compared with £12,402 million for the consolidated Lloyds TSB Group. The cost and availability of subordinated debt finance are influenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access. At 31 December 2005, the credit ratings of Lloyds TSB Bank were as follows: Senior debt
A significant part of the liquidity of the Group’s banking businesses arises from their ability to generate customer deposits. A substantial proportion of the customer deposit base is made up of current and savings accounts which, although repayable on demand, have traditionally provided a stable source of funding. During 2005, amounts deposited by customers increased by £11,259 million from £119,811 million at 31 December 2004 to £131,070 million at 31 December 2005. These customer deposits are supplemented by the issue of subordinated loan capital and wholesale funding sources in the capital markets, as well as from direct customer contracts. Wholesale funding sources include deposits taken on the inter-bank market, certificates of deposit, sale and repurchase agreements, a Euro Medium-Term Note programme, of which £6,683 million had been utilised for senior funding at 31 December 2005, and a commercial paper programme, under which £3,011 million had been utilised at 31 December 2005.
Assets attributable to the shareholder held outside the long-term funds – – – 1,513 1,513 Assets attributable to the shareholder held within the long-term funds – 2,619 2,619 – 2,619
The figures shown above for available capital resources within the insurance business relate to Scottish Widows plc only. The amounts relating to the other life assurance subsidiaries within the Group are not significant.
Scottish Widows has a formal arrangement with one of its subsidiary undertakings, Scottish Widows Unit Funds Limited, whereby the subsidiary company can draw down capital from Scottish Widows to finance new business which is reinsured from the parent to its subsidiary. Scottish Widows has also provided subordinated loans to its subsidiary Scottish Widows Annuities Limited and its fellow group undertaking Scottish Widows Bank plc.
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-Profit 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-Profit 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 2005, the net economic value of the Non-Profit Fund and its subsidiaries for the purposes of this test was £4,140 million (31 December 2004: £4,185 million) and the combined value of the Support Account and Further Support Account was £2,836 million (31 December 2004: £2,704 million).
Other restrictions in the Non-Profit Fund. In addition to the policies which existed at the date of demutualisation, the With-Profits 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 2005 is £267 million (31 December 2004: £300 million). There is a further test requiring that no amounts can be transferred from the Non-Profit 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.
Available capital in the Non-Profit Fund has decreased from £2,222 million at 31 December 2004 to an estimated £2,163 million (excluding the recognition of future profits) at 31 December 2005. This is primarily a result of proposed transfers from the Non-Profit Fund to the Shareholder Fund at the year end of £559 million. One of those proposed transfers relates to an investment in Abbey Life which, following a transfer of capital amounting to £560 million from the Shareholder Fund, was acquired by the Non-Profit Fund during the year at market value and then written down to its regulatory value in accordance with FSA asset valuation rules. The effect of these transactions has to a degree been offset by strong investment return and the emergence of surplus.
Available capital in the Shareholder Fund has increased from £770 million at 31 December 2004 to an estimated £1,307 million at 31 December 2005. During the year the Shareholder Fund issued £560 million of subordinated debt and, as noted above, transferred this amount into the Non-Profit Fund. This transaction has had no effect on the available capital of the Shareholder Fund. The reason for the increase in available capital is primarily a result of the proposed transfers from the Non-Profit Fund noted above.
Shareholders’ funds outside the long-term business fund, other than those used to match regulatory requirements, are mainly invested in assets that are less sensitive to market conditions.
The most critical non-economic assumptions are the level of take-up of options inherent in the contracts (higher take up rates are more onerous), mortality rates (lower mortality rates are generally more onerous) and lapses prior to dates at which a guarantee would apply (lower lapse rates are generally more onerous where guarantees are in the money). The sensitivity of the capital position and capital requirements of the With-Profits Fund is partly mitigated by the actions that can be taken by management.
In both Abbey Life and Scottish Widows, certain personal pension policyholders, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £108 million (31 December 2004: £89 million) in respect of those guarantees. If future salary growth were 0.5 per cent per annum greater than assumed, the liability would increase by some £8 million. If yields were 0.5 per cent lower than assumed, the liability would increase by some £19 million.
++ Chairman of the risk oversight committee � Independent director � Senior independent director
Sir Julian Horn-Smith�†+ Joined the board in January 2005. Joined Vodafone in 1984 and held a number of senior and general management appointments before being appointed to the board of that company in 1996 and deputy chief executive officer in 2005. Previously held positions in Rediffusion from 1972 to 1978, Philips from 1978 to 1982 and Mars GB from 1982 to 1984. A non-executive director of Smiths Group. Aged 57.
Lord Leitch�* Joined the board in October 2005. Held a number of senior and general management appointments in Allied Dunbar, Eagle Star and Threadneedle Asset Management before the merger of Zurich Group and British American Tobacco’s financial services businesses in 1998. Subsequently served as chairman and chief executive officer of Zurich Financial Services (UK & Asia Pacific) until his retirement in 2004. Chairman of HM Treasury’s Review of Skills and the National Employment Panel, and deputy chairman of the Commonwealth Education Fund. A nonexecutive director of United Business Media and BUPA. Aged 58.
Angela A Knight�* Joined the board in 2003. Deputy chairman of Scottish Widows, having been appointed to the board of that company before it became a member of the Lloyds TSB Group. A member of parliament from 1992 to 1997 and Economic Secretary to the Treasury from 1995 to 1997. Chief executive of the Association of Private Client Investment Managers and Stockbrokers. A non-executive director of LogicaCMG and the Port of London Authority. Aged 55.
Jan P du Plessis�* Joined the board in October 2005. Chairman of British American Tobacco and RHM. Held a number of senior and general management appointments in Rembrandt Group from 1981, before joining Compagnie Financière Richemont as group finance director in 1988, a position he held until 2004. From 1990 to 1995 he was also the group finance director of Rothmans International. Aged 52.
Gavin J N Gemmell CBE�* Chairman of Scottish Widows Joined the board in 2002. A non-executive director of Scottish Widows, having been appointed to the board of that company before it became a member of the Lloyds TSB Group. Retired as senior partner of Baillie Gifford in 2001, after 37 years with that firm. A non-executive director of Archangel Informal Investment. Chairman of the Court of Heriot-Watt University. Aged 64.
Wolfgang C G Berndt�†† 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 and GfK AG. Board member of the Institute for the Future. Aged 63.
Results and dividends The consolidated income statement on page 59 shows a profit attributable to shareholders for the year ended 31 December 2005 of £2,493 million.
Donations The income statement includes a charge for charitable donations totalling £34,870,000 (2004: £31,571,000), including £34,450,000 (2004: £31,230,000) under deeds of covenant to the four Lloyds TSB Foundations, which will be paid during 2006.
The chairman’s performance is evaluated by the non-executive directors, taking account of the views of executive directors. This appraisal is discussed at a meeting of the non-executive directors, led by the senior independent director, without the chairman being present.
The remuneration committee reviews the performance of the chairman, the deputy chairman, the group chief executive and the other group executive directors, when considering their remuneration arrangements. The nomination committee reviews the performance of all the directors. Like all board committees, the nomination committee and remuneration committee report to the board on their deliberations, including the results of these performance evaluations.
The resolutions to be considered at the annual general meeting in 2006 will also be decided on a poll. Details of the results will be announced on our website, www.lloydstsb.com and will also be available from the company secretary.
The audit committee comprises Mr Brown (chairman), Mr du Plessis, Mr Gemmell, Mrs Knight and Lord Leitch. The committee’s terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com.
During the year, the audit committee received reports from, and held discussions with, management and the auditors. In discharging its duties, the committee has approved the auditors’ terms of engagement, including their remuneration and, in discussion with them, has assessed their independence and objectivity (more information about which is given in note 10 to the accounts, in relation to the procedure for approving fees for audit and non-audit work) and recommended their re-appointment at the annual general meeting. The committee also reviewed the financial statements published in the name of the board and the quality and acceptability of the related accounting policies, practices and financial reporting disclosures; the scope of the work of the Group’s internal audit department, reports from that department and the adequacy of its resources; the effectiveness of the systems for internal control, risk management and compliance with financial services legislation and regulations (more information about which is given in the note about internal control on page 45); the results of the external audit and its cost effectiveness; reports from the external auditors on audit planning and their findings on accounting and internal control systems; and the committee’s own role and performance. Procedures for handling complaints regarding accounting, internal accounting controls or auditing matters and for staff to raise concerns in confidence were established by the committee. The committee also had a meeting with the auditors, without executives present, and a meeting with the head of internal audit alone.
Both the Association of British Insurers and the National Association of Pension Funds were consulted, in line with the principles of the combined code.
J E Daniels 9 T A Dial2 4 J P du Plessis3 2 1 M E Fairey 9 G J N Gemmell 9 5 1(co-opted) Sir Julian Horn-Smith4 8 6 3
The directors have responsibility for ensuring that the Company and the Group keep proper accounting records which disclose with reasonable accuracy the financial position of the Company and the Group and which enable them to ensure that the financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and the Group and to prevent and detect fraud and other irregularities.
The directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of published policies and procedures and regular management briefings. A requirement to comply with internal control and risk policies is a key component of individual staff objectives expressed in the balanced scorecard. Key business risks are identified, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. In addition, there is an annual control self-assessment exercise whereby the key businesses and head office functions review specific controls and attest to the accuracy of their assessments. The assessment covers all EWRM categories and is in accordance with the principles of the Combined Code. As in previous years, this exercise was completed for the year ended 31 December 2005. All returns have been satisfactorily completed and appropriately certified.
The effectiveness of the internal control system is reviewed regularly by the board and the audit committee, which also receives reports of reviews undertaken around the Lloyds TSB Group by its risk management function, including Group Compliance, and Group Audit. The audit committee receives reports from the Company’s auditors, PricewaterhouseCoopers LLP, (which include details of significant internal control matters that they have identified) and has a discussion with the auditors at least once a year without executives present, to ensure that there are no unresolved issues of concern.
This is a report made by the board of Lloyds TSB Group plc, on the recommendation of the remuneration committee. It covers the current and proposed components of the remuneration policy and details the remuneration for each serving director during 2005.
Role of remuneration committee The committee reviews the remuneration policy for the top management group, to ensure that members of the executive management are provided with appropriate incentives to encourage them to enhance the performance of the Group and that they are rewarded for their individual contribution to the success of the organisation. It advises on major changes of employee benefits schemes and it also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated power for settling remuneration for the chairman, deputy chairman, the group executive directors, the company secretary and any group employee whose salary exceeds a specified amount.
In addition, in 2005, Alithos Limited provided information for the testing of the total shareholder return (TSR) (calculated by reference to both dividends and growth in share price) performance conditions for the Group’s executive share option schemes.
Directors’ remuneration policy The Group’s remuneration policy is to ensure that individual rewards are aligned with the Group’s performance and the interests of its shareholders, and that cost effective packages are provided which attract and retain executive directors and senior management of the highest calibre and motivate them to perform to the highest standards. The main principles are: • FTSE 20 as the comparator group used to benchmark overall competitiveness of the remuneration package whilst taking account of practice within the financial services sector.
Sir Victor Blank has been appointed as deputy chairman from 1 March 2006 and his salary will be £275,000, increasing to £550,000 on his appointment as chairman in May. He will also receive benefits broadly similar to the executive directors, but he will not participate in the annual bonus, long-term incentive arrangements or be entitled to pension benefits.
For executive directors except Mr Daniels, individual bonus awards for 2005 were made from a bonus pool based on group performance with predetermined targets relating to profit before tax and economic profit. The maximum size of the bonus pool applicable to these executives was 100 per cent of the aggregate of their basic salaries, with an amount equal to 75 per cent of their basic salaries payable into the bonus pool on the achievement of a stretching budget; failure to achieve at least 90 per cent of this budget would result in no bonus payment. Executive directors are considered for awards from the bonus pool based on individual targets, contained in a balanced scorecard, which include profitability, franchise growth, risk, service and other specific goals that are relevant to improving overall business performance. These targets are weighted differently for each of the executive directors, reflecting differing strategic priorities. The maximum level of any bonus award distributable from the pool to any individual has been set at 150 per cent of salary for the achievement of exceptional performance targets, to reflect the competitive market position for total earnings opportunity.
From 2006 the current bonus pool arrangement will be discontinued and replaced by an approach based upon individual contribution and overall corporate results. Half of the bonus opportunity will be driven by corporate performance based on the stretching budget and the other half by business unit achievement driven through individual performance based on similar targets to those mentioned above. However, the maximum bonus opportunity will remain 150 per cent for the achievement of exceptional performance targets; an amount equal to 75 per cent of basic salary will continue to be available on the achievement of stretching budget and individual targets. Failure to achieve at least 90 per cent of the stretching budget target would result in no payment under the corporate half of the bonus.
Under the performance share plan, executive directors have been required to defer 50 per cent of any bonus payable into shares in the Group, known as bonus shares. The bonus shares are held on behalf of the executive for a period of three years before release. The amount of 2005 bonus deferred into bonus shares before the deduction of income tax was: Name J E Daniels M E Fairey T A Dial A G Kane G T Tate H A Weir
The full award of options for executive directors will only become exercisable if the Group is ranked within the top four places of the comparator group.
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 six months’ notice if they wished to leave. The current chairman, Mr van den Bergh, retires at the annual general meeting and the notice period for his successor, Sir Victor Blank, is shown in the table below.
Mr Fairey waived fees payable to him as a director of Lloyds TSB Group Pension Trust (No.1) Limited and Lloyds TSB Group Pension Trust (No.2) Limited, which totalled £10,000 in 2005 (2004: £nil).
Mr Pritchard left the board on 5 May 2005 but remained a director of Scottish Widows Group and received fees of £26,667 from that company for the period May until December.
Performance-related payments relate to cash bonuses based on Group performance and the attainment of pre-determined targets relating to profit before tax and economic profit. These payments also include the value of any award made under shareplan, the first £3,000 of which is made in the form of shares in Lloyds TSB Group plc.
The executive directors are members of one of the pension schemes provided by Lloyds TSB Group with benefits either on a defined benefit or defined contribution basis. Those directors who joined Lloyds TSB Group after 1 June 1989 and are members of a defined benefit scheme, have pensions provided on salary in excess of the earnings cap either through membership of a funded unapproved retirement benefits scheme (‘FURBS’) or by an unfunded pension promise.
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2005 and 2004, respectively (ignoring the two-year requirement to qualify for a deferred pension).
Column (d) is the equivalent transfer value, but calculated as at 31 December 2004 on the assumption that the director left service at that date.
Members of Lloyds TSB Group’s pension schemes have the option to pay additional voluntary contributions: neither the contributions nor the resulting benefits are included in the above table.
k) These share options lapsed after Mr Ayliffe and Mr Pritchard left the board as the performance condition had not been met.
The option will lapse if Ms Dial ceases to be an employee, or gives notice of resignation, before the normal exercise date, except in the circumstances described above.
The benefit conferred by this option is not pensionable and the option is not transferable.
We have reported separately on the parent company financial statements of Lloyds TSB Group plc for the year ended 31 December 2005 and on the information in the directors’ remuneration report that is described as having been audited.
Assets Cash and balances at central banks 1,156 1,078 Items in the course of collection from banks 1,310 1,462 Treasury bills and other eligible bills 15 92 Trading securities and other financial assets at fair value through profit or loss 16 60,374 Derivative financial instruments 17 5,878 Loans and advances to banks 18 31,655 31,848 Loans and advances to customers 19 174,944 155,318 Debt securities 21 43,485 Equity shares 22 27,310 Available-for-sale financial assets 23 14,940
Items in course of transmission to banks 658 631 Derivative financial instruments and other trading liabilities 17 6,396 Debt securities in issue 33 39,346 28,770 Liabilities arising from insurance contracts and participating investment contracts 34 40,550 52,289 Liabilities arising from non-participating investment contracts 35 21,839 Unallocated surplus within insurance businesses 36 518 1,362
Retirement benefit obligations 38 2,910 3,075 Current tax liabilities 552 459 Deferred tax liabilities 39 1,145 1,704
Estimates The Group’s estimates at the date of transition are consistent with those under UK GAAP.
Derecognition of financial instruments Financial instruments derecognised before 1 January 2004 have not been re-recognised by the Group under IFRS.
The Group has also adopted the requirements of Financial Reporting Standard (‘FRS’) 27 ‘Life Assurance’ issued by the UK Accounting Standards Board. FRS 27 has been applied from 1 January 2005; comparative figures have not been restated.
The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include all entities over which the Group has the power to govern the financial and operating policies which generally accompanies a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. Group undertakings are fully consolidated from the date on which control is transferred to the Group; they are de-consolidated from the date that control ceases. Open Ended Investment Companies (OEICs) and unit trusts where the Group, through the Group’s life funds, has a controlling interest are consolidated; the unit holders’ interest is reported in other liabilities. Intra-Group transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable net assets 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.
Revenue recognition policies specific to life assurance and general insurance business, except for investment management fees as noted above, are detailed below (see q).
The fair value of assets traded in active markets is based on current bid prices. If the market is not active the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s-length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants.
Purchases and sales of securities and other financial assets are recognised on trade date, being the date that the Group is committed to purchase or sell an asset. Trading securities and other financial assets at fair value through profit or loss are initially recognised at fair value. Available-for-sale financial assets are initially recognised at fair value inclusive of transaction costs. These financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all risks and rewards of ownership.
At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition, there is objective evidence that a financial asset or group of financial assets has become impaired. Evidence of impairment may include indications that the borrower or group of borrowers is experiencing significant financial difficulty, default or delinquency in interest or principal payments, or the fact that the debt is being restructured to reduce the burden on the borrower.
If there is objective evidence that an impairment loss has been incurred, a provision is established which is calculated as the difference between the balance sheet carrying value of the asset and the present value of estimated future cash flows discounted at that asset’s original effective interest rate. For the Group’s portfolios of smaller balance homogenous loans, such as the residential mortgage, personal lending and credit card portfolios, provisions are calculated for groups of assets taking into account historical cash flow experience. For the Group’s other lending portfolios, provisions are established on a case-by-case basis. If an asset has a variable interest rate, the discount rate used for measuring the impairment loss is the current effective interest rate. The calculation of the present value of the estimated future cash flows of a collateralised asset or group of assets reflects the cash flows that may result from foreclosure less the costs of obtaining and selling the collateral, whether or not foreclosure is probable.
The Group’s income statement includes the current service cost of providing pension benefits, the expected return on the schemes’ assets, net of expected administration costs, and the interest cost on the schemes’ liabilities. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are not recognised unless the cumulative unrecognised gain or loss at the end of the previous reporting period exceeds the greater of 10 per cent of the scheme assets or liabilities. In these circumstances the excess is charged or credited to the income statement over the employees’ expected average remaining working lives. Past-service costs are charged immediately to the income statement, unless the charges are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past-service costs are amortised on a straight-line basis over the vesting period.
A number of insurance and investment contracts contain a discretionary participation feature which entitles the holder to receive, as a supplement to guaranteed benefits, additional benefits or bonuses that are likely to be a significant portion of the total contractual benefits and whose amount or timing is contractually at the discretion of the Group and based on the performance of specified assets. Contracts containing a discretionary participation feature are referred to as participating contracts.
IFRS 4 allows entities to continue with existing accounting policies for insurance and participating investment contracts, subject to certain criteria; the Group continues to apply UK GAAP for such contracts. For insurance and participating contracts issued by the life assurance business, this includes continued application of the embedded value basis of accounting although, as described below, the underlying contracts are presented separately from the value of in-force life assurance business in respect of those contracts. Investment contracts that are non-participating are accounted for as financial instruments.
Allocated premiums in respect of unit-linked contracts that are either life insurance contracts or participating investment contracts are recognised as liabilities. These liabilities are increased or reduced by the change in the unit prices and are reduced by policy administration fees, mortality and surrender charges and any withdrawals. The mortality charges deducted in each period from the policyholders as a group are considered adequate to cover the expected total death benefit claims in excess of the contract account balances in each period and hence no additional liability is established for these claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges. Interest or changes in the unit prices credited to the account balances and excess benefit claims in excess of the account balances incurred in the period are charged as expenses in the income statement.
The Group recognises as an asset the value of in-force life assurance business in respect of life insurance contracts and participating investment contracts. The asset, which represents the present value of future profits expected to arise from these contracts, is determined by projecting the future surpluses and other cash flows arising from life insurance contract and participating investment contract business written by the balance sheet date but excluding any future investment margins, using appropriate economic and actuarial assumptions; the value of future cash flows on with-profits policies has been reduced, where necessary, to allow for the realistic value of options and guarantees. The result is discounted at a rate which removes investment risk margins and reflects the Group’s overall risk premium attributable to this business. The asset in the consolidated balance sheet is shown gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
Receivables and payables are recognised when due. These include amounts due to and from agents, brokers and insurance contract holders.
The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods are deferred and only credited to the income statement when earned. Broking commission is recognised when the underwriter accepts the risk of providing insurance cover to the customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience.
For other lending portfolios, provisions are calculated on an individual basis with reference to expected future cash flows including those arising from the realisation of collateral. The determination of these provisions often requires the exercise of considerable judgement by management involving matters such as future economic conditions and the resulting trading performance of the customer and the value of collateral, for which there may not be a readily accessible market. As a result these provisions can be subject to significant variation as time progresses and the circumstances of the customer become clearer.
The methodology and assumptions used for estimating both the amount and timing of future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience.
The Group reviews the goodwill arising on the acquisition of subsidiaries for impairment at least annually or when events or changes in economic circumstances indicate that impairment may have taken place. The impairment review is performed by projecting future cash flows, excluding finance and tax, based upon budgets and plans and making appropriate assumptions about rates of growth and discounting these using a rate that takes into account prevailing market interest rates and the risks inherent in the business. If the present value of the projected cash flows is less than the carrying value of the underlying net assets and related goodwill an impairment charge would be required in the income statement. This calculation requires the exercise of significant judgement by management; if the estimates made prove to be incorrect or changes in the performance of the subsidiaries affect the amount and timing of future cash flows, goodwill may become impaired in future periods.
Significant judgement is required in determining the Group’s income tax liabilities. There are many transactions and calculations for which the ultimate tax determination is uncertain and where calculations have been based on management’s assessment of legal and professional advice, case law and other relevant guidance. In these situations, the various risks are categorised and approximate weightings applied in arriving at the assessment of the expected liability. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred tax amounts in the period in which such determination is made.
Other income (net of fee and commission expense) 1,696 504 10,370 10,874 1,558 45 – 14,173
Interest receivable: Treasury bills and other eligible bills 6 Investment securities 418 Available-for-sale financial assets 3.58 508 Loans and advances to customers 6.41 10,095 8,440 Loans and advances to banks 3.59 1,199 979 Lease and hire purchase receivables 7.07 787 864
Fees and commission expense: Credit and debit card services (182) (176) Dealer commissions (247) (272)
Life insurance Gross premiums 3,996 5,581 Ceded reinsurance premiums (89) (65) Net premiums earned 3,907 5,516 Non-life insurance Gross premiums written 575 635 Ceded reinsurance premiums (22) (29)
Life insurance gross written premiums can be further analysed as follows: 2005 2004 £m £m
Non-life insurance gross written premiums can be further analysed as follows: 2005 2004 £m £m
Statutory audit 8.1 5.5 Other audit related fees: – Audit related regulatory reporting 0.8 0.9 – Further assurance services 1.5 6.4 Total other audit related fees 2.3 7.3
Impairment losses on loans and advances (note 20) 1,302 866 Other credit risk provisions (note 40) (3) –
The charge for tax on the profit for the year is based on a UK corporation tax rate of 30 per cent (2004: 30 per cent).
14 Earnings per share Basic earnings per share are calculated by dividing the net profit attributable to shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 5 million (2004: 6 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
Up to 31 December 2004 (prior to the implementation of IAS 32 and IAS 39 on 1 January 2005) treasury bills and other eligible bills were shown separately on the balance sheet. This balance sheet caption comprised both investment securities and other securities. Investment securities were those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. At 31 December 2005, treasury bills and other eligible bills are categorised as either trading securities and other financial assets at fair value through profit or loss (note 16) or available-for-sale financial assets (note 23).
From 1 January 2005 (upon the implementation of IAS 32 and IAS 39), the Group is required to disclose its trading securities and other financial assets at fair value through profit or loss separately on the face of the balance sheet.
Details of the balance sheet carrying value of these assets held at 31 December 2005 are: £m
Loans and advances to banks 5 5 Loans and advances to customers 161 445 Debt securities: Government securities 535 10,638 Other public sector securities 35 84 Bank and building society certificates of deposit – 898 Corporate debt securities 4,667 4,214 Mortgage backed securities 39 197 Other asset backed securities – 691 Other debt securities – 4,255
Transport, distribution and hotels 7,649 6,753 Property companies 8,267 5,775 Financial, business and other services 16,272 13,442 Personal: Lease financing 5,815 6,227 Hire purchase 4,853 4,828
The net investment in finance leases may be analysed as follows: 2005 2004 £m £m
Not later than 1 year 648 446 Later than 1 year and not later than 5 years 1,610 844 Later than 5 years 3,557 4,937
Geographical analysis by issuer: United Kingdom 21,288 Other European 13,464 North America and Caribbean 5,264 Latin America 76 Asia Pacific 2,866 Other 527 22 Equity shares
See notes 15, 21 and 22 for details of investments held at 31 December 2004.
At 1 January 2005 (following implementation of IAS 32 and IAS 39) 14,624 (31) 14,593 Exchange and other adjustments 559 – 559
Amortisation of premiums and discounts (65) – (65) Changes in fair value 11 – 11 £m £m
Rental income 272 158 Direct operating expenses arising from investment properties that generate rental income 24 17
Capital expenditure contracted for at the balance sheet date but not recognised in the financial statements 31 66
The Group recognises as an asset the value of in-force life assurance business in respect of life insurance contracts and participating investment contracts. The asset, which represents the present value of future profits expected to arise from these contracts, is determined by projecting future surpluses and other cash flows arising from life insurance contract and participating investment contract business written by the balance sheet date. This asset does not recognise any investment risk margins and is reduced by the value of any with-profits options and guarantees; it is presented gross of attributable tax. The asset in the consolidated balance sheet and movement recognised in the income statement are as follows: £m
The principal economic assumptions used in calculating the value of in-force business at 31 December 2005 were as follows: Risk adjusted discount rate (net of tax) 7.02 7.40 Return on equities (gross of tax) 6.72 7.17 Return on fixed interest securities (gross of tax) 4.12 4.57 Expenses inflation 3.79 3.76
The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this is significant, and relevant industry data otherwise.
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs. Explicit allowance is made for future expense inflation.
28 Tangible fixed assets Operating Total Premises Equipment lease assets fixed assets £m £m £m £m
Exchange and other adjustments 3 (1) 9 11 Charge for the year 76 267 278 621
At 31 December the future minimum rentals receivable under non-cancellable operating leases were as follows: £m £m
Excluding commitments in respect of investment property (see note 24), capital expenditure contracted but not provided for at 31 December 2005 amounted to £223 million (2004: £150 million). Of this amount, £215 million (2004: £146 million) relates to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
International: Non-interest bearing 335 296 Interest bearing 3,345 2,539 33 Debt securities in issue 2005 2004 £m £m
The movement in gross life insurance contract liabilities over the year can be analysed as follows: £m
The movement in liabilities arising from participating investment contracts may be analysed as follows: £m
At 31 December 2004 Adjustments to reflect the implementation of IAS 32, IAS 39, IFRS 4 and FRS 27 12,469
The guaranteed annuity option take up rates are set with regard to the Group’s actual experience.
LLOYDS TSB GROUP 91 34 Liabilities arising from insurance contracts and participating investment contracts (continued)
Annuitant mortality 1 155 Modelling of options and guarantees in the With-Profits Fund2 60 Lapse rates 3 58
The charge in respect of annuitant mortality reflects the introduction of an assumed minimum annual improvement in mortality.
The interest rate sensitivity shows the impact of a 1 per cent movement in gilt yields and all of the consequential impacts on key economic assumptions including the RDR, investment returns, valuation rates of interest and values of assets backing the business in question.
Estimate of ultimate claims costs: – at end of accident year 195 242 234 227 211 1,109
The Group has established a number of defined benefit pension schemes in the UK and overseas. The majority of the Group’s employees are members of the defined benefit sections of the Lloyds TSB Group Pension Schemes No’s 1 and 2. These are funded schemes providing retirement benefits calculated as a percentage of final salary depending upon the length of service; the minimum retirement age under the rules of the schemes is 50.
The latest full valuations of the schemes were carried out as at 30 June 2005; these have been updated to 31 December 2005 by qualified independent actuaries. The last full valuations of other group schemes were carried out on a number of different dates; these have been updated to 31 December 2005 by qualified independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows.
The mortality assumptions used in the scheme valuations were based on the experience of the relevant schemes. The mortality assumptions used in the valuations of the Group’s principal schemes are illustrated by the following years of life expectancy in retirement: 31 December 31 December
The allocation of the assets of the Group’s defined benefit schemes was as follows: 2005 2004 £m £m
The movements in the net amount recognised in the balance sheet are as follows: 2005 2004 £m £m
The expected return on scheme assets in 2006 will be calculated using the following assumptions: 2006 %
During the year ended 31 December 2005 the charge to the income statement in respect of these schemes was £49 million (2004: £32 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
Exchange and other adjustments (3) – Insurance premiums paid (6) (5) Charge for the year 16 7
The movement in the net deferred tax balance is as follows: 2005 2004 £m £m
Amount charged (credited) to equity: Available-for-sale financial assets (2) Cash flow hedges 1 Share based compensation (16) –
With effect from 1 January 2005 the Group implemented the requirements of IAS 39 ‘Financial Instruments: Recognition and Measurement’. As a result, certain financial assets and liabilities previously valued at amortised cost are now carried at fair value with a consequential adjustment being made to the deferred tax balance. Comparative figures have not been restated.
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.
The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales, in those cases where the original sales processes are found to be deficient. During 2005 management have reviewed the adequacy of the provisions held having regard to current complaint volumes and the level of payments being made and as a result an additional charge of £150 million (2004: £112 million) has been made.
The Group also carries provisions in respect of its obligations relating to UIC Insurance Company Limited (‘UIC’), which is in liquidation. The Group has indemnified a third party against losses in the event that UIC does not honour its obligations under a reinsurance contract, which is subject to asbestosis and pollution claims in the US. The ultimate cost of settling the Group’s exposure in respect of the insurance business of UIC and the timing remains uncertain. The provision held represents management’s current best estimate of the cost after having regard to the financial condition of UIC and actuarial estimates of future claims.
c) 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 payments are resumed. Any deferred payments will be made good on redemption of the securities. The securities can be redeemed at par at the option of Lloyds TSB Bank plc on or after 22 November 2007.
h) In the event that these notes are not redeemed at the callable date, the coupon will be reset to a fixed margin over the then five year Yen swap rate.
j) These securities constitute limited partnership interests in Lloyds TSB Capital 2 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. Non-cumulative income distributions accrue at a fixed rate of 7.834 per cent per annum up to 7 February 2015; thereafter they will accrue at a rate of 3.50 per cent above a rate based on the yield of specified UK government stock. This issue was made under the limited subordinated guarantee of Lloyds TSB Bank plc. In certain circumstances these preferred securities will be mandatorily exchanged for preference shares in Lloyds TSB Group plc. Lloyds TSB Group plc has entered into an agreement whereby dividends may only be paid on its ordinary shares if sufficient distributable profits are available for distributions due in the financial year on these preferred securities.
* On 1 January 2005, following implementation of IAS 32 and IAS 39, these authorised preference shares were reclassified so that, should any be issued, they would be included within liabilities; no such preference shares were issued in 2005.
Movements in other reserves were as follows: Merger reserve At 1 January and 31 December 343 343
Purchase/sale of treasury shares 18 8 Employee share option schemes – value of employee services 47 19
The Executive share option schemes are long-term incentive schemes and are available to certain senior executives of the Group, with grants usually made annually. Options are granted within limits set by the rules of the schemes. These limits relate to the number of shares under option and the price payable on the exercise of options. In 2005, options were granted without a performance multiplier and the maximum limit for the grant of options in normal circumstances was three times annual salary. Between April 2001 and August 2004, the aggregate value of the award based upon the market price at the date of grant could not exceed four times the executive’s annual remuneration and, normally, the limit for the grant of options to an executive in any one year would be equal to 1.5 times annual salary with a maximum performance multiplier of 3.5. Prior to 18 April 2001, the normal limit was equal to one year’s remuneration and no performance multiplier was applied.
The performance condition is linked to the performance of Lloyds TSB Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 17 companies including Lloyds TSB Group plc.
The performance condition is measured over a three year period commencing at the end of the financial year preceding the grant of the option and continuing until the end of the third subsequent year. If the performance condition is not then met, it will be measured at the end of the fourth financial year. If the condition has not then been met, the options will lapse.
Movements in the number of share options outstanding under the Executive share option schemes during 2005 are set out below: 2005 Weighted average 2004 Weighted average
The weighted average fair value of options granted in the year was £3.63. No options outstanding at 31 December were exercisable. The weighted average remaining contractual life of options outstanding at the end of the year was 2.4 years.
An award of shares may be made annually to employees based on a percentage of the employees’ 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 grant. The shares awarded are held in trust for a mandatory period of three years on the employees’ 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, a portion of the shares awarded will be forfeited (75 per cent within one year of the award, 50 per cent within two years and 25 per cent within three years).
Options granted in the year 4 3 Options granted in prior years 27 27 Shares granted in the year 24 19 Shares granted in prior years 21 16
Of the amounts shown above in respect of undrawn formal standby facilities and other commitments to lend £43,094 million (2004: £42,376 million) were irrevocable.
Not later than 1 year 1 2 Later than 1 year and not later than 5 years – 4 Later than 5 years 15 15
In the Group’s retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but which bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. There are a relatively small volume of deposits whose rate is contractually fixed for periods of up to two years.
The structural position is managed by Lloyds TSB Group Capital Funds having regard to the currency composition of the Group’s risk weighted assets and reported to the group asset and liability committee on a monthly basis. The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures are as follows: £m £m
Functional currency of Group operations: US dollar 102 114 Swiss franc 56 58 Other non-sterling 183 189
The matching and controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of the Group. An unmatched position potentially enhances profitability, but also increases the risk of losses.
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 cashflow 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.
Listed securities are valued at quoted mid-market prices. Unlisted securities and other financial assets are valued based on discounted cash flows, market prices of similar instruments and other appropriate valuation techniques.
– other securities 4 4 Trading securities and other financial assets at fair value through profit or loss 60,374 60,374 Derivative financial instruments 5,878 5,878 Loans and advances to banks 31,655 31,848 31,691 31,800 Loans and advances to customers 174,944 155,318 175,554 155,829 Debt securities – investment securities 14,368 14,380
53 Consolidated cash flow statement a Reconciliation of profit before tax to net cash (used in) provided by operating activities 2005 2004 £m £m
(Profit) loss on disposal of businesses (50) 21 Depreciation of fixed assets 639 638 Allowance for loan losses 1,302 866 Write-off of allowance for loan losses (1,078) (854) Insurance claims 12,186 9,622 Insurance claims paid (8,269) (5,338) Movement in value of in-force business (162) (16) Customer remediation provision 150 112 Customer remediation paid (77) (245) Net charge in respect of retirement benefit schemes 259 275 Contributions to retirement benefit schemes (425) (374) Net gain on sale of investment securities (5) (126) Revaluation of investment property (430) (329) Change in loans and advances to banks (1,277) (964) Change in loans and advances to customers (14,525) (19,681) Change in deposits from banks (8,168) 16,046 Change in customer accounts 4,619 5,676 Change in debt securities in issue 10,280 1,876 Change in trading assets (103) 844 Change in trading liabilities (3,937) – Change in investment contract liabilities 6,094 – Change in other assets (1,049) (1,518) Change in other liabilities 1,181 2,830 Tax paid (708) (763) Other non-cash movements (598) 139
Cash and balances with central banks (excluding mandatory deposits) 868 833 Loans and advances to banks with a maturity of less than three months 25,885 27,363
Subordinated liabilities and finance leases: Adjustments on adoption of IAS 32, IAS 39 and IFRS 4 959
IFRS 2 requires that a cost is recognised in the financial statements for all options granted under executive and employee Save-As-You-Earn (‘SAYE’) share-option schemes; no costs were recognised under UK GAAP in respect of these schemes.
Under UK GAAP the Group’s accounting policy was to capitalise, within tangible fixed assets, only software costs relating to separable new systems. Under IFRS, both external and directly related internal costs relating to enhancements that lead to additional system functionality are also now capitalised and included in other intangible assets.
The claims equalisation provision in respect of the Group’s general insurance business, established under law to minimise volatility in incurred claims, is not permitted under IFRS.
Whilst the requirements under IFRS are similar to those under UK GAAP, two principal differences arise between UK GAAP and IFRS with regard to the definition of cash and cash equivalents and the classification of items within the cash flow statement. Cash and cash equivalents comprise cash and balances at central banks and amounts due from banks with a maturity of less than three months (under UK GAAP only amounts due from banks repayable on demand were included in cash and cash equivalents), excluding mandatory deposits. In terms of classification, UK GAAP requires a more detailed classification of cash flows which includes separate classifications of cash flows arising from dividends and taxation.
Under UK GAAP debt securities held for continuing use in the business were classified as investment securities and carried in the balance sheet at cost less any provisions for permanent diminution in value. IAS 39 introduces strict requirements to be met before debt securities can be carried at amortised cost and the Group has determined that it does not meet these. Accordingly debt securities previously classified as investment securities have been reclassified as available-for-sale and valued at their fair values at 1 January 2005. Equity investments may not be carried at cost under IAS 39 and these have also been reclassified as available-for-sale.
Investment contracts that are not within the scope of IFRS 4 are accounted for as financial instruments under IAS 39. The principal effects of this change on the accounting for non-participating investment contracts are the removal of that portion of the embedded value which represents the value of in-force business relating to those contracts, the recognition of an asset for deferred acquisition costs, and the deferral of up-front fees received for investment management services; deferred acquisition costs and deferred up-front fees are amortised over the period of the provision of investment management services.
The classification of the majority of the Group’s capital and subordinated debt instruments continues to follow their UK GAAP treatment. However, the Group’s preferred securities, which were treated as non-equity minority interests under UK GAAP, have been reclassified as debt because the coupon payment is not discretionary. Distributions on these securities are shown as interest expense rather than as minority interests.
Under IFRS a financial liability may only be removed from the balance sheet after it has been settled, it has expired or alternatively the debtor has been legally released from the liability, either by process of law or by the creditor. Upon adoption of IFRS, certain financial liabilities in respect of which amounts had been released to the income statement under UK GAAP on the basis that the likelihood of their settlement was remote have been remeasured as at 1 January 2005 to reflect the entire legal obligation.
The Group recognises as an asset the value of in-force life assurance business in respect of life assurance contracts and participating investment contracts, representing the net present value of future profits expected to accrue to the shareholder from these contracts. In the Group’s first IFRS results for the six months ended 30 June 2005, the asset in the consolidated balance sheet and movements in the asset recognised in the income statement were calculated and disclosed on a net of tax basis. Since that time accounting practice has continued to evolve and a consensus has emerged that the value of in-force business should be presented gross of tax. Therefore, in order to facilitate comparisons with the results of other major UK life assurance operations, the Group has changed its accounting policy to present movements in the value of in-force business gross of attributable tax with a consequential adjustment to the tax charge; there is no effect upon the Group’s income statement or shareholders’ equity. Comparative figures have been restated accordingly.
Items in course of transmission to banks 626 – – – – – – – – – 626 Debt securities in issue 25,922 217 1,319 – – – – – – – 27,458 Insurance contract liabilities – 49,079 – – – – – – – (51) 49,028 Unallocated surplus within insurance business – 339 – – – – – – – – 339
Value of in-force business – 4,363 – – – – – – – – 4,363
Prepayments and accrued income 2,573 – – – – – – – – (2,573) –
Long-term assurance assets attributable to the policyholders 54,764 (54,764) – – – – – – – – –
Restated consolidated income statement (reconciliation of profit) for the year ended 31 December 2004 (excludes effects of IAS 32, IAS 39 and IFRS 4)
Profit attributable to minority interests 68 – 1 (1) – – – – (1) 67
Value of in-force business 4,363 – – – – – – (1,603) – – 2,760
Items in course of transmission to banks 631 – – – – – – – – – 631
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report, the directors’ remuneration report and the parent company 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.
We report to you our opinion as to whether the parent company financial statements give a true and fair view and whether the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation. We also report to you if, in our opinion, the directors’ report is not consistent with the parent company financial statements, if the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and other transactions is not disclosed.
We read other information contained in the annual report and consider whether it is consistent with the audited parent company financial statements. The other information comprises only the directors’ report, the chairman’s statement, the Group chief executive’s review, the operating and financial review and prospects and the unaudited part of the directors’ remuneration report. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the parent company financial statements. Our responsibilities do not extend to any other information.
Parent company statement of changes in equity * No income statement has been shown for the parent company, as permitted by section 230 of the Companies Act 1985.
The financial information has been prepared under the historical cost convention, as modified by the revaluation of all derivative contracts, on the basis of IFRS adopted by the EU. The parent company has applied IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ and the opening IFRS balance sheet position at 1 January 2004, the date of transition, has been determined in accordance with that standard; IFRS 1 requires IFRS accounting policies to be applied on a retrospective basis and takes account of any relevant mandatory exceptions and voluntary exemptions applied by the Group as detailed in note 1 to the consolidated accounts.
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 accounts, except that it has no policy in respect of consolidation and investments in subsidiaries are carried at historical cost, less any provisions for impairment.
At 1 January – restated 3 6 Income statement credit 2 9 Amount credited to equity in respect of employee share schemes 16 –
Restated balance at 1 January 2005 2,026 Profit for the year 1,898 Dividends (1,914) Purchase/sale of treasury shares (2) Employee share option schemes: value of employee services 47
Undated subordinated loan capital* 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 § 497 497 Dated subordinated loan capital 57/8% Subordinated Guaranteed Bonds 2014 (c750 million) 606 462
† Indirect interest * In certain circumstances, these notes and bonds would acquire the characteristics of preference share capital. Any repayments of undated loan capital would require the prior consent of the Financial Services Authority. They are accounted for as liabilities as coupon payments are mandatory as a consequence of the terms of certain preference shares.
Amounts due from subsidiaries 1,387 – – (1,314) – 73 Cash and cash equivalents 362 – – – – 362
Share capital 1,418 – – – – 1,418 Share premium account 1,136 – – – – 1,136 Revaluation reserve 4,687 – (4,687) – – –
Subordinated liabilities 1,356 – – – – 1,356 Current tax liabilities – 5 – – – 5
Share capital 1,419 – – – – 1,419 Share premium account 1,145 – – – – 1,145 Revaluation reserve 5,014 – (5,014) – – –
Subordinated liabilities 1,358 – – – – 1,358 Current tax liabilities – 7 – – – 7
Lloyds TSB Group plc was incorporated as a public limited company and registered in Scotland under the UK Companies Act 1985 on 21 October 1985 with the registered number 95000. Lloyds TSB Group plc’s registered office is Henry Duncan House, 120 George Street, Edinburgh EH2 4LH, Scotland, and its principal executive offices in the UK are located at 25 Gresham Street, London EC2V 7HN.
This annual report includes certain forward looking statements with respect to the business, strategy and plans of Lloyds TSB Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Lloyds TSB Group’s or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ‘will’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future.
At the date of this report, notifications had been received that Legal & General Investment Management Limited, Barclays PLC and The Capital Group Companies had interests of 3%, 3.30% and 6.04%, respectively, of the nominal value of the issued share capital. No other notification has been received that anyone has an interest of 3% or more of the nominal value of the issued share capital.
For details contact: The Bank of New York, Investor Services, PO Box 11258, Church Street S t a t i on , New Yo rk , NY 10286-1258 . Telephone: 888 BNY ADRS (US toll free),
A copy of the Group’s corporate responsibility report may be obtained by writing to Corporate Respons ib i l i t y, L loyds TSB Group p lc , 25 Gresham Street, London EC2V 7HN. This information together with the Group’s code of business conduct is also available on the Group’s website.
A copy of the code and information about it may be obtained from the DTI Publications Orderline 0845 0150010, quoting ref URN 04/606. Alternatively, log on to www.payontime.co.uk for details.
The Company’s share register is maintained by Lloyds TSB Registrars, The Causeway, Worthing, West Sussex BN99 6DA. Telephone 0870 600
• requesting copies of the report and accounts in alternative formats for shareholders with disabilities.