Report of the independent auditors on the consolidated financial statements 58
Total capital ratio 10.9 per cent, tier 1 capital ratio 7.9 per cent.
Dividend maintained. Final dividend of 23.5p per share, making a total of 34.2p for the year (2004: 34.2p). Dividend cover increased to 1.3 times.
Excluding customer redress provisions and the strengthening of reserves for mortality
Up to 31 December 2004 the Group prepared its financial statements in accordance with UK Generally Accepted Accounting Principles (UK GAAP). With effect from 1 January 2005 the Group implemented International Financial Reporting Standards (IFRS). In this document the 2004 comparative financial information has been restated to reflect the adoption of those IFRS standards which are required to be applied retrospectively, but does not include the additional impacts arising from first time application of IAS 32 ‘Financial Instruments: Disclosure and Presentation’, IAS 39 ‘Financial Instruments: Recognition and Measurement’
In Retail Banking we are clearly focused on ensuring that we earn the right to meet 100 per cent of our customers’ financial services needs. Customer satisfaction standards continue to improve and are at a higher level than at any time in recent years. This reflects several years of hard work during which all staff have focused their full attention on providing high levels of service to our customers.
* Comparable basis – excluding impact of volatility, other IFRS adjustments applied from 1 January 2005 and discontinued operations. Also excludes provisions for customer redress and the strengthening of reserves for mortality.
On the financial side, we increased our already high return on equity and we delivered a total return of 10.9 per cent to our shareholders. We grew the trading surplus in each division as the rate of growth in income exceeded that of costs and we achieved good overall earnings growth in the face of a slower economic environment.
Overall, I am pleased with the progress of the Group during 2005. We delivered on our financial plans and we also used the time to develop the franchise successfully in line with our growth strategy. We have continued to make good progress in each of the divisions, the highlights of which are summarised below.
We continue to focus our efforts on our existing customers where we have an information advantage that allows us to be more effective and efficient in providing sales and service that meet our customers’ financial needs. We have also stepped up our new customer recruitment efforts, which has helped drive good target customer recruitment, particularly in the second half of the year, to give a 28 per cent increase over last year.
We have committed ourselves to earning the right to meet 100 per cent of our customers’ financial services needs and helping them succeed financially. In 2005, we recorded our highest ever customer satisfaction scores across all our channels – branch, telephone and internet banking. The improvement in customer satisfaction and the renewed focus on meeting all our customers’ financial services needs has helped to drive an improving sales performance during 2005, and has been accompanied by good balance growth in our key product lines with mortgages up 10 per cent, credit cards (excluding Goldfish) up 9 per cent and customer deposits 7 per cent higher. Sales through our internet and telephone channels grew strongly by 28 per cent and 39 per cent respectively.
In Insurance and Investments, profits showed significant growth, reflecting further success in delivering our strategies. Profit before tax, on a comparable basis and excluding the 2004 customer redress provision and the strengthening of reserves for mortality, increased by 15 per cent, underpinned by strong growth in both the bancassurance and IFA channels and continued control of costs. Profits grew strongly in both our life assurance and general insurance businesses.
Scottish Widows remains strongly capitalised. In addition to the payment of a £200 million dividend to the Group in March 2005, Scottish Widows made a further £800 million distribution to the Group in December 2005 as part of our plans to improve capital efficiency. A second annual dividend will be paid in March 2006.
Our corporate vision is to make Lloyds TSB the best financial services company, firstly in the UK then across borders.
The business case for corporate responsibility is clear. Good management of corporate responsibility risks and opportunities is fundamental to delivering a successful business.
We seek our employees’ views on working for Lloyds TSB through our Engagement Index, a quarterly survey of all staff. We know from many years of monitoring staff views of the company that the six main factors influencing employee engagement are: • providing staff with opportunities for training and development
• giving staff the flexibility and scope to use their abilities and initiative
• the extent to which staff believe Lloyds TSB is highly regarded
We have been at the forefront of developing financial services to help tackle the problems of financial exclusion; these include basic bank accounts, support for community credit unions and other community finance initiatives. We have opened 348,000 basic bank accounts for customers since 2003.
Increasingly we are required to demonstrate our commitment to corporate responsibility to win business contracts. In turn, when awarding contracts to key suppliers we take account of their performance in areas of human rights, treatment of employees, treatment of their own customers and suppliers, the environment and the community. In demanding high ethical standards from our suppliers we recognise that our own employees must display the highest ethical standards themselves. We operate to a code of purchasing ethics to ensure fair treatment of suppliers.
Continuing to grow a successful business is the best way for Lloyds TSB to create value for all its stakeholders and to contribute to the wider economy. We are a major employer with nearly 70,000 employees. In 2005, salaries, national insurance, pension contributions and other staff costs totalled over £2.8 billion. Over £1.2 billion was paid to governments in tax and £1.9 billion was distributed to shareholders in the form of dividends. When dividends are added to share price appreciation, we delivered a total return to our shareholders of 10.9 per cent in 2005 and 15.1 per cent in 2004.
Community investment is not just about giving money to good causes. It is also about the substantial time given by our staff in supporting the work of community organisations, whether raising money, providing business expertise or simply providing another willing pair of hands. One of our biggest group wide activities is our Charity of the Year fundraising. In 2005 our staff chose to support Marie Curie Cancer Care, raising £1 million to fund 70 Marie Curie nurses for a year.
Internet banking. Internet banking provides online banking facilities for personal customers. Some 3.7 million customers have registered to use Lloyds TSB Group’s internet banking services. At the end of 2005, these customers were conducting more than 45 million transactions per month online, a 50 per cent increase on 2004.
Scottish Widows Investment Partnership. Scottish Widows Investment Partnership manages funds for Lloyds TSB Group’s retail life, pensions and investment products. Clients also include corporate pension schemes, local authorities and other institutions in the UK and overseas. At 31 December 2005 funds under management amounted to some £95 billion.
Structured Finance comprises the structured asset finance, leveraged lending and private equity, and other transactional lending and structuring businesses of Corporate Markets. Structured Finance executes transactions with existing corporate customers as well as introducing new to bank relationships to the franchise.
Financial Markets provides market access to sources of liquidity, hedging tools and investment products on behalf of Lloyds TSB Group and its customers. Financial Markets also provides risk management solutions to corporate customers and structured credit and investment products to the investor community.
Latin American banking. Lloyds TSB Group continues to have offices in Ecuador and Uruguay which provide mainly corporate banking services. The sale of the business in Paraguay is expected to complete in 2006 after receipt of the required regulatory approval.
Our strategy to deepen customer relationships has led to an increase in customer advances, particularly in mortgages, credit cards and corporate lending, and is reflected in a 9 per cent increase in loans and advances to customers to £175 billion. Customer deposits increased by £5 billion, or 4 per cent, to £131 billion, largely as a result of good growth in customer savings accounts in the retail business.
Scottish Widows continues to be one of the most strongly capitalised life assurance companies in the UK. The working capital ratio of the Scottish Widows Long-Term Fund remained strong at an estimated 17.8 per cent at the end of December 2005. The required risk capital margin was covered over 11 times. In March 2005, Scottish Widows paid a 2004 dividend of £200 million to Lloyds TSB reflecting the start of an expected regular dividend stream, and in December 2005 a further £800 million of surplus capital was repatriated to the Group. In March 2006, a second annual dividend will be paid to the Group. We are continuing to examine opportunities to improve our capital efficiency and have work in progress that we believe will allow Scottish Widows to repatriate further surplus capital to the Group.
The board has decided to maintain the final dividend at 23.5p per share, to make a total for the year of 34.2p. This represents a dividend yield for shareholders of 7 per cent, calculated using the 31 December 2005 share price of 488.5p.
Trading surplus 2,586 2,415 Impairment losses on loans and advances (905) (676)
Profit before tax 1,531 1,639 Other IFRS adjustments applied from 1 January 2005 (213) – Profit on sale of businesses 76 –
• Positive jaws with income growth of 4 per cent exceeding cost growth, excluding customer redress provisions, of 1 per cent.
• Good and broad customer balance growth: – Group mortgage balances increased by 10 per cent to £88.4 billion.
– Credit card balances, adjusted to exclude the effect of the Goldfish disposal, increased by 9 per cent to £7.2 billion.
– Customer deposit balances increased by 7 per cent to £71.0 billion.
• Customer satisfaction levels reached their highest level in recent years during 2005.
Profit before tax, on a comparable basis, from UK Retail Banking decreased by £108 million, or 7 per cent, to £1,531 million, reflecting good levels of business growth offset by higher impairment losses and customer redress provisions. Increased income from continued growth in the Group’s consumer lending and customer deposit portfolios and improved current account fee income was offset by a higher level of impairment losses in the Group’s unsecured lending portfolios. Total income increased by 4 per cent, notwithstanding a decrease in commissions from creditor insurance, whilst cost growth, excluding customer redress provisions, was 1 per cent. Other income increased by 7 per cent, and now represents 35 per cent of total income.
Customers are increasingly choosing to buy through direct channels as well as through our branches. Towards the end of 2005 we saw improved levels of growth in branch based sales, particularly current and savings accounts, whilst continued investment in our direct channel capabilities has supported good levels of business growth. Sales through direct channels represent half of total sales and, during 2005, internet product sales increased by 28 per cent and product sales via the telephone increased by 39 per cent. Our internet bank now has 3.7 million registered users and over 470 million transactions were processed through internet banking, an increase of 40 per cent.
Within personal loans, key initiatives have been the increased use of behavioural and risk-based pricing, and leveraging our customer insight capabilities to enable the Group to deliver more competitive pricing to better quality customers within our existing customer base. Over 99 per cent of new personal loans and 77 per cent of new credit cards sold during 2005 were to existing customers, where the Group has a better understanding of an individual customer’s total financial position. Dynamic delinquency measures remain in line with our expectations given the slowdown in consumer spending.
Profit before tax analysis Life, pensions and OEICs* 683 610 General insurance 209 172 Scottish Widows Investment Partnership 16 8
• Strong, and improving, sales performance. 21 per cent increase in Scottish Widows’ new business weighted sales, increasing the Group’s market share of life, pensions and long-term savings to an estimated 6.2 per cent, from 5.7 per cent.
• Good progress with General Insurance’s strategy to develop its manufacturing business and increase focus on direct channels. Strong focus on improving underwriting capability, supply chain efficiency and claims management led to profit before tax, on a comparable basis, increasing by 22 per cent.
Weighted sales (regular + 1/10 single) Life and pensions 754 657
Overall, weighted sales in 2005 increased by 21 per cent to £902 million and as a result the Group’s life, pensions and investments market share increased significantly to an estimated 6.2 per cent, compared with 5.7 per cent in 2004. During 2005 the Group launched a new group pensions platform which supported the strong growth in sales during the year. Scottish Widows is now also one of the largest UK providers of individual pensions. IFA sales grew 30 per cent to £562 million, supported by significant product and service enhancements in pensions and investments, and our estimated market share of the IFA market improved to 6.8 per cent, from 5.9 per cent in 2004. Bancassurance sales were 13 per cent higher at £274 million. Weighted sales of OEICs were 72 per cent higher, largely through the branch network and to Lloyds TSB private banking clients. Our estimated market share through the bancassurance and direct channels increased to 5.5 per cent, from 5.4 per cent
Operating income, net of claims 369 326 Operating expenses (160) (154)
Our strategy to increase investment in more cost efficient distribution through direct channels continues to generate earnings momentum with gross written premiums from new policies sold through direct channels increasing by 9 per cent in 2005. This reflected strong growth in levels of new business through the internet, where home insurance sales increased by 39 per cent and motor insurance sales by 12 per cent. New motor insurance sales by telephone increased by 15 per cent. The business has also delivered substantial improvements in business retention reflecting higher levels of customer satisfaction and improvements in operational efficiency.
Trading surplus 1,689 1,483 Impairment losses on loans and advances (185) (230)
Profit before tax 1,504 1,253 Other IFRS adjustments applied from 1 January 2005 20 – Loss on sale of businesses (6) (21) Trading results of discontinued operations – 40
• Strong income growth, up 10 per cent as Corporate Markets’ strategy begins to deliver results. Income momentum improved during the year.
Profit before tax in Business Banking grew by £53 million, or 35 per cent, to £206 million reflecting our strategy to move relationship managers back into branches, and closer to our customers. There was good growth in customer income, tight control of costs, and service and operational improvements. This supported a 4 percentage point reduction in the cost:income ratio for the business. Customer deposits rose by 4 per cent to £10.7 billion and customer lending increased by 11 per cent to £8.0 billion. Business Banking continued to develop and grow its customer franchise, with net customer recruitment of some 13,350 during 2005, reflecting a market leading position in both the overall and start-up markets. Over 18,000 customers transferred their banking arrangements to the Group from other banking providers.
During 2005, profit before tax included negative banking volatility of £124 million.
During 2005, profit before tax included positive policyholder interests volatility of £311 million.
The changing regulatory environment faced by the Group’s businesses, and developments in best practice, prompted the Group during 2003 and 2004 to perform an extensive review of its risk governance structures. During 2005 these structures have enabled the Group to strengthen risk evaluation and management.
Business management forms part of a tiered risk management model, as shown on page 24, with the divisional risk officers providing oversight and challenge, as described above, and the chief risk director and group committees establishing the group wide perspective.
Lloyds TSB Group uses an enterprise-wide framework for the identification, assessment, measurement and management of risk, designed to meet its customers’ needs and maximise value for shareholders over time by aligning risk management with the corporate strategy; assessing the impact of emerging risks from new technologies or markets; and developing risk tolerances and mitigating strategies. The framework strengthens the Group’s ability to identify and assess risks; aggregate groupwide risks and define the corporate risk appetite; develop solutions for reducing or transferring risk, where appropriate; and exploit risks to gain competitive advantage, thereby seeking to increase shareholder value.
The main policy levels are identified below: • Principles – high level policy for the six primary risk drivers (agreed by the board)
• Divisional policy – local policy that specifically applies to a division (agreed by the appropriate group risk director)
• Business unit policy – local policy that specifically applies to a business unit (agreed by the divisional risk officer)
Strategy risk is the risk arising from developing a strategy that does not maximise franchise value and/or fails to achieve the initiatives in the agreed strategic plan due to changing or flawed assumptions. In assessing strategic risk consideration is given to both: • external factors (ie economic, technological, political, social and ethical, environmental, legal and regulatory, market expectations, reputation and competitive behaviour), and
The Group defines a new product as a new or amended product that introduces a significantly different risk profile at group or business level. In line with defined policy, businesses provide divisional risk management with details of new products at an early stage of product or service development to seek to ensure compliance with the Group’s risk appetite and strategy. Businesses are required to demonstrate that new products meet clearly defined customer needs and that the sales process mitigates the risks of unsuitable sales. Where appropriate, technical advice and approval is sought from specialist functions. Only new products carrying the approval of divisional risk management and the businesses involved in their manufacture and delivery are offered to customers.
Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers. Control is exercised over those exposures through a suitable combination of formal limits set out in mandates, credit policy parameters and high level committee oversight.
Credit quality is supported by specialist units to provide, for example: intensive management and control; security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector-specific expertise; and legal services applicable to the particular market place and product range offered by the business.
Lending guidelines. These define the responsibilities of lending officers and seek to provide a disciplined and focused benchmark for credit decisions.
Concentration risk. Credit risk management sets portfolio controls on certain industries, sectors and product lines that reflect risk appetite, and monitors exposures to prevent excessive concentration of risk. These concentration risk controls are not necessarily in the form of a maximum limit on lending but may instead require new business in concentrated sectors to fulfil additional hurdle requirements. Amongst these controls is a series of time-referenced sector caps to manage residual value risk exposure, seeking to ensure an acceptable distribution of risk. The Group’s large exposures are managed in accordance with regulatory reporting requirements.
Facilities database. A database is maintained of all non-retail customer relationships to assist in the identification and aggregation of cross-business unit commitments. The Group uses a system known as parent company executives, under which there is a central person responsible for each non-retail customer relationship, to whom other business units wishing to do business with the same customer must apply for credit limits.
Stress testing and scenario analysis. The credit portfolio model is also used in stress-testing, to simulate a scenario and calculate its impact. Our modelling capabilities are currently subject to further development. Events are modelled both at a group wide level, at divisional and business unit level and by portfolio, for example, for a specific industry sector.
• Trading is restricted to a number of specialist centres, the most important centre being financial markets division in London. These centres also manage market risk in the wholesale banking books, both in the UK and internationally. The level of exposure is strictly controlled and monitored within approved limits. Active management of the wholesale book is necessary to meet customer requirements and changing market circumstances.
• Market risk in the Group’s retail portfolios and in the Group’s capital funds is managed within limits set out in the policy for group balance sheet management, which is reviewed annually and approved by the group asset and liability committee. The structural foreign exchange position is managed 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 objective is to limit the effect of exchange rate movements on the published risk asset ratio.
• Market risk exposure from the insurance businesses are controlled via approved investment policies consistent with the Group’s overall risk appetite and regularly reviewed by the group asset and liability committee
The Group liaises with the pension scheme trustees with regard to strategies for the overall mix of pension assets.
Based on the commonly used 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding three years, the VaR for the years ended 31 December 2005 and 2004 based on the Group’s global trading positions was as detailed in the table below (the table also aggregates potential loss measures from options portfolios).
The analysis above is subject to certain simplifying assumptions including, but not limited to, all rates of all maturities worldwide move simultaneously by the same amount; all positions in the wholesale books run to maturity; and there is no management action in response to movements in interest rates, in particular no changes to product margins.
The major sources of insurance risk within the Group are the insurance businesses and the Group’s defined benefit pension schemes. The nature of insurance business involves the accepting of insurance risks which relate primarily to mortality, morbidity, persistency, expenses, property damage and unemployment. The prime insurance risk carried by the Group’s pension schemes is related to mortality.
Control is exercised primarily through a suitable combination of high level committees/boards. For the life assurance businesses the key control body is the board of Scottish Widows Group Limited with the more significant risks also being subject to approval by the Lloyds TSB group executive committee and/or the Lloyds TSB Group board. For the general insurance businesses the key control body is the Lloyds TSB Insurance executive committee with the more significant risks again being subject to Lloyds TSB group executive committee and/or Lloyds TSB Group board approval. All group pension scheme issues are covered by the group asset and liability committee.
Limits are used as a control mechanism for insurance risk at policy level.
The policy regarding organisational structure is that the Group seeks to optimise performance by allowing divisions, subsidiaries and business units to operate within established capital and risk parameters and the Group’s policy framework. Group policy requires that they must do so in a way which is consistent with realising the Group’s strategy and meets agreed business performance targets.
The Group is committed to the fair treatment of its customers. It is an essential part of the way the Group conducts its business and develops deep long lasting relationships with its customers. A range of management information measures is in place across the Group to support the tracking of key customer treatment indicators. Group Risk and Group Audit are required to report regularly on customer treatment risk, management information trends and on compliance with the Group’s standards.
The Group has in place appropriate policies, procedures and tools for the management of theft, fraud and other criminal acts risks.
Performance and reward management. The Group seeks to ensure that all employees understand their role, the purpose of the role and where it fits into the wider team and organisational context. It manages and measures employees’ performance and contribution to collective goals and recognises the contribution of individuals in the context of the pay market and the performance of the business in which they work and rewards appropriately.
Liquidity risk is defined as the risk of a loss arising from the Group’s inability to meet its financial obligations as they fall due. These obligations include the repayment of deposits on demand or at their contractual maturity; the repayment of loan capital and other borrowings as they mature; the payment of insurance policy benefits, claims and surrenders; the payment of lease obligations as they become due; the payment of operating expenses and taxation; the payment of dividends to shareholders; the ability to fund new and existing loan commitments; and the ability to take advantage of new business opportunities.
A policy is in place which requires a common methodology to measuring liquidity across the Group. The methodology derives a liquidity ratio calculated by taking the sum of liquid assets, five-day wholesale inflows and back-up lines, and then dividing this by the sum of five-day wholesale outflows and a percentage of retail maturities and contingent claims drawable over the next five days. The Group complies with the FSA’s liquidity requirements and with similar liquidity policies in place across all trading centres worldwide. Compliance is monitored by regular liquidity returns to Group Treasury. Work is ongoing to seek to ensure the Group’s compliance with the new liquidity framework being proposed by the FSA. The liquidity policy requires all authorised local treasury operations to maintain a liquidity ratio of over 100 per cent, in addition to ensuring compliance with local regulatory requirements. It is the responsibility of local line management to ensure that the liquidity policy is met and the sources and maturities of assets and liabilities are continually managed and appropriately diversified to avoid any undue concentration as market conditions evolve. Compliance is monitored by regular liquidity returns to Group Treasury.
Lloyds TSB Group and its regulated subsidiary banks have been allocated an Individual Capital Ratio by the FSA, and the board has agreed a formal buffer to be maintained in addition to the Individual Capital Ratio. Actual or prospective breaches of the formal buffer must be notified to the FSA, together with proposed remedial action; no such notifications have been made during 2005. Informally, a further buffer is maintained. In addition, the board has agreed a maximum limit of the proportion of debt instruments in the capital base. Risk-weighted assets are monitored by businesses, while capital is controlled centrally.
For Scottish Widows, a further test is required in respect of the With-Profits Fund which compares the level of ‘realistic excess capital’ to the ‘statutory excess capital’ of the With-Profits Fund and, in circumstances where the ‘realistic excess capital’ position is less, the Company is required to hold additional capital to cover the shortfall. The ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the With-Profits Fund with a further deduction to cover various stress tests. Any additional capital requirement under this test is referred to as the With-Profits Insurance Capital Component.
Scottish Widows was created following the demutualisation of Scottish Widows Fund and Life Assurance Society in 2000. The terms of the demutualisation are governed by a Court-approved Scheme of Transfer (the ‘Scheme’) which, inter alia, created a With-Profits Fund and a Non-Profit Fund and established protected capital support for the with-profits policyholders in existence at the date of demutualisation. Much of that capital support is held in the Non-Profit Fund and, as such, the capital held in that fund is subject to the constraints noted below.
The primary reasons for the movement in total available capital resources during the year are as follows: With-Profits Fund
Available regulatory capital 2,302 4,965 Support arrangement assets 1,115 – Adjustments to replace statutory liabilities with ‘realistic’ liabilities (2,580) (2,291) Adjustments to include the value of future profits recognised in respect of Non-Participating business written in the With-Profits Fund 43 43 Removal of future profits allowable for regulatory capital purposes – (500) Recognition of future profits allowable for ‘realistic’ capital purposes – 1,923
Insurance and participating investment contract liabilities 18,720 16,712 35,432 4,524 39,956 Non-participating investment contract liabilities – 14,624 14,624 7,215 21,839
Under some of Abbey Life’s older contracts, the maturity value or the surrender value at the end of the selected period is guaranteed to be not less than total premiums paid or sums assured. The total provision for these options was £5 million at 31 December 2005 (£11 million at 31 December 2004) and was established using stochastic techniques after making prudent assumptions.
Share information Basic earnings per ordinary share 44.6p 42.8p 43.3p 58.3p 32.1p 40.4p Diluted earnings per ordinary share 44.2p 42.5p 43.0p 58.1p 32.0p 40.0p Total dividend per ordinary share1 34.2p 34.2p 34.2p 34.2p 34.2p 33.7p Market price (year-end) 488.5p 473p 473p 448p 446p 746p
Number of ordinary shares in issue (millions)2 5,603 5,596 5,596 5,594 5,583 5,564
The board * Member of the audit committee ** Chairman of the audit committee � Member of the nomination committee
Sir Victor Blank Deputy Chairman (succeeding Maarten van den Bergh as chairman) Joins the board on 1 March 2006 as deputy chairman. Will succeed Maarten van den Bergh as chairman following the annual general meeting in May 2006. Former partner in Clifford-Turner (now Clifford Chance) from 1969 to 1981 and chairman and chief executive of Charterhouse until 1997. Director of The Royal Bank of Scotland from 1985 to 1993. Chairman of GUS and Trinity Mirror (until May 2006) and a member of the Financial Reporting Council and of the Council of Oxford University. Chairs two charities, WellBeing of Women and UJS Hillel, as well as the Council of University College School. Aged 63.
Terri A Dial Group Executive Director UK Retail Banking Joined the board in June 2005. Served with Wells Fargo in the USA from 1973 to 2001 where she held a number of senior and general management appointments before becoming president and chief executive officer of Wells Fargo Bank in 1998. A non-executive director of the LookSmart Corporation and Onyz Software. Aged 56.
Sir Julian Horn-Smith joined the board on 1 January 2005 and was elected at the annual general meeting on 5 May 2005.
Ms Dial joined the board on 1 June 2005, Mr du Plessis and Lord Leitch joined the board on 1 October 2005 and Sir Victor Blank joins the board on 1 March 2006. In accordance with the articles of association, they offer themselves for election at the annual general meeting.
Also in accordance with the articles of association, Mr Kane retires at the annual general meeting and offers himself for re-election.
Schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement in Lloyds TSB Group.
Policy and practice on payment of creditors The Company follows ‘The Better Payment Practice Code’ published by the Department of Trade and Industry (DTI), regarding the making of payments to suppliers. A copy of the code and information about it may be obtained from the DTI as shown on page 129.
The Company’s policy is to agree terms of payment with suppliers and these normally provide for settlement within 30 days after the date of the invoice, except where other arrangements have been negotiated. It is the policy of the Company to abide by the agreed terms of payment, provided the supplier performs according to the terms of the contract.
Auditors Resolutions concerning the re-appointment of PricewaterhouseCoopers LLP as auditors and authorising the audit committee to set their remuneration will be proposed at the annual general meeting.
Compliance with the combined code The board considers that good governance is central to achieving the Group’s governing objective of maximising shareholder value over time. That has been uppermost in directors’ minds when applying the principles contained in the combined code on corporate governance issued by the Financial Reporting Council. The Group has complied with the provisions of the code, and has done so throughout the year regarding the code provisions whose requirements are of a continuing nature.
The board evaluates its performance and that of its committees and individual directors. The process adopted, using an internally produced questionnaire, affords directors the opportunity, through their membership of boards of other companies, in the UK and overseas, to draw on their experience to endeavour to ensure that the Group follows best practice. It also enables directors to suggest how the board’s procedures may be improved; to assess strengths and weaknesses; and to address its balance of skills, knowledge and experience. The committees, themselves, assess their respective roles, performance and terms of reference and report accordingly to the board.
The nomination committee, comprising Mr van den Bergh (chairman), Mr Brown and Dr Julius, reviews the composition of the board, taking into account the skills, knowledge and experience of directors and considers and makes recommendations to the board on potential candidates for appointment as directors. The committee also makes recommendations to the board concerning the re-appointment of any independent non-executive director by the board at the conclusion of his or her specified term; the re-election of any director by the shareholders under the retirement provisions of the articles of association; any matters relating to the continuation in office of a director; and the appointment of any director to executive or other office, other than the positions of chairman and group chief executive, the recommendation for which would be made at a meeting of the non-executive directors.
Sir Victor was selected for nomination after a thorough search in which the board was assisted by Egon Zehnder International. The process was led by the senior independent non-executive director, Mr Brown, and the nomination committee for this purpose comprised all the independent non-executive directors. Candidates were interviewed by several directors and the decision was taken by the whole board, on the recommendation of the nomination committee.
In deciding to nominate Sir Victor as chairman, the board considered the provision of the combined code on corporate governance, issued by the Financial Reporting Council, that no individual should be appointed to a second chairmanship of a FTSE 100 company. The board concluded that Sir Victor was an outstanding candidate with exceptional skills, knowledge and experience, both as a FTSE 100 company chairman and in the financial services industry, and in consultation with him, both the Lloyds TSB Group board and the GUS board have agreed that he would be able to devote sufficient time to his roles.
Information about the remuneration committee’s membership and work is given in the directors’ remuneration report on pages 46 to 57 and its terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com.
Number of meetings during the year 9 5 3 7 5
Statement of directors’ responsibilities The directors are required by the Companies Act 1985 to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the Company and the Lloyds TSB Group (‘the Group’) as at the end of the year and of the profit or loss for the year. The directors consider that in preparing the financial statements on pages 59 to 128, the Company and the Group have used appropriate accounting polices, consistently applied and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider applicable have been followed.
Statement from Wolfgang Berndt Recognising that the external reward context is not static and it is good practice to keep our approach under review, we initiated a comprehensive and independent policy review in early 2005. As a result, this has been a particularly busy and challenging year for the remuneration committee. Our focus over the course of seven full meetings has been on leveraging performance and maximising the value of available spend. Ensuring that we have a cost effective and competitive remuneration framework in place plays a critical part in attracting, retaining and motivating a top quality executive team. The timing of this review recognised the expiry of the current executive share option scheme in 2007. Our primary focus has been on reviewing our comparator group, how and from whom we receive independent advice and a review of the remuneration package itself, its components and their balance. A key theme of this work centred on establishing even firmer links between performance and reward and the associated measurements.
• Change the mechanism for determining an executive’s bonus, providing a stronger and more direct link to individual and Group performance.
• Increase the maximum annual bonus opportunity for the group chief executive to 175 per cent of annual salary for exceptional performance, bringing it closer to comparator group practice.
Advisers to the committee Towers Perrin and Kepler Associates were appointed by the committee to advise on matters relating to executive remuneration. Towers Perrin also provides the management of the Group with competitive market data relating to other employees and administrative services for the Group’s employee flexible benefits plan.
The chairman’s remuneration comprises a salary and benefits which are broadly similar to the executive directors, but he does not participate in the annual bonus and long-term incentive arrangements.
The chairman’s salary is reviewed annually, usually in December, taking into account performance and market information (which is provided by Towers Perrin) and then adjusted from 1 January of the following year. His salary from 1 January 2006 is £500,000 and his pension benefits continue to accrue as described on page 52.
The remuneration committee believes that the out-performance of the Group’s TSR compared with those of the companies in the comparator group will demonstrate the success of the Group’s strategy.
If the policy proposal mentioned earlier is approved by the shareholders, further options under the current executive option scheme will not be granted to directors in 2006.
The remuneration committee believes that the out-performance of the Group’s TSR compared with those of the companies in the comparator group will demonstrate the success of the Group’s strategy. The Group’s performance is assessed against the comparator group using data provided by Alithos Limited and PricewaterhouseCoopers LLP checks the results of the testing of the performance conditions.
Under the proposed long-term incentive plan, awards of shares may be made, with the receipt of shares and the number of shares received subject to the satisfaction of two distinct pre-determined performance conditions, measuring performance of the Group over a three year period. 50 per cent of the award will be based on a condition measuring the Group’s TSR against the comparator group. The comparator group will be the same as that used for the current executive share option scheme and performance share plan. In order for the part of the award subject to the TSR condition to vest in full, it will be necessary for the Group’s TSR to exceed the median of the TSR of the comparator group by an average of 7.5 per cent per annum. 8.75 per cent of the award will vest where the Group’s TSR is equal to median and vesting will occur on a straight line basis in between these points. Where the Group’s TSR is below the median of the comparator group, this part of the award will lapse. The remaining 50 per cent will be based on earnings per share (EPS) growth calculated on a compound annualised basis. In order for the award subject to the EPS condition to vest in full, the EPS growth over the performance period must be at least equivalent to an average of the Retail Price Index (RPI) plus 6 per cent per annum. 8.75 per cent of the award will vest where EPS growth is an average of the RPI plus 3 per cent per annum and vesting will occur on a straight line basis in between these points. Where the EPS growth is less than an average of the RPI plus 3 per cent per annum this part of the award will lapse. Awards in any one financial year will not normally exceed three times basic salary at the time of award. In exceptional circumstances this may be increased to up to four times basic salary. Awards will lapse at the end of the performance period to the extent that the performance conditions have not been satisfied. There will be no retesting. The aim of the plan is to deliver shareholder value through linking the receipt of shares to an improvement in the performance of the Group over a three year period.
Mr Brown waived fees payable to him as a director and chairman of Lloyds TSB Group Pension Trust (No.1) Limited and Lloyds TSB Group Pension Trust (No.2) Limited, which totalled £14,000 in 2005 (2004: £nil).
The cash column under ‘other benefits’ includes flexible benefits payments (4 per cent of basic salary), the tax planning allowances for Mr Daniels and Ms Dial, the housing allowance, relocation allowance and pension scheme allowance for Ms Dial, payments to certain directors who elect to take cash rather than a company car under the car scheme, cash balance of pension allowance for Mr Tate and Mrs Weir and an additional payment in respect of the contribution to the separate fund relating to Mr Fairey’s pension. The separate fund, which was mentioned in previous annual reports, was established to cover pension obligations of those who joined the Group after 1 June 1989 and who are subject to the Inland Revenue cap relating to pensions, introduced by the Finance Act 1989.
Ms Dial elected to become a member of a pension scheme for life cover only. She joined Lloyds TSB Group on 1 June 2005. She receives a salary supplement of 20 per cent of basic pay as an alternative to an employer contribution to a pension scheme.
Current directors At 1 January 2005 Granted Exercised/ Exercise periods who served (or later date of during lapsed during At 31 December Exercise during 2005 appointment) the year the year 2005 price From To Notes
March 1996 Growth in earnings per share which is equal to the aggregate percentage change in the retail price index plus two percentage points for each complete year of the relevant period.
March 1997 – August 1999 As for March 1996 plus a further condition that the Company’s ranking based on TSR over the relevant period should be in the top fifty companies of the FTSE 100.
Options granted in 2001 lapsed as the performance conditions had not been met.
A further share plan has been established in connection with the recruitment of Ms Dial as an executive director.
The Lloyds TSB Group executive share plan 2005 was adopted in May 2005, specifically to facilitate the recruitment of Ms Dial. Ms Dial is the only participant in the plan and she became eligible to participate in it when she joined Lloyds TSB Group on 1 June 2005. On that same date, an option was granted to her under the plan to acquire 242,825 ordinary shares in Lloyds TSB Group plc (with a value of £1,100,000 at the date of grant) for a total exercise price of £1. No further options may be granted to her under the plan.
The option is designed to encourage Ms Dial to remain with Lloyds TSB Group plc. Accordingly, the option, which is not subject to any performance conditions, will normally become exercisable only if Ms Dial remains as an employee, and has not given notice of resignation, on 31 May 2008. The option will also be exercisable if Ms Dial ceases to be an employee before that date in certain circumstances described in her service agreement, in which case the options will be exercisable for six months and then lapse. These circumstances include her being entitled to terminate her service agreement without notice by reason of the employer’s conduct or being removed as a director or employee otherwise than in accordance with that agreement. The options may also become exercisable early on a takeover or reconstruction of Lloyds TSB Group plc, if Ms Dial’s service agreement is terminated by Lloyds TSB Group plc due to sickness or injury, or if she dies (in which case her personal representatives would generally have twelve months from the date of death to exercise the option).
No new shares will be issued to satisfy the option under this plan.
To the members of Lloyds TSB Group plc We have audited the consolidated financial statements for the year ended 31 December 2005 which comprise the consolidated income statement, the consolidated balance sheet, the consolidated cash flow statement, the consolidated statement of changes in equity and the related notes. These consolidated financial statements have been prepared under the accounting policies set out therein.
We review whether the corporate governance statement reflects the Company’s compliance with the nine provisions of the 2003 Financial Reporting Council’s Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the group’s corporate governance procedures or its risk and control procedures.
Value of in-force business 26 2,922 4,363 Other intangible assets 27 50 28 Tangible fixed assets 28 4,291 4,180
The directors approved the consolidated financial statements on 23 February 2006.
Purchase/sale of treasury shares – – 8 8 – 8 Employee share option schemes: – value of employee services – – 19 19 – 19 – proceeds from shares issued 10 – – 10 – 10 Change in minority interests – – – – (151) (151)
Restated balance at 1 January 2005 (note 54) 2,564 371 6,554 9,489 81 9,570 Movement in available-for-sale financial assets, net of tax – 8 – 8 – 8 Movement in cash flow hedges, net of tax – 11 – 11 – 11
Net cash (used in) provided by operating activities 53a (331) 12,214 Cash flows from investing activities: Purchase of fixed asset investments (10,088) Proceeds from sale and maturity of fixed asset investments 9,732 Purchase of available-for-sale financial assets (10,108) Proceeds from sale and maturity of available-for-sale financial assets 10,266 Purchase of fixed assets (1,843) (1,565) Proceeds from sale of fixed assets 1,073 698 Acquisition of businesses, net of cash acquired 53e (27) (16) Disposal of businesses, net of cash disposed 53f (4) (25)
Cash flows from financing activities: Dividends paid to equity shareholders (1,914) (1,913) Dividends paid to minority interests 53d (37) (68) Proceeds from issue of subordinated liabilities 53d 1,361 699 Proceeds from issue of ordinary shares and transactions in own shares held in respect of employee share schemes 53d 26 11 Repayment of subordinated liabilities (loan capital) 53d (232) (764) Capital element of finance lease rental payments 53d (2) (1) Change in minority investment in subsidiaries 53d 329 (151)
Cash and cash equivalents at end of year 53b 26,753 28,196
Cumulative translation adjustment The Group has opted to reset the cumulative translation difference on adoption of IFRS to zero.
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial assets, trading securities and other financial assets at fair value through profit or loss and all derivative contracts, on the basis of IFRS as adopted by the EU. IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (‘IASB’) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee and its predecessor body.
Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided. Loan commitment fees for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an adjustment to the effective interest rate on the loan. Loan syndication fees are recognised as revenue when the syndication has been completed and the Group retains no part of the loan package for itself or retains a part at the same effective interest rate for all interest-bearing financial instruments, including loans and advances, as for the other participants.
Debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short-term gains are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from changes in their fair value are recognised in the income statement in the period in which they occur.
Other financial assets at fair value through profit or loss are designated as such by management upon initial recognition. Such assets are carried in the balance sheet at their fair value and gains and losses recognised in the income statement in the period in which they occur. Financial assets are only designated as at fair value through profit or loss when doing so results in more relevant information because it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets or recognising gains or losses on them on a different basis. No use is currently made of the option to designate financial liabilities at fair value through profit or loss.
Loans and advances to banks and customers are accounted for at amortised cost using the effective interest method, except those which the Group intends to sell in the short term and which are accounted for at fair value, with the gains and losses arising from changes in their fair value reflected in the income statement. Loans and advances are initially recognised when cash is advanced to the borrowers at fair value inclusive of transaction costs. Loans and advances are derecognised when the rights to receive cash flows from them have expired or where the Group has transferred substantially all risks and rewards of ownership.
Property held for long-term rental yields and capital appreciation within the long-term assurance funds is classified as investment property. Investment property comprises freehold and long leasehold land and buildings and is carried in the balance sheet at fair value. Fair value is based on active market prices, adjusted, if necessary, for any difference in the nature, location or condition of the specific asset. If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices on less active markets. These valuations are reviewed at least annually by an independent valuation expert. Investment property being redeveloped for continuing use as investment property, or for which the market has become less active, continues to be measured at fair value. Changes in fair values are recorded in the income statement.
Tangible fixed assets are included at cost less depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): • Freehold/long and short leasehold premises: shorter of 50 years or the remaining period of the lease
Operating lease assets are included within fixed assets at cost and depreciated over the life of the lease after taking into account anticipated residual values. Operating lease rental income is recognised on a straight line basis over the life of the lease.
For the Group’s long-term assurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on equity holders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under current UK tax rules.
The Group undertakes both life assurance and general insurance business. The general insurance business issues insurance contracts only. The life assurance business issues insurance contracts and investment contracts. Insurance contracts are those contracts which transfer significant insurance risk. As a general guideline, the Group defines as significant insurance risk the possibility of having to pay benefits on the occurrence of an insured event which are more than the benefits payable if the insured event were not to occur. Investment contracts are those contracts which carry no significant insurance risk.
– life insurance contracts or participating investment contracts which are unit-linked
The Group has an obligation to pay policyholders a specified portion of all interest and realised gains and losses arising from the assets backing participating contracts. Any amounts not yet determined as being due to policyholders are recognised as an unallocated surplus which is shown separately from other liabilities.
The element of premiums and claims in respect of non-participating investment contracts which is invested on behalf of the contract holder is excluded from the income statement, with all movements in the contract holder liability and related assets recorded in the balance sheet. Details of the basis of revenue recognition for the related investment management fees are set out above (see c).
Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (‘the functional currency’). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.
The Group makes assumptions and estimates that affect the reported amounts of assets and liabilities. Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. The accounting policies deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are discussed below.
The principal assumptions relate to the rate of inflation, mortality and the discount rate. The assumed rate of inflation is important because this affects the rate at which salaries grow and therefore the size of the pension that employees receive upon retirement. Over the longer term rates of inflation can vary significantly; at 31 December 2005 it was assumed that the longer term rate of inflation would be 2.7 per cent on average, although if this was increased by 0.2 per cent the net deficit would increase by approximately £600 million and the net cost by approximately £15 million. A reduction of 0.2 per cent would reduce the net deficit by approximately £575 million and the net cost by approximately £20 million.
The overall cost of the benefits payable by the schemes will also depend upon the length of time that members of the schemes live for; the longer they remain alive the higher the cost of the pension benefits to be met by the schemes. Assumptions are made regarding the expected lifetime of scheme members based upon recent experience, however given the rates of advance in medical science it is uncertain whether these assumptions will prove to be accurate in practice. An increase of one year in the expected lifetime of scheme members would increase the net deficit by approximately £450 million and the net cost by approximately £30 million; a reduction of one year reduces the net deficit and the net cost by similar amounts.
The net cost recognised in the income statement is also affected by the expected return on the schemes’ assets. This is determined on the basis of the asset mix within the schemes at the beginning of the year and market expectations for the return on each asset type. During 2005 the assumed return on equities was 8.2 per cent; a 0.25 per cent increase or decrease in the assumed return on equities increases or decreases the expected return reflected in the income statement by approximately £20 million.
Under the Group’s transfer pricing arrangements, inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds. In addition, with effect from 1 January 2005, for those derivative contracts entered into by business units for risk management purposes, the difference between the result that would have been recognised on an accruals accounting basis and the actual result calculated using fair values is charged or credited to the central segment where the resulting volatility is managed.
Impairment losses on loans and advances (676) – 3 3 (193) – – (866) Loss on sale of businesses – – – – (21) – – (21)
Fees and commission income: Current accounts 593 637 Insurance broking 681 672 Credit and debit card services 545 520
Credit protection 173 224 8 Other operating income 2005 2004 £m £m
Non-life insurance Claims and claims paid: – Reinsurers’ share (1) (1)
Staff costs 2,855 2,704 Other administrative expenses: Operating lease rentals 252 249 Repairs and maintenance 136 129 Communications and data processing 467 449
During the year the auditors also earned fees of £0.3 million (2004: £0.3 million) in respect of the audit of pension schemes and unconsolidated open ended investment companies managed by the Group.
Included in ‘Other audited related fees’ are the costs of advice provided in relation to the requirements of the Sarbanes-Oxley Act together with the costs of the audit of the Group’s Form 20-F filing.
The net profit on the disposal of businesses in 2005 principally relates to the sale of the Goldfish credit card business. During the year ended 31 December 2004 the Group completed the sales of its principal businesses in Colombia and substantially all of the businesses of the branches of Lloyds TSB Bank plc in Argentina, Panama, Guatemala and Honduras.
Current tax charge 774 749 Deferred tax (note 39) 491 269
The Group, as a proxy for policyholders in the UK, is required to record taxes on investment income and gains each year. Accordingly, the tax attributable to UK life insurance policyholder earnings is included in income tax expense. The tax expense attributable to policyholder earnings was £298 million (2004: £36 million), including a prior year tax credit of £25 million (2004: £6 million).
The effective tax rate of the Group excluding the gross policyholder tax charge and Open Ended Investment Company interests from profit before tax and the tax charge was 27.0 per cent (2004: 28.3 per cent).
Profit attributable to equity shareholders £2,493m £2,392m Weighted average number of ordinary shares in issue 5,595m 5,590m Adjustment for share options 44m 35m
Weighted average number of ordinary shares for diluted earnings per share 5,639m 5,625m
The weighted average number of anti-dilutive share options excluded from the calculation of diluted earnings per share was 17 million at 31 December 2005 (2004: 39 million).
Investment securities: Treasury bills and similar securities 75 Other eligible bills 13
Geographical analysis by issuer: Latin America 18 Other 74 16 Trading securities and other financial assets at fair value through profit or loss
Trading securities 5,442 Other financial assets at fair value through profit or loss 54,932
These assets are comprised as follows: Other financial assets at fair
Interest rate contracts: Interest rate swaps 288,725 2,814 3,860 Forward rate agreements 50,006 16 20 Options purchased 12,679 108 – Options written 8,812 – 85 Futures 29,358 – –
Trading Exchange rate contracts: Spot, forwards and futures 117,532 4,593 5,237
Equity and other contracts 4,294 538 215 Effect of netting (3,956) (3,956)
Investment securities Government securities 2,211 Bank and building society certificates of deposit 1,901 Corporate debt securities 2,581 Mortgage backed securities 2,774 Other asset backed securities 3,761 Other debt securities 1,140
Geographical analysis by issuer: United Kingdom 17,960 Other European 3,921 North America and Caribbean 2,302 Latin America 384 Asia Pacific 1,470 Other 1,273
Debt securities: Government securities 1,083 Other public sector securities 47 Bank and building society certificates of deposit 1,470 Corporate debt securities 3,036 Mortgage backed securities 4,161 Other asset backed securities 4,981 Other debt securities 29
The investment properties are valued at least annually at open-market value, by an independent, professionally qualified valuer, who has recent experience in the location and categories of the investment properties being valued.
An impairment charge of £6 million (2004: nil) was made during 2005 following a strategic review of a business acquired in previous years.
The recoverable amount of Asset Finance has also been based on a value in use calculation using cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 9 per cent. Due to similarities in the risk profile and the funding model management believes that Asset Finance is closely aligned to Lloyds TSB Group; the discount rate represents the Group’s cost of equity. The cash flows for each of the businesses of Asset Finance beyond the five-year period are extrapolated using steady growth rates, in each case not exceeding 3 per cent nor the long-term average growth rates for the markets in which the respective businesses of Asset Finance participate. Management also believes that any reasonably possible change in the key assumptions on which the recoverable amount of Asset Finance is based would not cause the carrying amount of Asset Finance to exceed its recoverable amount.
The principal subsidiaries involved in the Group’s life assurance operations during 2004 and 2005 were Scottish Widows plc (‘Scottish Widows’, the Group’s principal provider of life assurance, pensions and investment products, which holds the only large With-Profits Fund managed by the Lloyds TSB Group), Scottish Widows Annuities Limited (a subsidiary of Scottish Widows that accepts the reinsurance of annuity business from its parent), Scottish Widows Unit Funds Limited (a subsidiary of Scottish Widows that accepts the reinsurance of unit-linked business from its parent), Abbey Life Assurance Company Limited (‘Abbey Life’) and Lloyds TSB Life Assurance Company Limited (‘Lloyds TSB Life’). Since March 2000 both Abbey Life and Lloyds TSB Life have continued to administer existing policies and have undertaken only limited new business. No change in this activity is anticipated in respect of Abbey Life. On 31 December 2004, Lloyds TSB Life ceased trading and transferred most of its assets and insurance business to Scottish Widows.
The sensitivity of the value of in-force business to changes in these assumptions is included within the disclosures in note 34.
Exchange and other adjustments 1 (3) 63 61 Adjustments on acquisition and disposal of businesses 8 – – 8
Balance sheet amount at 31 December 2004 827 899 2,454 4,180
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2005 and 2004 no contingent rentals in respect of operating leases were recognised in the income statement.
Non-interest bearing current accounts 4,203 3,807 Interest bearing current accounts 40,365 32,157 Savings and investment accounts 62,206 58,773 Other customer deposits 24,296 25,074
Changes to the valuation of options and guarantees primarily reflects emerging best practice in this area.
Lapse rates have been set following a detailed review of the Group’s current and expected experience.
Adverse mortality means that mortality rates are either reduced or increased depending on the class of business – ie reduced for annuities and increased for protection business.
34 Liabilities arising from insurance contracts and participating investment contracts (continued)
Current estimate of cumulative claims 179 224 223 209 211 1,046
The liability of £138 million shown in the above table excludes £9 million of unallocated claims handling expenses.
35 Liabilities arising from non-participating investment contracts 2005 2004 £m £m
Gross unit-linked investment contracts (non-participating) 21,839 Reinsurance (included in other assets) (33)
Present value of scheme liabilities 17,320 14,866 Fair value of scheme assets (14,026) (11,648)
The actual return on scheme assets was £2,377 million (2004: £1,119 million).
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 2000; this valuation has been updated to 31 December 2005 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 6.81 per cent (2004: 6.70 per cent).
Restatement on implementation of IAS 32, IAS 39 and IFRS 4 (779)
Amounts transferred to the income statement: Available-for-sale financial assets – Cash flow hedges 4
Deferred tax assets and liabilities are comprised as follows: 2005 2004 £m £m
Deferred tax liabilities: Accelerated capital allowances 1,358 1,555 Investment reserve 90 90 Unrealised gains 338 59 Tax on value of in-force business 934 1,450 Other temporary differences 250 174
At 31 December 2005 the provisions held mainly related to past sales of mortgage endowment policies. Mortgage endowments were sold to customers through the branch network of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester, and underwritten by life assurance companies within the Group and also by third parties. The principal assumptions that have been made in the calculation of the provision relate to the number of cases that are likely to require redress and the estimated average cost per case. The ultimate cost and timing of the payments remains highly uncertain and will be influenced by external factors beyond the control of management, such as regulatory actions, media interest and the performance of the financial markets. However, it is expected that the majority of the expenditure will be incurred over the next two years.
Dated subordinated loan capital 51/4% Subordinated Notes 2008 (DM 750 million) 274 270 105/8% Guaranteed Subordinated Loan Stock 2008 (£100 million) e 100 100 61/4% Subordinated Notes 2010 (c400 million) 303 281 Subordinated Floating Rate Notes 2010 (US$400 million) a – 207 43/4% Subordinated Notes 2011 (c850 million) 597 582 57/8% Subordinated Guaranteed Bonds 2014 (c750 million) 606 462
b) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until any deferred payments have been made. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares.
g) In the event that these notes are not redeemed at the callable date, the coupon will be reset to a floating rate.
Authorised: Sterling £m £m 6,911 million Ordinary shares of 25p each 1,728 1,728 79 million Limited voting ordinary shares of 25p each 20 20 175 million Preference shares of 25p each* 44
Euro cm 160 million Preference shares of c25 cents each* 40
During 2004 the directors approved the allotment at par of 400 6 per cent non-cumulative redeemable preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a fixed rate non-cumulative preferential dividend at a rate of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company. With effect from 1 January 2005, following the implementation of IAS 39, these instruments have been reclassified as debt.
l) Issued during 2005 primarily to finance the general business of the Group.
Other reserves comprise: Merger reserve 343 343 Revaluation reserve in respect of available-for-sale financial assets 29 Cash flow hedging reserve 11
Retained profits are stated after deducting £73 million (2004: £94 million) repesenting 14 million (2004: 18 million) treasury shares held.
The movements over the year in the cumulative amount of foreign exchange differences taken directly to retained profits are as follows: 2005 £m
The dividends paid in the year were as follows: Final dividend in respect of preceding year 23.5 23.5 1,315 1,314
During the year ended 31 December 2005 the Group operated the following share based payment schemes, all of which are equity settled.
March 2000 – March 2001 As for March 1997 – August 1999 except that there must have been growth in the earnings per share equal to the change in the Retail Price Index plus three percentage points for each complete year of the relevant period.
Options granted to senior executives other than executive directors are not so highly leveraged and as a result, different performance multipliers are applied to their options. For the majority of executives, options are granted with the performance condition but no performance multiplier.
Movements in the number of share options outstanding under the Save-As-You-Earn schemes are set out below: 2005 Weighted average 2004 Weighted average
The weighted average share price at the time that the options were exercised during 2005 was 465.51 pence (2004: 427.55 pence). The weighted average remaining contractual life of options outstanding at the end of the year was 2.2 years (2004: 2.9 years).
The weighted average remaining vesting period as at 31 December 2005 was nil (2004: nil). No options were exercisable at 31 December 2005.
Number of exercise price Number of exercise price options (pence) options (pence)
Outstanding at 1 January 206,647 Nil – – Granted during the year 62,271 Nil 206,647 Nil
The fair value of the matching element of the performance shares awarded during 2005 was £1.78.
Weighted Weighted Weighted Weighted Weighted Weighted average average average average average average exercise remaining Number of exercise remaining Number of exercise remaining Number of 31 December 2005 price (pence) life (years) options price (pence) life (years) options price (pence) life (years) options
Weighted Weighted Weighted Weighted Weighted Weighted average average average average average average exercise remaining Number of exercise remaining Number of exercise remaining Number of 31 December 2004 price (pence) life (years) options price (pence) life (years) options price (pence) life (years) options
The weighted average fair value of options granted during the year was £0.67 (2004: £0.47) for executive options and £0.98 (2004: £0.92) for Save-As-You-Earn options. The values for executive options have been determined using a binomial model that uses a stochastic projection model to determine the effect of the market based conditions. The values for the SAYE options have been determined using a standard Black-Scholes model. The fair value calculations are based on the following assumptions: Other share Executive SAYE option plans
Expected dividend yield 7.0% 7.4% 7.3% Weighted average share price £4.74 £4.76 £4.59 Weighted average exercise price £4.74 £3.80 Nil
The table below details, on an aggregated basis, key management personnel compensation: 2005 2004 £m £m
Compensation Salaries and other short-term benefits 11 10 Post-employment benefits 3 3 Termination benefits – 1 Share based payments 2 2 million million
LLOYDS TSB GROUP 105 49 Related party transactions (continued) 2005 2004 £m £m
At 31 December 2005, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £3 million with seven directors and their connected persons (2004: £3 million with four directors and their connected persons).
At 31 December 2005, the Group’s pension funds had call deposits with Lloyds TSB Bank plc amounting to £14 million (2004: £14 million).
In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed to properly assess the merits of the case. No provisions are held against such cases, however the Group does not currently expect the final outcome to have a material effect upon the Group’s financial position.
Lloyds TSB Group’s maximum exposure to loss is represented by the contractual nominal amount detailed in the table below. Consideration has not been taken of any possible recoveries from customers for payments made in respect of such guarantees under recourse provisions or from collateral held.
The interest rate risk arising from the Group’s retail banking activities is managed centrally in part by the use of internal interest rate swaps. For accounting purposes IAS 39 does not permit the use of internal derivatives in hedge relationships and although economically the position is hedged this leads to volatility in the income statement. In response to this the Group has created a function the purpose of which is to establish accounting hedge relationships in order to reduce the volatility arising in the income statement.
Liabilities arising from insurance and investment contracts – – – – – 62,907 62,907
Liabilities arising from insurance contracts – – – – – 53,651 53,651
Cumulative interest rate repricing gap (40,945) (40,443) (23,061) 23,049 34,760 – –
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to Group Treasury. Group Treasury calculates the associated VaR and the closing, average, maximum and minimum for 2004 and 2005 are disclosed on page 30.
Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the foreign currency exchange equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to retained earnings.
Loans and advances to banks 31,656 Loans and advances to customers 177,016 Deposit amounts available for offset1 (6,414) Impairment losses (2,073)
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. These customer deposits are supplemented by the issue of subordinated loan capital and wholesale funding sources in the capital markets, including deposits taken on the inter-bank market, certificates of deposit, sale and repurchase agreements, a Euro Medium-Term Note programme and a commercial paper programme.
The table below analyses assets and liabilities of the Group into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
Because a variety of estimation techniques are employed and significant estimates made, comparisons of fair values between financial institutions may not be meaningful. Readers of these accounts are thus advised to use caution when using this data to evaluate the Group’s financial position.
The valuation technique and fair values for derivative financial instruments are disclosed in note 17; the valuation technique for each other major category of financial instrument is discussed below.
The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits and customer accounts is estimated using discounted cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.
The Group considers that, given the lack of an established market, the diversity of fee structures and the difficulty of separating the value of the instruments from the value of the overall transaction, it is not meaningful to provide an estimate of the fair value of financial commitments and contingent liabilities. These are therefore excluded from the following table. Carrying value Carrying value Fair value Fair value £m £m £m £m
During 2005 the Group, through its subsidiary The Dutton-Forshaw Motor Company Limited, completed the purchases of the assets and trade of three separate motor dealership businesses for a total consideration of £16 million, settled in cash. Goodwill of £3 million arose on these acquisitions; no significant fair value adjustments were made.
d Analysis of changes in financing during the year 2005 2004 £m £m
Share capital (including premium and merger reserve): Issue of share capital 26 10
Minority interests: Adjustments on adoption of IAS 32, IAS 39 and IFRS 4 (550)
At 1 January – restated 81 Exchange and other adjustments – 1 Capital invested by minority shareholders 329 – Repayment of capital to minority shareholders – (151) Minority share of profit after tax 62 67 Payments to minority shareholders (37) (68)
At 1 January – restated 11,232 Exchange and other adjustments 59 (136) Issue of subordinated liabilities 1,361 699 Repayments of subordinated liabilities (232) (764) Lease financing – 6 Finance lease capital repayments (2) (1)
e Acquisition of group undertakings and businesses 2005 2004 £m £m
f Disposal and closure of group undertakings and businesses 2005 2004 £m £m
Cash and cash equivalents – 46 Loans and advances to banks – 132 Loans and advances to customers 803 257 Debt securities and treasury bills – 59
Cash and cash equivalent consideration received – 21 Cash and cash equivalents disposed of – (46)
IFRS also requires consolidation of several entities that the Group was not required to consolidate under UK GAAP including companies supporting the Group’s securitisation conduits, which facilitate customers’ own securitisations, and Open Ended Investment Companies (OEICs) and unit trusts where the Group, through the Group’s life funds, has a controlling interest.
IFRS requires property, plant and equipment to be depreciated from the date of acquisition. Under UK GAAP, long leasehold and freehold properties have been depreciated only since 1 January 2000 and therefore it is necessary to adjust their carrying values to reflect the depreciation that would have been charged from the date of acquisition to 1 January 2000.
Accounting changes effective from 1 January 2005 and which do not affect 2004 comparatives: Fees integral to effective yield (IAS 18, IAS 39)
IFRS prohibits financial assets and financial liabilities from being offset unless there is a legal right of set-off and the asset and liability are in practice normally settled, or there is an intention to settle, on a net basis. In the banking business, this has resulted in the grossing-up on the balance sheet of certain assets and liabilities subject to set-off arrangements that were presented net under UK GAAP.
Following the implementation of FRS 27, the Group excludes from the value of in-force business recognised in the balance sheet any amounts that reflect future investment margins and measures the liabilities of the Scottish Widows With-Profits Fund in accordance with the realistic capital regime of the Financial Services Authority. This basis includes a realistic valuation of guarantees and options embedded within products written by the With-Profits Fund. The principal effect of these new requirements is on the measurement of the in-force business, as the valuation of the With-Profits Fund on a realistic basis reduces the expected income to the shareholder from that fund. Changes in the valuation are reflected in the income statement and because this is market related it is inherently volatile.
The effect of these changes is set out below. As previously Value of in-force Other reported business adjustments Restated £m £m £m £m
For the year ended 31 December 2004 Profit before tax 3,495 (18) – 3,477
UK Insurance New Employee Unit GAAP business entities Leasing benefits Software trusts Goodwill Dividend Other IFRS
Assets Cash and balances at central banks 1,195 – – – – – – – – – 1,195 Items in the course of collection from banks 1,447 – – – – – – – – – 1,447 Treasury bills and other eligible bills 539 – – – – – – – – – 539 Loans and advances to banks 15,547 4,948 1,649 – – – – – – (2) 22,142 Loans and advances to customers 135,251 (137) 1,178 (178) – – – – – (1) 136,113
Investment property – 3,551 – – – – – – – – 3,551
Other reserves 343 – – – – – – – – – 343
Intangible assets – – – – – 28 – – – – 28
Deposits from banks 39,738 – – – – – – – – (15) 39,723
Subordinated liabilities 10,252 – – – – – – – – – 10,252
Share capital 1,419 – – – – – – – – – 1,419
Share premium account 1,145 – – – – – – – – – 1,145
Other finance income 39 – – – (39) – – – – –
Dealing profits 271 – – – – – – – (271) –
Amortisation of goodwill (44) – – – – – – 44 – –
Restated Effective 31 December Reclassi- interest Impair- Available- Debt/ 1January 2004 fications rates ment Offset Derivatives for-sale Insurance equity Other 2005 £m £m £m £m £m £m £m £m £m £m £m
Debt securities 43,485 (43,485) – – – – – – – –
Investment property 3,776 – – – – – – – – – 3,776
Unallocated surplus within insurance business 1,362 – – – – – – (936) – – 426
Retirement benefit obligations 3,075 – – – – – – – – – 3,075
Interpretation provides guidance for determining whether arrangements comprising transactions that do not take the legal form of a lease but convey a right to use an asset contain leases that should be separately accounted for.
Introduces additional disclosures of the objectives, policies and processes for managing capital, quantitative data about what the entity regards as capital, and compliance with capital requirements.
*Amendment to IAS 1 Presentation of Financial Statements – Capital Disclosures
Permits actuarial gains and losses to be recognised outside profit and loss where those gains and losses are recognised in the period in which they occur, more clearly distinguishes between multi-employer plans and defined benefit plans between entities under common control, and requires additional disclosures about trends in the assets and liabilities in a defined benefit plan and the assumptions underlying the components of the defined benefit cost.
Our responsibility is to audit the parent company financial statements and the part of the directors’ remuneration report to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). This report, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with Section 235 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Assets Non-current assets: Investment in subsidiaries 7 5,589 5,589 Loans to subsidiaries 7 1,723 1,723 Deferred tax assets 2 21 15
Equity and liabilities Capital and reserves: Share premium account 4 1,170 1,145
Maarten A van den Bergh J Eric Daniels Helen A Weir Chairman Group Chief Executive Group Finance Director 122 LLOYDS TSB GROUP
Share capital Retained and premium profit Total £ million £ million £ million
Restated balance at 1 January 2005 (note 8) 2,564 2,026 4,590
Employee share option schemes: – value of employee services – 47 47
Cash flows from investing activities: Disposal of businesses, net of cash disposed – 1
Cash and cash equivalents comprise cash and amounts due from banks with a maturity of less than three months.
Further information on the principal differences between IFRS and the parent company’s previous accounting policies and the effect of their adoption on the parent company’s previously published information is given in note 8.
Restatement on implementation of IAS 32, IAS 39 and IFRS 4 (12)
Details of the Company’s share capital and share premium account are as set out in notes 42 and 43 to the consolidated accounts.
These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer.
In addition the parent company carried out all of its banking activities through its subsidiary, Lloyds TSB Bank plc. At 31 December 2005, the parent company held deposits of £107 million with the bank (2004: £208 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. In addition, at 31 December 2005 the parent company had interest rate and currency swaps with Lloyds TSB Bank plc with an aggregate notional principal amount of £1,379 million and a positive fair value of £188 million, designated as fair value hedges.
§ At the callable date the coupon on these bonds will be reset by reference to the applicable five year benchmark gilt rate.
In addition the parent company’s investment in subsidiaries, which under UK GAAP was revalued to an amount equal to the net assets of the underlying subsidiaries, is now carried at historical cost (less any provisions for impairment).
Restated parent company balance sheet (reconciliation of equity) at 31 December 2004 (excludes the effect of IAS 32 and IAS 39)
Restated parent company balance sheet (reconciliation of equity) at 1 January 2005 (includes the effect of IAS 32 and IAS 39)
Total equity and liabilities 7,766 159 7,925 9 Approval of the financial statements and other information
A full range of dealing services is available through Lloyds TSB Registrars.
For internet dealing, the current rate of commission for both purchases and sales is 0.5%: minimum £17.50. Visit www.shareview.co.uk/dealing for full details.
Final date for joining or leaving the dividend reinvestment plan for the interim dividend 4 October