Building our business
Annual Report and Accounts
2005
Forward looking statements
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
to events and depend upon
circumstances that will occur in the future.
relate
Examples of such forward looking statements
include, but are not limited to, projections or
expectations of profit attributable to shareholders,
provisions, economic profit, dividends, capital
structure or any other financial items or ratios;
statements of plans, objectives or goals of
Lloyds TSB Group or its management; statements
about the future trends in interest rates, stock
market levels and demographic trends and any
impact on Lloyds TSB Group; statements
concerning any future UK or other economic
environment or performance including in particular
any such statements included in this annual
strategic goals,
report;
competition,
and
consolidation or technological developments in the
financial services industry and statements of
assumptions underlying such statements.
statements about
dispositions
regulation,
interest
inflation,
internationally;
Factors that could cause actual results to differ
materially from the plans, objectives, expectations,
estimates and intentions expressed in such forward
looking statements made by Lloyds TSB Group or
on Lloyds TSB Group’s behalf include, but are not
limited to, general economic conditions in the UK
and
rate,
exchange rate, market and monetary fluctuations;
changing demographic developments, adverse
weather and similar contingencies outside the
Lloyds TSB Group’s control; inadequate or failed
internal or external processes, people and systems;
terrorist acts and other acts of war or hostility and
responses to those acts; changes in laws,
regulations or taxation; changes in competition and
pricing environments; the ability to secure new
customers and develop more business from
existing customers;
to achieve
value-creating mergers and/or acquisitions
at the appropriate time and prices and the success
of the Lloyds TSB Group in managing the risks
of the foregoing.
the ability
Lloyds TSB Group plc may also make or disclose
written and/or oral forward looking statements in
reports filed with or furnished to the Securities and
Exchange Commission (‘SEC’), Lloyds TSB Group
plc’s annual review, proxy statements, offering
circulars, prospectuses, press releases and other
written materials and in oral statements made by
the directors, officers or employees of Lloyds TSB
Group plc to third parties, including financial
analysts. The
looking statements
contained in this annual report are made as of the
date hereof, and Lloyds TSB Group undertakes
no obligation to update any of its forward
looking statements.
forward
Contents
Forward looking statements
2005 highlights
Chairman’s statement
Group chief executive’s review
Corporate responsibility
The businesses of Lloyds TSB
Operating and financial review and prospects
Five year financial summary
The board
Directors’ report
Corporate governance
Directors’ remuneration report
Report of the independent auditors on the consolidated financial statements
Primary consolidated financial statements
Notes to the group accounts
Report of the independent auditors on the parent company financial statements
Parent company primary financial statements
Notes to the parent company accounts
Information for shareholders
3
4
7
10
12
14
39
40
42
43
46
58
59
64
121
122
125
129
LLOYDS TSB GROUP 1
We are building our business by…
Deepening customer relationships
Improving customer service
Improving processing efficiency
Delivering earnings momentum
Statutory
profit before
tax £m
Income and
cost growth
2005*
+10%
+7%
Profit
before tax
£m*
+9%
Economic
profit
£m*
+14%
Return
on equity*
Customer
service
index
Employee
engagement
index
22.2%
23.3%
65.0% 66.6%
69
4
0
0
2
74
5
0
0
2
74
0
3,726
3,432
1,620
1,417
4
0
0
2
5
0
0
2
4
0
0
2
5
0
0
2
4
0
0
2
5
0
0
2
4
0
0
2
5
0
0
2
3,820
3,477
4
0
0
2
5
0
0
2
+4%
s
t
s
o
C
e
m
o
c
n
I
* 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.
2 LLOYDS TSB GROUP
2005 highlights
Profit before tax
Results – statutory
By division
Profit before tax increased by £343 million,
or 10 per cent, to £3,820 million.
Profit attributable to equity shareholders
increased by £101 million, or 4 per cent, to
£2,493 million.
Earnings per share increased by 4 per cent
to 44.6p.
Post-tax return on average shareholders’
equity increased to 25.6 per cent, from
22.8 per cent.
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.
Results – comparable basis
Profit before tax increased by £146 million,
or 4 per cent, to £3,466 million.
Excluding customer redress provisions and
the strengthening of reserves for mortality
Profit before tax increased by £294 million,
or 9 per cent, to £3,726 million.
Income growth of 7 per cent exceeded cost
growth of 4 per cent.
Earnings per share increased by 11 per cent
to 47.2p.
Economic profit increased by 14 per cent to
£1,620 million.
Post-tax return on average shareholders’
equity increased to 23.3 per cent, from
22.2 per cent.
2005
£ million
2004
£ million
UK Retail Banking
– Before provisions for customer redress
– Provisions for customer redress
Insurance and Investments
– Before provisions for customer redress and
strengthening of reserves for mortality
– Provisions for customer redress
– Strengthening of reserves for mortality
Wholesale and International Banking
Central group items
Profit before tax – comparable basis
Volatility*
Other IFRS adjustments applied from 1 January 2005**
– Before strengthening of reserves for mortality
– Strengthening of reserves for mortality
Profit (loss) on sale and closure of businesses†
Trading results of discontinued operations in 2004††
Profit before tax
Earnings per share
1,681
(150)
1,531
908
–
(110)
798
1,504
(367)
3,466
625
(276)
(45)
(321)
50
–
3,820
44.6p
1,739
(100)
1,639
790
(12)
–
778
1,253
(350)
3,320
138
–
–
–
(21)
40
3,477
42.8p
* Volatility relates to Insurance and Investments (2005: £749 million, 2004: £138 million) and Central group items (2005:
£(124) million, 2004: nil).
** Other IFRS adjustments applied from 1 January 2005 relate to UK Retail Banking (£(213) million), Insurance and Investments
(£(73) million), Wholesale and International Banking (£20 million) and Central group items (£(55) million).
† Profit (loss) on sale and closure of businesses relates to UK Retail Banking (2005: £76 million, 2004: nil), Wholesale and International
Banking (2005: £(6) million, 2004: £(21) million) and Central group items (2005: £(20) million, 2004: nil).
†† Trading results of discontinued operations in 2004 relates to Wholesale and International Banking.
Presentation of information
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’
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
impact of
implementing IFRS on comparative information
was published in the Group’s ‘Transition to
IFRS’ announcement on 27 May 2005.
information on
the
The impact of IFRS, and in particular the
increased use of fair values, has resulted in
greater earnings volatility. In order to provide a
more comparable representation of business
performance this volatility has been separately
analysed for the Group’s insurance and
banking businesses. In addition, other IFRS
related adjustments applied with effect from
1 January 2005, for which comparatives are
not required to be restated, the profit (loss) on
sale and closure of businesses and the impact
on the Group’s results of businesses sold in
2004 have been separately analysed in the
Group’s results. A reconciliation of this
‘comparable’ basis of presentation to the
statutory profit before tax is shown on this page.
LLOYDS TSB GROUP 3
Chairman’s statement
2005 was a successful year for the Lloyds TSB
Group, as we continue to build our business
and deliver good earnings momentum. Each
division has again delivered revenue growth in
excess of cost growth, costs have remained
firmly under control and overall credit quality
has remained satisfactory. Above all the Group
has made substantial progress in the execution
of its organic growth strategy focused on
improving and deepening relationships with
our personal and business customers.
introduced by
Over the last two years the changes that have
been
the Group’s new
management team have addressed the
significant external challenges of competition
regulation and have substantially
and
improved the outlook for the Group. There is
plenty of scope for organic growth in our
chosen markets and our aim is to attract more
of the business that our customers have with
other financial services companies. We want
to be the most successful company in the UK
financial services industry.
I am proud of what this Group has achieved
in a very short space of time; wherever I go
in the business we are making substantial
progress.
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.
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
financial
advisers. We have achieved higher levels of
new business profitability and have improved
our market share of new business.
independent
through
In Wholesale and International Banking we
have streamlined our international portfolio of
businesses to focus on leveraging our strong
customer relationships with business and
corporate customers. As a result we have
delivered excellent levels of profit growth and
made great progress in delivering our strategy to
build an integrated wholesale bank.
Whilst we have made considerable progress,
we are not resting on our laurels. We know we
have to continue to produce good levels of
earnings growth and strong results. Going
forward, the main thrust of our strategy will be
continuing to invest in our businesses to
deliver revenue growth through gaining
new customers, deepening our relationship
with customers, and leveraging the strength of
our brands and our multi-channel distribution
capability, whilst at the same time continuing
to improve the products and services that we
offer to our customers. In addition we will
4 LLOYDS TSB GROUP
further improve our processing efficiency and
seek to reduce day-to-day operating costs.
By focusing on this clearly articulated strategy
I believe the Group can continue to deliver a
strong return on equity together with good
levels of economic profit growth. Over the last
few years we have substantially improved the
quality of the Group’s earnings and have
re-established satisfactory levels of earnings
growth. As a result, during 2005 we delivered
a total shareholder return (share price
appreciation plus dividends) of 10.9 per cent.
Economic outlook
Whilst the economic outlook for the UK
remains dependent on events that unfold in the
global economy, we expect economic growth to
increase slightly in 2006 to just over 2 per
cent. Interest rate changes are expected to
remain modest. Consumer spending, which
was the major factor behind the economic
slowdown in the UK in 2005, is showing some
signs of recovery, although we expect only a
modest recovery during 2006. The mortgage
market should remain reasonably healthy,
although personal borrowers are expected to
continue to cut back on unsecured borrowing.
The regulatory burden upon the UK financial
services industry continues to be a major
concern. The adoption of
International
Financial Reporting Standards, compliance
with Sarbanes-Oxley and preparations for the
introduction of the Basel capital adequacy
regime have all been time consuming and
expensive. We welcome signs that notice is at
last being taken of the extent of this regulatory
burden. We shall, however, wait to see
whether de-regulation initiatives, announced
by both the UK Government and the European
Commission, have any material impact upon
the significant burden faced by the industry.
The UK financial services industry is one of
the great success stories of the last 20 years
and great care must be taken to ensure that
the conditions remain in place for this success
story to continue.
Capital and dividend
During 2005 Lloyds TSB has continued to
maintain robust capital ratios and remains
one of the very few banks in the world with an
‘Aaa’ long-term debt rating from Moody’s, the
credit rating agency. In addition, Scottish
Widows remains one of the strongest
capitalised life assurance companies in the
UK, and the repatriation of £1 billion of
surplus capital from Scottish Widows to the
Group during 2005 shows the significant
improvements that have been made in the
capital management of Scottish Widows over
the last few years.
The board has decided to maintain the final
dividend at 23.5p per share, making a total
for the year of 34.2p (2004: 34.2p). This
represents a yield of 7.0 per cent calculated
using the 31 December 2005 share price
of 488.5p.
Community
Lloyds TSB remains one of the UK’s largest
corporate givers, principally through the
excellent work of
the Lloyds TSB
Foundations who made grants to charities of
over £30 million in 2005.
Staff
The Lloyds TSB Group is all about people and
in my five and a half years as chairman I have
them.
enjoyed meeting so many of
Throughout our businesses, our employees
are the Group’s ambassadors – I am extremely
proud of them all and am truly grateful
for their continuing efforts, without which
the Group could not have made such
considerable recent progress. We are a service
company and I am certain that improved
levels of customer service will lead to
improved sales performance.
Board changes
Since the 2005 annual general meeting, we
have welcomed three directors to the board.
Terri Dial was appointed as Group Executive
Director, UK Retail Banking in June and
Jan du Plessis and Lord Leitch joined us
as
independent non-executive directors
in October.
As previously announced, I shall be retiring as
chairman at the annual general meeting in
May and I am delighted that Sir Victor Blank
will be succeeding me. He will join the board
in March as Deputy Chairman. The board
carefully considered the provisions of the
combined code on corporate governance
when nominating Sir Victor as my successor.
Outlook
We are making good progress in meeting our
corporate objectives of achieving sustainable
earnings growth, strong cost control, high
levels of customer and staff satisfaction,
satisfactory asset quality and balance sheet
efficiency and strength. As the board looks to
the future, the increasing momentum in our
businesses, supported by new revenue growth
initiatives, gives us
and cost control
confidence that Lloyds TSB can achieve its
objective of being the leading financial
services company in the UK.
I have thoroughly enjoyed my time in the
banking industry. I know that Lloyds TSB is in
great hands and I wish my colleagues all the
very best for the future.
Maarten van den Bergh
Chairman
23 February 2006
In Retail Banking we will earn the right to meet
100% of our customers’ financial services needs
Income and
cost growth
2005*
+4%
Customer
deposits
£bn*
+7%
Group
mortgage
balances
£bn*
Target
customer
recruitment
000s
+10%
+28%
66.3
71.0
88.4
80.1
e
m
o
c
n
I
+1%
s
t
s
o
C
4
0
0
2
5
0
0
2
4
0
0
2
5
0
0
2
222
5
0
0
2
173
4
0
0
2
* Comparable basis – excluding impact of volatility,
other IFRS adjustments applied from 1 January 2005
and discontinued operations. Also excludes provisions
for customer redress.
LLOYDS TSB GROUP 5
In Insurance and Investments our focus is on
profitability and returns, combined with strong
new business sales
Income and
cost growth
2005*
+11%
+5%
s
t
s
o
C
e
m
o
c
n
I
Estimated
market
share of life,
pensions and
investments
New
business
margin
New business
contribution
£m
6.2%
28.6% 29.7%
+19%
5.7%
4
0
0
2
5
0
0
2
4
0
0
2
5
0
0
2
224
5
0
0
2
188
4
0
0
2
* 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.
6 LLOYDS TSB GROUP
Group chief executive’s review
2005 was a good year for the Group, both in
terms of our financial performance and, as
importantly, in making further progress in the
development of our organic growth strategy.
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.
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.
In terms of delivering the Group strategy, we
have established better sales momentum and
stronger levels of customer acquisition in our
banking businesses and delivered good sales
growth in our life assurance business over the
course of the year. Our market shares are
either stable, or growing, in most of our key
product lines. Most importantly, our customer
relationship programmes are being effectively
implemented and we are delivering higher
revenues per customer in our retail and
corporate banking businesses.
reserves
redress provisions and
We have significantly enhanced our productivity,
as the quality programmes that we commenced
in 2003 continue to show improving results.
This is reflected in our cost:income ratio
which, on a comparable basis and excluding
customer
the
strengthening of
for mortality,
improved to 52.7 per cent, from 54.3 per cent
in 2004, and I am pleased that we have
achieved this whilst continuing to invest
substantially in the business. Our customer
satisfaction scores hit record highs in 2005,
again reflecting the improvement programmes
established over the last couple of years, and
we will continue to drive further improvements
as we seek to differentiate our service
performance against that of our competitors.
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.
Our employee engagement scores have also
the year,
improved significantly during
indicating that our people understand and are
committed to our strategy, and we have
improved our performance management
processes in support of the Group strategy. We
also strengthened our senior management
team, with the addition of key hires in the
Retail Bank.
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
In the Retail Bank, income grew 4 per cent
whilst costs rose by just 1 per cent, on a
comparable basis and excluding customer
redress provisions. This led to 7 per cent
growth in the trading surplus which was
offset by an increase in the charge for
impaired lending, reflecting an increase in
customers experiencing repayment difficulties.
Profit before tax reduced by 3 per cent. To
reflect the general slowdown in the consumer
credit markets, a number of actions were
taken over the course of the year to tighten
credit underwriting.
It is not in the interests of the individual
customer or the Group to lend money to a
customer who cannot afford to repay. The
Group takes its responsibilities in this regard
very seriously and has a responsible lending
programme,
to ensure we help our
customers clearly understand the nature of
the agreements they are entering into and
we confirm affordability before agreeing to
any borrowing requests. Where customers
do experience repayment difficulties, our
staff are trained to offer the necessary
advice and support to manage their finances
and we have a Customer Support Unit,
whose role it is to identify customers who are
showing early signs of financial difficulty
so that we can provide early advice and
support to them.
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.
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.
redress provision and
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
the
for mortality,
strengthening of
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.
reserves
Scottish Widows delivered a significant
increase in sales as we focused on more
profitable and more capital efficient business
lines. This led to a 19 per cent increase in
new business contribution. Bancassurance
sales grew by 13 per cent despite a slowdown
seen in the levels of mortgage related
protection business. The sales of OEICs
increased by 72 per cent, building on the
launch of the simplified product suite that was
introduced at the end of 2004.
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
in 2005, compared to
of 6.8 per cent
5.9 per cent last year.
We have also invested in the development of
new pensions and life platforms, and continue
to develop our distribution capabilities. We
remain well placed to benefit from the
anticipated growth in savings and investment
product sales over the coming years. The new
life platform has already supported the launch
of the new partnership with Virgin Money.
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.
to both
delivering
development,
Our General Insurance business continued its
successful
a
22 per cent growth in profits, supported by
the claims and
improvements
combined ratios. The results reflect continued
successful cross-sales to franchise customers
in both retail and business banking as well as
continued
service
performance, direct channel business and
claims processing.
investment
in our
LLOYDS TSB GROUP 7
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.
Turning to 2006, our objective across each of
the divisions is to continue to improve sales
performance and deepen our customer
relationships, which will result in market share
growth. To support our efficiency and
productivity objectives, we will continue
to
centralisation and
industrialisation of our manufacturing
capabilities, take the next steps in our
procurement programme and further embed
our quality approach throughout the Group.
focus on
the
In support of our customer objectives, we
have set stretching customer satisfaction
targets and will continue to develop our
products, policies and procedures in line with
those targets. Our strong risk and control
infrastructure remains an important element of
our growth strategy and will be further
enhanced as we seek to develop risk into a
differentiating competency. We will also
continue to focus on the development of our
staff, whilst aiming
for even stronger
engagement scores.
In summary, 2005 was a good year for the
Group. We delivered on our short-term
financial goals whilst also investing in the
long-term health of the business, which is
necessary to drive sustainable future earnings
growth. This is our last set of results under the
chairmanship of Maarten van den Bergh and
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.
Continuing to grow a successful business is
the best way for Lloyds TSB to create value
for all our stakeholders and to contribute to
the wider economy. We maintain one of the
largest community investment programmes
in the UK, supporting our customers and
staff, and making a significant contribution to
the local communities in which we operate.
Since 1997, the Lloyds TSB Foundations
have received over £250 million from the
Group’s pre-tax profits to distribute to
community groups and in 2006 they will
receive in excess of £30 million.
Finally, I would like to express my continued
thanks to all of the staff who work for the
Lloyds TSB Group. They remain committed to
serving the needs of our customers and their
wonderful efforts are the key element to our
continued success.
J Eric Daniels
Group Chief Executive
23 February 2006
Group chief executive’s review
In Wholesale and International Banking, our
results show excellent progress in our core
businesses and the division delivered a
20 per cent improvement in profit before tax,
on a comparable basis, at the same time as
improving returns. The good results were
achieved by the successful implementation of
our strategies in Business Banking and
Corporate Markets, and these businesses will
continue to provide the platform for profitable
growth in the division. We again maintained
our management discipline of positive jaws,
with the rate of growth in income increasing
by 10 per cent whilst costs grew by
7 per cent, partly reflecting the increase in
investment costs necessary to fund the
ongoing development of the division.
In Business Banking, we have again reported
strong franchise growth winning increasing
numbers of new customers both through
attracting profitable ‘switchers’ from other banks
and by cementing our position as the leader
in the business start-ups market with a share of
22 per cent. We have continued to build stronger
relationships with our customers, as we satisfy
more of their needs, and this has been reflected
in good balance growth in both customer
lending and deposits, as well as fee income.
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,
8 LLOYDS TSB GROUP
In Wholesale and International Banking we are
growing our earnings by deepening relationships
with our customers
Income and
cost growth
2005*
+10%
+7%
e
m
o
c
n
I
s
t
s
o
C
Post-tax return
on risk-weighted
assets*
Corporate
Markets profit
before tax
£m*
1.41%
1.50%
+31%
958
5
0
0
2
732
4
0
0
2
4
0
0
2
5
0
0
2
0.0
Market share
of Business
Banking
start-ups
22%
19%
4
0
0
2
5
0
0
2
* Comparable basis – excluding impact of volatility,
other IFRS adjustments applied from 1 January 2005
and discontinued operations.
LLOYDS TSB GROUP 9
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.
functions. The committee meets quarterly to
recommend strategy and provide direction.
The board
corporate
responsibility performance annually and
individual
to board
issues are subject
discussion throughout the year.
reviews overall
Corporate responsibility
Our corporate vision is to make Lloyds TSB the
best financial services company, firstly in the
UK then across borders.
Our corporate responsibility strategy is to help
achieve our corporate vision by building a
great place for our people to work, a great
place for our customers to do business, and
generating great returns for our shareholders.
In so doing, we believe we create value for all
our stakeholders.
We have strong evidence that there is a clear
link between employee satisfaction and
customer satisfaction, which in turn leads to
improved financial performance.
The business case for corporate responsibility
is clear. Good management of corporate
responsibility risks and opportunities is
to delivering a successful
fundamental
business.
A great place for our people to work
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
• inspiring leadership from top management
• the extent to which staff believe Lloyds TSB
is highly regarded
• creating a culture where people feel involved
and understand how their work contributes
to the Group’s overall success
• the extent to which the Group is seen
as being socially and environmentally
responsible and ethical in its operations
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
finance
unions and other community
initiatives. We have opened 348,000 basic
bank accounts for customers since 2003.
A great return for our shareholders
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.
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
the
suppliers,
the
environment and
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.
By adopting these corporate responsibility
policies we aim to provide a better return for
our shareholders.
Our employee engagement scores have
reached record levels this year.
Balanced scorecard
We have developed award-winning
programmes in the areas of training and
development, career management, work-life
balance, diversity and community involvement.
A great place for our customers to do
business
We are committed to deepening relationships
with our customers by understanding and
meeting their needs. We measure our
customers’ satisfaction with our service and
track our progress through our ‘CARE Index’
which is based on information obtained from
over 10,000 interviews with customers each
month. The ‘CARE Index’ reached its highest
ever level in 2005.
Staff performance is measured using a
balanced scorecard that takes account of the
needs of customers, employees and
shareholders. All staff have objectives which,
in addition to financial performance measures,
include building the business in the longer
term, customer service, risk management and
people development. Where
relevant,
management remuneration and incentives are
linked directly to specific areas of corporate
responsibility, such as service quality.
Corporate responsibility management
Our corporate responsibility steering group is
chaired by the deputy group chief executive
and comprises senior executives from all
group
business divisions and
relevant
10 LLOYDS TSB GROUP
We have been developing a management
framework for corporate responsibility that
ensures we have:
• a clear and constant purpose, helping us to
focus on the delivery of results;
• a focus on customers and how we can create
value by better meeting their needs;
• a systematic application of processes and
fact-based assessments to manage our
business and
to make our strategic
decisions;
• the ability to identify what we need to do to
develop our people and maximise their
potential;
• the scope to derive value from meeting our
responsibilities to the communities we serve.
We have adopted the European Foundation
of Quality Management’s Corporate
Responsibility Framework. This helps us align
corporate responsibility with business strategy,
and also with individual balanced scorecard
priorities. As part of the process we conduct
an annual self-assessment of our performance
with independent oversight and assurance.
This allows us to identify strengths and areas
for improvement and to prioritise actions
and objectives. It also provides a benchmark
against which we can compare our
performance both internally and externally.
The board believes that the systems in place
to manage significant social, ethical and
environmental (SEE) risks are effective and
provide adequate information to identify and
assess the short and long-term risks arising
from SEE matters. The board is also satisfied
that relevant SEE risks have been assessed
during 2005 and that they have been
managed in compliance with relevant policies
and procedures.
Creating value in the community
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
to share price
dividends are added
appreciation, we delivered a total return to our
shareholders of 10.9 per cent in 2005
and 15.1 per cent in 2004.
Corporate responsibility
Through one of the largest community
investment programmes in the UK, we are
able to make a significant contribution to the
local communities in which we operate. The
majority of Lloyds TSB’s charitable giving is
channelled through the four Lloyds TSB
Foundations, which cover England and Wales,
Scotland, Northern Ireland and the Channel
Islands. Their mission is to improve the lives
of people in local communities, especially
those who are disadvantaged or disabled.
During 2005, the Foundations distributed
£31 million to community causes across
the UK.
time given by our
Community investment is not just about giving
money to good causes. It is also about the
staff
substantial
the work of community
in supporting
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.
More information on all of the above issues is
available in the Group’s 2005 corporate
responsibility report and there are details of
how to obtain a copy on page 129.
LLOYDS TSB GROUP 11
The businesses of Lloyds TSB
Lloyds TSB Group’s activities are organised into three divisions: UK Retail Banking, Insurance and Investments, and Wholesale and International
Banking. The main activities of Lloyds TSB Group’s three divisions are described below.
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.
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.
Telephone banking. Telephone banking continues to grow and Lloyds TSB Group now provides one of the largest telephone banking services in
Europe. At the end of 2005, some 4.2 million customers had registered to use the services of PhoneBank and the automated voice response
service, PhoneBank Express. Lloyds TSB Group’s telephone banking centres handled some 69 million calls during 2005.
Cash machines. Lloyds TSB Group has one of the largest cash machine networks of any leading banking group in the UK and, at 31 December
2005, personal customers of Lloyds TSB Bank and Lloyds TSB Scotland were able to withdraw cash and check balances through some
4,200 ATMs at branches and external locations around the country. In addition, our personal customers have access to a further 54,000 cash
machines via LINK in the UK and to cash machines worldwide through the VISA and MasterCard networks.
Current accounts. Lloyds TSB Bank and Lloyds TSB Scotland offer a wide range of current accounts, including interest-bearing current accounts
and a range of added value accounts.
Savings accounts. Lloyds TSB Bank and Lloyds TSB Scotland offer a wide range of savings accounts and Cheltenham & Gloucester provide retail
investments through their branch networks and a postal investment centre.
Personal loans. Lloyds TSB Bank and Lloyds TSB Scotland offer a range of personal loans through their branch networks and directly to the
customer via the internet and telephone.
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.
Mortgages. Cheltenham & Gloucester is Lloyds TSB Group’s specialist residential mortgage provider, offering a range of mortgage products to
personal customers through its own branches and those of Lloyds TSB Bank in England and Wales, as well as through the telephone, internet
and postal service, C&G TeleDirect. Lloyds TSB Group also provides mortgages through Lloyds TSB Scotland and Scottish Widows Bank.
Lloyds TSB Group is one of the largest residential mortgage lenders in the UK on the basis of outstanding balances, with mortgages outstanding
at 31 December 2005 of £88.4 billion, representing a market share of 9.1 per cent.
UK Wealth Management. Private Banking provides a range of tailor-made wealth management services and products to individuals from 28 offices
throughout the UK. In addition to asset management, these include tax and estate planning, executor and trustee services, deposit taking, lending
and insurance. Shareview Dealing provides retail stockbroking services, personal equity plan and individual savings account (ISA) products.
Insurance and Investments
Insurance and Investments offers life assurance, pensions and investment products, general insurance and fund management services.
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.
General insurance. Lloyds TSB General Insurance provides general insurance through the retail branches of Lloyds TSB Bank and Cheltenham
& Gloucester, and through a direct telephone operation and the internet. Lloyds TSB General Insurance is one of the leading distributors of
household insurance in the UK.
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.
12 LLOYDS TSB GROUP
The businesses of Lloyds TSB
Wholesale and International Banking
Wholesale and International Banking provides banking and related services for major UK and multinational corporates and financial institutions,
and small and medium-sized UK businesses. It also provides asset finance and share registration services to personal and corporate customers,
manages Lloyds TSB Group’s activities in financial markets through its treasury function and provides banking and financial services overseas.
Wholesale
Corporate Markets, combining the respective strengths of 2,700 people in Corporate Banking, Structured Finance and Financial Markets,
plays an integral role in leveraging and expanding our customer franchise and building deep, long-lasting relationships with around 16,000
corporate customers.
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.
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.
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.
Asset Finance. Lloyds TSB Group’s asset finance businesses provide individuals and companies with finance through leasing, hire purchase
and contract hire packages. Through its invoice discounting and factoring subsidiary, Lloyds TSB Commercial Finance, Lloyds TSB Group
provides working capital finance for its customers. Specialist personal lending, store credit and the Dutton-Forshaw motor dealerships complete
this group of businesses. Altogether Asset Finance has over 1.7 million individual customers and relationships with some 40,000 companies
and small businesses.
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.
International Banking
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 private banking. Lloyds TSB Group has international private banking operations for wealthy individuals. The business is
conducted through branches of Lloyds TSB Bank located in Switzerland, Luxembourg, Monaco, Gibraltar, Uruguay, Dubai and the US,
supported by representative offices in Latin America.
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.
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.
LLOYDS TSB GROUP 13
Operating and financial review and prospects
Summary of Group results
With effect from 1 January 2005, the Group has been using IFRS for financial reporting. Although IFRS significantly changes the timing of
earnings recognition in financial results it has no impact on our business fundamentals and cash flows, the development of our organic growth
strategies, or our capital management policies.
Details of the retrospective impact of the Group’s implementation of IFRS were published in our ‘Transition to IFRS’ announcement on 27 May
2005. The increased use in IFRS of fair values has, however, led to greater volatility in the earnings of the Group. In order to provide a more
comparable representation of our business performance this earnings volatility, together with other IFRS related adjustments applied with effect
from 1 January 2005 and the impact on the Group’s results of businesses sold in 2004, have been separately analysed to provide a comparable
basis of presentation.
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.
On a comparable basis, profit before tax increased by £146 million, or 4 per cent, to £3,466 million (2004: £3,320 million). Excluding the
impact of customer redress provisions and the strengthening of reserves for mortality, profit before tax increased by 9 per cent to £3,726 million.
Income increased by 7 per cent whilst costs grew by only 4 per cent. Earnings per share increased by 11 per cent to 47.2p. The post-tax return
on shareholders’ equity increased to 23.3 per cent (2004: 22.2 per cent) and economic profit rose by 14 per cent to £1,620 million.
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.
Group net interest income, on a comparable basis, increased by £423 million, or 8 per cent, compared with last year. Good levels of consumer
lending growth increased average personal lending and credit card balances by £1.7 billion and average mortgage balances by £7.8 billion.
Customer lending growth in our Business Banking and Corporate Markets franchises increased average interest-earning assets by £4.4 billion.
The banking net interest margin decreased by 6 basis points to 2.78 per cent. Much of this margin decline has been caused by the impact of
lower earnings on the Group’s capital and other interest-free liabilities and, excluding this funding impact, the margin was broadly stable year
on year. The banking net interest margin in the second half of 2005 actually increased by 5 basis points to 2.80 per cent, compared with
2.75 per cent in the first half of 2005.
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.
Operating expenses continued to be tightly controlled and on a comparable basis increased by 5 per cent to £5,506 million. Excluding the impact
of customer redress provisions, operating expenses increased by only 4 per cent. Significant improvements continue to be made in processing
and operational efficiency and we have continued to expand our programme of offshoring a number of our processing and back office operations
to India. Staff numbers reduced by 3,652 to 69,778 during the year, improving group productivity. As a result of this constant focus on day-to-
day operating cost control, the cost:income ratio, excluding customer redress provisions and the strengthening of reserves for mortality, improved
to 52.7 per cent, from 54.3 per cent in 2004.
Whilst the Group has demonstrated strong cost control during 2005, we have also identified a number of key initiatives which collectively have
the potential to significantly improve our cost:income ratio over the next few years whilst also improving operational efficiency and speed of
execution. These self-funding initiatives will capture significant group wide synergies and fall broadly into three categories:
• improving our operational efficiency and management accountabilities through organisational redesign and process re-engineering;
• consolidating similar back-office operations and achieving cost reductions through standardising the way we operate and manage back-office
processes across the Group; and
• transforming group wide procurement to enhance the way we manage suppliers and achieve the most efficient pricing available.
This programme of efficiency improvement initiatives is expected to deliver gross benefits of £275 million per annum for an initial investment of
less than £200 million, of which £40 million was charged in 2005. This will continue to improve the Group’s cost:income ratio whilst allowing
substantial scope to re-invest in the business. From 2007 onwards we expect the Group’s profit before tax to be increased by approximately
£100 – £150 million per annum as a result of this programme of cost saving initiatives.
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.
We expect a further deterioration in the retail credit environment in the first half of 2006 however, as a result of the improved quality of new
business written in the last 12 months, we expect greater stability in the second half of 2006. In Wholesale Markets, impairment levels have
remained low throughout 2005 and the outlook for corporate lending remains good, although we expect a return to more normal levels of
impairment over time.
14 LLOYDS TSB GROUP
Operating and financial review and prospects
Following the publication of revised annuitant mortality tables and consultation on future mortality projections by the actuarial profession’s
Mortality Committee, the Group has reviewed the annuitant mortality assumptions used in its life assurance businesses. While the actuarial
profession is still consulting on the adoption of the new projections, the Group has decided to strengthen its mortality related reserves by
£155 million (£110 million on a comparable basis).
Following the introduction of time-barring, and the consequent increase in claims, the Group has also reviewed the estimated cost of redress
payments to customers, principally relating to past sales of mortgage endowment policies through the branch network. This has led to an
increased provision for customer redress of £150 million.
Our capital position remains robust. At the end of December 2005, the total capital ratio was 10.9 per cent and the tier 1 capital ratio was
7.9 per cent. During the year, risk-weighted assets increased by 10 per cent to £144.9 billion, reflecting good levels of growth in consumer
lending and mortgages and strong growth in our Corporate Markets businesses. We continue to plan for risk-weighted asset growth of mid-to-high
single digits over the next few years, and expected profit retentions remain sufficient to support this level of risk-weighted asset growth. We are
also significantly improving our balance sheet management and capital efficiency, moving from a ‘buy and hold’ model towards an ‘origination
and distribution’ framework. In this context we are planning to initiate a rolling residential mortgage securitisation programme in the second half
of 2006.
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 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.
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.
LLOYDS TSB GROUP 15
Operating and financial review and prospects
UK Retail Banking
Comparable basis
Net interest income
Other income
Total income
Operating expenses
Trading surplus
Impairment losses on loans and advances
Profit before tax, before provisions for customer redress
Provisions for customer redress
Profit before tax
Other IFRS adjustments applied from 1 January 2005
Profit on sale of businesses
Statutory profit before tax
Cost:income ratio, before provisions for customer redress
Total assets
Total risk-weighted assets
Key achievements
2005
£m
3,307
1,811
5,118
(2,532)
2,586
(905)
1,681
(150)
1,531
(213)
76
1,394
49.5%
31 December
2005
£103.9bn
£60.6bn
2004
£m
3,228
1,696
4,924
(2,509)
2,415
(676)
1,739
(100)
1,639
–
–
1,639
51.0%
1 January
2005
£96.5bn
£57.2bn
• Satisfactory income growth in a more challenging consumer environment, with good growth in income per customer and a 28 per cent increase
in target customer current account recruitment.
• Tight cost control, with a clear focus on improving efficiency. Staff reductions of 2,713 during the year resulted in lower costs in the second
half of the year.
• 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.
– Personal loan balances increased by 3 per cent to £11.0 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.
• Higher impairment charge reflecting marketwide deterioration in retail credit quality as a result of more customers, with higher levels of
indebtedness, experiencing repayment difficulties.
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.
During 2005, good levels of growth were achieved in all key product areas. Gross new mortgage lending for the Group totalled £26.0 billion
(2004: £26.3 billion). Net new lending totalled £8.3 billion resulting in a market share of net new lending of 9.1 per cent, and mortgage
balances outstanding increased by 10 per cent to £88.4 billion. Personal loan balances outstanding at the year end were £11.0 billion, an
increase of 3 per cent and credit card balances totalled £7.2 billion, an increase of 9 per cent, adjusting to exclude the effect of the Goldfish
disposal. Credit balances on current accounts and savings and investment accounts increased by 7 per cent. Income per customer continued to
improve during the year.
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.
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.
16 LLOYDS TSB GROUP
Operating and financial review and prospects
Operating expenses remained well controlled and, excluding customer redress provisions, increased by only £23 million, or 1 per cent. This
included higher levels of restructuring costs as we continue to rationalise back office operations to improve efficiency. Levels of customer service
and satisfaction have also continued to improve.
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.
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.
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).
LLOYDS TSB GROUP 17
Operating and financial review and prospects
Insurance and Investments
Comparable basis
Net interest income
Other income
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment losses on loans and advances – credit
Profit before tax, excluding customer redress provisions and
strengthening of reserves for mortality
Provisions for customer redress
Strengthening of reserves for mortality
Profit before tax
Volatility
Other IFRS adjustments applied from 1 January 2005
Statutory profit before tax
Profit before tax analysis
Life, pensions and OEICs*
General insurance
Scottish Widows Investment Partnership
Profit before tax*
2005
£m
411
15,820
16,231
(14,684)
1,547
(639)
908
–
908
–
(110)
798
749
(73)
1,474
683
209
16
908
2004
£m
283
10,736
11,019
(9,622)
1,397
(610)
787
3
790
(12)
–
778
138
–
916
610
172
8
790
* Excluding customer redress provisions and strengthening of reserves for mortality
Key achievements
• 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.
• 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.
• 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.
• 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.
• Strong capital position maintained. During 2005, Scottish Widows Group repatriated £1 billion surplus capital to the Group.
18 LLOYDS TSB GROUP
Operating and financial review and prospects
Profit before tax, on a comparable basis, increased by £20 million, or 3 per cent to £798 million despite a significant strengthening of reserves
for mortality which, on a comparable basis, totalled £110 million.
Scottish Widows profit before tax analysis*
Life and pensions
New business contribution
Existing business
Investment earnings – normalised
Profit before tax
OEICs
Profit before tax
Profit before tax (life, pensions and OEICs)
New business margin (life and pensions)
2005
£m
224
181
196
601
82
683
2004
£m
188
181
167
536
74
610
29.7%
28.6%
* Comparable basis, excluding customer redress provisions and the strengthening of reserves for mortality
Profit before tax, excluding customer redress provisions and the strengthening of reserves for mortality, from the Group’s life, pensions and OEICs
business increased by 12 per cent to £683 million. The Group’s strategy to improve its returns by focusing on more profitable, less capital
intensive, business whilst constantly seeking to improve process and distribution efficiency has led to a 19 per cent increase in new business
contribution to £224 million. As a result of this improved capital efficiency and strong sales of pensions and single premium investments, the
life and pensions new business margin increased to 29.7 per cent (2004: 28.6 per cent).
Weighted sales (regular + 1/10 single)
Life and pensions
OEICs
Life, pensions and OEICs
Bancassurance
Independent financial advisers
Direct
Life, pensions and OEICs
2005
£m
754
148
902
274
562
66
902
2004
£m
657
86
743
242
432
69
743
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
in 2004.
In January 2006, Scottish Widows announced a new partnership with Virgin to market life assurance and a new cancer insurance product under
the Virgin Money brand. This supports Scottish Widows’ long-term strategy to secure a greater breadth of distribution for its products.
Scottish Widows Investment Partnership
Pre-tax profit, on a comparable basis, from Scottish Widows Investment Partnership (SWIP) increased to £16 million, compared with £8 million
in 2004, reflecting improved market performance and increased revenues from new business. SWIP won £4.4 billion of gross new business in
2005, an increase of 110 per cent on 2004, and its assets under management increased by 16 per cent to £95 billion. Overall investment
performance during 2005 has continued to improve. Group wide funds under management increased by 12 per cent to £121 billion.
LLOYDS TSB GROUP 19
Operating and financial review and prospects
General insurance
Comparable basis
Commission receivable
Commission payable
Underwriting income (net of reinsurance)
Other income
Net operating income
Claims paid on insurance contracts (net of reinsurance)
Operating income, net of claims
Operating expenses
Profit before tax
Claims ratio
Combined ratio
2005
£m
681
(695)
562
18
566
(197)
369
(160)
209
34%
80.8%
2004
£m
672
(750)
554
64
540
(214)
326
(154)
172
37%
83.2%
Profit before tax, on a comparable basis, from our general insurance operations increased by £37 million, or 22 per cent, to £209 million.
Operating income, net of claims, increased by 13 per cent compared with cost growth of 4 per cent. Good progress continues to be made in
implementing new platforms for underwriting and claims processes.
Net operating income improved by £26 million, as growth in income from home and motor business was partly offset by reduced broking
commission from loan protection insurance, reflecting the slowdown in unsecured consumer lending growth during 2005 and lower health
premiums following the transfer of the Group’s private medical insurance business to BUPA during 2004. Good progress has also been made
in building the Group’s corporate partnering capability with a new distribution agreement secured with MORE TH>N during 2005.
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.
Claims fell by £17 million to £197 million and the claims ratio improved to 34 per cent (2004: 37 per cent), reflecting good progress in
re-engineering the claims process and improvements in the cost effectiveness of the claims supply chain, as well as lower health claims as a
result of the transfer of the Group’s private medical insurance business to BUPA. As a result, the combined ratio relating to the underwriting
business improved to 80.8 per cent in 2005 (2004: 83.2 per cent).
20 LLOYDS TSB GROUP
Operating and financial review and prospects
Wholesale and International Banking
Comparable basis
Net interest income
Other income
Total income
Operating expenses
Trading surplus
Impairment losses on loans and advances
Profit before tax
Other IFRS adjustments applied from 1 January 2005
Loss on sale of businesses
Trading results of discontinued operations
Statutory profit before tax
Cost:income ratio
Total assets
Total risk-weighted assets
Profit before tax by business unit
Corporate Markets
Business Banking
Asset Finance
International Banking
Other
Key achievements
2005
£m
2,165
1,710
3,875
(2,186)
1,689
(185)
1,504
20
(6)
–
1,518
56.4%
31 December
2005
£124.0bn
£80.1bn
2005
£m
958
206
219
133
(12)
1,504
2004
£m
1,986
1,544
3,530
(2,047)
1,483
(230)
1,253
–
(21)
40
1,272
58.0%
1 January
2005
£123.8bn
£71.0bn
2004
£m
732
153
240
120
8
1,253
• Excellent profit growth. Profit before tax, on a comparable basis, increased by 20 per cent to £1,504 million.
• Strong income growth, up 10 per cent as Corporate Markets’ strategy begins to deliver results. Income momentum improved during the year.
• Positive jaws. Income growth of 10 per cent exceeded cost growth of 7 per cent. Continued investment in people and systems to support new
product capabilities.
• Low levels of impairment as a result of high corporate liquidity and a continued strong level of recoveries. Impairment charge reduced by
20 per cent.
• Good progress in delivering the strategy to build an integrated wholesale bank for corporate markets. 17 per cent increase in Corporate Markets’
trading surplus, and 31 per cent increase in profit before tax.
• Good levels of franchise growth in Business Banking. 24 per cent growth in trading surplus, and 35 per cent growth in profit before tax.
• Good new business growth in Asset Finance with trading surplus up 12 per cent. However, higher levels of retail impairment resulted in a fall
of 9 per cent in profit before tax.
• Improved post-tax return on risk-weighted assets from 1.41 per cent to 1.50 per cent.
Wholesale and International Banking profit before tax, on a comparable basis, increased by £251 million, or 20 per cent, to £1,504 million.
Income growth of 10 per cent exceeded cost growth of 7 per cent, leading to a reduction in the cost:income ratio to 56.4 per cent. Trading
surplus increased by £206 million, or 14 per cent, to £1,689 million. There was strong profit growth in Corporate Markets, Business Banking
and International Banking while Asset Finance saw strong trading surplus growth before higher impairment losses. Overall growth in profit was
ahead of growth in risk-weighted assets and has led to an increase in the post-tax return on average risk-weighted assets to 1.50 per cent,
compared to 1.41 per cent in 2004.
Net interest income increased by £179 million, or 9 per cent, reflecting higher income from strong growth in customer lending in Corporate
Markets, Business Banking and Asset Finance. Other income increased by £166 million, or 11 per cent. Strong growth in structured finance
transactions, increased fee income from relationship business products and higher levels of cross-selling activity led to an increase of 18 per cent
in other income from Corporate Markets. In addition, other income benefited from the impact of motor dealership acquisitions in Asset Finance
and sustained customer growth in Business Banking. Costs were 7 per cent higher at £2,186 million, reflecting higher staff costs as a result of
our increased investment in people, as we continue to build up our Corporate Markets product capability and expertise, and the impact of the
motor dealership acquisitions within Asset Finance.
The charge for impairment losses on loans and advances decreased by £45 million, or 20 per cent, to £185 million, as a result of lower
provisions and a good level of recoveries from the corporate lending portfolio, partially offset by higher charges in the Asset Finance business.
LLOYDS TSB GROUP 21
Operating and financial review and prospects
In Corporate Markets, profit before tax grew by 31 per cent, from £732 million in 2004, to £958 million, driven by a combination of higher
income and a reduction in impairment losses. Income increased by 15 per cent, including higher levels of cross-selling income which increased
by 27 per cent reflecting our increased customer focus and integration across the business. Income growth was strong in both relationship and
transactional business. Customer relationships continue to be deepened, and there has been considerable investment in the business to broaden
origination, distribution and portfolio management capabilities. This has included the build up of new credit structuring and loan trading teams
and the launch of a variety of new products.
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.
Profit before tax in Asset Finance decreased by 9 per cent to £219 million, largely reflecting higher impairment losses, which offset the continued
development of the motor and leisure, and contract hire businesses. Income increased by £71 million, or 8 per cent, leading to a 12 per cent
growth in the trading surplus. New business has increased by 7 per cent in the personal and retail finance business. Lloyds TSB Commercial
Finance has continued to grow strongly with a 19 per cent market share, measured by client numbers, and the motor and leisure business
continues to be the largest independent lender in the UK motor and leisure point of sale market with a market share of 18 per cent.
In International Banking, profit before tax increased by £13 million, or 11 per cent, to £133 million. This reflects a reduction in costs and lower
impairment provisions which offset a £12 million, or 3 per cent, reduction in income as a result of lower earnings on retained capital following
the repatriation of offshore capital to the Group.
Central group items
Comparable basis
Lloyds TSB Foundations
Funding cost of acquisitions less earnings on capital
Central costs and other unallocated items
Loss before tax
Volatility
Other IFRS adjustments applied from 1 January 2005
Loss on sale and closure of businesses
Statutory loss before tax
2005
£m
(34)
(325)
(8)
(367)
(124)
(55)
(20)
(566)
2004
£m
(31)
(317)
(2)
(350)
–
–
–
(350)
The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly disabled and
disadvantaged, to play a fuller role in society. The Foundations receive 1 per cent of the Lloyds TSB Group’s pre-tax profit after adjusting for gains
and losses on the disposal of businesses and pre-tax minority interests, averaged over three years, instead of a dividend on their shareholdings.
In 2005, £34 million was accrued for payment to registered charities.
22 LLOYDS TSB GROUP
Operating and financial review and prospects
Volatility
Banking volatility
In accordance with IFRS, it is the Group’s policy to recognise all derivatives at fair value. The banking businesses manage their interest rate and
other market risks primarily through the use of intra-Group derivatives, with the resulting net positions managed centrally using external
derivatives. IFRS does not, however, permit the intra-Group derivatives to be used in a hedge relationship for reporting purposes. Although fair
value accounting can have a significant impact on reported earnings, it does not impact on the business fundamentals or cash flows of the
businesses. The Group has, therefore, implemented an internal pricing structure that allows divisions to transfer to central group items the
volatility associated with marking to market derivatives held for risk management purposes. ‘Banking volatility’ is principally comprised of the
difference between the result that would be recognised on an accrual accounting basis for derivatives held for risk management purposes and
their mark to market value. The Group has set up a central hedging function to reduce the impact of this volatility by establishing, where possible,
accounting hedge relationships for the external derivatives.
During 2005, profit before tax included negative banking volatility of £124 million.
Insurance volatility
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.
The Group’s insurance businesses have substantial holdings of investments which are accounted for at fair value with changes being reflected
within the income statement. The difference between the actual return on these investments attributable to shareholders and the expected return
based upon economic assumptions made at the beginning of the year is included within insurance volatility. In addition, the calculation of the
value of in-force business makes assumptions about future investment returns; to the extent that actual experience is different the effect is also
included within insurance volatility.
The main assumptions used in the calculation of the value of in-force business at 31 December 2005 were as follows:
Risk-adjusted discount rate (net of tax)
Return on equities (gross of tax)
Return on fixed interest securities (gross of tax)
Expenses inflation
31 December
2005
%
7.02
6.72
4.12
3.79
31 December
2004
%
7.40
7.17
4.57
3.76
Changes in stock market performance also affect the realistic valuation of the guarantees and options embedded within products written in the
Scottish Widows With-Profits Fund, which following the implementation of FRS 27 is now reflected in the Group’s balance sheet. Fluctuations
in this valuation caused by market-related movements are also included within insurance volatility.
During 2005, profit before tax included positive insurance volatility of £438 million.
Policyholder interests volatility
As a result of the requirement contained in IFRS to consolidate the Group’s life and pensions businesses on a line by line basis, the Group’s
income statement includes amounts attributable to policyholders which affect profit before tax; the most significant of these items is policyholder
tax. Under IFRS, tax on policyholder investment returns is included in the Group’s tax charge rather than being offset against the related income,
either increasing or decreasing profit before tax with a corresponding change in the tax charge. In order to provide a clearer representation of the
underlying performance of the Group’s life and pensions businesses the impact of these items upon pre-tax profit has been separately identified
within volatility.
During 2005, profit before tax included positive policyholder interests volatility of £311 million.
Regulation
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.
LLOYDS TSB GROUP 23
Operating and financial review and prospects
Risk management
Risk as a strategic differentiator
Following the embedding of the risk governance framework and the repositioning of specialist risk functions closer to the business in 2004, the focus for 2005 has
been the development of a new risk framework which clearly aligns our risk taking to the objectives and priorities of Lloyds TSB Group and facilitates more effective
decision making. The Group’s ability to take risks which are well understood, consistent with our strategy and plans and appropriately remunerated, is a key driver
of shareholder return.
The maintenance of a strong control framework remains a priority and is the foundation for the delivery of effective risk management. Risk analysis and reporting
have been further strengthened to identify opportunities as well as risks, to improve the Group’s ability to take an aggregate view of the overall risk portfolio and assign
clear responsibilities and timescales at group and divisional level for risk mitigation strategies. Risk continues to be a key component of routine management
information reporting and is embedded within staff objectives via balanced scorecards.
The objective remains to go beyond risk mitigation and control to developing risk capabilities as a key strategic differentiator for Lloyds TSB.
s
e
i
t
i
l
i
b
a
p
a
C
Regulatory requirements
Differentiating excellence
in risk management
Defining and promoting
effective use of the
Group’s risk capacity
Risk control
Effectiveness
Risk governance structures
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.
Board and committees
Lloyds TSB board
Audit committee
Risk oversight committee
Group executive committee
Group chief executive
Group executive directors
Chief risk director
Group asset and liability
committee
Group business risk
committee
Risk management oversight
Business risk management
Director of group audit
Divisional risk officers
Group Risk
Business risk functions*
Board and board committees
Direct reporting line
Management committees
Functional reporting line to support committees
Personnel
Functions
Functional reporting line
*
Business risk functions report to their respective managing director, who in turn reports to the group executive directors
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.
24 LLOYDS TSB GROUP
Operating and financial review and prospects
The group executive committee, assisted by its sub-committees the group business risk committee and the group asset and liability committee, supports the group
chief executive in ensuring the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s
risk policies, and reviews the Group’s aggregate risk exposures and concentrations of risk. The group executive committee’s duties are described more fully on page 44.
Directors of the Group’s businesses have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are required
to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within the parameters set by the board, group executive
committee and Group Risk. Compliance with policies and parameters is overseen by the risk oversight committee, the group business risk committee, the group asset
and liability committee, Group Risk and the divisional risk officers.
The chief risk director, a member of the group executive committee and reporting directly to the group chief executive, oversees and promotes the development and
implementation of a consistent group wide risk management framework. The chief risk director, supported by Group Risk, provides objective challenge to the Group’s
senior management.
Divisional risk officers provide oversight of risk management activity within each of the Group’s operating divisions. Reporting directly to the group executive directors
responsible for the divisions and the chief risk director, their day-to-day contact with business management, business operations and risk initiatives seeks to provide
an effective risk oversight mechanism.The direct reporting line to the chief risk director enables the Group to maintain a wide ranging and current perspective on
material risks facing the Group and provides a mechanism to share best risk management practice.
The director of group audit provides the required independent assurance to the audit committee and the board that risks within the Group are recognised,
monitored and managed within acceptable parameters. Group Audit is fully independent of Group Risk, seeking to ensure objective challenge to the effectiveness
of the risk governance framework.
Accountability of line management has been further reinforced in relation to the management of risks arising from the Group’s business and in developing the risk
awareness and risk management capability of the Group’s staff. A key objective is to ensure that business decisions strike an appropriate balance between risk and
reward, consistent with the Group’s risk appetite. The top management team received regular briefings and guidance from the chief risk director to ensure awareness
of the overarching risk model and a clear understanding of their accountabilities for risk and internal control.
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.
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.
The model seeks to provide the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned
with the risks faced by its businesses. It also facilitates effective communication on these matters across the Group. These arrangements enable the Group to anticipate
and pre-empt risks better, and to manage more effectively those risks which crystallise.
Reflecting the importance the Group places on risk management, risk is one of the five principal criteria that it includes in its balanced scorecard on which individual
staff performance is judged. Business executives have specified risk management objectives, and incentive schemes take account of performance against these.
Risk management framework
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.
A key focus for 2005 has been the enhancement of this framework. The approach starts with a simple but clear articulation of the Group’s strategic vision and the
desired outcomes for our key stakeholders (shareholders, customers, staff, debtholders and regulators). The risk implications are expressed in a risk vision and high
level risk appetite measures, which are in turn translated into high level risk principles and risk appetite measures and metrics for the primary risk types (credit risk,
market risk, insurance risk, operational risk, strategy risk and financial soundness). The degree of sophistication continues to evolve. An overview of each of the
primary risk drivers is set out on pages 27 to 34. The more detailed articulation of the risk principles and distribution of the risk appetite measures amongst the
divisions and businesses is subsequently agreed by the group chief executive, through consultation with the group executive committee and on the advice of the
group business risk committee and the group asset and liability committee.
LLOYDS TSB GROUP 25
Operating and financial review and prospects
Risk language
The Group has revised the risk language during the year such that all risks are classified within one of six primary risk drivers. These are further broken down into
thirteen enterprise wide risk management (EWRM) risk types to enable more detailed review and facilitate appropriate reporting and analysis of root causes, as set
out below.
Primary risk
drivers
EWRM
risk types
Strategy
Strategy
Product and service
Credit
Credit
Market
Insurance
Operational
Financial soundness
Market
Insurance
Governance
Financial soundness
Legal and regulatory
Customer treatment
Process and resource
Theft, fraud and
other criminal acts
People
Change
Governance risk, legal and regulatory risk, customer treatment risk, process and resource risk, theft, fraud and other criminal acts risk, people risk and change-related
risk are all categories of operational risk. A more detailed language has been identified for these operational risks.
Risk policy
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.
The main policy levels are identified below:
• Principles – high level policy for the six primary risk drivers (agreed by the board)
• Group policy – policy for the main EWRM risk types aligned to the risk drivers (agreed by the group chief executive)
• Detailed group policy – detailed policy that applies across the Group (agreed by the chief risk director)
• 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)
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.
Group and divisional risk functions have responsibility for overseeing effective implementation of policy. Group Audit provides independent assurance to the board
about the effectiveness of the Group’s control framework and adherence to policy.
Policies are reviewed regularly to seek to ensure accuracy and appropriateness.
Risk reporting
Divisional risk functions use the standard language when reporting risks centrally, to enable risk aggregation, and when assessing risk levels of new products, change
initiatives or business plans. Divisional risk committees monitor their risk levels against their risk appetite seeking to ensure effective mitigating action is being taken
where appropriate. Divisional risk reports are reviewed by divisional executive committees to ensure divisional senior management are satisfied with the overall risk
profile, risk accountabilities and progress on any necessary mitigating actions.
At group level a consolidated risk report is produced which is reviewed and debated by group business risk committee, group executive committee, risk oversight
committee and board to ensure senior management and the board are satisfied with the overall risk profile, risk accountabilities and any necessary mitigating actions.
During the year the Group’s consolidated risk report was further enhanced to support the identification, control and effective management of risk.
Basel II
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.
26 LLOYDS TSB GROUP
Operating and financial review and prospects
Strategy risk
The Group includes product and service risk within the wider definition of strategy risk and the two categories are described in further detail below.
Strategy risk
Definition
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
• internal factors (ie resource capability and availability, customer treatment, service level agreements, products and funding and the risk appetite of other risk
categories).
Control
An annual strategic planning process is conducted at group and business level which includes a quantitative and qualitative assessment of the risks in the Group’s
plan. Within the planning round, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams.
The Group’s strategy is reviewed and approved by the board. Regular reports are provided to the group executive committee and the board on the progress of the
Group’s key strategies and plans. Group Risk conducts oversight to seek to ensure the business plans remain consistent with the Group’s strategy. Revenue and capital
investment decisions require additional formal assessment and approval. Formal risk assessment is conducted as part of the financial approval process. Significant
company mergers and acquisitions require specific approval by the board. In addition to the standard due diligence conducted during a merger or acquisition, Group
Risk conducts, where appropriate, an independent risk assessment of the target company and its proposed integration into Lloyds TSB Group.
A common approach is applied across the Group to assess the creation of shareholder value. This is measured by economic profit (the profit attributable to
shareholders, less a notional charge for the equity invested in the business). The focus on economic profit allows the Group to compare the returns being made on
capital employed in each business. The use of risk-based economic capital and regulatory capital is closely monitored at business and group level. The Group’s
economic capital model covers credit, market, insurance, business and operational risks.
Product and service risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, from the inherent characteristics, management or distribution of products or
services, or from failure to meet or better customer expectations and competitor offerings.
Control
The Group is strongly committed to the fair treatment of its customers. This is embedded into the processes and risk assessment which takes place to seek to ensure
businesses have developed customer centric strategies for product and business development, marketing, selling and after sales service. Businesses maintain a range
of products to meet customers’ needs and the business strategy and are responsible for managing and controlling product risks and complying with applicable
regulations.
Businesses have formal processes for reviewing the range of their product portfolios and subject all product development to rigorous assessment. The assessment
includes seeking to ensure that the product meets clearly defined customer needs. Businesses have a defined channel distribution strategy for products, consistent
with the Group’s distribution strategy. Businesses launching new products are responsible for ensuring compliance with all applicable regulations and that the
proposed sales activity is appropriate for the type of customer and their attitude to risk.
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.
Businesses establish and monitor performance standards for all marketed products across a range of indicators, for example sales volumes, customer service and
risk profile. Significant deviations from these standards are investigated and appropriate action taken.
Credit risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, as a result of the failure of the party with whom we have contracted to meet
its obligations (both on and off balance sheet).
Credit risk framework
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 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 risk also arises from the use of derivatives. Note 17 shows the total notional principal amount of interest rate, exchange rate and equity and other contracts
outstanding at 31 December 2005. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost
of replacing contracts with a positive value to the Group. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and
collateralisation, where security is provided against the exposure.
LLOYDS TSB GROUP 27
Operating and financial review and prospects
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.
Day-to-day credit management and asset quality within each business is primarily the responsibility of the relevant business director.
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.
Impairment provisions are provided for losses that have been incurred at the balance sheet date. Changes in general economic conditions in the UK or in interest
rates could result in losses that are different from those provided for at the balance sheet date.
Control
The following are the principal mechanisms through which the Group operates the credit risk framework set out above:
Credit rating systems. All business units operate appropriate rating system(s) for their portfolio(s). All rating systems, which are authorised by executive management,
comply with the Group’s standard methodology. The Group uses a ‘Master Scale’ rating structure with ratings corresponding to a range of probabilities of future default.
Monitoring of rating systems. The Group uses rating systems as an integral part of the credit process deployed within the credit life cycle. Whilst divisional risk teams
have responsibility for monitoring rating model performance, Group Risk reviews new models and material changes to existing models, seeking executive management
approval as necessary.
Portfolio monitoring and reporting. With Group Risk, businesses and divisions identify and define portfolios of credit and related risk exposures and the key
benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular
portfolio monitoring reports for review by Group Risk. Group Risk in turn produces an aggregated review of credit risk throughout the Group, which is presented to
the group business risk committee.
Credit principles and policy. Group Risk sets out the group credit principles according to which credit risk is managed. These form the basis of the group credit policy, which
in turn is the basis for divisional and business unit credit policy. Principles and policy are reviewed regularly and any changes are subject to a review and approval process.
Lending guidelines. These define the responsibilities of lending officers and seek to provide a disciplined and focused benchmark for credit decisions.
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.
Cross-border and cross-currency exposures. Country limits are authorised and managed by a dedicated unit taking into account economic and political factors.
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.
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.
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.
Credit portfolio model. The Group models portfolio credit risk based on defaults, using a statistically-based model which calculates the economic equity employed
and credit value at risk for each portfolio.
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.
Risk assurance and oversight. Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes and
test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of
key risk indicators. Risk assurance teams and Group Audit are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.
Risk appetite
Credit risk appetite is defined as the quantum and quality of the desired credit portfolio and the direction in which the Group wants to manage it, in order to achieve
its short and long-term strategic goals.
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.
These appetite ranges will not replace the existing controls and measures set out above. It is expected that our appetite measures will be improved over time as usage
is widened and methodologies developed.
Risk mitigation
Lloyds TSB Group uses a range of approaches to mitigate credit risk. In the case of individual exposures, the Group makes use of credit enhancement techniques
such as netting and collateralisation, where security is provided against the exposure. The Group will also consider the sale of assets, where credit concerns exist.
Securitisation is another credit mitigation technique which receives consideration as does the use of credit derivative-based approaches.
Where it is efficient and likely to be effective (generally with counterparties with which it undertakes a significant volume of transactions), the Group enters into master
netting arrangements. Although master netting arrangements do not generally result in an offset of balance sheet assets and liabilities, as transactions are usually
settled on a gross basis, they do reduce the credit risk to the extent that if an event of default occurs, all amounts with the counterparty are terminated and settled
on a net basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting arrangements can change substantially within a short
period since it is affected by each transaction subject to the arrangement.
28 LLOYDS TSB GROUP
Operating and financial review and prospects
Market risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, arising from unexpected changes in financial prices, including interest rates,
exchange rates and bond, commodity and equity prices. It arises in all areas of Lloyds TSB Group’s activities and is managed by a variety of different techniques.
Sources
The Group’s banking activities expose it to the risk of adverse movements in interest rates or exchange rates, with little or no exposure to equity or commodity risk.
• Most of the Group’s trading activity is undertaken to meet the requirements of wholesale and retail customers for foreign exchange and interest rate products.
However, some interest rate and exchange rate positions are taken using derivatives and on-balance sheet instruments with the objective of earning a profit from
favourable movements in market rates
• Market risk in the Group’s retail portfolios and in the Group’s capital funds arises from the different repricing characteristics of the Group’s banking assets and
liabilities. Interest rate risk arises from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets
• 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.
• The management of with-profits funds leads to assets and liabilities that are mismatched with the aim of generating a higher rate of return to meet policyholders’
expectations
• 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
• For other insurance liabilities the aim is to invest in assets such that the cash flows on investments will match those on the projected future liabilities. It is not
possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result the cash
flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch
• Surplus assets are held primarily in three portfolios; the surplus in the non-profit fund within the Long-Term Fund of Scottish Widows plc, assets in shareholder
funds of life assurance companies and an investment portfolio within the general insurance business
The Group’s defined benefit pension schemes are exposed to significant risks from the constituent parts of their assets, primarily equity and interest rate risk, and
from the present value of their liabilities.
Control
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.
Banking activity
• 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.
Insurance activity
• 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
• With-profits funds are managed in accordance with the relevant fund’s Principles and Practices of Financial Management
• 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
• Investment strategy for surplus assets held in excess of liabilities takes account of the regulatory and internal business requirements for capital to be held to support
the business now and in the future
The Group liaises with the pension scheme trustees with regard to strategies for the overall mix of pension assets.
Risk appetite
Market risk appetite is defined as the quantum and composition of market risk that exists currently in the Group and the direction in which the Group wishes to
manage this.
This statement of the Group’s overall appetite for market risk is reviewed and approved annually by the board. The group chief executive allocates this risk appetite
across the Group. Individual members of the group executive committee ensure that market risk appetite is further delegated to an appropriate level within their areas
of responsibility.
Exposures
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.
The risk of loss measured by the VaR model is the potential loss in earnings. The total and average trading VaR does not assume any diversification benefit across
the three risk types. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR
reported as a whole.
LLOYDS TSB GROUP 29
Operating and financial review and prospects
Trading
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).
Interest rate risk
Foreign exchange risk
Equity risk
Total VaR (no diversification)
Non-trading
31 December 2005
31 December 2004
Closing
£m
Average
£m
Maximum
£m
Minimum
£m
Closing
£m
Average
£m
Maximum
£m
Minimum
£m
0.9
0.2
0.0
1.1
1.8
0.3
0.0
2.1
4.5
0.4
0.0
4.7
0.5
0.2
0.0
0.8
0.7
0.2
0.0
0.9
0.9
0.3
0.0
1.3
1.7
0.6
0.0
2.0
0.5
0.2
0.0
0.8
The Group’s banking non-trading exposure is summarised in the form of an interest rate repricing table, as set out in note 51 to the financial statements. Items are
allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date. However, the table does not take into
account the effect of interest rate options used by the Group to hedge its exposure.
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.
Change in net interest income from a +100 basis point
shift in yield curves
Change in net interest income from a –100 basis point
shift in yield curves
UK
£m
North
America
£m
Asia &
Australasia
£m
Europe &
Middle East
£m
Total
2006
£m
Total
2005
£m
(76.4)
(25.7)
0.1
(10.5)
(112.5)
(80.7)
68.6
25.7
(0.1)
10.5
104.7
76.3
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.
In practice, positions in both the retail and wholesale books are actively managed and actual impact on net interest income may be different to the model.
The composition, and value, of both the Scottish Widows plc Non-Profit Fund and the General Insurance portfolio are reported to Group Risk on a monthly basis and
a VaR is calculated which is presented to the group asset and liability committee. The VaR methodology used is the same in all respects to that used for the traded
risk in banking activities, except that in the case of equity risk, the model maps the portfolio composition onto a series of appropriate indices by region and sector. In
addition the risks are calculated based on a 99 per cent confidence level and a ten day holding period. The figures quoted below are the sum of the two portfolios
with no allowance for diversification between portfolios or asset classes and represents the potential loss in earnings.
The following table shows closing, average, maximum and minimum VaR for the years ended 31 December 2005 and 2004 on a 99 per cent confidence ten day basis.
Interest rate risk
Foreign exchange risk
Equity risk
Total VaR
31 December 2005
Closing
£m
Average
£m
Maximum
£m
Minimum
£m
19.8
3.3
41.7
64.8
17.9
2.8
47.7
68.4
20.0
3.5
57.3
77.8
15.8
2.3
39.4
59.1
Closing
£m
15.5
2.4
55.2
73.1
31 December 2004
Average
£m
Maximum
£m
Minimum
£m
16.1
2.7
54.2
73.0
17.9
3.4
56.4
75.9
11.2
2.2
51.6
67.1
The Group’s structural foreign exchange position at 31 December 2005 is set out in note 51 to the financial statements. The position implies that at 31 December
2005 a hypothetical increase of 10 per cent in the value of sterling against all other currencies would have led to a £42 million reduction in reserves, and vice versa.
On this basis, there would have been no material impact on Lloyds TSB Group’s risk asset ratios.
Insurance risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity of insured/underwritten
events and to fluctuations in the timing and amount of claim settlements. This includes fluctuations in profits due to customer behaviour.
Sources
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
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.
Insurance risks are measured through deterministic studies of the impact of different insurance market scenarios on the future free assets of the business together
with relevant stochastic modelling.
30 LLOYDS TSB GROUP
Operating and financial review and prospects
New insurance proposals are underwritten to ensure an appropriate premium is charged for the risk or the risk is declined.
Limits are used as a control mechanism for insurance risk at policy level.
Exposures
Some insurance risks are retained while others are reinsured with external underwriters. The retained risk level is carefully controlled and monitored, with close
attention being paid to underwriting, claims management, product design, policy wordings, adequacy of reserves, solvency management and regulatory requirements.
General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different
reinsurers. Detailed modelling, including that of the probable maximum loss under various catastrophe scenarios, supports the choice of reinsurance arrangements.
Appropriate reinsurance arrangements also apply within the life and pensions businesses with significant mortality risk and morbidity risk being transferred to our
chosen reinsurers.
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).
Expenses are monitored by an analysis of the Group’s experience relative to budget. Reasons for any significant divergence from expectation are investigated and
remedial action taken.
Persistency rates of life assurance policies, which relate to the rate of policy termination and the rate at which policies cease to pay regular premiums, are regularly
assessed by reference to appropriate risk factors.
Operational risk
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 Group has seven sub operational risk types: governance risk, legal and regulatory risk, customer treatment risk, process and resource risk, theft, fraud and other
criminal acts risk, people risk and change-related risk each of which is described in further detail below.
Governance
Definition
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.
Control
The Group’s governance arrangements are based upon the following core principles:
• the interests of shareholders and other stakeholders are protected by ensuring that excessive powers are not delegated to individuals;
• decisions taken by management are consistent with the Group’s strategic objectives and risk appetite, which are approved by the board;
• managers are accountable for the management of risk, including internal controls, in their business;
• risk management arrangements and risk exposures (including material transactions, financial positions or portfolios) are subject to independent oversight;
• business is conducted in line with authorities and accountabilities ultimately delegated by the board; these are described within specific policies;
• clear accountabilities are delegated by management to people who have the right level of skills, competencies and experience;
• managers are required to safeguard against conflicts of interest;
• every member of staff is responsible for understanding and managing the risk they take on behalf of the Group and for ensuring that they act within the authorities
and accountabilities delegated to them; and
• all staff are required to comply with group policies.
The Group’s policy is to maintain good corporate governance arrangements, as it believes this is consistent with the Group’s objective of maximising shareholder value
over time. This includes the means by which risks are effectively managed in order to enable successful implementation of the Group’s strategy. The Group’s high
level governance arrangements are described on pages 43 to 45. These arrangements reflect the Group’s policy which is that the board adheres to the principles
contained in the Combined Code on corporate governance, issued by the Financial Reporting Council, when determining and reviewing its governance arrangements.
The directors review the application of the principles and provisions of the Code annually.
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.
Group functions (eg Group Human Resources, Group Risk, Group Finance, Group Strategy, Group Audit) are established to provide functional leadership (eg policy,
strategy, and standards), challenge and support across the Group and ensure information is consolidated at group level.
Group Audit has unrestricted access to all functions, property, records and staff. It independently reviews adherence to the policies and processes that make up the
control environment, disseminating best practices throughout the Group in the course of its monitoring and corrective action activities. The director of group audit
reports to and meets regularly with the group chief executive and the audit committee chairman and periodically with the audit committee.
LLOYDS TSB GROUP 31
Operating and financial review and prospects
Legal and regulatory risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, from failing to comply with the laws, regulations or codes applicable.
Control
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.
All compliance personnel also have a reporting line to the group compliance director who sets compliance standards across the Group and provides independent
reporting and assessment to the board and business directors.
Group Compliance also provides leadership on compliance with money laundering and terrorist financing legislation and regulation across the Group. It sets group
policy and standards on the topic and undertakes high level oversight of anti money laundering risks. A specialist team within Group Compliance provides a centre
of excellence on the relevant legislation and regulation as well as interfacing with external public and private bodies in order to evolve the Group’s approach and seek
to ensure greater effectiveness and focus on key risk areas. Its remit also includes compliance with financial sanctions.
Each business unit is responsible for complying with relevant laws and legal principles. Business units have access to legal advice both internal and external. The
group chief legal adviser provides policies to assist business units identify areas where legal risk management procedures are necessary. Reports to the group chief
legal adviser are required in relation to both significant litigation and also material legal issues.
The group compliance director and the group chief legal adviser have access to the chairman and group chief executive.
Customer treatment risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate or poor customer treatment.
Control
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.
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.
A framework is in place to guide the consideration and documentation of customer treatment risk when developing policies and procedures. The Group has defined
customer treatment principles and benchmark standards in all the key areas and enhanced its processes and procedures for a number of individual initiatives including
the governance of responsible lending and complaints handling. The divisions are required to meet or exceed these standards, tailoring customer treatment to the
needs of each customer segment.
Trends across all the CARE Index categories are monitored and fed into a programme of continuous customer service improvement. The Group also provides its staff
with clear FSA compliant guidelines and processes for dealing with customer complaints.
All advertising and marketing material is required to comply with the Group’s governing policy on business conduct. Businesses are required to have procedures in
place to seek to ensure that the material is clear, fair and not misleading bearing in mind the knowledge and sophistication of the customer. Any statement of fact
should be substantiated through documentary evidence; any comparison should be made in a fair and balanced way; and any reference to past performance should
clearly state the basis of measurement.
Process and resource risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from inadequate or failed internal processes and systems,
people-related events, damage to resources (excluding human resources), and deficiencies in the performance of external suppliers/service providers.
Control
Businesses have primary responsibility for identifying and managing their process and resource risks. They employ internal control techniques to reduce their
likelihood or impact to tolerable levels within the Group’s risk appetite. Where appropriate, risk is mitigated by way of insurance.
The Group has defined high-level process and resource risk policies to seek to ensure a wide-ranging and consistent approach to the identification and management
of process and resource risk.
Theft, fraud and other criminal acts risk
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from frauds carried out against the Group, and/or theft of the Group’s
assets, and other criminal acts.
Control
The Group has in place appropriate policies, procedures and tools for the management of theft, fraud and other criminal acts risks.
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.
Group Security has primary responsibility for the security of the people, premises and assets, including identifying and developing countermeasures to minimise the
impact of physical threats to the Group. Business unit management seek to ensure that the level of security risk applicable to each site they occupy is assessed, and
that the appropriate security countermeasures are determined in order to protect people, premises and assets.
32 LLOYDS TSB GROUP
Operating and financial review and prospects
People
Definition
The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate staff behaviour, industrial action or health and safety issues.
Loss can also be incurred through failure to recruit, retain, train, reward and incentivise appropriately skilled staff to achieve business objectives and through failure
to take appropriate action as a result of staff underperformance.
Control
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.
Standards of behaviour. The Group has a code of business conduct which applies to all employees. It seeks to ensure that employees act with integrity and endeavour
to deliver high levels of customer service. It promotes a working environment free from discrimination, harassment, bullying or victimisation of any kind. Employees
are encouraged and expected to alert management to suspected misconduct, fraud or other serious malpractice. We provide mechanisms to facilitate disclosure if an
employee is unable to inform their direct line management and will thoroughly investigate any reports made in good faith. The code as amended from time to time
is available to the public on the Group’s website at www.lloydstsb.com.
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.
Training and development. The Group believes that long-term success depends on the quality and skills of its staff and that it has a joint responsibility with employees
for their personal and career development to improve current performance and to enhance future prospects.
Change-related risk
Definition
Change-related risk is the risk of reductions in earnings and/or value, through financial or reputational loss, from change initiatives failing to deliver to requirements,
budget or timescale or failing to implement change effectively or realise the desired benefits.
Control
To deliver the Group’s strategic aims, change must be managed in an effective, risk-aware and appropriately controlled manner throughout the organisation. The
Group’s change management standards seek to ensure appropriate control across the project portfolio and the approach is regularly benchmarked against other
leading institutions and practices. The Group’s change management committee reviews the overall change portfolio monthly, with particular focus on initiatives having
a high impact on customers and staff. The committee ensures that the aggregate impact of the implementation of change on customers, staff and systems is
understood, managed and controlled.
Financial soundness
Definition
The risk of financial failure arising from lack of liquidity or capital, poor management or poor quality/volatile earnings.
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.
The international standard for measuring capital adequacy is the risk asset ratio, which relates to on- and off-balance sheet exposures weighted according to broad
categories of risk. The Group’s capital ratios, calculated in line with the requirements of the FSA, are set out in detail on page 34.
Control
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.
For non-linked funds investments are arranged to minimise the possibility of being a distressed seller whilst at the same time investing to meet policyholder obligations.
For unit-linked business, deferral provisions are designed to give time to realise linked assets without being a forced seller.
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.
Capital ratios are a key factor in the Group’s budgeting and planning processes and updates of expected ratios are prepared regularly during the year. Capital raised
takes account of expected growth and currency of risk assets and also allows for the sensitivity of the Group’s capital to movements in equity markets.
The Group seeks to use appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates. Each reporting
entity within the Group has a finance function which is responsible for the production of financial, management and regulatory information. It is the responsibility of
Group Finance to produce consolidated information for use internally and to meet external regulatory and statutory reporting requirements. Group Finance requires
businesses and reporting entities to follow common processes and reporting standards.
Businesses or reporting entities have formal month-end and quarter-end procedures in place for preparation of management and financial accounts respectively,
review and approval of management accounts at a determined level of detail, ensuring consistency with financial accounts, and preparation of forecasts and detailed
annual budgets that are subject to formal review and approval. They are further required to implement measures to monitor performance at local level to identify
significant fluctuations or unusual activity.
LLOYDS TSB GROUP 33
Operating and financial review and prospects
Liquidity sources
The principal sources of liquidity for Lloyds TSB Group plc are dividends received from its directly owned subsidiary company, Lloyds TSB Bank, and loans from this
and other Lloyds TSB Group companies. The ability of Lloyds TSB Bank to pay dividends, or for Lloyds TSB Bank or other Lloyds TSB Group companies to make
loans to Lloyds TSB Group plc, depends on a number of factors, including their own regulatory capital requirements, distributable reserves and financial performance.
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:
Moody’s
Standard & Poor’s
Senior debt
Aaa
AA
The rating outlook from Moody’s for Lloyds TSB Bank is stable. The Standard & Poor’s rating outlook is negative. These credit ratings are not a recommendation to
buy, hold or sell any security; and each rating should be evaluated independently of every other rating.
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.
The ability to sell assets quickly is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of marketable debt
securities which could be disposed of to provide additional funding should the need arise.
Group regulatory capital ratios
The international standard for measuring capital adequacy is the risk asset ratio, which relates regulatory capital to balance sheet assets and off-balance sheet
exposures weighted according to broad categories of risk.
The Group’s regulatory capital is divided into tiers defined by the European Community Banking Consolidation Directive as implemented in the UK by the FSA’s Interim
Prudential Sourcebook for Banks. Tier 1 comprises mainly shareholders’ funds, tier 1 capital instruments and minority interests, after deducting goodwill and other
intangible assets. Tier 2 comprises collective impairment provisions, and qualifying subordinated loan capital, with restrictions on the amount of collective impairment
provisions and loan capital which may be included. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting
investments in subsidiaries and associates which are not consolidated for regulatory purposes and investments in the capital of other credit/financial institutions. In
the case of Lloyds TSB Group, this means that the net assets of its life assurance and general insurance businesses are deducted from the Group’s regulatory capital.
Risk-weighted assets are determined according to a broad categorisation of the nature of each asset or exposure and counterparty and, for the trading book, by taking
into account market-related risks.
Capital:
Tier 1
Tier 2
Supervisory deductions
Total regulatory capital
Total risk-weighted assets
Risk asset ratios:
Total capital
Tier 1
31 December
2005
£m
11,478
10,447
21,925
(6,160)
15,765
144,921
10.9%
7.9%
1 January
2005
£m
10,753
8,767
19,520
(6,219)
13,301
131,830
10.1%
8.2%
At 31 December 2005, the risk asset ratios were 10.9 per cent for total capital and 7.9 per cent for tier 1 capital. The 7.9 per cent tier 1 capital ratio appears higher
than would perhaps be expected and reflects the higher level of supervisory deductions resulting from the Group’s significant investment in its life assurance
operations.
The Group’s capital management policy is focused on optimising value for shareholders. There is a clear focus on delivering organic growth and expected capital
retentions are sufficient to support planned levels of growth. However, management also wishes to maintain the flexibility to make value enhancing ‘in market’
acquisitions and therefore, at this stage, there are no plans to return capital to shareholders other than by way of dividend payments. Management will keep all options
for the utilisation of capital under review.
There are strict limits imposed by the regulatory authorities as to the proportion of the Group’s regulatory capital base that can be made up of subordinated debt and
preferred securities. The Group’s capacity to raise new debt capital for regulatory purposes increases as profits are retained; at 31 December 2005, the Group had
capacity to raise approximately £1,000 million of tier 2 debt capital. The unpredictable nature of movements in the value of the investments supporting the
long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Group seeks to ensure that even
in the event of such restrictions the total capital ratio will remain adequate.
34 LLOYDS TSB GROUP
Operating and financial review and prospects
Regulatory capital position of the Group’s life assurance businesses
Basis of determining regulatory capital of the life assurance business
Available capital resources
Available capital resources represent the excess of assets over liabilities calculated in accordance with detailed regulatory rules issued by the FSA. Different rules apply
depending on the nature of the fund, as detailed below.
Statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed
to assets is limited) and which follows a market value approach where possible. With the express permission of the FSA, an intangible asset can be recognised which
represents the present value of future releases of prudent margins on business written. The liabilities are calculated using a projection of future cash flows after making
prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk
adjusted yields on the underlying assets in accordance with the FSA rules. Other assumptions are based on recent actual experience, supplemented by industry
information where appropriate. The assessment of liabilities does not include future bonuses for with-profits policies that are at the discretion of the Company, but
does include a value for policyholder options likely to be exercised.
‘Realistic’ basis. The FSA requires each life assurance company which contains a with-profits fund in excess of £500 million, including Scottish Widows plc (‘Scottish
Widows’), to carry out a ‘realistic’ valuation of that fund. The word ‘realistic’ in this context reflects the terminology used for reporting to the FSA and is an assessment
of the financial position of a with-profits fund calculated under a prescribed methodology.
The valuation of with-profits assets in the With-Profits Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-profits business
written in the With-Profits Fund, it includes the present value of the anticipated future release of the prudent margins for adverse deviation. The realistic valuation
uses the market value of assets without the limit affecting the statutory basis noted above.
The realistic valuation of liabilities is carried out using a stochastic simulation model which values liabilities on a basis consistent with tradable market option contracts
(a ‘market-consistent’ basis). The model takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties
where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given below in the section
entitled ‘Options and guarantees’.
Regulatory capital requirements
Each life assurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FSA; the basis of calculating the regulatory
capital requirement is given below. For Abbey Life Assurance Company Limited (‘Abbey Life’), the regulatory capital requirement is a combination of amounts held
in respect of actuarial reserves and sums at risk (the Long-Term Insurance Capital Requirement) and amounts required to cover various stress tests. The regulatory
capital requirement is deducted from the available capital resources to give ‘statutory excess capital’.
For Scottish Widows, 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.
The determination of realistic liabilities of the With-Profits Fund in respect of Scottish Widows includes the value of internal transfers expected to be made from the
With-Profits Fund to the Non-Profit Fund of Scottish Widows. These internal transfers include charges on policies where the associated costs are borne by the
Non-Profit Fund. The value of the transfers exceeds the value of the costs which, in the case of Scottish Widows, results in the somewhat artificial increase in the
With-Profits Insurance Capital Component of over £500 million.
LLOYDS TSB GROUP 35
Operating and financial review and prospects
Capital statement
The following table provides more detail regarding the sources of capital in the life assurance business and reconciles those amounts to the Group’s balance sheet.
The figures quoted are based on management’s current expectations regarding completion of the annual financial return to the FSA.
Scottish Widows plc
Non-
Profit
Fund
£m
Total
Long-Term
Fund
£m
Share-
holder’s
funds
£m
Statutory Consolidation
basis adjustments
£m
£m
Total life
business on
a Group
basis
£m
With-Profits
Fund
£m
Other
sources Consolidation
of capital adjustments
£m
£m
Group
total
£m
–
–
–
–
–
1,513
1,513
2,619
2,619
–
2,619
2,619
2,619
1,513
4,132
1,346
5,478
9,909
(5,192) 10,195
Assets attributable to the shareholder held outside
the long-term funds
Assets attributable to the shareholder held within
the long-term funds
Total shareholders’ funds
Adjustments onto a regulatory basis:
Life assurance business
Unallocated surplus within insurance business
Adjustments to remove differences between IFRS
and regulatory valuation of assets and liabilities
Adjustment to include estimated ‘realistic’ liabilities
payable to the shareholder
Adjustment to replace ‘realistic’ liabilities with
statutory liabilities
Adjustment to remove the value of future profits
recognised in respect of non-participating contracts
written in the With-Profits Fund
Recognition of future profits for regulatory
capital purposes
Banking business
Collective impairment provisions
Goodwill
Pensions deficit adjustment
Other
Qualifying loan capital
494
–
494
–
494
–
(456)
(456)
(767)
(1,223)
(729)
2,580
(43)
–
–
–
(729)
2,580
(43)
–
500
500
–
–
–
–
(729)
2,580
(43)
500
–
–
–
561
561
(561)
–
1,782
(2,373)
1,372
13
10,936
1,782
(2,373)
1,372
13
10,936
(5,478)
(682)
15,765
Available capital resources – insurance business
2,302
2,663
4,965
1,307
6,272
Supervisory deductions
Net investment in life assurance business
Other
Available capital resources – Group
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.
Formal intra-group capital arrangements
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.
Constraints over available capital resources
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.
Requirement to maintain a Support Account. The Scheme requires the maintenance of a ‘Support Account’ within the Non-Profit Fund. The quantum of the Support
Account is calculated with reference to the value of assets backing current with-profits policies which also existed at the date of demutualisation and must be
maintained until the value of these assets reaches a minimum level. Assets can only be transferred from the Non-Profit Fund if the value of the remaining assets in
the fund exceeds the value of the Support Account. Scottish Widows has obtained from the FSA permission to include the value of the Support Account in assessing
the realistic value of assets available to the With-Profits Fund. At 31 December 2005, the estimated value of surplus admissible assets in the Non-Profit Fund was
£2,163 million (31 December 2004: £2,222 million) and the value of the Support Account was £1,115 million (31 December 2004: £1,265 million).
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).
36 LLOYDS TSB GROUP
Operating and financial review and prospects
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.
Movements in regulatory capital
The primary reasons for the movement in total available capital resources during the year are as follows:
With-Profits Fund
Available capital in the With-Profits Fund has increased from £1,351 million at 31 December 2004 to an estimated £2,302 million at 31 December 2005 primarily
as a result of strong investment market performance.
Non-Profit Fund
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.
Shareholder Fund
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.
Financial information calculated on a ‘realistic’ basis
The estimated financial position of the With-Profits Fund of Scottish Widows at 31 December 2005, calculated on a ‘realistic’ basis, is given in the following table,
in the form that the information will be reported to the FSA. As a result of the capital support arrangements, it is considered appropriate to also disclose the ‘realistic’
financial position of the Long-Term Fund of Scottish Widows as a whole, which consists of both the With-Profits Fund and the Non-Profit Fund.
31 December 2005
31 December 2004
Realistic value of assets of fund
Support arrangement assets (value of ‘Support Account’)
Realistic value of assets available to the fund
Realistic value of liabilities of fund
Working capital for fund
Working capital ratio for fund
With-Profits
Fund
£m
19,018
1,115
20,133
(19,253)
880
4.4%
Long-Term
Fund
£m
23,242
–
23,242
(19,102)
4,140
17.8%
With-Profits
Fund
£m
17,814
1,265
19,079
(18,108)
971
5.1%
Long-Term
Fund
£m
22,012
–
22,012
(17,827)
4,185
19.0%
Scottish Widows continues to be well capitalised with the working capital ratios for the With-Profits Fund and the Long-Term Fund being an estimated 4.4 per cent
(31 December 2004: 5.1 per cent) and 17.8 per cent (31 December 2004: 19.0 per cent) respectively. The decrease in the Long-Term Fund ratio is a result of the
proposed transfers to the Shareholder Fund noted above.
The financial information calculated on a ‘realistic’ basis reconciles to the Capital Statement as follows:
31 December 2005
Available regulatory capital
Support arrangement assets
Adjustments to replace statutory liabilities with ‘realistic’ liabilities
Adjustments to include the value of future profits recognised in respect of Non-Participating business written in
the With-Profits Fund
Removal of future profits allowable for regulatory capital purposes
Recognition of future profits allowable for ‘realistic’ capital purposes
With-Profits
Fund
£m
2,302
1,115
(2,580)
43
–
–
880
Analysis of policyholder liabilities in respect of the Group’s life assurance business:
Scottish Widows plc
With-Profits Fund liabilities
Unit-linked business (excluding those accounted for as investment contracts)
Other life assurance business
Insurance and participating investment contract liabilities
Non-participating investment contract liabilities
With-Profits Fund
(in accordance
with FRS 27)
£m
Non-Profit
Fund
£m
Total long-
term fund
£m
Other long-
term funds
£m
18,720
–
–
18,720
–
–
8,041
8,671
16,712
14,624
18,720
8,041
8,671
35,432
14,624
133
2,738
1,653
4,524
7,215
Long-Term
Fund
£m
4,965
–
(2,291)
43
(500)
1,923
4,140
Total life
business
£m
18,853
10,779
10,324
39,956
21,839
Total policyholder liabilities
18,720
31,336
50,056
11,739
61,795
LLOYDS TSB GROUP 37
Operating and financial review and prospects
Capital sensitivities
Shareholders’ funds
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.
With-Profits Fund
The with-profits realistic liabilities and the available capital for the With-Profits Fund are sensitive to both market conditions and changes to a number of non-economic
assumptions that affect the valuation of the liabilities of the fund. The available capital resources (and capital requirements) are most sensitive to the level of the stock
market, with the position worsening at lower stock market levels as a result of the guarantees to policyholders increasing in value. An increase in the level of equity
volatility implied by the market cost of equity put options also increases the market consistent value of the options given to policyholders and worsens the capital position.
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.
Other long-term funds
Outside the With-Profits Fund, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are
broadly matched. The most critical non-economic assumptions are mortality rates in respect of annuity business written (lower mortality rates are more onerous).
The Group has reduced its exposure to deteriorating mortality rates in respect of life assurance contracts through its reinsurance arrangements. In addition, poor cost
control would gradually depreciate the available capital and lead to an increase in the valuation of the liabilities (through an increased allowance for future costs).
Assets held in excess of those backing actuarial reserves are invested across a range of investment categories including fixed interest securities, equities, properties
and cash. The mix of investments is determined in line with the policy of Lloyds TSB Group to optimise shareholder risk and return. The value of the investments is
sensitive to prevailing conditions in the markets selected.
Options and guarantees
The Group has sold insurance products that contain options and guarantees, both within the With-Profits Fund and in other funds.
Options and guarantees within the With-Profits Fund
The most significant options and guarantees provided from within the With-Profits Fund are in respect of guaranteed minimum cash benefits on death, maturity,
retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies. For those policies written pre-demutualisation
containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up within the With-Profits Fund of
Scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies.
The Additional Account had a value at 31 December 2005 of £1.7 billion (2004: £1.4 billion). The eventual cost of providing benefits on policies written both
pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as
persistency and mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
As noted above, under the realistic capital regime of the FSA, the liabilities of the With-Profits Fund are valued using a market-consistent stochastic simulation model.
This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
The most significant economic assumptions included in the model are:
• Risk-free yield curve. This is derived from the yield on UK gilts, with an additional 0.1 per cent yield assumed to be risk-free;
• Investment volatility. This is derived from derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices.
For example, as at 31 December 2005, the 10 year equity-implied at-the-money assumption was set at 20.0 per cent (31 December 2004: 18.0 per cent).
The long-term at-the-money assumptions for property and fixed interest stocks were 15.0 per cent (31 December 2004: 15.0 per cent) and 13.5 per cent
(31 December 2004: 13.0 per cent) respectively.
The model includes a matrix of the correlations between each of the underlying modelled asset types. The correlations used are consistent with long-term historical
returns. The most significant non-economic assumptions included in the model are management actions (in respect of investment policy and bonus rates), guaranteed
annuity option take up rates and assumptions regarding persistency (both of which are based on recent actual experience), and assumptions regarding mortality
(which are based on recent actual experience and industry tables).
Options and guarantees outside the With-Profits Fund of Scottish Widows
Abbey Life currently has a number of policies in-force which have a guaranteed annuity option. In total it holds traditional regulatory reserves of £332 million to cover
this liability at 31 December 2005 (£288 million at 31 December 2004). These reserves have been determined using prudent future interest rate, mortality rate and
rate of annuity option take-up assumptions and exceed the value that would be placed on them using a market-consistent stochastic model. It is estimated that a
0.5 per cent reduction in future interest rates would increase the liability by some £54 million.
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.
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.
38 LLOYDS TSB GROUP
Five year financial summary
The financial information set out in the table below has been derived from the annual reports and accounts of Lloyds TSB Group plc for each of the past five years.
2005 is the first year in which the annual report and accounts have been prepared under International Financial Reporting Standards (IFRS). 2004 and earlier years
have been prepared under UK Generally Accepted Accounting Principles (UK GAAP) and earlier years have been adjusted for subsequent changes in accounting
policy and presentation. To bridge the change in framework, 2004 figures have been presented under both IFRS and UK GAAP. Under IFRS, accounting standards
dealing with financial instruments (IAS 32 and IAS 39) and insurance (IFRS 4 and FRS 27) have been applied only from 1 January 2005. The comparative IFRS
balance sheet data is presented as at 1 January 2005; the 2005 and 2004 IFRS income statement data are not comparable. Details of changes to the Group’s
2004 figures arising from transition to IFRS and accounting changes under IFRS that are effective from 1 January 2005 and which do not affect 2004 IFRS
comparatives are outlined in note 54 to the 2005 accounts and in the Group’s announcement setting out the effects of the implementation of IFRS and FRS 27
published on 27 May 2005. The financial statements for 2001 were audited by PricewaterhouseCoopers, independent accountants; the financial statements for
each of the years 2002 to 2005 have been audited by their successor firm PricewaterhouseCoopers LLP, independent accountants.
Income statement data for the year ended 31 December (£m)
Net interest income
Other income
Trading surplus
Impairment losses on loans and advances
Profit before tax
Profit for the year
Profit for the year attributable to equity shareholders
Total dividend for the year1
Balance sheet data (£m)
Share capital
Shareholders’ equity
Net asset value per ordinary share
Customer accounts
Undated subordinated loan capital
Dated subordinated loan capital
Loans and advances to customers
Total assets
Share information
Basic earnings per ordinary share
Diluted earnings per ordinary share
Total dividend per ordinary share1
Market price (year-end)
Number of shareholders (thousands)
Number of ordinary shares in issue (millions)2
Financial ratios (%)3
Dividend payout ratio
Post-tax return on average shareholders’ equity
Post-tax return on average risk-weighted assets
Cost:income ratio4
Capital ratios (%)
Total capital
Tier 1 capital
IFRS
UK GAAP
2005
2004
2004
2003
2002
2001
5,671
17,055
5,069
(1,299)
3,820
2,555
2,493
1,915
5,110
14,173
4,364
(866)
3,477
2,459
2,392
1,914
4,920
4,647
4,650
(866)
3,493
2,489
2,421
1,914
5,255
4,653
4,735
(950)
4,348
3,323
3,254
1,911
5,171
3,716
3,974
(1,029)
2,618
1,852
1,790
1,908
4,922
3,966
4,119
(747)
3,167
2,290
2,233
1,872
31 December
2005
1 January
2005
31 December
2004
31 December
2003
31 December
2002
31 December
2001
1,420
10,195
180p
131,070
7,733
4,669
174,944
309,754
1,419
9,489
167p
126,349
6,614
4,597
161,162
292,854
1,419
9,977
176p
122,062
5,852
4,400
154,240
279,843
1,418
9,624
170p
116,496
5,959
4,495
135,251
252,012
1,416
7,943
140p
116,334
5,496
4,672
134,474
252,561
1,411
10,326
183p
109,116
4,102
4,006
122,935
235,501
2005
2004
2004
2003
2002
2001
44.6p
44.2p
34.2p
488.5p
920
5,603
42.8p
42.5p
34.2p
473p
953
5,596
43.3p
43.0p
34.2p
473p
953
5,596
58.3p
58.1p
34.2p
448p
974
5,594
32.1p
32.0p
34.2p
446p
973
5,583
40.4p
40.0p
33.7p
746p
981
5,564
2005
2004
2004
2003
2002
2001
76.8
25.6
1.81
51.9
80.0
22.8
1.99
54.8
79.1
24.3
2.01
51.4
58.7
38.5
2.63
52.2
106.6
16.8
1.62
55.3
83.8
18.1
2.26
53.7
31 December
2005
1 January
2005
31 December
2004
31 December
2003
31 December
2002
31 December
2001
10.9
7.9
10.1
8.2
10.0
8.9
11.3
9.5
9.6
7.7
8.8
7.7
1 Annual dividends comprise both interim and final dividend payments. Under IFRS, the total dividend for the year represents the interim dividend paid during the year
and the final dividend which will be paid and accounted for during the following year. Under UK GAAP, final dividends are included in the year to which they relate
rather than in the year in which they are paid.
2 This figure excludes 79 million limited voting ordinary shares.
3 Averages are calculated on a monthly basis from the consolidated financial data of Lloyds TSB Group.
4 The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims for the IFRS numbers in 2004 and 2005).
LLOYDS TSB GROUP 39
The board
Non-executive directors
Maarten A van den Bergh(cid:1)(cid:1)++
Chairman
(retiring at the annual general meeting on 11 May 2006)
Joined the board in 2000 as deputy chairman and was
appointed chairman in 2001. Joined the Royal
Dutch/Shell Group of companies in 1968 and after a
number of senior and general management appointments
in that group, became group managing director in 1992.
Appointed president of Royal Dutch Petroleum Company
and vice chairman of the committee of managing directors
of the Royal Dutch/Shell Group in 1998 and continued in
these roles until 2000. A non-executive director of Royal
Dutch Shell, BT Group and British Airways, and a member
of the supervisory board of Akzo Nobel. Aged 63.
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.
Wolfgang C G Berndt(cid:2) ††
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.
Ewan Brown CBE FRSE (cid:3)**(cid:1)+
Chairman of Lloyds TSB Scotland
Joined the board in 1999. A non-executive director of
Lloyds TSB Scotland since 1997. Joined Noble Grossart in
1969 and was an executive director of that company until
December 2003. Chairman of Transport Initiatives
Edinburgh. A non-executive director of John Wood Group,
Noble Grossart and Stagecoach Group. Aged 63.
Jan P du Plessis(cid:2)*
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(cid:2)*
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.
Sir Julian Horn-Smith(cid:2) †+
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.
DeAnne S Julius CBE(cid:2) †(cid:1)
Joined the board in 2001. Held a number of senior
appointments in the UK and USA with the World Bank,
Royal Dutch/Shell Group and British Airways, before
membership of the Bank of England Monetary Policy
Committee from 1997 to 2001. Chaired HM Treasury’s
banking services consumer codes review group in 2000/1.
Chairman of the Royal Institute of International Affairs. A
non-executive director of BP, Serco Group and Roche
Holdings SA. Aged 56.
Angela A Knight(cid:2)*
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.
Lord Leitch(cid:2)*
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 non-
executive director of United Business Media and BUPA.
Aged 58.
40 LLOYDS TSB GROUP
* Member of the audit committee
** Chairman of the audit committee
(cid:1) Member of the nomination committee
(cid:1)(cid:1) Chairman of the nomination committee
† Member of the remuneration committee
†† Chairman of the remuneration committee
+ Member of the risk oversight committee
++ Chairman of the risk oversight committee
(cid:2) Independent director
(cid:3) Senior independent director
The board
Executive directors
J Eric Daniels
Group Chief Executive
Joined the board in 2001 as group executive director, UK
retail banking before his appointment as group chief
executive in June 2003. Served with Citibank from 1975
and held a number of senior and general management
appointments in the USA, South America and Europe
before becoming chief operating officer of Citibank
Consumer Bank in 1998. Following the Citibank/Travelers
merger in 1998, he was chairman and chief executive
officer of Travelers Life and Annuity until 2000. Chairman
and chief executive officer of Zona Financiera from 2000
to 2001. Aged 54.
Michael E Fairey
Deputy Group Chief Executive
Joined TSB Group in 1991 and held a number of senior
and general management appointments before being
appointed to the board in 1997 and deputy group chief
executive in 1998. Joined Barclays Bank in 1967 and
held a number of senior and general management
appointments, including managing director of Barclays
Direct Lending Services from 1990 to 1991. President of
The British Quality Foundation. Aged 57.
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.
Archie G Kane
Group Executive Director
Insurance and Investments
Joined TSB Commercial Holdings in 1986 and held a
number of senior and general management appointments
in Lloyds TSB Group before being appointed to the board
in 2000, as group executive director, IT and operations.
Appointed group executive director, insurance and
investments in October 2003. After some 10 years in the
accountancy profession, joined General Telephone &
Electronics Corporation in 1980, serving as finance
director in the UK from 1983 to 1985. Aged 53.
G Truett Tate
Group Executive Director
Wholesale and International Banking
Joined the Group in 2003 as managing director, corporate
banking before being appointed to the board in 2004.
Served with Citigroup from 1972 to 1999, where he
held a number of senior and general management
appointments in the USA, South America, Asia and
Europe. He was president and chief executive officer of
eCharge Corporation from 1999 to 2001 and co-founder
and vice chairman of the board of Chase Cost Management
Inc from 1996 to 2003. Aged 55.
Helen A Weir
Group Finance Director
Joined the board in 2004. Group finance director of
Kingfisher from 2000 to 2004. Previously finance director
of B&Q from 1997, having joined that company in 1995,
and held a senior position at McKinsey & Co from 1990 to
1995. Began her career at Unilever in 1983. A non-
executive director of Royal Mail Holdings and a member of
the Accounting Standards Board. Aged 43.
Company Secretary
Alastair J Michie FCIS FCIBS
LLOYDS TSB GROUP 41
Directors’ report
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.
An interim dividend of 10.7p per ordinary share was paid on 5 October 2005 and a final dividend of 23.5p per ordinary share will be paid on 3 May 2006.
These dividends will absorb £1,915 million.
Principal activities, business review, future developments and financial risk management objectives and policies
The Company is a holding company and its subsidiaries provide a wide range of banking and financial services through branches and offices in the UK and
overseas. A review of the business and an indication of future developments are given on pages 4 to 38. Information regarding the financial risk management
objectives and policies of the Company and its subsidiary undertakings, in relation to the use of financial instruments, is given on pages 24 to 34 and in note 51
on pages 107 to 111.
Authority to purchase shares
The authority for the Company to purchase, in the market, up to 567 million of its shares, representing some 10 per cent of the issued ordinary share capital, expires
at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give a similar authority.
Directors
Biographical details of directors are shown on pages 40 and 41. Particulars of their emoluments and interests in shares in the Company are given on pages 46 to 57.
Dr Gibson-Smith and Mr Pritchard left the board at the annual general meeting in 2005. Mr Ayliffe left the board on 31 January 2005.
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.
Employees
Lloyds TSB Group is committed to employment policies which follow best practice, based on equal opportunities for all employees irrespective of sex, race, national
origin, religion, colour, disability, sexual orientation, age or marital status.
In the UK, Lloyds TSB Group supports Opportunity Now and is represented on the board of Race for Opportunity; campaigns to improve opportunities for women
and ethnic minorities in the work place. Lloyds TSB Group is a gold card member of the Employers’ Forum on Disability, in support of employment of people with
disabilities. This recognises the need for ensuring fair employment practices in recruitment and selection, and the retention, training and career development of
disabled staff.
Employees are kept closely involved in major changes affecting them through such measures as team meetings, briefings, internal communications and opinion
surveys. There are well established procedures, including regular meetings with recognised unions, to ensure that the views of employees are taken into account in
reaching decisions.
Schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement in Lloyds TSB Group.
Directors’ indemnities
Directors’ service agreements or letters of appointment, which are available for inspection, contain indemnities as provided for in the Companies (Audit, Investigations
and Community Enterprise) Act 2004.
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.
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.
As the Company owed no amounts to trade creditors at 31 December 2005, the number of days required to be shown in this report, to comply with the provisions
of the Companies Act 1985, is nil.
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.
On behalf of the board
A J Michie
Company Secretary
23 February 2006
42 LLOYDS TSB GROUP
Corporate governance
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 and its committees
The Group is led by a board comprising executive and non-executive directors with wide experience. The appointment of directors is considered by the board and,
following the provisions in the articles of association, they must stand for election by the shareholders at the first annual general meeting following their appointment
and must retire, and may stand for re-election by the shareholders, at least every three years. Executive directors normally retire at age 60, as required by their service
agreements. Independent non-executive directors are appointed for three-year renewable terms, which may be terminated without notice or payment of compensation.
The board meets at least nine times a year. It has a programme designed to enable the directors regularly to review corporate strategy and the operations and results
of the businesses and discharge their duties within a framework of prudent and effective controls relating to the assessing and managing of risk.
The roles of the chairman, the group chief executive and the board and its governance arrangements, including the schedule of matters specifically reserved to the
board for decision, are reviewed annually. The matters reserved to the board for decision include the approval of the annual report and accounts and any other financial
statements; the payment of dividends; the long-term objectives of the Group; the strategies necessary to achieve these objectives; the Group’s budgets and plans;
significant capital expenditure items; significant investments and disposals; the basis of allocation of capital within the Group; the organisation structure of the Group;
the arrangements for ensuring that the Group manages risks effectively; any significant change in accounting policies or practices; the appointment of the Company’s
main professional advisers; and the appointment of senior executives within the organisation and the related forward planning.
The board has delegated to management the power to make decisions on operational matters, including those relating to credit, liquidity and market risk, within an
agreed framework.
All directors have access to the services of the company secretary, and independent professional advice is available to the directors at the Group’s expense, where
they judge it necessary to discharge their duties as directors.
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 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 chairman has a private discussion at least once a year with every director on a wide range of issues affecting the Group, including any matters which the directors,
individually, wish to raise.
There is an induction programme for all new directors, which is tailored to their specific requirements and includes visits to individual businesses and meetings with
senior management. Additional training and updates on particular issues are arranged as appropriate.
Meetings with shareholders
In order to develop an understanding of the views of major shareholders, the board receives regular reports from the group finance director and the director of
investor relations.
The chairman, the group chief executive and the group finance director also have meetings with representatives of major shareholders and the senior independent
director also attends some of these meetings. In addition, all directors are invited to attend investment analysts’ and stockbrokers’ briefings on the financial results.
All shareholders are encouraged to attend and participate in the Group’s annual general meeting.
Each resolution considered at the annual general meeting in 2005 was decided on a poll. Votes representing some 50 per cent of the total number of shares in issue
were cast and each resolution was passed by a substantial majority. Details of the poll results are available from the company secretary.
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.
Audit committee
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.
Chairman’s committee
The chairman’s committee, comprising the chairman, the group chief executive and the deputy group chief executive, meets to assist the chairman in preparing for
board meetings.
The committee may have specific powers delegated to it by the board from time to time and following the exercising of these powers, it reports to the board.
LLOYDS TSB GROUP 43
Corporate governance
Group executive committee
The group executive committee, comprising the group chief executive, the deputy group chief executive, the group executive directors, the chief risk director, the group
human resources director and the director of group IT and operations, meets to assist the group chief executive in performing his duties. Specifically, the committee
considers the development and implementation of strategy, operational plans, policies and budgets; the monitoring of operating and financial performance; the
assessment and control of risk; the prioritisation and allocation of resources; and the monitoring of competitive forces in each area of operation. The committee,
assisted by its sub-committees, the group business risk and group asset and liability committees, also supports the group chief executive in endeavouring to ensure
the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, and in reviewing
the Group’s aggregate risk exposures and concentrations of risk.
The committee may have specific powers delegated to it by the board from time to time and following the exercising of these powers, it reports to the board. To comply
with the Group’s articles of association, only committee members who are also directors of the Company participate in the exercising of any powers delegated by
the board.
Nomination committee
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.
During the year, the committee recommended the appointment of one executive director and two non-executive directors. In that regard, detailed role specifications
were drawn up, external search consultants were engaged and candidates were interviewed by committee members and the other directors.
In January 2006, it was announced that Mr van den Bergh had decided to retire as chairman of the Group at the annual general meeting in May. Sir Victor Blank
will become deputy chairman on 1 March and, subject to shareholder approval of his election as a director at the annual general meeting, will succeed
Mr van den Bergh as chairman.
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.
It has already been announced that Sir Victor will retire from the board of Trinity Mirror at its annual general meeting in May of this year. As recently announced by
GUS plc, he will remain as chairman of GUS until the proposed separation of its businesses, announced last year, but will have no continuing role in these businesses
after that.
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.
Lloyds TSB Group acknowledges Sir Victor’s responsibilities as chairman of two FTSE 100 companies for a transitional period but the board feels that his experience
will enable him to discharge his duties fully during that time. The senior independent non-executive director, Mr Brown, also recognises the importance of his role in
being available to shareholders, especially during this transitional period.
Both the Association of British Insurers and the National Association of Pension Funds were consulted, in line with the principles of the combined code.
The committee’s terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com.
Remuneration committee
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.
Risk oversight committee
The risk oversight committee comprises Mr van den Bergh (chairman), Mr Brown and Sir Julian Horn-Smith. All non-executive directors are also invited to attend
meetings if they wish. The risk oversight committee’s duties include overseeing the development, implementation and maintenance of the Group’s overall risk
governance framework, risk appetite, risk strategy and policies, to ensure they are in line with emerging regulatory, corporate governance and industry best practice.
The committee also oversees the Group’s risk exposures; facilitates the involvement of non-executive directors in risk issues and aids their understanding of these
issues; oversees adherence to Group risk policies and standards and considers any material amendments to them; and reviews the work of the Group Risk division.
The risk oversight committee reports to the board on its deliberations after each meeting.
44 LLOYDS TSB GROUP
Corporate governance
Attendance at meetings
The attendance of directors at board meetings and at meetings of the audit, nomination, remuneration and risk oversight committees during 2005 was as follows:
Board
Audit
committee
Nomination Remuneration Risk oversight
committee
committee
committee
Number of meetings during the year
Current directors who served during 2005
W C G Berndt
Ewan Brown1
J E Daniels
T A Dial2
J P du Plessis3
M E Fairey
G J N Gemmell
Sir Julian Horn-Smith4
D S Julius
A G Kane
A A Knight
Lord Leitch3
G T Tate
M A van den Bergh
H A Weir
Former directors who served during 2005
C S Gibson-Smith5
D P Pritchard5
1 Appointed to the nomination committee from 3 March 2005
2 Appointed to the board from 1 June 2005
3 Appointed to the board and audit committee from 1 October 2005
4 Appointed to the risk oversight committee from 3 March 2005
5 Left the board on 5 May 2005
Statement of directors’ responsibilities
9
9
9
9
4
2
9
9
8
9
9
9
2
9
9
9
3
4
5
5
1
5
5
1
3
2
3
3
2
7
7
5
5
1 (co-opted)
6
6
3
4
2
1
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.
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.
A copy of the financial statements of the Company is placed on the website of Lloyds TSB Group plc. The directors are responsible for the maintenance and integrity
of statutory and audited information on the Company’s website. Information published on the internet is accessible in many countries with different legal requirements.
Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
Internal control
The board of directors is responsible for the establishment and review of the Lloyds TSB Group’s system of internal control, which is designed to ensure effective and
efficient operations, quality of internal and external reporting, internal control, and compliance with laws and regulations. It should be noted, however, that such a
system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control
the directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system
of internal control can only provide reasonable but not absolute assurance against the risk of material loss.
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.
Going concern
The directors are satisfied that the Company and Lloyds TSB Group have adequate resources to continue to operate for the foreseeable future and are financially
sound. For this reason they continue to adopt the going concern basis in preparing the accounts.
LLOYDS TSB GROUP 45
Directors’ remuneration report
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.
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.
As a result of this review, the remuneration committee has decided to:
• Adopt the FTSE 20 as the comparator group used to benchmark the overall competitiveness of our remuneration package, providing a more realistic comparison
in terms of company size and a key market for talent. Measured by market capitalisation, the Group is currently positioned around the median of this
comparator group.
• Increase executive director expected levels of personal shareholding in the Group.
• 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.
In addition, we will be recommending to shareholders the adoption of a new long-term incentive plan which will replace the current executive share option scheme.
We believe that these changes, which have the full support of the board, should even more firmly align executive director remuneration with shareholders’ interests
as well as engaging them in pursuing long-term shareholder value. The remuneration committee unanimously recommends that the long-term incentive plan proposal
and the wider remuneration report be approved.
Dr Wolfgang Berndt
Chairman, Remuneration Committee
Content of remuneration report
• Role of remuneration committee
• Remuneration committee membership
• Advisers to the committee
• Directors’ remuneration policy
• Dilution limits
• Pensions
• Service agreements
• External appointments
• Performance graph
• Audited information
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.
All the independent non-executive directors are invited to attend meetings if they wish, and they receive the minutes and have the opportunity to comment and have
their views taken into account before the committee’s decisions are implemented.
The committee’s terms of reference are available from the company secretary and are displayed on the Group’s website www.lloydstsb.com.
Remuneration committee membership
The remuneration committee is comprised of the following independent non-executive directors:
• Dr Berndt (chairman)
• Dr Gibson-Smith (until 5 May 2005 when he left the board)
• Sir Julian Horn-Smith
• Dr Julius
46 LLOYDS TSB GROUP
Directors’ remuneration report
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.
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.
Mr van den Bergh, Mr Daniels, Mr Hijkoop (Group Human Resources Director) and Mr Farley (Group Compensation & Benefits Director) provided guidance to the
committee (other than for their own remuneration).
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.
• The majority of total compensation is linked to the achievement of stretching performance targets.
• The long-term rewards are aligned to shareholder interests, which is achieved by taking account of measures that reflect shareholder interests, and by expecting
executive directors to build a shareholding in the Group equivalent to 1 times the director’s base pay over a period of four years. This has now increased to 1.5 times
(2 times for the group chief executive), with the executives being expected to retain at least 50 per cent of all net vested equity until the guideline is met.
• The overall package reflects market practice and takes account of the terms and conditions applying to other employees of the Group.
As a consequence of the proposed changes in policy, the composition of the remuneration package in 2006 will be as follows:
Group chief executive
Other executive directors
8%
23%
28%
9%
5%
24%
29%
41%
38%
Basic salary
Cash bonus
Long-term incentives
Pension
In 2006, approximately 67 per cent (69 per cent for the group chief executive) of an executive director’s potential direct remuneration (salary, annual bonus and
long-term incentives) will be performance related. The value of long-term incentives is the expected value calculated by using a ‘binomial’ model, which is a widely
accepted methodology for this purpose.
Chairman’s and deputy chairman’s remuneration
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.
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.
Independent non-executive directors’ fees
The fees of the independent non-executive directors are agreed by the board within a total amount determined by the shareholders. An increase in the total amount
that can be paid is being proposed at the annual general meeting. Directors may also receive fees, agreed by the board, for membership of board committees. The
fees are designed to recognise the various responsibilities of a non-executive director’s role and to attract individuals with relevant skills, knowledge and experience.
The fees are neither performance related nor pensionable and are comparable with those paid by other companies. The annual fees are listed below:
Board
Audit committee chairmanship
Audit committee membership
Nomination committee membership
Remuneration committee chairmanship
Remuneration committee membership
Risk oversight committee membership
£50,000
£40,000
£15,000
£5,000
£20,000
£15,000
£15,000
Independent non-executive directors who serve on the boards of subsidiary companies may also receive fees from the subsidiaries. These are included in the table
shown on page 51.
LLOYDS TSB GROUP 47
Directors’ remuneration report
Executive director basic salaries
Basic salaries are reviewed annually, usually in December, taking into account individual performance and market information (which is provided by Towers Perrin)
and then adjusted from 1 January of the following year. Basic salary increases for other employees across the Group will be generally in the range of 0-10 per cent,
and the salary increase awarded to executive directors are consistent with this policy. Salaries payable from 1 January 2006 are as follows:
Name
Amount
J E Daniels
£880,000
M E Fairey
£570,000
T A Dial
£570,000
A G Kane
£500,000
G T Tate
£515,000
H A Weir
£500,000
Annual incentive scheme
The annual incentive scheme for executive directors is designed to reflect specific goals linked to the performance of the business.
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.
The maximum annual bonus opportunity for 2005 for Mr Daniels was also set at 150 per cent of basic salary for exceptional performance. An amount equal to
112.5 per cent of basic salary is available on the achievement of stretching budget targets relating to profit before tax and economic profit; failure to achieve at least
90 per cent of these performance targets would result in no bonus payment. The actual level of bonus award made takes account of Mr Daniels’ individual
performance and contribution.
Regarding Mr Daniels’ 2006 bonus opportunity, an amount equal to 112.5 per cent of basic salary will continue to be available on the achievement of stretching
targets contained in a balanced scorecard. However, his maximum bonus opportunity will be increased to 175 per cent of basic salary for the achievement of
exceptional performance targets, bringing Mr Daniels’ bonus opportunity closer to comparator group levels. In line with the revised bonus arrangements for the
executive directors, half of the bonus will be driven by corporate results and the other half by individual performance. 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.
PricewaterhouseCoopers LLP check the calculation of the annual incentive payments for executive directors based on the achievement of performance against targets
set. In respect of performance in 2005, the bonus percentages awarded to the directors are shown in the table below.
Performance share plan
If shareholders approve the policy proposal mentioned earlier, further grants under this scheme will not be awarded to directors after 2006. From 2007, therefore,
awards under the annual incentive scheme will be in cash only. However, it is envisaged that the loss of the performance share dynamics under the current plan will
be compensated for under the proposed new long-term incentive plan.
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
Opportunity
% awarded
Deferred bonus
J E Daniels
150%
118.5%
£488,812
M E Fairey
150%
79%
£215,500
T A Dial
150%
100%
£162,250
A G Kane
150%
83%
£197,000
G T Tate
150%
111%
£262,500
H A Weir
150%
81%
£192,500
Under the performance share plan executives will be eligible for an award of free shares, known as performance shares, to match the bonus shares. The maximum
match will be two performance shares for each bonus share, awarded at the end of the three year retention period. The number of performance shares actually
awarded will depend on the Group’s TSR performance measured over the three year period ending December 2008, compared with the TSR of the other companies
in the comparator group listed below. The maximum of two performance shares for each bonus share will be awarded only if the Group’s TSR performance places it
first in the comparator group; one performance share will be awarded for each bonus share if the Group is placed fifth; and one performance share for every two
bonus shares if the Group is placed eighth (median). Between first and fifth positions and fifth and eighth positions sliding scales will apply. If the TSR performance
is below median no performance shares will be awarded. There will be no retest. Whilst income tax is deducted from the deferred bonus before the conversion to
bonus shares, where a match of performance shares is justified, these shares will be awarded as if income tax had not been deducted. This maintains the original
design of the plan prior to the issue of guidance from HM Revenue & Customs in December 2004.
Other companies in the comparator group:
Alliance & Leicester
Bradford & Bingley
Legal & General
Royal & Sun Alliance
Aviva
Friends Provident
Northern Rock
Standard Chartered
Banco Santander
HBOS
Prudential
Barclays
HSBC Holdings
Royal Bank of Scotland
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.
Long-term rewards – current executive share option scheme
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.
48 LLOYDS TSB GROUP
Directors’ remuneration report
In 2005, options were granted to executive directors and senior executives within the scheme limits. These limits relate to the number of shares under option and
the price payable on exercise. The maximum limit for the grant of options to an executive director in any one year is equal to 3 times annual basic salary, although
in exceptional circumstances, for example on the recruitment of a new executive director, that could be increased to 4 times annual basic salary.
A performance condition was set when the grant of options was made and the options will not normally be exercisable unless the condition is met. The performance
condition requires the Group’s ranking, based on TSR over the relevant (three year) period, to be at least eighth within the comparator group.
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.
The comparator group is the same as that used for the performance share plan.
The following table illustrates the percentage of the grant which would be exercisable depending on the Group’s TSR ranking within the comparator group set
out above.
Ranking position within comparator group
Per cent of option which may be exercised
1
2
3
4
5
6
7
8
9 or below
100
100
100
100
82.5
65
47.5
30
Nil – options not exercisable
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.
Long-term rewards – proposed long-term incentive plan
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.
Other share plans
The executive directors and the chairman are also eligible to participate in the Group’s ‘sharesave’ scheme and the Group’s ‘shareplan’. These are ‘all-employee’ share
schemes and performance conditions do not apply.
Dilution limits
The following charts illustrate the shares available for the Group’s share schemes.
All schemes
(10% in any consecutive 10 years)
Executive schemes
(5% in any consecutive 10 years)
Shares used (million)
Shares available (million)
46.2
233.9
182.4
377.9
Pensions
Executive directors are either entitled to participate in the Group’s defined benefit pension schemes (based on salary and length of service, with a maximum pension
of two thirds of final salary), or the Group’s defined contribution scheme (under which their final entitlement will depend on their contributions and the final value of
their fund). The defined benefit schemes are closed to new entrants on recruitment.
LLOYDS TSB GROUP 49
Directors’ remuneration report
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.
Independent non-executive directors do not have service agreements and, in accordance with the articles of association, their appointment may be terminated at any
time without compensation.
It is the Group’s policy that where compensation on early termination is due, it should be paid on a phased basis, mitigated in the event that alternative employment
is secured, and that bonus payments should relate to the period of actual service, rather than the full notice period and will be determined on the basis of performance.
Any entitlements under the pension scheme or equity plans will be in accordance with the scheme rules on leaving.
Notice to be given by the Company
Date of service agreement/letter of appointment
Sir Victor Blank
J E Daniels
M E Fairey
T A Dial
A G Kane
G T Tate
H A Weir
External appointments
6 months
12 months
12 months
12 months
12 months
12 months
12 months
25 January 2006
19 October 2001
28 August 1991
23 May 2005
9 February 2000
29 July 2004
4 March 2004
The Group recognises that executive directors may be invited to become non-executive directors of other companies and that these appointments may broaden their
knowledge and experience, to the benefit of the Group. Fees are normally retained by the individual directors as the post entails personal responsibility. Executive
directors are generally allowed to accept one non-executive directorship.
During 2005, Ms Dial and Mrs Weir received fees of $88,775 and £14,375 respectively, which were retained by them, for serving as non-executive directors of
other companies.
Performance graph
The graph illustrates the performance of the Group measured by TSR against a ‘broad equity market index’ over the past five years. As the Group has been a constituent
of the FTSE 100 index throughout this five-year period, that index is considered to be the most appropriate benchmark.
Comparative TSR
50 LLOYDS TSB GROUP
Directors’ remuneration report
Audited information
Directors’ emoluments for 2005
Current directors who served during 2005
Executive directors
J E Daniels
M E Fairey
T A Dial
A G Kane
G T Tate
H A Weir
Non-executive directors
M A van den Bergh
W C G Berndt
Ewan Brown
J P du Plessis
G J N Gemmell
Sir Julian Horn-Smith
D S Julius
A A Knight
Lord Leitch
Former directors who served during 2005
P G Ayliffe
C S Gibson-Smith
D P Pritchard
Former directors who served during 2004
P R Hampton
Others
Salaries/
fees
£000
Other benefits
Cash
£000
Non cash
£000
Performance- Compensation
for loss of
office
£000
related
payments
£000
2005
Total
£000
2004
Total
£000
825
545
321
475
475
475
475
67
122
16
121
74
66
105
16
33
21
88
100
462
222
18
52
73
12
2
4
3
8
18
9
16
1,002
447
334
408
539
399
366
5
3
1,930
1,462
877
919
1,075
963
487
67
122
16
121
74
66
105
16
401
21
100
1,903
1,478
–
858
403
654
454
55
84
–
110
–
55
93
–
588
55
279
4,320
945
59
3,132
370
8,826
8,478
4
4
359
1,050
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 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).
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.
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.
The non cash column includes amounts relating to the use of a company car, use of a company driver and private medical insurance. It also includes the value of
any matching shares which are received under the terms of shareplan, through which employees have the opportunity to purchase shares up to a maximum of
£125 per month and receive matching shares on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share.
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.
Mr Ayliffe left the board on 31 January 2005. However, he remained with the Company until his employment was terminated on 31 March 2005 and was
paid £71,442 for that period. Mr Hampton’s employment was terminated on 12 January 2004. Subsequently they both received payments in accordance with their
contractual entitlement.
LLOYDS TSB GROUP 51
Directors’ remuneration report
Audited information
Directors’ pensions
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.
Retirement pensions accrue at rates of between 1/60 and 1/30 of basic salary per annum.
Directors have a normal retirement age of 60. In the event of death in service, a lump sum of four times salary is payable plus, for members of a defined benefit
scheme, a spouse’s pension of two-thirds of the member’s prospective pension. On death in retirement, a spouse’s pension of two-thirds of the member’s pension
is payable. The defined benefit schemes are non-contributory. Members of defined contribution schemes are required to contribute.
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.
Defined contribution scheme members
Mr Tate is a member of a defined contribution scheme. During the year to 31 December 2005, the employer has made contributions to the defined contribution
scheme in respect of him totalling £62,937.
Mrs Weir is a member of a defined contribution scheme. During the year to 31 December 2005, the employer has made contributions to the defined contribution
scheme in respect of her totalling £40,375.
Defined benefit scheme members
P G Ayliffe
J E Daniels
M E Fairey
A G Kane
Accrued
pension at
31 December
2005
£000
(a)
Accrued
pension at
31 December
2004
£000
(b)
Change in
accrued
pension
£000
(a)-(b)
Transfer
value at
31 December
2005
£000
(c)
Transfer
value at
31 December
2004
£000
(d)
139
99
256
240
132
77
226
216
7
22
30
24
2,045
1,599
5,003
3,700
1,780
1,139
3,996
3,039
Change in
transfer
value
£000
(c)-(d)
265
460
1,007
661
In addition, the following unfunded benefits have accrued for Mr van den Bergh instead of a salary increase in 2002:
M A van den Bergh
13
10
3
190
136
54
Additional
pension
earned to
31 December
2005
£000
(e)
Transfer
value of the
increase
£000
(f)
3
19
23
17
3
46
309
449
264
40
Mr Ayliffe’s pension entitlement at 31 December 2005 includes additional service in respect of his notice period in accordance with the terms of his contract.
The disclosures in columns (a) to (d) are as required by the Companies Act 1985 Schedule 7A.
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 (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2005 based on factors supplied by the actuary of the relevant
Lloyds TSB Group pension scheme in accordance with actuarial guidance note GN11. The underlying bases used to arrive at the factors have not changed during
the year.
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.
Column (e) is the increase in pension built up during the year, recognising (i) the accrual rate for the additional service based on the pensionable salary in force at
the year end, and (ii) where appropriate the effect of pay changes in ‘real’ (inflation adjusted) terms on the pension already earned at the start of the year.
Column (f) is the capital value of the pension in column (e).
The disclosures in columns (e) and (f) are as required by the UK Listing Authority listing rules. The requirements of the listing rules differ from those of the Companies
Act. The listing rules require the additional pension earned over the year to be calculated as the difference between the pension accrued at the end of the financial
year and the pension accrued at the start of the financial year less the increase in the pension earned over the year solely due to inflation. The transfer value in column
(f) can differ significantly from the change in transfer value as required by the Companies Act because the additional pension accrued over the year calculated in
accordance with the listing rules makes allowance for inflation and the change in the transfer value required by the Companies Act will be significantly influenced by
changes in the assumptions underlying the transfer value calculation at the beginning and end of the financial year.
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.
52 LLOYDS TSB GROUP
Directors’ remuneration report
Directors’ interests
The interests, all beneficial, of those who were directors at 31 December 2005 in shares in Lloyds TSB Group were:
Shares
Executive directors
J E Daniels
M E Fairey
T A Dial
A G Kane
G T Tate
H A Weir
Non-executive directors
M A van den Bergh
W C G Berndt
Ewan Brown
J P du Plessis
G J N Gemmell
Sir Julian Horn-Smith
D S Julius
A A Knight
Lord Leitch
At 1 January 2005
(or later date of
appointment)
At 31 December
2005
At 23 February
2006†
160,999
79,125
100,158
38,136
77,858
–
98,979
701
1,699
5,079
46,000
4,027
–
70,000
5,000
2,000
4,940
–
160,942
79,104
–
100,101
1,356
3,992
5,098
61,000
4,260
10,000
70,000
5,000
2,000
4,940
–
† The changes in beneficial interests between 31 December 2005 and 23 February 2006 related to ‘partnership’ and ‘matching’ shares acquired under the
Lloyds TSB Group shareplan.
Non-beneficial interests
Directors had non-beneficial interests as follows:
Mr Daniels, Mr Fairey, Ms Dial, Mr Kane, Mr Tate, Mr van den Bergh and Mrs Weir, together with some 77,000 other employees, were potential beneficiaries in the
1,364 and 1,237,191 shares held at the end of the year by the Lloyds TSB qualifying employee share ownership trust and the Lloyds TSB Group employee share
ownership trust respectively. 1,364 and 1,467,422 shares, respectively, were held by these trusts at the beginning of the year. These holdings were 1,364
and 1,224,846 respectively on 23 February 2006. In addition, the above directors, with the exception of Mr van den Bergh, together with some 77,000 other
employees, were potential participants in shareplan and were, therefore, treated as interested in the 582,462 shares held at the end of the year by the trustee
of the shareplan. 471,989 shares were held by the trustee at the beginning of the year. This holding was 729,451 on 23 February 2006.
LLOYDS TSB GROUP 53
Directors’ remuneration report
Audited information
Interests in share options
Current directors
who served
during 2005
J E Daniels
M E Fairey
T A Dial
A G Kane
G T Tate
H A Weir
Exercise periods
From
To
Notes
At 1 January 2005
(or later date of
appointment)
Granted
during
the year
Exercised/
lapsed during
the year
At 31 December
2005
907,780
330,419
3,327
599,239
305,232
939,177
797
54,000
48,000
57,000
85,896
10,931
42,884
148,618
345,104
1,330
531
663,157
555,992
907,780
148,618
–
330,419
3,327
599,239
305,232
939,177
521,876
797
54,000
48,000
57,000
85,896
10,931
42,884
–
345,104
1,330
531
663,157
555,992
344,754
521,876
344,754
Exercise
price
694p
715p
284p
394.25p
430p
419.25p
474.25p
474p
510p
859.5p
817p
549.5p
615.5p
655p
733p
715p
284p
348p
394.25p
419.25p
474.25p
1/11/2004
6/3/2005
1/6/2006
21/2/2006
14/8/2006
18/3/2007
17/3/2008
1/11/2005
26/3/2000
15/5/2001
2/8/2002
6/3/2003
8/8/2003
6/3/2004
21/8/2004
6/3/2005
1/6/2006
1/11/2006
21/2/2006
18/3/2007
17/3/2008
31/10/2011
5/3/2012
30/11/2006
20/2/2013
13/8/2013
17/3/2014
16/3/2015
30/4/2006
25/3/2007
14/5/2008
1/8/2009
5/3/2010
7/8/2010
5/3/2011
20/8/2011
5/3/2012
30/11/2006
30/4/2007
20/2/2013
17/3/2014
16/3/2015
–
464,134
464,134
474p
11/8/2008
10/8/2015
25,000
40,000
50,000
27,000
64,786
11,841
34,759
118,178
275,349
5,783
529,105
523,255
348,837
268,336
195,409
556,208
5,093
118,178
300,474
300,474
300,474
25,000
40,000
50,000
27,000
64,786
11,841
34,759
–
275,349
5,783
529,105
523,255
300,474
348,837
268,336
195,409
300,474
556,208
5,093
300,474
–
242,825
321p
510p
880p
887.5p
549.5p
615.5p
655p
733p
715p
284p
394.25p
419.25p
474.25p
430p
419.25p
403p
474.25p
424.75p
321p
474.25p
28/3/1999
26/3/2000
4/3/2001
4/3/2002
6/3/2003
8/8/2003
6/3/2004
21/8/2004
6/3/2005
1/6/2008
21/2/2006
18/3/2007
17/3/2008
14/8/2006
18/3/2007
12/8/2007
17/3/2008
29/4/2007
1/11/2009
17/3/2008
27/3/2006
25/3/2007
3/3/2008
3/3/2009
5/3/2010
7/8/2010
5/3/2011
20/8/2011
5/3/2012
30/11/2008
20/2/2013
17/3/2014
16/3/2015
13/8/2013
17/3/2014
11/8/2014
16/3/2015
28/4/2014
30/4/2010
16/3/2015
(see page 57)
1/6/2008
30/11/2008
d,j
d,g
a,h
d,h
d,h
d,h
e,h
a,f
b,f
b,f
b,g
c,g
c,g
c,g
d,j
d,g
a,h
a,h
d,h
d,h
e,h
e,h
b,f
b,f
b,f
b,g
c,g
c,g
c,g
d,j
d,g
a,h
d,h
d,h
e,h
d,h
d,h
d,h
e,h
d,h
a,h
e,h
i
h
Other share plans:
J E Daniels
T A Dial
216,763
216,763
242,825
54 LLOYDS TSB GROUP
Directors’ remuneration report
Audited information
Interests in share options (continued)
Former directors
who served
during 2005
P G Ayliffe
D P Pritchard
At 1 January 2005
Granted
during
the year
Exercised/
lapsed during
the year
At 31 December
2005 (or earlier
date of leaving
the board)
3,327
13,000
12,000
20,000
3,000
23,657
10,560
16,717
44,562
104,895
218,769
177,034
429,338
50,000
40,000
71,519
10,385
36,374
127,131
286,363
3,327*
13,000‡
12,000
20,000
3,000
23,657
10,560
16,717
44,562
104,895
157,999
98,352
155,038
50,000
40,000
71,519
10,385
36,374
127,131
286,363
60,770*
78,682*
274,300*
Exercise
price
284p
321p
510p
880p
887.5p
549.5p
615.5p
655p
733p
715p
394.25p
430p
419.25p
859.5p
817p
549.5p
615.5p
655p
733p
715p
Exercise periods
From
To
Notes
1/6/2006
28/3/1999
26/3/2000
4/3/2001
4/3/2002
6/3/2003
8/8/2003
6/3/2004
21/8/2004
6/3/2005
21/2/2006
14/8/2006
18/3/2007
15/5/2001
2/8/2002
6/3/2003
8/8/2003
6/3/2004
21/8/2004
6/3/2005
30/11/2006
27/3/2006
25/3/2007
3/3/2008
3/3/2009
5/3/2010
7/8/2010
5/3/2011
20/8/2011
5/3/2012
20/2/2013
13/8/2013
17/3/2014
14/5/2008
1/8/2009
5/3/2010
7/8/2010
5/3/2011
20/8/2011
5/3/2012
a
b,f
b,f
b,f
b,g
c,g
c,g
c,g
d,k
d,g
d,h
d,h
d,h
b,f
b,g
c,g
c,g
c,g
d,k
d,g
a) Sharesave.
b) Executive option granted between March 1996 and August 1999.
c) Executive option granted between March 2000 and March 2001.
d) Executive option granted between August 2001 and August 2004.
e) Executive option granted from March 2005.
f) Exercisable.
g) Not exercisable as the performance conditions had not been met.
h) Not exercisable as the option has not been held for the period required by the relevant scheme.
i) Market price on day of exercise was 497p. In that regard Mr Daniels made a gain of £1,077,312. This is the difference between the market price of the shares on the
day on which the share option was exercised and the price paid for the shares.
j) These share options lapsed as the performance condition had not been met.
k) These share options lapsed after Mr Ayliffe and Mr Pritchard left the board as the performance condition had not been met.
‡ Mr Ayliffe exercised this share option after he left the board. The date of exercise was 14 December 2005 and the market price of the shares on that day was 480.25p.
* These share options lapsed when Mr Ayliffe left the board.
Lloyds TSB performance share plan
The following bonus and performance shares relating to the bonus award for 2004 are available under the plan. Further information is given on page 48.
Bonus shares
At
1 January
2005
Purchased
during
the year
At
31 December
2005
At
1 January
2005
Performance shares
Conditional
award during
the year
(maximum)
–
–
–
–
–
57,737
31,901
22,171
22,710
16,628
57,737
31,901
22,171
22,710
16,628
–
–
–
–
–
195,720
108,140
75,156
76,982
56,366
At
31 December
2005
195,720
108,140
75,156
76,982
56,366
Bonus shares
release and
performance
share
award date
18/3/2008
18/3/2008
18/3/2008
18/3/2008
18/3/2008
Award
price
479p
479p
479p
479p
479p
J E Daniels
M E Fairey
A G Kane
G T Tate
H A Weir
The market price for a share in the Company at 1 January 2005 and 31 December 2005 was 473p and 488.5p, respectively. The range of prices between
1 January 2005 and 31 December 2005 was 439.5p to 509p.
None of the other directors at 31 December 2005 had options to acquire shares in Lloyds TSB Group plc or its subsidiaries.
LLOYDS TSB GROUP 55
Directors’ remuneration report
Audited information
The following table contains information on the performance conditions for executive options granted since 1996. The remuneration committee chose the relevant
performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
Options granted
Performance conditions
Prior to March 1996
None
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.
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.
August 2001 – August 2004
March 2005 – August 2005
That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international
financial services companies including Lloyds TSB Group) must be at least ninth, when 14 per cent of the option will
be exercisable. If the company is ranked first in the group, then 100 per cent of the option will be exercisable and if
ranked tenth or below the performance condition is not met.
At the end of 2005 Lloyds TSB Group was ranked:
15th after four years of the performance period for options granted in 2002;
17th after three years of the performance period for options granted in 2003; and
8th after two years of the performance period for the options granted in 2004.
Options granted in 2001 lapsed as the performance conditions had not been met.
That the Company’s ranking based on TSR over the relevant period against a comparator group (15 companies including
Lloyds TSB Group) must be at least eighth, when 30 per cent of the option will be exercisable. If the company is ranked
first to fourth position in the group, then 100 per cent of the option will be exercisable and if ranked ninth or below the
performance condition is not met.
At the end of 2005 Lloyds TSB Group was ranked 10th after one year of the performance period.
56 LLOYDS TSB GROUP
Directors’ remuneration report
Audited information
Other share plans
Share retention plan
Mr Daniels was the only participant in this plan and held an option, granted to him on 2 November 2001, to acquire 216,763 ordinary shares in Lloyds TSB
Group plc for a total price of £1. The option was granted as part of the remuneration package considered necessary to attract him from the USA and was designed
to encourage him to remain with Lloyds TSB Group plc. The option was not subject to any performance condition and vested on 31 December 2004. Mr Daniels
exercised this option on 4 March 2005. Full details of the plan were set out in the 2002 annual report.
Lloyds TSB Group executive share plan 2005
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).
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 number and/or nominal amount of shares may be adjusted by the board on certain variations in the share capital of Lloyds TSB Group plc.
The benefit conferred by this option is not pensionable and the option is not transferable.
No new shares will be issued to satisfy the option under this plan.
None of those who were directors at the end of the year had any other interest in the capital of Lloyds TSB Group plc or its subsidiaries.
The register of directors’ interests, which is open to inspection, contains full particulars of directors’ shareholdings and options to acquire shares in Lloyds TSB Group.
On behalf of the board
A J Michie
Company Secretary
23 February 2006
LLOYDS TSB GROUP 57
Report of the independent auditors on the
consolidated financial statements
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 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.
Respective responsibilities of directors and auditors
The directors’ responsibilities for preparing the annual report and the consolidated financial statements in accordance with applicable law and International Financial
Reporting Standards (IFRSs) as adopted by the European Union are set out in the statement of directors’ responsibilities.
Our responsibility is to audit the consolidated financial statements 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.
We report to you our opinion as to whether the consolidated financial statements give a true and fair view and whether the consolidated financial statements 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 consolidated financial statements, 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 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.
We read other information contained in the annual report and consider whether it is consistent with the audited consolidated financial statements. The other
information comprises only the directors’ report, the 2005 highlights, the chairman’s statement, the Group chief executive’s review, the operating and financial review
and prospects, the five year financial summary, the unaudited part of the directors’ remuneration report and the corporate governance statement. We consider the
implications for our report if we become aware of any apparent misstatements or material inconsistencies with the consolidated financial statements. Our
responsibilities do not extend to any other information.
Basis of audit opinion
We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes
examination, on a test basis, of evidence relevant to the amounts and disclosures in the consolidated financial statements. It also includes an assessment of the
significant estimates and judgments made by the directors in the preparation of the consolidated financial statements, and of whether the accounting policies are
appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence
to give reasonable assurance that the consolidated financial statements are free from material misstatement, whether caused by fraud or other irregularity or error.
In forming our opinion we also evaluated the overall adequacy of the presentation of information in the consolidated financial statements.
Opinion
In our opinion:
• the consolidated financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union, of the state of the Group’s affairs as
at 31 December 2005 and of its profit and cash flows for the year then ended;
• the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation.
PricewaterhouseCoopers LLP
Chartered Accountants and Registered Auditors
Southampton, England
23 February 2006
58 LLOYDS TSB GROUP
Consolidated income statement
for the year ended 31 December 2005
Interest and similar income
Interest and similar expense
Net interest income
Fees and commission income
Fees and commission expense
Net fees and commission income
Net trading income
Insurance premium income
Other operating income
Other income
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment losses on loans and advances
Profit (loss) on sale and closure of businesses
Profit before tax
Taxation
Profit for the year
Profit attributable to minority interests
Profit attributable to equity shareholders
Profit for the year
Basic earnings per share
Diluted earnings per share
The accompanying notes are an integral part of the consolidated financial statements.
Note
4
5
6
7
8
9
10
11
12
13
14
14
2005
£ million
12,589
(6,918)
5,671
2,990
(842)
2,148
9,298
4,469
1,140
17,055
22,726
(12,186)
10,540
(5,471)
5,069
(1,299)
50
3,820
(1,265)
2,555
62
2,493
2,555
44.6p
44.2p
2004
£ million
10,707
(5,597)
5,110
3,054
(844)
2,210
5,036
6,070
857
14,173
19,283
(9,622)
9,661
(5,297)
4,364
(866)
(21)
3,477
(1,018)
2,459
67
2,392
2,459
42.8p
42.5p
LLOYDS TSB GROUP 59
Consolidated balance sheet
at 31 December 2005
Assets
Cash and balances at central banks
Items in the course of collection from banks
Treasury bills and other eligible bills
Trading securities and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and advances to banks
Loans and advances to customers
Debt securities
Equity shares
Available-for-sale financial assets
Investment property
Goodwill
Value of in-force business
Other intangible assets
Tangible fixed assets
Other assets
Note
2005
£ million
2004
£ million
1,156
1,310
60,374
5,878
31,655
174,944
14,940
4,260
2,373
2,922
50
4,291
5,601
1,078
1,462
92
31,848
155,318
43,485
27,310
3,776
2,469
4,363
28
4,180
9,013
15
16
17
18
19
21
22
23
24
25
26
27
28
30
Total assets
309,754
284,422
The accompanying notes are an integral part of the consolidated financial statements.
The directors approved the consolidated financial statements on 23 February 2006.
Maarten A van den Bergh
Chairman
J Eric Daniels
Group Chief Executive
Helen A Weir
Group Finance Director
60 LLOYDS TSB GROUP
Consolidated balance sheet
at 31 December 2005
Equity and liabilities
Liabilities
Deposits from banks
Customer accounts
Items in course of transmission to banks
Derivative financial instruments and other trading liabilities
Debt securities in issue
Liabilities arising from insurance contracts and participating investment contracts
Liabilities arising from non-participating investment contracts
Unallocated surplus within insurance businesses
Other liabilities
Retirement benefit obligations
Current tax liabilities
Deferred tax liabilities
Other provisions
Subordinated liabilities
Total liabilities
Equity
Share capital
Share premium account
Other reserves
Retained profits
Shareholders’ equity
Minority interests
Total equity
Total equity and liabilities
The accompanying notes are an integral part of the consolidated financial statements.
Note
2005
£ million
2004
£ million
31
32
17
33
34
35
36
37
38
39
40
41
42
43
44
45
48
31,527
131,070
658
6,396
39,346
40,550
21,839
518
9,843
2,910
552
1,145
368
12,402
39,723
119,811
631
28,770
52,289
1,362
14,457
3,075
459
1,704
211
10,252
299,124
272,744
1,420
1,170
383
7,222
10,195
435
1,419
1,145
343
8,140
11,047
631
10,630
11,678
309,754
284,422
LLOYDS TSB GROUP 61
Consolidated statement of changes in equity
Attributable to equity shareholders
Balance at 1 January 2004 (note 54)
Currency translation differences
Profit for the year
Total recognised income for 2004
Dividends
Purchase/sale of treasury shares
Employee share option schemes:
– value of employee services
– proceeds from shares issued
Change in minority interests
Balance at 31 December 2004 (note 54)
Adjustments on transition to IAS 32,
IAS 39 and IFRS 4 (note 54)
Restated balance at 1 January 2005 (note 54)
Movement in available-for-sale financial assets,
net of tax
Movement in cash flow hedges, net of tax
Currency translation differences
Net income recognised directly in equity
Profit for the year
Total recognised income for 2005
Dividends
Purchase/sale of treasury shares
Employee share option schemes:
– value of employee services
– proceeds from shares issued
Change in minority interests
Share capital
and premium
£ million
Other
reserves
£ million
2,554
–
–
–
–
–
–
10
–
2,564
–
2,564
–
–
–
–
–
–
–
–
–
26
–
343
–
–
–
–
–
–
–
–
343
28
371
8
11
(7)
12
–
12
–
–
–
–
–
Retained
profits
£ million
7,646
(12)
2,392
2,380
(1,913)
8
19
–
–
Total
£ million
10,543
(12)
2,392
2,380
(1,913)
8
19
10
–
Minority
interests
£ million
782
1
67
68
(68)
–
–
–
(151)
Total
£ million
11,325
(11)
2,459
2,448
(1,981)
8
19
10
(151)
8,140
11,047
631
11,678
(1,586)
(1,558)
(550)
(2,108)
6,554
9,489
–
–
24
24
2,493
2,517
(1,914)
18
47
–
–
8
11
17
36
2,493
2,529
(1,914)
18
47
26
–
81
–
–
–
–
62
62
(37)
–
–
–
329
435
9,570
8
11
17
36
2,555
2,591
(1,951)
18
47
26
329
10,630
Balance at 31 December 2005
2,590
383
7,222
10,195
The accompanying notes are an integral part of the consolidated financial statements.
62 LLOYDS TSB GROUP
Consolidated cash flow statement
for the year ended 31 December 2005
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Purchase of fixed asset investments
Proceeds from sale and maturity of fixed asset investments
Purchase of available-for-sale financial assets
Proceeds from sale and maturity of available-for-sale financial assets
Purchase of fixed assets
Proceeds from sale of fixed assets
Acquisition of businesses, net of cash acquired
Disposal of businesses, net of cash disposed
Net cash used in investing activities
Cash flows from financing activities:
Dividends paid to equity shareholders
Dividends paid to minority interests
Proceeds from issue of subordinated liabilities
Proceeds from issue of ordinary shares and transactions in own shares
held in respect of employee share schemes
Repayment of subordinated liabilities (loan capital)
Capital element of finance lease rental payments
Change in minority investment in subsidiaries
Net cash used in financing activities
Change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Note
53a
2005
£ million
(331)
2004
£ million
12,214
(10,088)
9,732
(1,565)
698
(16)
(25)
(10,108)
10,266
(1,843)
1,073
(27)
(4)
(643)
(1,264)
(1,914)
(37)
1,361
26
(232)
(2)
329
(469)
(1,443)
28,196
(1,913)
(68)
699
11
(764)
(1)
(151)
(2,187)
8,763
19,433
53e
53f
53d
53d
53d
53d
53d
53d
53b
26,753
28,196
Cash and cash equivalents comprise cash and balances at central banks (excluding mandatory deposits) and amounts due from banks with a maturity
of less than three months.
The accompanying notes are an integral part of the consolidated financial statements.
LLOYDS TSB GROUP 63
Notes to the group accounts
1 Accounting policies
In accordance with the requirements of Regulation (EC) No 1606/2002 of the European Parliament, the Group has applied International Financial Reporting
Standards (‘IFRS’) as adopted by the European Union (EU) in its financial statements for the year ended 31 December 2005. The rules for first time adoption of IFRS
are set out in IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’. On 1 January 2004, the date of transition, the opening IFRS balance sheet
position has been determined in accordance with IFRS 1 which requires IFRS accounting policies to be applied on a retrospective basis with certain exceptions and
exemptions detailed below.
Mandatory exception
Impact
Estimates
The Group’s estimates at the date of transition are consistent with those under UK GAAP.
Assets held for sale and discontinued
operations
The Group has no transactions prior to 1 January 2005 that are affected by the transitional requirements of IFRS 5.
Derecognition of financial instruments
Financial instruments derecognised before 1 January 2004 have not been re-recognised by the Group under IFRS.
Hedge accounting
Voluntary exemption
Business combinations
IFRS compliant hedge accounting is applied by the Group from 1 January 2005.
By electing to apply IFRS 3 on a prospective basis from 1 January 2004, the Group has not restated past acquisitions
and mergers. Goodwill previously written off to reserves has not been reinstated and no additional intangible assets have
been recognised in this regard.
Retirement benefits
Under UK GAAP, the Group has recognised all cumulative actuarial gains and losses and elects to apply this treatment at
the date of transition to IFRS.
Cumulative translation adjustment
The Group has opted to reset the cumulative translation difference on adoption of IFRS to zero.
Comparatives for financial instruments
and designation of financial assets
The Group has chosen not to restate comparatives for IAS 32 and IAS 39, but to reflect the impact of these standards
through adjustments to shareholders’ equity as at 1 January 2005. At this date the Group has designated various financial
assets as at fair value through profit or loss or as available-for-sale. The Group has applied UK GAAP to financial
instruments and hedging transactions for its 2004 comparatives.
Share-based payments
The Group has elected to apply IFRS 2 to equity instruments that were granted before 7 November 2002.
Insurance contracts
The Group has chosen not to restate its comparatives for IFRS 4 but to reflect the impact of this standard through
adjustments to shareholders’ equity at 1 January 2005. The Group has applied UK GAAP for its 2004 comparatives.
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 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.
The EU endorsed version of IAS 39 which is operative for years commencing 1 January 2005 relaxes some of the hedge accounting requirements; the Group has
not taken advantage of this relaxation.
Further information on the principal differences between IFRS and FRS 27 and the Group’s previous accounting policies and the effect of their adoption on the Group’s
previously published information is given in note 54.
The Group’s accounting policies are set out below.
(a) Consolidation
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.
(b) Goodwill
Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable net assets 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.
Goodwill arising on acquisitions prior to 1 January 2004, the date of transition to IFRS, has been retained at the balance sheet amount at that date and has been
tested for impairment at that date. Goodwill previously written off directly to reserves under UK GAAP has not been reinstated and will not be included in calculating
any subsequent profit or loss on disposal.
(c) Revenue recognition
Interest income and expense are recognised in the income statement for all interest-bearing financial instruments, including loans and advances, using the effective
interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or
interest expense. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the instrument
or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. The effective interest rate is calculated on initial recognition
of the financial asset or liability, estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses.
The calculation includes all amounts paid or received by the Group that are an integral part of the overall return, direct incremental transaction costs related to the
acquisition, issue or disposal of a financial instrument and all other premiums or discounts. Once a financial asset or a group of similar financial assets has been
written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of
measuring the impairment loss (see i).
64 LLOYDS TSB GROUP
Notes to the group accounts
1 Accounting policies (continued)
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.
The Group receives investment management fees in respect of services rendered in conjunction with the issue and management of investment contracts where the
Group actively manages the consideration received from its customers to fund a return that is based on the investment profile that the customer selected on origination
of the instrument. These services comprise an indeterminate number of acts over the lives of the individual contracts and, therefore, the Group recognises these fees
on a straight-line basis over the estimated lives of the contracts.
Revenue recognition policies specific to life assurance and general insurance business, except for investment management fees as noted above, are detailed
below (see q).
(d) Trading securities, other financial assets at fair value through profit or loss, and available-for-sale financial assets
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.
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.
Debt securities and equity shares, other than those classified as trading securities or at fair value through profit or loss, are classified as available-for-sale and
recognised in the balance sheet at their fair value. Gains and losses arising from changes in the fair value of investments classified as available-for-sale are recognised
directly in equity, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in equity is
recognised in the income statement. Interest calculated using the effective interest method is recognised in the income statement; dividends on available-for-sale
equity instruments are recognised in the income statement when the Group’s right to receive payment is established.
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.
(e) Loans and advances to banks and customers
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.
(f) Sale and repurchase agreements
Securities sold subject to repurchase agreements (‘repos’) are reclassified in the financial statements as assets pledged when the transferee has the right by contract
or custom to sell or repledge the collateral; the counterparty liability is included in deposits from banks or customer accounts, as appropriate. Securities purchased
under agreements to resell (‘reverse repos’) are recorded as loans and advances to banks or customers, as appropriate. The difference between sale and repurchase
price is treated as interest and accrued over the life of the agreements using the effective interest method. Securities lent to counterparties are also retained in the
financial statements.
Securities borrowed are not recognised in the financial statements, unless these are sold to third parties, in which case the obligation to return them is recorded at
fair value as a trading liability.
(g) Derivative financial instruments and hedge accounting
All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using
valuation techniques, including discounted cash flow and options pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their
fair value is positive and as liabilities when their fair value is negative.
The method of recognising the movements in the fair value of the derivatives depends on whether they are designated as hedging instruments, and if so, the nature
of the item being hedged. Derivatives may only be designated as hedges provided certain strict criteria are met. At the inception of a hedge its terms must be clearly
documented and there must be an expectation that the derivative will be highly effective in offsetting changes in the fair value or cash flow of the hedged risk.
The effectiveness of the hedging relationship must be tested throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its
objective the hedge relationship is terminated.
The Group designates certain derivatives as either: (1) hedges of the fair value of the interest rate risk inherent in recognised assets or liabilities (fair value hedges);
or (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges). These are accounted for as follows:
(1) Fair value hedges
Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the
fair value of the hedged asset or liability that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, changes in the fair
value of the hedged risk are no longer recognised in the income statement; the adjustment that has been made to the carrying amount of a hedged item is amortised
to the income statement over the period to maturity.
LLOYDS TSB GROUP 65
Notes to the group accounts
1 Accounting policies (continued)
(2) Cash flow hedges
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in equity. The gain or loss relating
to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are recycled to the income statement in the periods in
which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any
cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the income
statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the
income statement.
Changes in the fair value of any derivative instrument that is not part of a hedging relationship are recognised immediately in the income statement.
Derivatives embedded in financial instruments and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated as separate
derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through
profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement.
(h) Offset
Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention
to settle on a net basis, or realise the asset and settle the liability simultaneously.
(i) Impairment
(1) Assets accounted for at amortised cost
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.
If there is no objective evidence of individual impairment the asset is included in a group of financial assets with similar credit risk characteristics and collectively
assessed for impairment. Segmentation takes into account such factors as the type of asset, industry, geographical location, collateral type, past-due status and other
relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to
pay all amounts due according to the contractual terms of the assets being evaluated. Future cash flows are estimated on the basis of the contractual cash flows of
the assets in the group and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted on the basis of current
observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of
conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the
Group to reduce any differences between loss estimates and actual loss experience.
If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was
recognised, such as an improvement in the borrower’s credit rating, the provision is adjusted and the amount of the reversal is recognised in the income statement.
When a loan or advance is uncollectable, it is written off against the related provision once all the necessary procedures have been completed and the amount of the
loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement.
(2) Available-for-sale assets
The Group assesses at each balance sheet date whether there is objective evidence that an available-for-sale asset is impaired. In addition to the factors set out above,
a significant or prolonged decline in the fair value of the asset below its cost is considered in determining whether an impairment loss has been incurred. If an
impairment loss has been incurred, the cumulative loss measured as the difference between the original cost and the current fair value, less any impairment loss on
that asset previously recognised, is removed from equity and recognised in the income statement. If, in a subsequent period, the fair value of a debt instrument
classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, the impairment
loss is reversed through the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the
income statement.
(j) Investment property
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.
(k) Tangible fixed assets
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
• Leasehold improvements: shorter of 10 years or the remaining period of the lease
Equipment:
• Fixtures and furnishings: 10-20 years
• Other equipment and motor vehicles: 3-8 years
The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
66 LLOYDS TSB GROUP
Notes to the group accounts
1 Accounting policies (continued)
Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In the event that an
asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately.
(l) Leases
(1) As lessee
The leases entered into by the Group are primarily operating leases. Operating lease rentals are charged to the income statement on a straight-line basis over the
period of the lease.
When an operating lease is terminated before the end of the lease period, any payment made to the lessor by way of penalty is recognised as an expense in the period
of termination.
(2) As lessor
Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee; all other
leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments is recognised as a receivable within loans
and advances to banks and customers. Finance lease income is recognised over the term of the lease using the net investment method (before tax) reflecting a constant
periodic rate of return.
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.
(m) Borrowings
Borrowings are recognised initially at fair value, being their issue proceeds net of transaction costs incurred. Borrowings are subsequently stated at amortised cost
using the effective interest method.
Preference shares and other instruments which carry a mandatory coupon or are redeemable on a specific date are classified as financial liabilities. The coupon on
these instruments is recognised in the income statement as interest expense.
(n) Pensions and other post-retirement benefits
The Group operates a number of post-retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined
benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as
age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation
to pay further contributions.
Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening years; these
valuations are updated to 31 December each year by qualified independent actuaries, or in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified
actuary employed by Scottish Widows. For the purposes of these annual updates scheme assets are included at their fair value and scheme liabilities are measured
on an actuarial basis using the projected unit credit method adjusted for unrecognised actuarial gains and losses. The defined benefit scheme liabilities are discounted
using rates equivalent to the market yields at the balance sheet date on high-quality corporate bonds that are denominated in the currency in which the benefits will
be paid, and that have terms to maturity approximating to the terms of the related pension liability. The resulting net surplus or deficit is included in the Group’s
balance sheet. Surpluses are only recognised to the extent that they are recoverable through reduced contributions in the future or through refunds from the schemes.
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.
The costs of the Group’s defined contribution plans are charged to the income statement in the period in which they fall due.
(o) Share-based compensation
The Group operates a number of equity-settled, share-based compensation plans. The value of the employee services received in exchange for equity instruments
granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined
by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices,
if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate
valuation technique, such as a Black-Scholes option pricing model. The determination of fair values excludes the impact of any non-market vesting conditions,
which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and
if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting period, together with a corresponding
adjustment to equity.
(p) Income taxes, including deferred income taxes
Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
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.
Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts
in the consolidated financial statements. However, deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction
other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax is determined using tax rates
that have been enacted or substantially enacted by the balance sheet date which are expected to apply when the related deferred tax asset is realised or the deferred
tax liability is settled.
Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred tax is
provided on temporary differences arising from investments in subsidiaries and associates, except where the timing of the reversal of the temporary difference is controlled
by the Group and it is probable that the difference will not reverse in the foreseeable future. Income tax payable on profits is recognised as an expense in the period in
which those profits arise. The tax effects of losses available for carry forward are recognised as an asset when it is probable that future taxable profits will be available
against which these losses can be utilised. Deferred tax related to fair value re-measurement of available-for-sale investments and cash flow hedges, which are charged
or credited directly to equity, is also credited or charged directly to equity and is subsequently recognised in the income statement together with the deferred gain or loss.
Deferred and current tax assets and liabilities are offset when they arise in the same tax reporting group and where there is both a legal right of offset and the intention
to settle on a net basis or to realise the asset and settle the liability simultaneously.
LLOYDS TSB GROUP 67
Notes to the group accounts
1 Accounting policies (continued)
(q) Insurance
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.
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.
(1) Life assurance business
(i) Accounting for life insurance contracts and participating investment contracts
The majority of the life insurance contracts issued by the Group are long-term life assurance contracts. The Group also issues life insurance contracts to protect customers
from the consequences of events (such as death, critical illness or disability) that would affect the ability of the customer or their dependants to maintain their current level
of income. Guaranteed claims paid on occurrence of the specified insurance event are either fixed or linked to the extent of the economic loss suffered by the policyholder.
Premiums and claims
Premiums received in respect of life insurance contracts and participating investment contracts are recognised as revenue when due and are shown before deduction
of commission.
Claims are recorded as an expense when they are incurred.
Liabilities
– life insurance contracts or participating investment contracts in the Group’s With-Profits Fund
Liabilities of the Group’s With-Profits Fund, including guarantees and options embedded within products written by that fund, are stated at their realistic values in
accordance with the Financial Services Authority’s realistic capital regime.
– life insurance contracts or participating investment contracts which are not unit-linked or in the Group’s With-Profits Fund
A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by estimating
the future cash flows over the duration of in-force policies and discounting them back to the valuation date allowing for probabilities of occurrence. The liability will
vary with movements in interest rates and with the cost of life assurance and annuity benefits where future mortality is uncertain. Assumptions are made in respect
of all material factors affecting future cash flows, including future interest rates, mortality and costs.
– life insurance contracts or participating investment contracts which are unit-linked
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.
Unallocated surplus
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.
Value of in-force life assurance business
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
Receivables and payables are recognised when due. These include amounts due to and from agents, brokers and insurance contract holders.
(ii) Accounting for non-participating investment contracts
All of the Group’s non-participating investment contracts are unit-linked. In accordance with industry practice, these contracts are accounted for as financial liabilities
whose value is contractually linked to the fair values of financial assets within the Group’s unitised investment funds. The value of the unit-linked financial liabilities
is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet date. Their value is never less than
the amount payable on surrender, discounted for the required notice period where applicable.
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).
68 LLOYDS TSB GROUP
Notes to the group accounts
1 Accounting policies (continued)
Directly incremental commissions that vary with and are related to either securing new or renewing existing non-participating investment contracts are deferred;
all other costs are recognised as expenses when incurred. This asset is subsequently amortised over the period of the provision of investment management services
and is reviewed for impairment in circumstances where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written
down immediately.
(2) General insurance business
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.
The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date.
The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all
known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the
cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used
to determine the provision for claims incurred but not reported at the balance sheet date.
(3) Liability adequacy test
At each balance sheet date liability adequacy tests are performed to ensure the adequacy of insurance and participating investment contract liabilities. In performing
these tests current best estimates of future contractual cash flows and claims handling and administration expenses, as well as investment income from the assets
backing such liabilities, are used. Any deficiency is immediately charged to profit or loss by establishing a provision for losses arising from liability adequacy tests.
(4) Reinsurance
Contracts entered into by the Group with reinsurers under which the Group is compensated for losses on one or more contracts issued by the Group and that meet
the classification requirements for insurance contracts are classified as reinsurance contracts held. Insurance contracts entered into by the Group under which the
contract holder is another insurer (inwards reinsurance) are included with insurance contracts.
The benefits to which the Group is entitled under its reinsurance contracts held are recognised as reinsurance assets. These assets consist of short-term balances
due from reinsurers as well as longer term receivables that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts.
Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured insurance contracts and in accordance with
the terms of each reinsurance contract. Reinsurance liabilities are primarily premiums payable for reinsurance contracts and are recognised as an expense when due.
(r) Foreign currency translation
(1) Functional and presentation currency
Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity
operates (‘the functional currency’). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.
(2) Transactions and balances
Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains
and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in
foreign currencies are recognised in the income statement, except when deferred in equity as qualifying cash flow hedges. Translation differences on non-monetary
items, such as equities held at fair value through profit or loss, are reported as part of the fair value gain or loss. Translation differences on non-monetary items, such
as equities classified as available-for-sale financial assets, are included in the fair value reserve in equity.
(3) Group companies
The results and financial position of all the Group entities (none of which has the currency of a hyperinflationary economy) that have a functional currency different
from the presentation currency are translated into the presentation currency as follows:
(i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet;
(ii)
income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative
effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and
(iii) all resulting exchange differences are recognised as a separate component of equity.
On consolidation, exchange differences arising from the translation of the net investment in foreign entities are taken to shareholders’ equity. When a foreign operation
is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale.
Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the
closing rate.
(s) Provisions
Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the
obligations and they can be reliably estimated.
The Group recognises provisions in respect of vacant leasehold property where the unavoidable costs of the present obligations exceed anticipated rental income.
Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of
resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.
(t) Dividends
Dividends on ordinary shares are recognised in equity in the period in which they are paid.
LLOYDS TSB GROUP 69
Notes to the group accounts
2 Critical accounting estimates and judgements
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.
Impairment on assets accounted for at amortised cost
The Group regularly reviews its loan portfolios to assess for impairment. In determining whether an impairment has occurred the Group considers whether there is
any observable data indicating that there has been a measurable decrease in the estimated future cash flows and their timings; such observable data includes whether
there has been an adverse change in the payment status of borrowers or changes in economic conditions that correlate with defaults on assets in the Group.
The methodology used to calculate the required provision varies according to the type of lending portfolio. For portfolios of smaller balance homogenous loans, such
as residential mortgages, personal loans and credit card balances, impairment provisions are calculated collectively using formulae which take into account factors
such as the length of time that the customer’s account has been delinquent, historical loss rates and the value of any collateral held in order to determine expected
future cash flows. The variables used in the formulae are kept under regular review to ensure that as far as possible they reflect the current economic circumstances,
although actual experience may differ from that assumed.
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.
Pensions
The net liability recognised in the balance sheet in respect of the Group’s retirement benefit obligations represents the liabilities of the Group’s defined benefit pension
schemes after deduction of the fair value of the related assets. The schemes’ liabilities are derived by estimating the ultimate cost of benefits payable by the schemes
and reflecting the discounted value of the proportion accrued by the year end in the balance sheet. In order to arrive at this estimate a number of key financial and
non-financial assumptions are made by management, changes to which could have a material impact upon the net deficit and also the net cost recognised in the
income statement.
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 rate used to discount the resulting cash flows is equivalent to the market yield at the balance sheet date on high quality bonds with a similar duration to the
schemes’ liabilities. This rate is potentially subject to significant variation. At 31 December 2005 the discount rate used was 4.8 per cent; a reduction of 0.2 per cent
would result in an increase in the net deficit of approximately £650 million and in the net cost of approximately £15 million, while an increase of 0.2 per cent would
reduce the net deficit by approximately £600 million and the net cost by approximately £15 million.
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.
Goodwill
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.
Customer remediation provisions
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 have been deficient. The ultimate cost is inherently uncertain and in determining the level of provisions required it is necessary for
management to exercise significant judgement. The principal assumptions underlying the provisions relate to the number of cases requiring redress and the estimated
average cost of redress per case; these will be affected by external factors beyond the control of management, such as regulatory actions and the performance of the
financial markets. Therefore over time it is possible that adjustments will be necessary to the level of provisions held.
Insurance
Life assurance business
Calculation of the value of in-force life assurance business assets and life assurance business policy liabilities are dependent on assumptions made regarding future
experience. If actual experience differs from that assumed, this could significantly affect the value attributed to these items. Any profit or loss arising from such changes
would be recognised in the income statement in that period. The key assumptions upon which these items are dependent are described in notes 26 and 34, along
with the impact on profit before tax which would occur if they were to change.
70 LLOYDS TSB GROUP
Notes to the group accounts
2 Critical accounting estimates and judgements (continued)
General insurance business
A provision is made for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost
of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. In those cases
where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently
been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for
claims incurred but not reported at the balance sheet date.
While management believes that the liability carried at year end is adequate, the application of statistical techniques requires significant judgment. An increase of
10 per cent in the cost of claims would result in the recognition of an additional loss of approximately £14 million. Similarly, an increase of 10 per cent in the ultimate
number of such claims would lead to an additional loss of approximately £15 million. There is no relief arising from reinsurance contracts held.
Income taxes
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.
LLOYDS TSB GROUP 71
Notes to the group accounts
3 Segmental analysis
Lloyds TSB Group is a leading UK-based financial services group, whose businesses provide a wide range of banking and financial services in the UK and in certain
locations overseas.
The Group’s activities are organised into three segments: UK Retail Banking, Insurance and Investments and Wholesale and International Banking. Services provided
by UK Retail Banking encompass the provision of banking and other financial services to personal customers, private banking, stockbroking and mortgages. Insurance
and Investments offers life assurance, pensions and savings products, general insurance and asset management services. Wholesale and International Banking
provides banking and related services for major UK and multinational companies, banks and financial institutions, and small and medium-sized UK businesses. It
also provides asset finance to personal and corporate customers, manages the Group’s activities in financial markets through its Treasury function and provides
banking and financial services overseas.
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.
General
Life, pensions
and asset
insurance management
£m
£m
Insurance
and
Investments
£m
Wholesale
and
International
Banking
£m
Central
group items
£m
Inter-segment
eliminations
£m
Total
£m
850
(478)
877
(482)
6,944
(4,679)
1,091
(1,601)
(2,975)
2,975
12,589
(6,918)
UK Retail
Banking
£m
6,652
(3,131)
3,521
1,605
5,126
–
5,126
(2,697)
2,429
(1,111)
76
1,394
7,833
744
27
(4)
23
571
594
(197)
397
(160)
237
–
–
237
372
13,288
395
13,859
13,660
(11,989)
14,254
(12,186)
1,671
(434)
1,237
–
–
2,068
(594)
1,474
–
–
2,265
1,628
3,893
–
3,893
(2,181)
1,712
(188)
(6)
1,237
1,474
1,518
(510)
(37)
(547)
–
(547)
1
(546)
–
(20)
(566)
–
–
–
–
–
–
–
–
–
–
5,671
17,055
22,726
(12,186)
10,540
(5,471)
5,069
(1,299)
50
3,820
30,486
–
1,272
16
14,127
330
15,399
346
7,283
1,686
(29)
1,175
–
(3,951)
8,577
1,288
14,457
15,745
8,969
1,146
(3,951)
30,486
103,930
2,146
968
593
79,180
3,893
80,148
4,486
124,044
81,728
1,632
50,855
–
(139,215)
309,754
–
106,076
1,561
83,073
84,634
205,772
52,487
(139,215)
309,754
72,335
30,492
829
280
71,894
5,133
72,723
5,413
141,878
59,224
12,188
44,086
–
(139,215)
299,124
–
102,827
1,109
77,027
78,136
201,102
56,274
(139,215)
299,124
77
219
150
134
13
11
–
4
844
26
–
22
857
37
–
26
702
383
–
84
207
–
–
15
–
–
–
–
1,843
639
150
259
Year ended 31 December 2005
Interest and similar income
Interest and similar expense
Net interest income
Other income (net of fee and commission expense)
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment losses on loans and advances
Profit (loss) on sale and closure of businesses
Profit (loss) before tax
External revenue
Inter-segment revenue
Segment revenue
External assets
Inter-segment assets
Total assets
External liabilities
Inter-segment liabilities
Total liabilities
Other segment items:
Capital expenditure
Depreciation
Customer remediation provision
Retirement benefit scheme charges
72 LLOYDS TSB GROUP
Notes to the group accounts
3 Segmental analysis (continued)
Year ended 31 December 2004
Interest and similar income
Interest and similar expense
Net interest income
Other income (net of fee and commission expense)
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment losses on loans and advances
Loss on sale of businesses
Profit (loss) before tax
External revenue
Inter-segment revenue
Segment revenue
External assets
Inter-segment assets
Total assets
External liabilities
Inter-segment liabilities
Total liabilities
Other segment items:
Capital expenditure
Depreciation
Customer remediation provision
Retirement benefit scheme charges
UK Retail
Banking
£m
5,825
(2,597)
3,228
1,696
4,924
–
4,924
(2,609)
2,315
(676)
–
1,639
7,089
791
General
Life, pensions
and asset
insurance management
£m
£m
Insurance
and
Investments
£m
Wholesale
and
International
Banking
£m
Central
group items
£m
Inter-segment
eliminations
£m
537
(298)
593
(310)
5,954
(3,948)
883
(1,290)
(2,548)
2,548
56
(12)
44
504
548
(214)
334
(154)
180
–
–
180
239
10,370
283
10,874
10,609
(9,408)
11,157
(9,622)
1,201
(468)
1,535
(622)
733
3
–
736
913
3
–
916
2,006
1,558
3,564
–
3,564
(2,078)
1,486
(193)
(21)
1,272
6,135
1,716
(407)
45
(362)
–
(362)
12
(350)
–
–
(350)
91
851
942
Total
£m
10,707
(5,597)
5,110
14,173
19,283
(9,622)
9,661
(5,297)
4,364
(866)
(21)
3,477
–
–
–
–
–
–
–
–
–
–
1,288
48
11,121
19
12,409
67
7,880
1,336
11,140
12,476
7,851
–
(3,425)
25,724
–
(3,425)
25,724
96,763
1,340
1,058
526
70,874
2,644
71,932
3,170
114,086
70,947
1,641
39,503
–
(114,960)
284,422
–
98,103
1,584
73,518
75,102
185,033
41,144
(114,960)
284,422
68,149
27,035
931
75
62,305
4,105
63,236
4,180
130,171
50,643
11,188
33,102
–
(114,960)
272,744
–
95,184
1,006
66,410
67,416
180,814
44,290
(114,960)
272,744
103
217
100
142
–
11
12
3
386
25
–
24
386
36
12
27
907
385
–
90
169
–
–
16
–
–
–
–
1,565
638
112
275
As the activities of the Group are predominantly carried out in the UK, no geographical analysis is presented.
LLOYDS TSB GROUP 73
2005
Average
effective
interest rate
%
3.58
6.41
3.59
7.07
5.82
3.44
2.84
4.23
5.22
4.53
7.24
3.42
2005
£m
593
681
545
1,171
2,990
(182)
(247)
(413)
(842)
2,148
2005
£m
13
150
163
430
8,705
9,298
2005
£m
508
10,095
1,199
787
12,589
(953)
(3,401)
(1,307)
(601)
(394)
(262)
(6,918)
5,671
2004
£m
6
418
8,440
979
864
10,707
(558)
(3,003)
(972)
(601)
(319)
(144)
(5,597)
5,110
2004
£m
637
672
520
1,225
3,054
(176)
(272)
(396)
(844)
2,210
2004
£m
22
152
174
329
4,533
5,036
Notes to the group accounts
4 Net interest income
Interest receivable:
Treasury bills and other eligible bills
Investment securities
Available-for-sale financial assets
Loans and advances to customers
Loans and advances to banks
Lease and hire purchase receivables
Interest payable:
Deposits from banks
Customer accounts
Debt securities in issue
Subordinated liabilities
Liabilities under sale and repurchase agreements
Other
Net interest income
Included within interest income in 2005 is £209 million in respect of impaired financial assets.
5 Net fees and commission income
Fees and commission income:
Current accounts
Insurance broking
Credit and debit card services
Other
Fees and commission expense:
Credit and debit card services
Dealer commissions
Other
Net fees and commission income
6 Net trading income
Foreign exchange translation gains
Gains on foreign exchange trading transactions
Total foreign exchange
Investment property gains
Securities and other gains
74 LLOYDS TSB GROUP
Notes to the group accounts
7 Insurance premium income
The table below reflects the insurance premiums, substantially all of which relate to business written in the United Kingdom, broken down into life insurance and
non-life insurance:
Life insurance
Gross premiums
Ceded reinsurance premiums
Net premiums earned
Non-life insurance
Gross premiums written
Ceded reinsurance premiums
Net premiums
Change in provision for unearned premiums
Net premiums earned
Total net premiums earned
Life insurance gross written premiums can be further analysed as follows:
Life
Pensions
Annuities
Other
Gross premiums
Non-life insurance gross written premiums can be further analysed as follows:
Credit protection
Home
Health
8 Other operating income
Operating lease rental income
Income from investment property
Other rents receivable
Gains less losses on disposal of available-for-sale financial assets, net of allowances
for impairment
Gains less losses on disposal of investment securities, net of amounts written off
Movement in value of in-force insurance business (note 26)
Other income
2005
£m
3,996
(89)
3,907
575
(22)
553
9
562
4,469
2005
£m
1,286
2,136
547
27
3,996
2005
£m
173
390
12
575
2005
£m
433
272
30
5
162
238
1,140
2004
£m
5,581
(65)
5,516
635
(29)
606
(52)
554
6,070
2004
£m
2,100
2,826
626
29
5,581
2004
£m
224
396
15
635
2004
£m
422
158
32
74
16
155
857
LLOYDS TSB GROUP 75
Notes to the group accounts
9 Insurance claims
Insurance claims comprise:
Life insurance
Claims and surrenders:
– Gross
– Reinsurers’ share
Changes in life insurance policyholder liabilities:
– Gross
– Reinsurers’ share
Change in unallocated surplus
Total life insurance
Non-life insurance
Claims and claims paid:
– Gross
– Reinsurers’ share
Changes in non-life insurance policyholder liabilities:
– Gross
– Reinsurers’ share
Total non-life insurance
Total insurance claims expense
Life insurance gross claims can also be analysed as follows:
Deaths
Maturities
Surrenders
Annuities
Other
A non-life insurance claims development table is included in note 34.
10 Operating expenses
Salaries
Pensions
Other staff costs
Staff costs
Other administrative expenses:
Operating lease rentals
Repairs and maintenance
Communications and data processing
Advertising
Professional fees
Provisions for customer remediation (note 40)
Other
Depreciation
Impairment charges:
Goodwill (note 25)
Total operating expenses
76 LLOYDS TSB GROUP
2005
£m
4,279
(56)
4,223
7,641
33
7,674
92
11,989
195
(1)
194
3
–
3
197
12,186
298
1,197
2,204
528
52
4,279
2005
£m
2,068
308
479
2,855
252
136
467
207
216
150
543
1,971
639
6
5,471
2004
£m
5,242
(62)
5,180
3,206
(1)
3,205
1,023
9,408
204
(1)
203
11
–
11
214
9,622
354
1,617
2,700
528
43
5,242
2004
£m
1,970
307
427
2,704
249
129
449
205
222
112
589
1,955
638
–
5,297
Notes to the group accounts
10 Operating expenses (continued)
The average number of persons on a headcount basis employed by the Group during the year was as follows:
UK
Overseas
During the year the auditors earned the following fees:
Statutory audit
Other audit related fees:
– Audit related regulatory reporting
– Further assurance services
Total other audit related fees
Audit and audit related fees
Tax advisory
Other non-audit fees
– Due diligence
– Other
Total other non-audit fees
Total fees
2005
77,620
1,974
79,594
2005
£m
8.1
0.8
1.5
2.3
10.4
0.6
0.3
0.5
0.8
11.8
2004
79,581
3,372
82,953
2004
£m
5.5
0.9
6.4
7.3
12.8
0.8
0.9
0.3
1.2
14.8
The auditors’ remuneration for the holding company was £57,000 (2004: £51,500).
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.
It is the Group’s policy to use the auditors on assignments in cases where their knowledge of the Group means that it is neither efficient nor cost effective to employ
another firm of accountants. Such assignments typically relate to the provision of advice on tax issues, assistance in transactions involving the acquisition and disposal
of businesses and accounting advice. The auditors are not permitted to provide management consultancy services to the Group.
The Group has procedures that are designed to ensure auditor independence, including that fees for audit and non-audit services are approved in advance. The audit
committee has established de minimis fee limits for particular detailed types of service and has approved in advance all non-audit assignments where the fee falls
below the relevant limit. All statutory audit work as well as non-audit assignments where the fee is expected to exceed the relevant limit are subject to individual
pre-approval by the audit committee. On a quarterly basis, the audit committee receives a report detailing all pre-approved services and amounts paid to the auditors
for such pre-approved services.
11 Impairment losses on loans and advances
Specific bad debt provisions
General bad debt provisions
Impairment losses on loans and advances (note 20)
Other credit risk provisions (note 40)
12 Profit (loss) on sale and closure of businesses
Net profit (loss) on disposal of businesses
Adjustment to consideration received in respect of prior period disposals
Provision for costs in respect of the closure of businesses
2005
£m
1,302
(3)
1,299
2005
£m
74
(4)
(20)
50
2004
£m
953
(87)
866
–
866
2004
£m
(21)
–
–
(21)
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.
The businesses sold in 2004 and 2005 were not material to the Group, and consequently they have not been treated as discontinued operations.
LLOYDS TSB GROUP 77
Notes to the group accounts
13 Taxation
a Analysis of charge for the year
UK corporation tax:
Current tax on profits for the year
Adjustments in respect of prior years
Double taxation relief
Foreign tax:
Current tax on profit for the year
Adjustments in respect of prior years
Current tax charge
Deferred tax (note 39)
2005
£m
862
(20)
842
(138)
704
78
(8)
70
774
491
1,265
2004
£m
759
(69)
690
(57)
633
118
(2)
116
749
269
1,018
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).
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).
b Factors affecting the tax charge for the year
A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the tax charge for the year is given below:
Profit before tax
Tax charge thereon at UK corporation tax rate of 30%
Factors affecting charge:
Disallowed and non-taxable items
Overseas tax rate differences
Net tax effect of disposals and unrealised gains
Tax deductible coupons on non-equity minority interests
Policyholder tax and Open Ended Investment Companies
Other items
Tax on profit on ordinary activities
Effective rate
2005
£m
3,820
1,146
(47)
(1)
(59)
–
223
3
1,265
33.1%
2004
£m
3,477
1,043
(32)
(14)
(2)
(12)
33
2
1,018
29.3%
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).
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.
2005
2004
Profit attributable to equity shareholders
Weighted average number of ordinary shares in issue
Basic earnings per share
£2,493m
5,595m
44.6p
£2,392m
5,590m
42.8p
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential
ordinary shares. The Company has dilutive potential ordinary shares in respect of share options granted to employees. The number of shares that could have been
acquired at market price (determined as the average annual share price of the Company’s shares) based on the monetary value of the subscription rights attached
to outstanding share options is determined; the residual bonus shares are added to the weighted average number of ordinary shares in issue, but no adjustment is
made to the profit attributable to equity shareholders.
2005
2004
Profit attributable to equity shareholders
Weighted average number of ordinary shares in issue
Adjustment for share options
Weighted average number of ordinary shares for diluted earnings per share
Diluted earnings per share
£2,493m
5,595m
44m
5,639m
44.2p
£2,392m
5,590m
35m
5,625m
42.5p
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).
78 LLOYDS TSB GROUP
Notes to the group accounts
15 Treasury bills and other eligible bills
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).
Details of the balance sheet carrying value of the treasury bills and other eligible bills held at 31 December 2004 were as follows:
Investment securities:
Treasury bills and similar securities
Other eligible bills
Other securities:
Treasury bills and similar securities
Balance sheet carrying value – treasury bills and other eligible bills
Geographical analysis by issuer:
Latin America
Other
£m
75
13
88
4
92
18
74
92
16 Trading securities and other financial assets at fair value through profit or loss
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:
Trading securities
Other financial assets at fair value through profit or loss
These assets are comprised as follows:
Loans and advances to banks
Loans and advances to customers
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Corporate debt securities
Mortgage backed securities
Other asset backed securities
Other debt securities
Equity shares:
Listed
Unlisted
See notes 15, 21 and 22 for details of investments held at 31 December 2004.
Trading
securities
£m
5
161
535
35
–
4,667
39
–
–
5,276
–
–
–
5,442
£m
5,442
54,932
60,374
Other financial
assets at fair
value through
profit or loss
£m
5
445
10,638
84
898
4,214
197
691
4,255
20,977
27,497
6,008
33,505
54,932
LLOYDS TSB GROUP 79
Notes to the group accounts
17 Derivative financial instruments and other trading liabilities
The principal derivatives used by the Group are interest rate and exchange rate contracts; particular attention is paid to the liquidity of the markets and products in
which the Group trades to ensure that there are no undue concentrations of activity and risk.
Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange
fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate
agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific
date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or
deposit, for a specified period and commencing on a specified future date.
Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy
or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment
obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium,
the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date.
Equity derivatives are also used by the Group as part of its equity based retail product activity to eliminate the Group’s exposure to fluctuations in various international
stock exchange indices. Index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities,
or basket of equities in the form of published indices on or before a specified future date.
The principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive
value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and
collateralisation, where security is provided against the exposure. Fair values are obtained from quoted market prices in active markets, including recent market
transactions, and using valuation techniques, including discounted cash flow and options pricing models, as appropriate.
Contract/notional
amount
£m
Fair value
assets
£m
Fair value
liabilities
£m
145,591
12,306
3,623
3,892
165,412
288,725
50,006
12,679
8,812
29,358
389,580
5,349
69
39,499
39,568
648
1,515
267
58
–
1,840
2,814
16
108
–
–
2,938
610
5,388
12
473
485
5
490
5,878
1,345
204
–
45
1,594
3,860
20
–
85
–
3,965
84
5,643
–
730
730
23
753
6,396
31 December 2005
Trading
Exchange rate contracts:
Spot, forwards and futures
Currency swaps
Options purchased
Options written
Interest rate contracts:
Interest rate swaps
Forward rate agreements
Options purchased
Options written
Futures
Equity and other contracts
Total derivative assets/liabilities held for trading
Hedging
Derivatives designated as fair value hedges:
Cross currency interest rate swaps
Interest rate swaps (including swap options)
Derivatives designated as cash flow hedges:
Interest rate swaps
Total derivative assets/liabilities held for hedging
Total recognised derivative assets/liabilities
80 LLOYDS TSB GROUP
Notes to the group accounts
17 Derivative financial instruments and other trading liabilities (continued)
31 December 2004
Trading
Exchange rate contracts:
Spot, forwards and futures
Currency swaps
Options purchased
Options written
Interest rate contracts:
Interest rate swaps
Forward rate agreements
Options purchased
Options written
Futures
Equity and other contracts
Effect of netting
Total derivative assets/liabilities held for trading
Contract/notional
amount
£m
Fair value
assets
£m
Fair value
liabilities
£m
117,532
11,386
2,059
1,922
132,899
275,547
62,797
9,679
7,430
48,278
403,731
4,294
4,593
426
44
–
5,063
3,118
28
78
–
–
3,224
538
(3,956)
4,869
5,237
588
–
41
5,866
3,631
24
–
163
–
3,818
215
(3,956)
5,943
At 31 December 2004, the fair value amounts shown above were included on the balance sheet within other assets and other liabilities (see notes 30 and 37).
The maturity of the notional principal amounts and replacement cost of trading instruments entered into with third parties was:
Exchange rate contracts
Notional principal amount
Replacement cost
Interest rate contracts
Notional principal amount
Replacement cost
Equity and other contracts
Notional principal amount
Replacement cost
Total
Notional principal amount
Replacement cost
18 Loans and advances to banks
Lending to banks
Money market placements with banks
Total loans and advances to banks
Allowance for impairment losses (note 20)
Under 1 year
£m
120,794
4,610
203,851
458
638
262
325,283
5,330
Over 5 years
£m
4,012
276
46,458
1,413
298
18
50,768
1,707
1 to 5 years
£m
8,093
177
153,422
1,353
3,358
258
164,873
1,788
2005
£m
2,510
29,146
31,656
(1)
31,655
Total
£m
132,899
5,063
403,731
3,224
4,294
538
540,924
8,825
2004
£m
2,483
29,366
31,849
(1)
31,848
The Group holds collateral with a fair value of £6,381 million, which it is permitted to sell or repledge, of which £5,550 million was repledged or sold to third parties
for periods not exceeding three months from the transfer.
LLOYDS TSB GROUP 81
Notes to the group accounts
19 Loans and advances to customers
Domestic
Agriculture, forestry and fishing
Manufacturing
Construction
Transport, distribution and hotels
Property companies
Financial, business and other services
Personal:
– Mortgages
– Other
Lease financing
Hire purchase
Other
International
Latin America
USA
Europe
Rest of the world
Total international
Allowance for impairment losses (note 20)
Interest held in suspense
2005
£m
2,299
5,983
2,059
7,649
8,267
16,272
88,528
22,776
5,815
4,853
7,696
172,197
173
1,984
1,927
735
4,819
177,016
(2,072)
174,944
2004
£m
2,076
3,292
1,877
6,753
5,775
13,442
80,065
22,830
6,227
4,828
5,223
152,388
125
2,385
1,587
516
4,613
157,001
(1,662)
(21)
155,318
The Group holds collateral with a fair value of £1,018 million, which it is permitted to sell or repledge, of which £741 million was repledged or sold to third parties
for periods not exceeding three months from the transfer.
Loans and advances to customers include finance lease receivables, which may be analysed as follows:
Gross investment in finance leases, receivable:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
Unearned future finance income on finance leases
Rentals received in advance
Commitments for expenditure in respect of equipment to be leased
Net investment in finance leases
The net investment in finance leases may be analysed as follows:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
2005
£m
673
2,388
6,025
9,086
(2,954)
(200)
(117)
5,815
2005
£m
648
1,610
3,557
5,815
2004
£m
603
2,698
7,481
10,782
(4,021)
(338)
(196)
6,227
2004
£m
446
844
4,937
6,227
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other ‘big ticket’
items. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £4 million (2004: £10 million).
82 LLOYDS TSB GROUP
Notes to the group accounts
20 Allowance for impairment losses on loans and advances
At 1 January
Adjustment on transition to IAS 39
Restated balance at 1 January
Exchange and other adjustments
Reclassifications
Adjustments on acquisitions and disposals
Advances written off
Recoveries of advances written off in previous years
Effect of unwinding of discount recognised through interest income
Charge (release) to the income statement
At 31 December
In respect of:
Loans and advances to banks (note 18)
Loans and advances to customers (note 19)
21 Debt securities
2005
£m
1,663
256
1,919
1
43
(27)
(1,236)
158
(87)
1,302
2,073
1
2,072
2,073
2004
Specific
£m
1,313
(8)
–
(21)
(1,028)
174
953
1,383
2004
General
£m
382
(3)
–
(12)
–
–
(87)
280
2004
Total
£m
1,695
(11)
–
(33)
(1,028)
174
866
1,663
1
1,662
1,663
As at 31 December 2004 (prior to the implementation of IAS 32 and IAS 39 on 1 January 2005) debt securities 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, debt securities 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).
Details of the balance sheet carrying value of the debt securities held at 31 December 2004 were as follows:
Investment securities
Government securities
Bank and building society certificates of deposit
Corporate debt securities
Mortgage backed securities
Other asset backed securities
Other debt securities
Other securities
Government securities
Other public sector securities
Bank and building society certificates of deposit
Corporate debt securities
Mortgage backed securities
Other asset backed securities
Balance sheet carrying value – debt securities
£m
2,211
1,901
2,581
2,774
3,761
1,140
14,368
14,018
321
488
13,445
533
312
29,117
43,485
LLOYDS TSB GROUP 83
Notes to the group accounts
21 Debt securities (continued)
Investment securities
Listed
Unlisted
Other securities
Listed
Unlisted
Geographical analysis by issuer:
United Kingdom
Other European
North America and Caribbean
Latin America
Asia Pacific
Other
22 Equity shares
£m
8,925
5,443
14,368
28,400
717
29,117
21,288
13,464
5,264
76
2,866
527
43,485
As at 31 December 2004 (prior to the implementation of IAS 32 and IAS 39 on 1 January 2005) equity shares 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, equity shares 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).
Details of the balance sheet carrying value of the equity shares held at 31 December 2004 were as follows:
£m
5
36
41
24,497
2,772
27,269
27,310
17,960
3,921
2,302
384
1,470
1,273
27,310
Investment securities
Listed
Unlisted
Other securities
Listed
Unlisted
Balance sheet carrying value – equity shares
Geographical analysis by issuer:
United Kingdom
Other European
North America and Caribbean
Latin America
Asia Pacific
Other
84 LLOYDS TSB GROUP
Notes to the group accounts
23 Available-for-sale financial assets
From 1 January 2005 (upon the implementation of IAS 32 and IAS 39), the Group is required to disclose its available-for-sale financial assets separately on the face
of the balance sheet. Details of the balance sheet carrying value of these assets held at 31 December 2005 are:
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Corporate debt securities
Mortgage backed securities
Other asset backed securities
Other debt securities
Equity shares:
Listed
Unlisted
Treasury bills and other eligible bills:
Treasury bills and similar securities
Other eligible bills
See notes 15, 21 and 22 for details of investments held at 31 December 2004.
The movement in available-for-sale financial assets is summarised as follows:
Carrying value
before provisions
£m
Provisions
£m
At 1 January 2005 (following implementation of IAS 32 and IAS 39)
Exchange and other adjustments
Additions
Disposals
Reclassifications
Amortisation of premiums and discounts
Changes in fair value
At 31 December 2005
24 Investment property
At 1 January
Fair value movements
Additions to investment properties
Disposals of investment properties
At 31 December
(31)
–
–
–
31
–
–
–
14,624
559
10,108
(10,266)
(31)
(65)
11
14,940
2005
£m
3,776
430
807
(753)
4,260
£m
1,083
47
1,470
3,036
4,161
4,981
29
14,807
34
12
46
70
17
87
14,940
Balance sheet
value
£m
14,593
559
10,108
(10,266)
–
(65)
11
14,940
2004
£m
3,551
329
351
(455)
3,776
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.
In addition, the following amounts have been recognised in the income statement:
Rental income
Direct operating expenses arising from investment properties that generate rental income
Capital expenditure in respect of investment properties:
Capital expenditure contracted for at the balance sheet date but not recognised in the
financial statements
2005
£m
272
24
2005
£m
31
2004
£m
158
17
2004
£m
66
LLOYDS TSB GROUP 85
Notes to the group accounts
25 Goodwill
At 1 January
Acquisition adjustment
Acquisitions of businesses (note 52)
Adjustments on disposal of businesses
Impairment charge
At 31 December
Cost*
Accumulated impairment losses
2005
£m
2,469
–
3
(93)
(6)
2,373
2,379
(6)
2,373
2004
£m
2,513
(34)
–
(10)
–
2,469
2,469
–
2,469
* For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.
An impairment charge of £6 million (2004: nil) was made during 2005 following a strategic review of a business acquired in previous years.
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the
appropriate cash generating unit; of the total balance of £2,373 million (2004: £2,469 milllion), £1,836 million (or 77 per cent of the total) has been allocated to
Scottish Widows and £517 million (or 22 per cent of the total) to Asset Finance.
The recoverable amount of Scottish Widows has been based on a value in use calculation. The calculation uses projections of future cash flows based upon budgets
and plans approved by management covering a five-year period, and a discount rate of 11 per cent (gross of tax). The budgets and plans are based upon past
experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor
activity. The discount rate is determined with reference to internal measures and available industry information. Cash flows beyond the five-year period have been
extrapolated using a steady 3 per cent growth rate which does not exceed the long-term average growth rate for the life assurance market. Management believes that
any reasonably possible change in the key assumptions would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
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.
26 Long-term assurance business
Life assurance businesses
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.
Further information on the Group’s life assurance businesses, including its available capital resources and regulatory capital requirements, the realistic value of its
assets and liabilities and its capital sensitivities is given in note 34 and on pages 35 to 38.
Value of in-force business
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:
At 1 January 2004
Movement in value of in-force business (gross of tax)
At 31 December 2004
Adjustments on the adoption of FRS27
Adjustments on the adoption of IFRS4 and IAS39
At 1 January 2005
Movement in value of in-force business (gross of tax)
At 31 December 2005
86 LLOYDS TSB GROUP
£m
4,347
16
4,363
(386)
(1,217)
2,760
162
2,922
Notes to the group accounts
26 Long-term assurance business (continued)
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)
Return on equities (gross of tax)
Return on fixed interest securities (gross of tax)
Expenses inflation
2005
%
7.02
6.72
4.12
3.79
2004
%
7.40
7.17
4.57
3.76
The process for determining the key assumptions used in the calculations of the value of in-force business is set out below.
• Investment returns
The assumption for future investment returns for fixed (or index linked) investments reflects the actual portfolio. Projected returns from fixed and index linked
investments are based on risk-free (gilt-edged) returns and are reduced for the risk of default but not adjusted for liquidity. Where an assumption on future equity or
property returns is required, this is based on such returns having an equity or property yield margin over the corresponding risk-free (gilt-edged) return assumed.
• Risk Discount Rate (RDR)
The RDR is set to remove investment risk margins, including those assumed to be generated by equities, whilst retaining a margin for other, non-investment, risks.
• Mortality and morbidity
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.
• Persistency rates
Persistency rates refer to the rate of policy termination and the rate at which policies cease to pay regular premiums. These rates are based on a combination of
historical experience and management’s views on future experience.
• Maintenance expenses
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.
The sensitivity of the value of in-force business to changes in these assumptions is included within the disclosures in note 34.
27 Other intangible assets
These comprise capitalised software enhancements. Amounts are amortised over periods of up to five years, being their estimated useful lives, using the straight-line
method. Other intangible assets are reviewed for impairment whenever events or any changes in circumstances indicate that the carrying amount may not be
recoverable. In the event that an asset’s carrying amount is determined to be greater than its recoverable amount, it is written down immediately.
Cost:
At 1 January
Additions
Disposals
At 31 December
Accumulated depreciation:
At 1 January
Charge for the year
Disposals
At 31 December
Balance sheet amount at 31 December
2005
£m
107
40
–
147
79
18
–
97
50
2004
£m
103
18
(14)
107
62
22
(5)
79
28
LLOYDS TSB GROUP 87
Notes to the group accounts
28 Tangible fixed assets
Cost:
At 1 January 2004
Exchange and other adjustments
Adjustments on acquisition and disposal of businesses
Additions
Disposals
At 31 December 2004
Exchange and other adjustments
Adjustments on acquisition and disposal of businesses
Additions
Disposals
At 31 December 2005
Accumulated depreciation and impairment:
At 1 January 2004
Exchange and other adjustments
Adjustments on acquisition and disposal of businesses
Charge for the year
Disposals
At 31 December 2004
Exchange and other adjustments
Charge for the year
Disposals
At 31 December 2005
Balance sheet amount at 31 December 2005
Balance sheet amount at 31 December 2004
Premises
£m
Equipment
£m
Operating
lease assets
£m
Total
fixed assets
£m
1,313
2
(10)
73
(18)
1,360
1
8
89
(37)
1,421
475
–
(4)
68
(6)
533
3
76
(11)
601
820
827
2,378
(1)
(13)
283
(121)
2,526
(3)
–
280
(136)
2,667
1,439
2
(8)
267
(73)
1,627
(1)
267
(97)
1,796
871
899
2,488
(46)
–
801
(476)
2,767
63
–
615
(484)
2,961
321
(3)
–
281
(286)
313
9
278
(239)
361
2,600
2,454
6,179
(45)
(23)
1,157
(615)
6,653
61
8
984
(657)
7,049
2,235
(1)
(12)
616
(365)
2,473
11
621
(347)
2,758
4,291
4,180
2004
£m
326
601
258
1,185
At 31 December the future minimum rentals receivable under non-cancellable operating leases were as follows:
Receivable within 1 year
1 to 5 years
Over 5 years
2005
£m
393
695
165
1,253
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.
29 Capital commitments
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.
30 Other assets
Assets arising from reinsurance contracts held
Deferred acquisition costs
Settlement balances
Derivative financial instruments (see note 17)
Other assets and prepayments
88 LLOYDS TSB GROUP
2005
£m
548
429
336
4,288
5,601
2004
£m
581
2
79
4,869
3,482
9,013
Notes to the group accounts
31 Deposits from banks
The breakdown of deposits from banks between the domestic and international offices of the Group is set out below:
Domestic:
Non-interest bearing
Interest bearing
International:
Non-interest bearing
Interest bearing
32 Customer accounts
Non-interest bearing current accounts
Interest bearing current accounts
Savings and investment accounts
Other customer deposits
2005
£m
105
24,707
24,812
24
6,691
6,715
31,527
2005
£m
4,203
40,365
62,206
24,296
131,070
The breakdown of customer accounts between the domestic and international offices of the Group is set out below:
Domestic:
Non-interest bearing
Interest bearing
International:
Non-interest bearing
Interest bearing
33 Debt securities in issue
Euro medium-term note programme
Other bonds and medium-term notes
Certificates of deposit issued
Commercial paper
Other marketable paper
Total debt securities in issue
2005
£m
3,868
123,522
127,390
335
3,345
3,680
131,070
2005
£m
6,683
141
22,101
10,421
–
39,346
2004
£m
171
33,023
33,194
31
6,498
6,529
39,723
2004
£m
3,807
32,157
58,773
25,074
119,811
2004
£m
3,511
113,465
116,976
296
2,539
2,835
119,811
2004
£m
5,097
266
15,226
8,026
155
28,770
LLOYDS TSB GROUP 89
Notes to the group accounts
34 Liabilities arising from insurance contracts and participating investment contracts
Insurance contract liabilities
Participating investment contract liabilities
Insurance contract liabilities
2005
£m
26,482
14,068
40,550
2004
£m
52,289
52,289
Insurance contract liabilities, substantially all of which relate to business written in the United Kingdom, are comprised as follows:
Life insurance
Non-life insurance:
Unearned premiums
Claims outstanding
Life insurance
Gross
£m
2005
Reinsurance
£m
Net
£m
Gross
£m
2004
Reinsurance
£m
Net
£m
25,888
(511)
25,377
51,692
(577)
51,115
447
147
594
–
(4)
(4)
447
143
590
456
141
597
–
(4)
(4)
456
137
593
26,482
(515)
25,967
52,289
(581)
51,708
The movement in gross life insurance contract liabilities over the year can be analysed as follows:
At 31 December 2004
Adjustments to reflect the implementation of IAS 32, IAS 39, IFRS 4 and FRS 27
At 1 January 2005
New business
Changes in existing business
At 31 December 2005
The movement in liabilities arising from participating investment contracts may be analysed as follows:
At 31 December 2004
Adjustments to reflect the implementation of IAS 32, IAS 39, IFRS 4 and FRS 27
At 1 January 2005
New business
Changes in existing business
At 31 December 2005
Process for determining key assumptions
£m
51,692
(28,033)
23,659
1,381
848
25,888
£m
12,469
12,469
1,181
418
14,068
The process for determining the key assumptions for insurance contracts and participating investment contracts is set out below.
Insurance policy liabilities can be split into With-Profits Fund liabilities, accounted for using the FSA’s realistic capital regime (realistic liabilities) and Non-Profit Fund
liabilities, accounted for using a traditional prospective actuarial discounted cash flow methodology as described in the accounting policies.
With-Profits Fund Realistic Liabilities
The Group’s With-Profits Fund contains life insurance contracts and participating investment contracts. The calculation of With-Profits realistic liabilities uses best
estimate assumptions for mortality and morbidity, persistency rates and expenses. These are calculated in a similar manner to those used for the value of the in-force
business as discussed in note 26.
Other key assumptions are:
• Investment returns and discount rates
The realistic capital regime dictates that With-Profits Fund liabilities are valued on a market consistent basis. This is achieved by setting assumed investment returns
and discount rates equal to a risk-free yield, defined as 0.1 per cent higher than the yield on UK gilts.
• Guaranteed annuity option take up rates
The guaranteed annuity option take up rates are set with regard to the Group’s actual experience.
• Investment volatility
Investment volatility is derived from derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, as
at 31 December 2005, the 10 year equity-implied at-the-money assumption was set at 20.0 per cent (31 December 2004: 18.0 per cent). The long-term
at-the-money assumptions for property and fixed interest stocks were 15.0 per cent (31 December 2004: 15.0 per cent) and 13.5 per cent (31 December 2004:
13.0 per cent) respectively.
90 LLOYDS TSB GROUP
Notes to the group accounts
34 Liabilities arising from insurance contracts and participating investment contracts (continued)
Non-Profit Fund liabilities
Generally, assumptions used to value Non-Profit Fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse
deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement
of Non-Profit Fund liabilities are:
• Interest rates
The rates used are derived in accordance with the FSA Rules. These limit the rates of interest that can be used by reference to a number of factors including the
redemption yields on fixed interest assets at the valuation date.
Margins for risk are allowed for in the assumed interest rates. These are derived from the limits in the FSA Rules, including reductions made to the available yields
to allow for default risk based upon the credit rating of each stock.
• Mortality and morbidity
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 provides a reliable basis, and relevant industry data otherwise, and includes a margin for adverse deviation.
• Maintenance expenses
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs plus a margin
for adverse deviations. Explicit allowance is made for future expense inflation.
Key changes in assumptions
Changes in certain key assumptions were made during 2005 with the following impacts on profit before tax. These amounts include movements in liabilities and
value of the in-force business in respect of insurance contracts and participating investment contracts:
Annuitant mortality 1
Modelling of options and guarantees in the With-Profits Fund 2
Lapse rates 3
Reduction in
profit before tax
£m
155
60
58
1
The charge in respect of annuitant mortality reflects the introduction of an assumed minimum annual improvement in mortality.
2
Changes to the valuation of options and guarantees primarily reflects emerging best practice in this area.
3
Lapse rates have been set following a detailed review of the Group’s current and expected experience.
Sensitivity analysis
The following table demonstrates the effect of changes in key assumptions on profit before tax assuming that the other assumptions remain unchanged. In practice
this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in liabilities and the value of the in-force business
in respect of insurance contracts and participating investment contracts:
Mortality1
Lapse rates
Maintenance expenses
Interest rates2
Guaranteed annuity option take up
Equity investment volatility
Reduction
(increase)
in profit
before tax
(Participating
Investment)
Reduction
in profit
before tax
(Insurance)
414
21
40
242
81
12
11
32
29
(18)
–
17
Total
reduction
in profit
before tax
425
53
69
224
81
29
Change in
variable
10% adverse
20% increase
10% increase
1% addition
5% increase
1% addition
1
2
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.
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.
Non-life insurance
Non-life insurance contract liabilities are analysed by line of business as follows:
Credit protection
Home
Health
2005
£m
284
304
6
594
2004
£m
290
299
8
597
For non-life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims provisioning levels
are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or expected outcome. A margin is placed
on these best estimate claims reserves to provide confidence in being able to achieve this objective and varies according to product class. A relatively small margin
was used for most products where sufficient past experience has been accumulated. An additional margin was used to allow for reserve uncertainty of claims where
there is less experience and the introduction of claims re-engineering processes, which will affect how claims are being reported for household and domestic all
risks products.
The reserving methodology and associated assumptions are set out below:
The unearned premium reserve is determined on a basis that reflects the length of time for which contracts have been in force and the projected incidence of risk
over the term of each contract.
LLOYDS TSB GROUP 91
Notes to the group accounts
34 Liabilities arising from insurance contracts and participating investment contracts (continued)
Claims outstanding comprise those claims that have been notified and those that have been incurred but not reported. Claims incurred but not reported are determined
based on the historical emergence of claims and their average cost. The notified claims element represents the best estimate of the cost of claims reported using
projections and estimates based on historical experience.
The movements in non-life insurance contract liabilities and reinsurance assets over the year have been as follows:
Provisions for unearned premiums
At 1 January 2005
Increase in the year
Release in the year
At 31 December 2005
Gross
£m
456
575
(584)
447
Reinsurance
£m
–
–
–
–
These provisions represent the liability for short-term insurance contracts for which the Group’s obligations are not expired at the year end.
Claims and loss adjustment expenses
Notified claims
Incurred but not reported
At 1 January 2005
Cash paid for claims settled in the year
Increase in liabilities:
– arising from current year claims
– arising from prior year claims
At 31 December 2005
Notified claims
Incurred but not reported
At 31 December 2005
Non-life insurance claims development table
Gross
£m
117
24
141
(221)
239
(12)
147
120
27
147
Reinsurance
£m
(4)
–
(4)
–
–
–
(4)
(4)
–
(4)
Net
£m
456
575
(584)
447
Net
£m
113
24
137
(221)
239
(12)
143
116
27
143
The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The top half of the table below illustrates
how the Group’s estimate of total claims outstanding for each accident year has changed at successive year ends. The bottom half of the table reconciles the
cumulative claims to the amount appearing in the balance sheet. The accident year basis is considered the most appropriate for the business written by the Group.
Non-life insurance all risks – gross
Accident year
Estimate of ultimate claims costs:
– at end of accident year
– one year later
– two years later
– three years later
– four years later
Current estimate of cumulative claims
Cumulative payments to date
Liability recognised in the balance sheet
Liability in respect of prior years
Total liability included in the balance sheet
2001
£m
195
177
184
181
179
179
(172)
7
2002
£m
242
230
228
224
–
224
(221)
3
2003
£m
234
220
223
–
–
223
(206)
17
2004
£m
227
209
–
–
–
209
(192)
17
2005
£m
211
–
–
–
–
211
(123)
88
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
Gross unit-linked investment contracts (non-participating)
Reinsurance (included in other assets)
2005
£m
21,839
(33)
21,806
The movement in liabilities arising from gross non-participating investment contracts may be analysed as follows:
At 31 December 2004
Adjustments to reflect the implementation of IAS 32, IAS 39 and IFRS 4
At 1 January 2005
New business
Changes in existing business
At 31 December 2005
92 LLOYDS TSB GROUP
Total
£m
1,109
1,046
(914)
132
6
138
2004
£m
£m
16,361
16,361
3,413
2,065
21,839
Notes to the group accounts
36 Unallocated surplus within insurance businesses
The movement in the unallocated surplus within long-term insurance business over the year can be analysed as follows:
At 31 December 2004
Adjustments to reflect the implementation of IAS 39 and FRS 27
At 1 January 2005
Change in unallocated surplus recognised in the income statement
At 31 December 2005
37 Other liabilities
Settlement balances
Unitholders’ interest in OEICs
Derivative financial instruments (see note 17)
Other creditors and accruals
38 Retirement benefit obligations
Amounts recognised in the balance sheet:
Pension schemes
Other post-retirement benefit schemes
Pension schemes
Defined benefit schemes
2005
£m
779
3,296
5,768
9,843
2005
£m
2,809
101
2,910
£m
1,362
(936)
426
92
518
2004
£m
134
2,680
5,943
5,700
14,457
2004
£m
2,981
94
3,075
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 principal financial assumptions used in the scheme valuations were as follows:
Rate of inflation
Rate of salary increases
Rate of increase for pensions in payment and deferred pensions
Discount rate
2005
%
2.70
3.98
2.50
4.80
2004
%
2.60
4.14
2.60
5.30
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:
Life expectancy for member aged 60, on the valuation date
– Men
– Women
Life expectancy for member aged 60, 15 years after the valuation date
– Men
– Women
The amounts recognised in the balance sheet are as follows:
Present value of scheme liabilities
Fair value of scheme assets
Unrecognised actuarial losses
31 December
2005
Years
25.6
27.6
26.8
28.7
2005
£m
17,320
(14,026)
3,294
(485)
2,809
31 December
2004
Years
24.7
26.8
25.7
27.8
2004
£m
14,866
(11,648)
3,218
(237)
2,981
LLOYDS TSB GROUP 93
Notes to the group accounts
38 Retirement benefit obligations (continued)
The allocation of the assets of the Group’s defined benefit schemes was as follows:
Market values of scheme assets:
Equities
UK fixed interest gilts
UK index linked gilts
Sterling non-government bonds
Property
Cash
Total fair value of scheme assets
The movements in the net amount recognised in the balance sheet are as follows:
At 1 January
Exchange and other adjustments
Net charge to the income statement
Contributions paid
At 31 December
The amounts recognised in the income statement are as follows:
Current service cost
Interest cost
Expected return on scheme assets
Past service cost
The actual return on scheme assets was £2,377 million (2004: £1,119 million).
The expected return on scheme assets has been calculated using the following assumptions:
Equities
UK fixed interest gilts
UK index linked gilts
Sterling non-government bonds
Property
Cash
The expected return on scheme assets in 2006 will be calculated using the following assumptions:
2005
£m
9,021
946
920
1,415
1,185
539
14,026
2005
£m
2,981
4
243
(419)
2,809
2005
£m
292
775
(839)
15
243
2005
%
8.2
4.6
4.3
5.3
6.9
3.6
Equities
UK fixed interest gilts
UK index linked gilts
Sterling non-government bonds
Property
Cash
Defined contribution schemes
2004
£m
8,032
550
561
938
959
608
11,648
2004
£m
3,080
2
268
(369)
2,981
2004
£m
280
728
(757)
17
268
2004
%
8.1
4.8
4.4
5.4
7.1
3.5
2006
%
8.0
4.1
3.9
4.8
6.4
3.7
The Group operates a number of defined contribution pension schemes in the UK and overseas, principally the defined contribution sections of the Lloyds TSB Group
Pension Schemes No’s 1 and 2.
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.
Other post-retirement benefit schemes
The Group operates a number of schemes which provide post-retirement healthcare benefits to certain employees, retired employees and their dependent relatives.
The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post-retirement healthcare for all eligible
former employees (and their dependents) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a
provision has been made for the estimated cost of future insurance premiums payable.
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).
The movements in the amounts recognised in the balance sheet are as follows:
At 1 January
Exchange and other adjustments
Insurance premiums paid
Charge for the year
94 LLOYDS TSB GROUP
2005
£m
94
(3)
(6)
16
101
2004
£m
92
–
(5)
7
94
Notes to the group accounts
39 Deferred tax liabilities
The movement in the net deferred tax balance is as follows:
At 1 January
Restatement on implementation of IAS 32, IAS 39 and IFRS 4
At 1 January – restated
Disposals
Exchange and other adjustments
Income statement charge (note 13)
Amount charged (credited) to equity:
Available-for-sale financial assets
Cash flow hedges
Share based compensation
Amounts transferred to the income statement:
Available-for-sale financial assets
Cash flow hedges
At 31 December
2005
£m
1,704
(779)
925
(256)
(2)
491
(2)
1
(16)
–
4
1,145
2004
£m
1,454
(23)
4
269
–
1,704
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.
The deferred tax charge in the income statement comprises the following temporary differences:
Accelerated capital allowances
Pensions and other post-retirement benefits
Investment reserve
Allowances for impairment losses (provisions for bad and doubtful debts in 2004)
Unrealised gains
Tax on value of in-force business
Other temporary differences
Deferred tax assets and liabilities are comprised as follows:
Deferred tax assets:
Pensions and other post-retirement benefits
Allowances for impairment losses (provisions for bad and doubtful debts in 2004)
Other provisions
Derivatives
Tax losses carried forward
Other temporary differences
Deferred tax liabilities:
Accelerated capital allowances
Investment reserve
Unrealised gains
Tax on value of in-force business
Other temporary differences
2005
£m
59
44
–
23
279
64
22
491
2005
£m
(873)
(165)
(31)
(164)
(322)
(270)
(1,825)
2005
£m
1,358
90
338
934
250
2,970
2004
£m
80
37
96
48
40
(18)
(14)
269
2004
£m
(917)
(84)
(64)
–
(372)
(187)
(1,624)
2004
£m
1,555
90
59
1,450
174
3,328
LLOYDS TSB GROUP 95
Notes to the group accounts
39 Deferred tax liabilities (continued)
Deferred tax assets
Deferred tax assets are recognised for tax losses and tax credit carry forwards to the extent that the realisation of the related tax benefit through future taxable profits
is probable.
Deferred tax assets of £526 million (2004: £527 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital
profits. Capital losses can be carried forward indefinitely.
In addition, deferred tax assets have not been recognised in respect of Eligible Unrelieved Foreign Tax (‘EUFT’) and other foreign tax credits carried forward as at
31 December 2005 of £88 million (2004: £32 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised.
EUFT can be carried forward indefinitely.
Deferred tax liabilities
Deferred tax liabilities have not been recognised for tax that may be payable if earnings of certain subsidiaries were remitted to the UK. Such amounts are either
permanently reinvested or can be remitted free of tax. Unremitted earnings totalled £609 million (2004: £639 million).
Future transfers from Scottish Widows plc’s long-term business funds to its Shareholder Fund will be subject to a shareholder tax charge. Under IAS 12, no provision
is required to be made to the extent that the timing of such transfers is under Scottish Widows plc’s control. Accordingly, deferred tax liabilities of £110 million
(2004: £230 million) have not been recognised.
40 Other provisions
At 31 December 2004
Adjustments to reflect the implementation
of IAS 32, IAS 39 and IFRS 4
At 1 January 2005
Exchange and other adjustments
Reclassifications
Provisions applied
Charge (credit) for the year
At 31 December 2005
Provisions for
contingent
liabilities and
commitments
£m
Customer
remediation
provisions
£m
–
49
49
–
(12)
(1)
(3)
33
121
–
121
–
–
(77)
150
194
Vacant
leasehold
property
and other
£m
90
10
100
24
–
(16)
33
141
Total
£m
211
59
270
24
(12)
(94)
180
368
Provisions for contingent liabilities and commitments
Provisions are held in cases where the Group is irrevocably committed to provide additional funds, but where there is doubt as to the potential borrower’s ability to
meet its repayment obligations.
Customer remediation provisions
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.
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.
Vacant leasehold property and other
Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income and the possibility of disposing of the Group’s interest
in the lease, taking into account conditions in the property market. These provisions are reassessed on an annual basis and will normally run off over the period of
under-recovery of the leases concerned, currently averaging four years; where a property is disposed of earlier than anticipated, any remaining balance in the provision
relating to that property is released.
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.
96 LLOYDS TSB GROUP
Notes to the group accounts
41 Subordinated liabilities
Undated subordinated loan capital*
Primary Capital Undated Floating Rate Notes:
Series 1 (US$750 million)
Series 2 (US$500 million)
Series 3 (US$600 million)
113/4% Perpetual Subordinated Bonds (£100 million)
6.625% Perpetual Capital Securities (c750 million) callable 2006
6.90% Perpetual Capital Securities callable 2007 (US$1,000 million)
55/8% Undated Subordinated Step-up Notes callable 2009 (c1,250 million)
Undated Step-up Floating Rate Notes callable 2009 (c150 million)
65/8% Undated Subordinated Step-up Notes callable 2010 (£410 million)
Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (c430 million)
6.35% Step-up Perpetual Capital Securities callable 2013 (c500 million)
5.125% Step-up Perpetual Subordinated Notes callable 2015 (£560 million)
5.57% Undated Subordinated Step-up Coupon Notes callable 2015 (¥20,000 million)
Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015 (£250 million)
5.125% Undated Subordinated Step-up Notes callable 2016 (£500 million)
4.385% Step-up Perpetual Capital Securities callable 2017 (c750 million)
61/2% Undated Subordinated Step-up Notes callable 2019 (£270 million)
8% Undated Subordinated Step-up Notes callable 2023 (£200 million)
61/2% Undated Subordinated Step-up Notes callable 2029 (£450 million)
6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million)
Dated subordinated loan capital
81/2% Subordinated Bonds 2006 (£250 million)
73/4% Subordinated Bonds 2007 (£300 million)
51/4% Subordinated Notes 2008 (DM 750 million)
105/8% Guaranteed Subordinated Loan Stock 2008 (£100 million)
91/2% Subordinated Bonds 2009 (£100 million)
61/4% Subordinated Notes 2010 (c400 million)
Subordinated Floating Rate Notes 2010 (US$400 million)
12% Guaranteed Subordinated Bonds 2011 (£100 million)
91/8% Subordinated Bonds 2011 (£100 million)
43/4% Subordinated Notes 2011 (c850 million)
57/8% Subordinated Guaranteed Bonds 2014 (c750 million)
57/8% Subordinated Notes 2014 (£150 million)
65/8% Subordinated Notes 2015 (£350 million)
Subordinated Step-up Floating Rate Notes 2016 callable 2011 (£300 million)
Subordinated Step-up Floating Rate Notes 2016 callable 2011 (c500 million)
Subordinated Floating Rate Notes 2020 (c100 million)
5.75% Subordinated Step-up Notes 2025 callable 2020 (£350 million)
95/8% Subordinated Bonds 2023 (£300 million)
Note
a
b
c
g
a
f
i,k
b,g
d,l
h
j,k
b,g,l
f
f
f
f
e
a
e
a,l
a
a
2005
£m
436
291
349
100
518
553
892
103
407
337
371
553
127
248
501
522
269
202
457
497
7,733
250
300
274
100
99
303
–
100
149
597
606
148
345
300
343
68
346
341
4,669
2004
£m
389
259
311
100
526
512
877
105
407
350
–
101
497
–
267
199
455
497
5,852
250
299
270
100
100
281
207
100
149
582
462
148
345
–
353
70
346
338
4,400
Total subordinated loan capital
12,402
10,252
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 certain circumstances, these notes, bonds and securities 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.
a) These notes bear interest at rates fixed periodically in advance based on London Interbank rates.
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.
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.
d) In certain circumstances the interest payments on these securities can be deferred although in this case Scottish Widows plc cannot declare or pay a dividend until
any deferred payments have been made.
e) Issued by a group undertaking under the Company’s subordinated guarantee.
f) At the callable date the coupon on these notes will be reset by reference to the applicable five year benchmark gilt rate.
g) In the event that these notes are not redeemed at the callable date, the coupon will be reset to a floating rate.
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.
LLOYDS TSB GROUP 97
■
■
■
■
■
■
■
■
Notes to the group accounts
41 Subordinated liabilities (continued)
i) These securities constitute limited partnership interests in Lloyds TSB Capital 1 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 7.375 per cent per annum up to 7 February 2012;
thereafter they will accrue at a rate of 2.33 per cent above EURIBOR, to be set annually. 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.
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.
k) At 31 December 2004, prior to the implementation of the prospective standards IAS 32 and IAS 39 from 1 January 2005, these instruments were classified as
minority interests (see note 48).
l) Issued during 2005 primarily to finance the general business of the Group.
42 Share capital
Authorised:
Sterling
6,911 million Ordinary shares of 25p each
79 million Limited voting ordinary shares of 25p each
175 million Preference shares of 25p each*
US dollars
160 million Preference shares of US$25 cents each*
Euro
160 million Preference shares of c25 cents each*
Japanese yen
50 million Preference shares of ¥25 each*
2005
£m
1,728
20
1,748
2004
£m
1,728
20
44
1,792
US$m
40
cm
40
¥m
1,250
* 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.
Issued and fully paid:
Ordinary shares of 25p each
At 1 January
Issued under employee share schemes
2005
Number
of shares
2004
Number
of shares
5,596,397,111
6,216,489
5,593,737,422
2,659,689
At 31 December
5,602,613,600
5,596,397,111
Limited voting ordinary shares of 25p each
At 1 January and 31 December
78,947,368
78,947,368
2005
£m
1,399
1
1,400
20
1,420
2004
£m
1,398
1
1,399
20
1,419
The limited voting ordinary shares are held by the Lloyds TSB Foundations. These shares carry no rights to dividends but rank pari passu with the ordinary shares
in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning
acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the
limited voting ordinary shares. Lloyds TSB Group plc has entered into deeds of covenant with the Lloyds TSB Foundations, under the terms of which the Company
makes annual donations to the foundations equal, in total, to 1 per cent of the Group’s pre-tax profits (after certain adjustments) averaged over three years. The deeds
of covenant can be cancelled by the Company at nine years’ notice.
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.
43 Share premium account
At 1 January
Premium arising on issue of shares under share option schemes
At 31 December
98 LLOYDS TSB GROUP
2005
£m
1,145
25
1,170
2004
£m
1,136
9
1,145
Notes to the group accounts
44 Other reserves
Other reserves comprise:
Merger reserve
Revaluation reserve in respect of available-for-sale financial assets
Cash flow hedging reserve
Movements in other reserves were as follows:
Merger reserve
At 1 January and 31 December
2005
£m
343
29
11
383
343
2004
£m
343
343
343
The merger reserve arose on the combination of Lloyds Bank Plc and TSB Group plc in 1995, as permitted by UK GAAP at the time. In accordance with the transitional
provisions of IFRS 1, the accounting treatment of this combination was not revisited when the Lloyds TSB Group adopted International Financial Reporting Standards
on 1 January 2004.
2005
£m
Revaluation reserve in respect of available-for-sale financial assets
At 1 January 2005 (following implementation of IAS 32 and IAS 39)
Exchange and other adjustments
Change in fair value of available-for-sale financial assets
Deferred tax thereon
Transfer to income statement
Disposal
Deferred tax thereon
At 31 December 2005
Cash flow hedging reserve
At 1 January 2005 (following implementation of IAS 32 and IAS 39)
Change in fair value of hedging derivatives
Deferred tax thereon
Transfer to income statement
Deferred tax thereon
At 31 December 2005
45 Retained profits
At 1 January
Restatement on implementation of IAS 32, IAS 39 and IFRS 4
At 1 January – restated
Currency translation differences
Profit for the year
Dividends
Purchase/sale of treasury shares
Employee share option schemes – value of employee services
At 31 December
2005
£m
8,140
(1,586)
6,554
24
2,493
(1,914)
18
47
7,222
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:
At 1 January 2005
Currency translation differences arising in the year
At 31 December 2005
28
(7)
11
2
13
(5)
–
(5)
29
2005
£m
–
4
(1)
3
12
(4)
8
11
2004
£m
7,646
(12)
2,392
(1,913)
8
19
8,140
2005
£m
(12)
24
12
LLOYDS TSB GROUP 99
Notes to the group accounts
46 Ordinary dividends
2005
Pence per share
2004
Pence per share
The dividends paid in the year were as follows:
Final dividend in respect of preceding year
Interim dividend
23.5
10.7
34.2
23.5
10.7
34.2
2005
£m
1,315
599
1,914
2004
£m
1,314
599
1,913
The directors have proposed a final dividend of 23.5 pence per share (2004: 23.5 pence per share) representing a total cost of £1,316 million (2004: 1,315 million)
which will be paid on 3 May 2006.
47 Share based payments
During the year ended 31 December 2005 the Group operated the following share based payment schemes, all of which are equity settled.
Executive schemes
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.
Performance conditions for executive options
For options granted up to March 2001
Options granted
Performance conditions
Prior to March 1996
None
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 Lloyds TSB Group plc’s ranking based on shareholder return (calculated
by reference to both dividends and growth in share price) over the relevant period should be in the top fifty companies of
the FTSE 100.
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.
In respect of options granted between March 1996 and March 2001, the relevant period for the performance conditions begins at the end of the financial year
preceding the date of grant and will continue until the end of the third subsequent year following commencement or, if not met, the end of such later year in which
the conditions are met. Once the conditions have been satisfied the options will remain exercisable without further conditions. If they are not satisfied by the tenth
anniversary of the grant the option will lapse.
For options granted from August 2001 to August 2004
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.
To meet the performance conditions, the Group’s ranking against the comparator group must be at least ninth. The full grant of options will only become exercisable
if the Group is ranked first. A performance multiplier (of between nil and 100 per cent) will be applied below this level to calculate the number of shares in respect
of which options granted to executive directors will become exercisable, and will be calculated on a sliding scale. If Lloyds TSB Group plc is ranked below median
the options will not be exercisable.
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.
For options granted in 2005
The same conditions apply as for grants made up to August 2004, except that:
– 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 15 companies including Lloyds TSB Group plc;
– if the performance condition has not been met at the end of the third subsequent year, the options will lapse; and
– the full grant of options becomes exercisable only if the Group is ranked in the top four places of the comparator group. A sliding scale applies between fourth and
eighth positions. If Lloyds TSB Group is ranked below the median (ninth or below) the options will not be exercisable and will lapse.
100 LLOYDS TSB GROUP
Notes to the group accounts
47 Share based payments (continued)
Movements in the number of share options outstanding under the Executive share option schemes during 2005 are set out below:
Outstanding at 1 January
Granted
Exercised
Forfeited
Outstanding at 31 December
Exercisable at 31 December
2005
Number of
options
39,289,430
10,869,357
(202,708)
(5,978,668)
43,977,411
1,430,218
2005
Weighted average
exercise price
(pence)
515.95
474.23
273.37
673.41
485.35
685.23
2004
Number of
options
33,141,522
12,998,345
(474,028)
(6,376,409)
39,289,430
1,949,426
2004
Weighted average
exercise price
(pence)
557.80
418.67
218.95
557.24
515.95
650.12
The weighted average share price at the time that the options were exercised during 2005 was 490.15 pence (2004: 423.80 pence). The weighted average
remaining contractual life of options outstanding at the end of the year was 7.4 years (2004: 7.7 years).
Save-As-You-Earn schemes
Eligible employees may enter into contracts through the Save-As-You-Earn (SAYE) schemes to save up to £250 per month and, at the expiry of a fixed term of three
or five years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a price equal to 80 per cent of
the market price at the date the options were granted. Grants in periods up to 31 December 2001 also had options exercising after seven years.
Movements in the number of share options outstanding under the Save-As-You-Earn schemes are set out below:
Outstanding at 1 January
Granted
Exercised
Forfeited
Cancelled
Expired
Outstanding at 31 December
Exercisable at 31 December
2005
Number of
options
122,115,907
9,610,466
(6,086,150)
(4,404,042)
(3,722,135)
(3,054,572)
114,459,474
2,153,227
2005
Weighted average
exercise price
(pence)
321.71
380.00
418.80
315.36
415.76
488.49
314.17
497.86
2004
Number of
options
124,683,429
16,225,108
(1,280,773)
(2,993,735)
(7,640,996)
(6,877,126)
122,115,907
1,308,580
2004
Weighted average
exercise price
(pence)
335.85
322.90
354.59
332.84
383.71
501.03
321.71
620.34
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).
Other share option plans
Lloyds TSB Group plc Share Retention Plan
In 2001, the Group adopted the Lloyds TSB Group plc Share Retention Plan. Options granted under this scheme are not subject to any conditions other than to
remain employed by the Group for three years.
Outstanding at 1 January
Exercised
Outstanding at 31 December
2005
Number of
options
216,763
(216,763)
–
The weighted average remaining vesting period as at 31 December 2005 was nil (2004: nil). No options were exercisable at 31 December 2005.
Lloyds TSB Group plc Share Plan 2003
In 2003, the Group adopted the Lloyds TSB Group plc Share Plan 2003. Options granted under this scheme were not subject to any performance conditions. An
option was granted in 2003 specifically to facilitate the recruitment of one executive director, this option had a total exercise price of £1, and would have been
exercisable in the six month period beginning 31 December 2005; however this option lapsed during 2004 following the executive director’s resignation.
Outstanding at 1 January
Lapsed during the year
Outstanding at 31 December
2004
Number of
options
331,125
(331,125)
–
LLOYDS TSB GROUP 101
Notes to the group accounts
47 Share based payments (continued)
Lloyds TSB Group Executive Share Plan 2003
The plan was adopted in December 2003 and under the plan share options may be granted to senior employees, who may also be directors of Lloyds TSB Group.
Options granted to date under this scheme were granted specificially to facilitate recruitment. Options granted under this plan are not subject to any performance
condiitions.
Outstanding at 1 January
Granted during the year
Outstanding at 31 December
2005
Number of
options
206,647
62,271
268,918
2005
Weighted average
exercise price
(pence)
Nil
Nil
Nil
2004
Number of
options
–
206,647
206,647
2004
Weighted average
exercise price
(pence)
–
Nil
Nil
The weighted average fair value of options granted in the year was £4.18 (2004: £3.69). No options outstanding at 31December were exercisable. The weighted
average remaining contractual life of options outstanding at the end of the year was 1.9 years (2004: 3.0 years).
Lloyds TSB Group executive share plan 2005
This plan was adopted by the Group in 2005, specificially to facilitate the recruitment of Ms Dial. Ms Dial is the only participant in the plan. Options granted under
this plan are not subject to any performance conditions and 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.
Outstanding at 1 January
Granted during the year
Outstanding at 31 December
2005
Number of
options
–
242,825
242,825
2005
Weighted average
exercise price
(pence)
–
Nil
Nil
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.
Performance share plan
Under the performance share plan, introduced during 2005, executive directors will be eligible for an award of free shares, known as performance shares, to match
the bonus shares awarded as part of their 2004 bonus. The maximum match will be two performance shares for each bonus share, awarded at the end of a three
year period. The actual number of shares awarded will depend on the Group’s TSR performance measured over a three year period, compared to other companies
in the comparator group. The maximum of two performance shares for each bonus share will be awarded only if the Group’s TSR performance places it first in the
comparator group; one performance share for each bonus share will be granted if the Group is placed fifth; and one performance share for every two bonus shares
if the Group is placed eighth (median). Between first and fifth, and fifth and eighth, sliding scales will apply. If the TSR performance is below median, no performance
shares will be awarded. There will be no retest. Whilst income tax is deducted from the bonus before deferral into the plan, where a match of performance shares is
justified, these shares will be awarded as if income tax had not been deducted.
Outstanding at 1 January
Granted during the year
Forfeited
Outstanding at 31 December
2005
Number of
shares
–
854,116
(27,678)
826,438
The fair value of the matching element of the performance shares awarded during 2005 was £1.78.
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding for the option schemes
were as follows:
Executive schemes
SAYE schemes
Other share option plans
Weighted
average
exercise
price (pence)
Weighted
average
remaining
life (years)
Weighted
average
exercise
price (pence)
Weighted
average
remaining
life (years)
Number of
options
Weighted
average
exercise
price (pence)
Weighted
average
remaining
life (years)
Number of
options
–
–
393.33
444.04
542.22
652.79
715.04
868.08
–
–
–
–
7.1 10,112,857
8.6 24,177,788
2,320,524
3.7
1,823,756
5.1
4,111,758
6.2
1,430,728
2.8
–
284.00
346.71
469.50
544.77
632.00
720.20
–
–
–
2.0 78,553,860
3.1 28,535,928
3,415,737
1.4
3,821,055
1.1
95,572
0.2
37,322
1.0
–
–
Nil
–
–
–
–
–
–
–
2.2
–
–
–
–
–
–
–
Number of
options
511,743
–
–
–
–
–
–
–
31 December 2005
Exercise price range
£0 to £2
£2 to £3
£3 to £4
£4 to £5
£5 to £6
£6 to £7
£7 to £8
£8 to £9
102 LLOYDS TSB GROUP
Notes to the group accounts
47 Share based payments (continued)
Executive schemes
SAYE schemes
Other share option plans
31 December 2004
Exercise price range
£0 to £2
£2 to £3
£3 to £4
£4 to £5
£5 to £6
£6 to £7
£7 to £8
£8 to £9
Weighted
average
exercise
price (pence)
Weighted
average
remaining
life (years)
Weighted
average
exercise
price (pence)
Weighted
average
remaining
life (years)
Weighted
average
exercise
price (pence)
Weighted
average
remaining
life (years)
Number of
options
Number of
options
–
245.01
392.82
419.89
541.65
665.06
717.64
873.34
–
0.2
8.0
9.2
4.6
6.3
7.1
3.7
–
127,058
10,386,979
13,813,324
2,767,256
3,063,872
7,392,741
1,738,200
–
284.00
330.51
452.21
554.84
632.00
723.79
–
–
3.0
3.7
1.4
1.6
1.2
0.5
–
–
83,117,427
21,992,866
10,674,528
5,849,754
105,995
375,337
–
Nil
–
–
–
–
–
–
–
2.5
–
–
–
–
–
–
–
Number of
options
206,647
–
–
–
–
–
–
–
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:
Risk-free interest rate
Expected life
Expected volatility
Expected dividend yield
Weighted average share price
Weighted average exercise price
Expected forfeitures
Executive
4.73%
4.8 years
33%
7.0%
£4.74
£4.74
5%
SAYE
4.61%
4.1 years
30%
7.4%
£4.76
£3.80
9%
Other share
option plans
4.41%
2.8 years
28%
7.3%
£4.59
Nil
5%
Expected volatility is a measure of the amount by which the Group’s shares are expected to fluctuate during the life of an option. The expected volatility is estimated
based on the historical volatility of the closing daily share price over the most recent period that is commensurate with the expected life of the option. The historical
volatility is compared to the implied volatility generated from market traded options in the Group’s shares to assess the reasonableness of the historical volatility and
adjustments made where appropriate.
Share incentive plan
Free shares
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).
Matching shares
The Group undertakes to match shares purchased by employees up to the value of £30 per month, these shares 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 within this three year period for other than a ‘good’
reason or the accompanying partnership shares are sold within that time, 100 per cent of the matching shares are forfeited (or the portion relating to the shares sold).
The number of shares awarded relating to free shares in 2005 was 8,748,521 (2004: 8,903,125), with an average fair value of £4.57 (2004: £4.27), based on
the market price at the date of award. The number of shares awarded relating to matching shares in 2005 was 2,296,575 (2004: 2,431,305), with an average
fair value of £4.73 (2004: £4.28), based on market prices at the date of award.
The charge to the income statement is set out below:
Options granted in the year
Options granted in prior years
Shares granted in the year
Shares granted in prior years
2005
£m
4
27
24
21
76
2004
£m
3
27
19
16
65
LLOYDS TSB GROUP 103
Notes to the group accounts
48 Minority interests
Minority interests comprise:
Euro Step-up Non-voting Non-cumulative Preferred Securities callable 2012 (c430 million)*
Sterling Step-up Non-voting Non-cumulative Preferred Securities callable 2015**
Capital instruments†
Other minority interests (note 53d)
2005
£m
435
435
2004
£m
302
248
550
81
631
*
These securities constitute limited partnership interests in Lloyds TSB Capital 1 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 7.375 per cent per annum up to 7 February 2012;
thereafter they will accrue at a rate of 233 basis points above EURIBOR, to be set annually.
**
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 350 basis points above a rate based on the yield of specified UK government stock.
Both of the above issues were 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.
†
Following the implementation of IAS 32 and IAS 39 on 1 January 2005, these securities are now classified as subordinated loan capital (see note 41).
49 Related party transactions
Key management personnel
Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Group, which for the
Group is the group executive committee of Lloyds TSB Group plc together with its non-executive directors.
The table below details, on an aggregated basis, key management personnel compensation:
Compensation
Salaries and other short-term benefits
Post-employment benefits
Termination benefits
Share based payments
Total
Share options
At 1 January
Granted (including options of appointed directors)
Exercised/lapsed (including options of retired directors)
At 31 December
2005
£m
11
3
–
2
16
2005
million
12
3
(3)
12
2004
£m
10
3
1
2
16
2004
million
10
5
(3)
12
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other
transactions between the Group and its key management personnel:
Loans
At 1 January
Advanced
Interest
Repayments
At 31 December
2005
£m
3
1
–
(1)
3
2004
£m
3
1
–
(1)
3
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 4.6 per cent and
17.9 per cent in 2005 (2004: 5.4 per cent and 17.9 per cent).
No provisions have been recognised in respect of loans given to key management personnel (2004: nil).
104 LLOYDS TSB GROUP
Notes to the group accounts
49 Related party transactions (continued)
Deposits
At 1 January
Placed
Interest
Withdrawn
At 31 December
2005
£m
2
22
–
(19)
5
2004
£m
2
5
–
(5)
2
Deposits placed by key management personnel attracted interest rates of up to 4.5 per cent (2004: 4.8 per cent).
At 31 December 2005, the Group provided guarantees totalling £19,744 in respect of one director (2004: nil).
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).
Subsidiaries
Details of the principal subsidiaries are given in note 7 to the parent company financial statements. In accordance with IAS 27 transactions and balances with
subsidiaries that have been eliminated on consolidation are not reported.
Other related party disclosures
At 31 December 2005, the Group’s pension funds had call deposits with Lloyds TSB Bank plc amounting to £14 million (2004: £14 million).
The Group manages 86 (2004: 76) Open Ended Investment Companies (‘OEICs’), and of these 36 (2004: 47) are consolidated. The Group invested £345 million
(2004: £131 million) and redeemed £265 milllion (2004: £164 million) in the unconsolidated OEICs during the year and had investments, at fair value, of
£2,074 million (2004: £1,415 million) at 31 December. The Group earned fees of £85 million from the unconsolidated OEICs (2004: £78 million). The company
held no investments in OEICs at any time during 2004 or 2005.
The Group has a number of venture capital associates that it accounts for at fair value through profit or loss. At 31 December 2005, these companies had total assets
of approximately £1,194 million (2004: £1,095 million), total liabilities of approximately £1,072 million (2004: £968 million) and for the year ended 31 December
2005 had turnover of £1,782 million (2004: £1,551 million) and made a net profit of approximately £36 million (2004: £42 million). In addition, the Group has
provided £363 million (2004: £335 million) of financing to these companies on which it received £19 million (2004: £13 million) of interest income in the year.
50 Contingent liabilities and commitments
Legal proceedings
During the ordinary course of business the Group is subject to threatened or actual legal proceedings. All material cases are periodically reassessed, with the assistance
of external professional advisors where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is
more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the obligation at the
balance sheet date.
In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed 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.
Contingent liabilities and commitments arising from the banking business
Acceptances and endorsements arise where the Lloyds TSB Group agrees to guarantee payment on a negotiable instrument drawn up by a customer.
Guarantees include those given on behalf of a customer to stand behind the current obligations of the customer and to carry out those obligations should the customer
fail to do so.
Other items serving as direct credit substitutes include standby letters of credit, or other irrevocable obligations, serving as financial guarantees where the Lloyds TSB
Group has an irrevocable obligation to pay a third party beneficiary if the customer fails to repay an outstanding commitment; they also include acceptances drawn
under letters of credit or similar facilities where the acceptor does not have specific title to an identifiable underlying shipment of goods.
Performance bonds and other transaction related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs & Excise bonds and
standby letters of credit relating to a particular contract or non-financial transaction) are undertakings where the requirement to make payment under the guarantee
depends on the outcome of a future event.
Where the guarantees are issued on behalf of customers, Lloyds TSB Group usually holds collateral against the exposure or has a right of recourse to the customer.
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.
LLOYDS TSB GROUP 105
Notes to the group accounts
50 Contingent liabilities and commitments (continued)
Contingent liabilities
Acceptances and endorsements
Guarantees
Other:
Other items serving as direct credit substitutes
Performance bonds and other transaction-related contingencies
2005
£m
35
9,373
550
1,737
2,287
11,695
2004
£m
71
6,786
345
1,324
1,669
8,526
The contingent liabilities of the Group, as detailed above, arise in the normal course of its banking business and it is not practicable to quantify their future
financial effect.
Commitments
Documentary credits and other short-term trade-related transactions
Forward asset purchases and forward deposits placed
Undrawn formal standby facilities, credit lines and other commitments to lend:
Less than 1 year maturity
1 year or over maturity
283
277
55,310
24,123
79,993
431
1,654
59,085
20,009
81,179
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.
Operating lease commitments
Where a Group company is the lessee the future minimum lease payments under non-cancellable premises operating leases are as follows:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
2005
£m
216
784
1,016
2,016
2004
£m
211
783
980
1,974
Operating lease payments represent rental payable by the Group for certain of its properties. Some of these operating lease arrangements have renewal options and
rent escalation clauses, although the effect of these are not material. No arrangements have been entered into for contingent rental payments.
Finance lease commitments
Where a Group company is the lessee the future obligations payable under finance leases are as follows:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
2005
£m
1
–
15
16
2004
£m
2
4
15
21
Finance lease payments relate to leases of certain premises and equipment. No arrangements have been entered into for contingent rental payments. The fair value
of these finance lease obligations approximates their carrying amount at 31 December 2005 and 2004.
Capital commitments
Details of capital commitments are given in note 29.
106 LLOYDS TSB GROUP
Notes to the group accounts
51 Financial risk management
Strategy in using financial instruments
The Group uses financial instruments (including derivatives) to meet the financial needs of its customers, as part of its trading activities and to reduce its own exposure
to fluctuations in interest and exchange rates.
The Group accepts deposits from and makes loans to commercial and retail customers at both fixed and floating rates and for various periods. Such exposures to
customers involve both on-balance sheet loans and advances and guarantees and other commitments such as letters of credit and irrevocable commitments.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk;
and liquidity risk. Information about the Group’s management of these risks is given on pages 24 to 34, with further disclosure provided below.
Interest rate risk
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.
Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be
considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However a significant proportion of the Group’s lending assets, for
example personal loans and mortgages, bear interest rates which are contractually fixed for periods of up to five years or longer.
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.
The Group establishes two types of hedge accounting relationships; fair value hedges and cash flow hedges. The Group is exposed to fair value interest rate risk on
its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans
and deposits together with its floating rate subordinated debt. The majority of the Group’s hedge accounting relationships are fair value hedges where interest rate
swaps are used to hedge the interest rate risk inherent in the fixed rate mortgage portfolio. At 31 December 2005 the aggregate notional principal of interest rate
swaps designated as fair value hedges was £39,568 million with a net fair value (liability) of £245 million (see note 17). In addition the Group has a small number
of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. These cash flows are expected to occur
over the next seven years and will be reported in the income statement as they take place. The notional principal of the interest rate swaps designated as cash flow
hedges at 31 December 2005 was £648 million with a net fair value (liability) of £18 million (see note 17).
The table below summarises the repricing mismatches of the Group’s financial assets and liabilities. Items are allocated to time bands by reference to the earlier of
the next contractual interest rate repricing date and the maturity date.
1 month
or less
£m
3 months
or less
but over
1 month
£m
1 year
or less
but over
3 months
£m
5 years
or less
but over
1 year
£m
Over
5 years
£m
Non-
interest
bearing
£m
Total
£m
As at 31 December 2005
Assets
Trading securities and other financial assets at fair value
through profit or loss
Derivative financial instruments*
Loans and advances to banks
Loans and advances to customers
Available-for-sale financial assets
Other assets
1,734
–
25,107
72,912
1,695
195
2,418
–
2,483
17,048
8,674
50
1,035
–
2,923
20,327
1,221
–
3,796
–
370
51,044
1,497
–
17,886
–
57
13,594
1,678
–
33,505
5,878
715
19
175
21,718
60,374
5,878
31,655
174,944
14,940
21,963
Total assets
101,643
30,673
25,506
56,707
33,215
62,010
309,754
Liabilities
Deposits from banks
Customer accounts
Derivative financial instruments*
Debt securities in issue
Liabilities arising from insurance and investment contracts
Other liabilities
Subordinated liabilities
Total liabilities
Net repricing gap
23,859
112,551
–
13,167
–
50
2,046
4,866
4,901
–
15,640
–
23
788
1,472
3,941
–
3,905
–
65
503
131
4,061
–
1,709
–
1
2,282
1,070
1,413
–
4,925
–
3,296
6,783
129
4,203
6,396
–
62,907
12,041
–
31,527
131,070
6,396
39,346
62,907
15,476
12,402
151,673
26,218
9,886
8,184
17,487
85,676
299,124
(50,030)
4,455
15,620
48,523
15,728
(23,666)
10,630
*
Derivative financial instruments which are exposed to interest rate risk are carried in the balance sheet at fair value and for the purposes of this analysis have been
treated as non-interest bearing.
LLOYDS TSB GROUP 107
Notes to the group accounts
51 Financial risk management (continued)
As at 31 December 2004
Assets
Treasury bills and other eligible bills
Loans and advances to banks
Loans and advances to customers
Debt securities and equity shares
Other assets
1 month
or less
£m
21
21,979
82,251
1,967
234
3 months
or less
but over
1 month
£m
1 year
or less
but over
3 months
£m
5 years
or less
but over
1 year
£m
Over
5 years
£m
Non-
interest
bearing
£m
Total
£m
25
5,561
18,302
10,788
60
41
2,984
13,565
2,724
1
5
629
36,681
6,444
3
–
81
6,198
21,643
–
–
614
(1,679)
27,229
26,071
92
31,848
155,318
70,795
26,369
Total assets
106,452
34,736
19,315
43,762
27,922
52,235
284,422
Equity and liabilities
Deposits from banks
Customer accounts
Debt securities in issue
Liabilities arising from insurance contracts
Other liabilities
Subordinated liabilities
Equity
Total equity and liabilities
Off-balance sheet items
Interest rate repricing gap
31,646
104,026
10,624
–
180
921
–
5,142
5,579
9,484
–
–
776
–
2,521
2,034
3,227
–
19
458
–
122
3,676
1,436
–
1
1,884
–
90
689
3,999
–
2,680
6,213
–
202
3,807
–
53,651
17,657
–
11,678
39,723
119,811
28,770
53,651
20,537
10,252
11,678
147,397
20,981
8,259
7,119
13,671
86,995
284,422
–
(13,253)
6,326
9,467
(2,540)
–
(40,945)
502
17,382
46,110
11,711
(34,760)
–
–
–
Cumulative interest rate repricing gap
(40,945)
(40,443)
(23,061)
23,049
34,760
–
Currency risk
Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the
Group’s overseas operations.
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.
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:
Functional currency of Group operations:
Euro
US dollar
Swiss franc
Other non-sterling
2005
£m
80
102
56
183
421
2004
£m
82
114
58
189
443
108 LLOYDS TSB GROUP
Notes to the group accounts
51 Financial risk management (continued)
Credit risk
At 31 December 2005, the maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account
is taken of any collateral held and the maximum exposure to loss is considered to be the instruments’ balance sheet carrying amount or, for non-derivative off-balance
sheet transactions, their contractual nominal amounts.
2005
£m
Loans and advances to banks
Loans and advances to customers
Deposit amounts available for offset 1
Impairment losses
Available for sale debt securities and treasury bills
Contingent liabilities
Undrawn irrevocable formal standby facilities, credit lines and other commitments to lend2
Derivative assets, before netting
Amounts available for offset under master netting arrangements1
Trading securities and other financial assets at fair value through profit or loss
31,656
177,016
(6,414)
(2,073)
200,185
14,894
11,695
43,094
5,878
(3,235)
2,643
26,869
299,380
1
Deposit amount available for offset and amounts available for offset under master netting arrangements do not meet the criteria under IAS 32 to enable loans and
advances and derivative assets respectively to be presented net of these balances in the financial statements.
2
See note 50 – Contingent liabilities and commitments for further information.
Liquidity risk
The Group is exposed to daily calls on its cash resources from current account and other amounts repayable on demand, overnight and other maturing deposits, loan
draw-downs and cash-settled derivative instruments.
The Group’s policy requires that each business unit meets its financial obligations as they fall due, that the Group complies with the Financial Services Authority
Sterling Stock Liquidity Policy in the UK and that all local regulatory requirements are met.
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 ability to sell assets quickly is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of marketable debt
securities which could be disposed of to provide additional funding should the need arise.
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.
Maturities of assets and liabilities
Up to
1 month
£m
1-3
months
£m
3-12
months
£m
1-5
years
£m
Over 5
years
£m
Total
£m
As at 31 December 2005
Assets
Trading securities and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and advances to banks
Loans and advances to customers
Available-for-sale financial assets
Other assets
520
848
24,372
22,999
130
6,284
818
617
1,513
7,696
1,092
246
1,051
603
3,955
10,859
1,839
66
6,271
1,906
1,357
39,132
6,638
154
51,714
1,904
458
94,258
5,241
15,213
60,374
5,878
31,655
174,944
14,940
21,963
Total assets
55,153
11,982
18,373
55,458
168,788
309,754
Liabilities
Deposits from banks
Customer accounts
Derivative financial instruments
Debt securities in issue
Liabilities arising from insurance and investment contracts
Other liabilities
Subordinated liabilities
Total liabilities
Net liquidity gap
As at 31 December 2004
Total assets
Total liabilities
Net liquidity gap
23,839
117,410
690
20,629
1,030
5,602
–
4,778
5,065
639
8,395
359
340
250
1,710
3,317
799
3,887
1,263
524
–
141
3,773
1,893
1,586
9,502
265
1,076
1,059
1,505
2,375
4,849
50,753
8,745
11,076
31,527
131,070
6,396
39,346
62,907
15,476
12,402
169,200
19,826
11,500
18,236
80,362
299,124
(114,047)
(7,844)
6,873
37,222
88,426
10,630
53,988
165,187
14,668
16,369
15,231
9,609
51,495
14,192
149,040
67,387
284,422
272,744
(111,199)
(1,701)
5,622
37,303
81,653
11,678
LLOYDS TSB GROUP 109
Notes to the group accounts
51 Financial risk management (continued)
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.
Fair values of financial assets and liabilities
Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument could
be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, fair values have
been estimated using quoted values for instruments with characteristics either identical or similar to those of the instruments held by the Group. In certain cases,
where no ready markets currently exist, various techniques (such as discounted cash flows, or observations of similar recent market transactions) have been developed
to estimate what the approximate fair value of such instruments might be. These estimation techniques are necessarily subjective in nature and involve
several assumptions.
The fair values presented in the following table are at a specific date and may be significantly different from the amounts which will actually be paid or received on
the maturity or settlement date.
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.
Fair value information is not provided for items that do not meet the definitions of a financial instrument. These items include intangible assets, such as the value of
the Group’s branch network, the long-term relationships with depositors and credit card relationships, premises and equipment and shareholders’ equity. These items
are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.
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.
Treasury bills and other eligible bills
Fair value is estimated using market prices, where available.
Trading securities and other financial assets at fair value through profit or loss
Fair value is determined using market prices.
Derivative financial instruments
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.
Loans and advances to banks and customers
The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates. The carrying value of the variable rate
loans and those relating to lease financing is assumed to be their fair value. For fixed rate lending, several different techniques are used to estimate fair value, as
considered appropriate. For commercial and personal customers, fair value is principally estimated by discounting anticipated cash flows (including interest at
contractual rates) at market rates for similar loans offered by the Group and other financial institutions. The fair value for corporate loans was estimated by discounting
anticipated cash flows at a rate which reflects the effects of interest rate changes, adjusted for changes in credit risk. Certain loans secured on residential properties
are made at a fixed rate for a limited period, typically two to five years, after which the loans revert to the relevant variable rate. The fair value of such loans has been
estimated by reference to the market rates for similar loans of maturity equal to the remaining fixed interest rate period.
Debt securities and equity shares
Listed investment securities are valued at quoted market prices. Unlisted investment securities are valued based on discounted cash flows, market prices of similar
securities and other appropriate valuation techniques. Trading securities are valued using market prices.
Available-for-sale financial assets
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.
Investment properties
Fair values represent open-market values determined by an independent, professionally qualified valuer.
Deposits from banks and customer accounts
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.
Debt securities in issue and subordinated liabilities
The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities
is estimated using quoted market prices.
Liabilities arising from non-participating investment contracts
The value of the Group’s non-participating investment contracts, all of which are unit-linked, is contractually linked to the fair values of financial assets within the
Group’s unitised investment funds and is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet
date. Their value is never less than the amount payable on surrender, discounted for the required notice period where applicable.
110 LLOYDS TSB GROUP
Notes to the group accounts
51 Financial risk management (continued)
Financial commitments and contingent liabilities
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.
Fair value
2004
£m
Carrying value
2005
£m
Carrying value
2004
£m
Fair value
2005
£m
Financial assets
Treasury bills and other eligible bills – investment securities
– other securities
Trading securities and other financial assets at fair value
through profit or loss
Derivative financial instruments
Loans and advances to banks
Loans and advances to customers
Debt securities – investment securities
– other securities
Equity shares – investment securities
– other securities
Available-for-sale financial assets
Investment properties
Financial liabilities
Deposits from banks
Customer accounts
Derivative financial instruments and other trading liabilities
Debt securities in issue
Liabilities arising from non-participating investment contracts
Subordinated liabilities
52 Acquisitions
60,374
5,878
31,655
174,944
14,940
4,260
31,527
131,070
6,396
39,346
21,839
12,402
88
4
31,848
155,318
14,368
29,117
41
27,269
3,776
39,723
119,811
28,770
10,252
60,374
5,878
31,691
175,554
14,940
4,260
31,508
131,052
6,396
39,352
21,839
13,262
90
4
31,800
155,829
14,380
29,117
65
27,269
3,776
39,725
119,773
28,477
11,544
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.
53 Consolidated cash flow statement
a Reconciliation of profit before tax to net cash (used in) provided by operating activities
Profit before tax
(Profit) loss on disposal of businesses
Depreciation of fixed assets
Allowance for loan losses
Write-off of allowance for loan losses
Insurance claims
Insurance claims paid
Movement in value of in-force business
Customer remediation provision
Customer remediation paid
Net charge in respect of retirement benefit schemes
Contributions to retirement benefit schemes
Net gain on sale of investment securities
Revaluation of investment property
Change in loans and advances to banks
Change in loans and advances to customers
Change in deposits from banks
Change in customer accounts
Change in debt securities in issue
Change in trading assets
Change in trading liabilities
Change in investment contract liabilities
Change in other assets
Change in other liabilities
Tax paid
Other non-cash movements
Total adjustments
Net cash (used in) provided by operating activities
2005
£m
3,820
(50)
639
1,302
(1,078)
12,186
(8,269)
(162)
150
(77)
259
(425)
(5)
(430)
(1,277)
(14,525)
(8,168)
4,619
10,280
(103)
(3,937)
6,094
(1,049)
1,181
(708)
(598)
(4,151)
(331)
2004
£m
3,477
21
638
866
(854)
9,622
(5,338)
(16)
112
(245)
275
(374)
(126)
(329)
(964)
(19,681)
16,046
5,676
1,876
844
–
–
(1,518)
2,830
(763)
139
8,737
12,214
LLOYDS TSB GROUP 111
Notes to the group accounts
53 Consolidated cash flow statement (continued)
b Analysis of cash and cash equivalents as shown in the balance sheet
Cash and balances with central banks (excluding mandatory deposits)
Loans and advances to banks with a maturity of less than three months
2005
£m
868
25,885
26,753
2004
£m
833
27,363
28,196
Included within cash and cash equivalents at 31 December 2005 is £8,860 million (2004: £7,920 million) held within the Group’s life funds, which is not
immediately available for use in the business. In addition, mandatory reserve deposits of £288 million (2004: £245 million) are also held with local central banks
in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-day operations.
c Analysis of changes in cash and cash equivalents during the year
At 1 January
Net cash (outflow) inflow before adjustments for the effect of foreign exchange movements
Effect of foreign exchange movements
At 31 December
d Analysis of changes in financing during the year
Share capital (including premium and merger reserve):
At 1 January
Issue of share capital
At 31 December
2005
£m
28,196
(1,423)
(20)
(1,443)
26,753
2005
£m
2,907
26
2,933
2004
£m
19,433
8,777
(14)
8,763
28,196
2004
£m
2,897
10
2,907
The amounts shown as cash inflows from financing include proceeds in respect of the above issues of share capital together with a net cash inflow in 2004 of
£1 million relating to transactions in own shares held in respect of employee share schemes.
2005
£m
631
(550)
81
–
329
–
62
(37)
435
2005
£m
10,273
959
11,232
59
1,361
(232)
–
(2)
12,418
2004
£m
782
1
–
(151)
67
(68)
631
2004
£m
10,469
(136)
699
(764)
6
(1)
10,273
Minority interests:
At 1 January
Adjustments on adoption of IAS 32, IAS 39 and IFRS 4
At 1 January – restated
Exchange and other adjustments
Capital invested by minority shareholders
Repayment of capital to minority shareholders
Minority share of profit after tax
Payments to minority shareholders
At 31 December
Subordinated liabilities and finance leases:
At 1 January
Adjustments on adoption of IAS 32, IAS 39 and IFRS 4
At 1 January – restated
Exchange and other adjustments
Issue of subordinated liabilities
Repayments of subordinated liabilities
Lease financing
Finance lease capital repayments
At 31 December
112 LLOYDS TSB GROUP
Notes to the group accounts
53 Consolidated cash flow statement (continued)
e Acquisition of group undertakings and businesses
Net assets acquired:
Other assets
Tangible fixed assets
Other liabilities
Goodwill arising on consolidation
Net cash outflow from acquisitions in the year*
Payments to former members of Scottish Widows Fund and Life Assurance Society
acquired during 2000
Deferred consideration in respect of acquisition in 2002
Net cash outflow from acquisitions
2005
£m
8
8
(3)
13
3
16
11
–
27
The consideration of £16 million in respect of these acquisitions was settled in cash in 2005 (see note 52).
f Disposal and closure of group undertakings and businesses
Cash and cash equivalents
Loans and advances to banks
Loans and advances to customers
Debt securities and treasury bills
Goodwill
Other intangible assets
Deposits by banks
Customer accounts
Debt securities in issue
Other net assets and liabilities
Profit (loss) on sale and closure of businesses
Cash and cash equivalent consideration received
Cash and cash equivalents disposed of
Net cash outflow from disposals in the year
Adjustment to consideration received in respect of prior period disposals
Net cash outflow from disposals
2005
£m
–
–
803
–
93
–
–
–
–
(946)
(50)
50
–
–
–
(4)
(4)
2004
£m
–
–
–
–
–
–
15
1
16
2004
£m
46
132
257
59
10
9
(42)
(327)
(111)
9
42
(21)
21
(46)
(25)
–
(25)
LLOYDS TSB GROUP 113
Notes to the group accounts
54 Adoption of International Financial Reporting Standards
IFRS differs in certain respects from the Group’s previous accounting policies, which complied with UK Generally Accepted Accounting Principles (‘UK GAAP’). Set
out below are explanations and reconciliations showing the effect of the adoption of IFRS and FRS 27 upon the Group’s previously published financial information.
Accounting changes effective from 1 January 2004 and which impact 2004 comparatives:
Consolidation (IAS 27 and SIC-12)
IFRS requires line-by-line consolidation for all items of income and expenditure; consequently, the Group no longer reports the results and balances of the life
assurance business as one line items.
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.
Leasing (IAS 17)
IFRS requires income from finance leases to be credited to the income statement to give a constant pre-tax rate of return on the net investment in the lease; UK GAAP
required a constant post-tax rate of return. In addition, IFRS requires depreciation on operating lease assets to be charged on the same basis as for other tangible
fixed assets, which for the Group is a straight-line basis. Under UK GAAP depreciation was charged so as to give a constant rate of return on the leased asset.
Employee benefits (IFRS 2, IAS 19)
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.
The Group has elected to apply the corridor approach to determine the treatment of actuarial gains and losses arising during the year as permitted under IAS 19.
The effect of this has been to derecognise the actuarial losses charged to reserves in 2004 under UK GAAP in the restated figures.
Capitalisation of software (IAS 38)
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.
Investment management fees (IAS 18)
Under IFRS the Group moved from immediate recognition of up-front fees received for investment management services to recognising them on a straight-line basis
over the estimated lives of the investment contracts.
Goodwill (IFRS 3 and IAS 36)
Under UK GAAP the Group’s accounting policy was to amortise goodwill arising on acquisitions after 1 January 1998, with the exception of goodwill which arose
on the acquisition of Scottish Widows. Under IFRS all goodwill recognised in the UK GAAP balance sheet at 1 January 2004 is carried forward without adjustment
in the balance sheet and is now subject to impairment testing annually, or more frequently if events or circumstances indicate that it might be impaired.
Dividends (IAS 10)
Under IFRS equity dividends declared after the balance sheet date may not be included as a liability at the balance sheet date.
Depreciation (IAS 16)
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.
Claims equalisation provision (IAS 37)
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.
Cash flow statement (IAS 7)
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.
Accounting changes effective from 1 January 2005 and which do not affect 2004 comparatives:
Fees integral to effective yield (IAS 18, IAS 39)
Fees and commissions that are an integral part of the effective yield on a financial instrument, and direct incremental costs associated with its origination, are included
in the calculation of the effective interest rate and recognised over the expected life of the instrument, or a shorter period if appropriate. As a result the recognition of
up-front fees and costs that were recognised when received, or incurred, under UK GAAP, for example those related to loan origination, are now deferred and the
recognition of fee income typically charged at the end of an agreement, for example early redemption charges on mortgages, brought forward.
Loan impairment (IAS 39)
IFRS adopts an incurred loss model for impairment losses on loans and provides guidance on the measurement of impairment. Any provision required is calculated
by comparing the book value of the loans with the net present value of the expected future cash flows from the loans discounted at their effective interest rates or,
as a practical expedient for variable rate loans, using observable market prices. The impairment principles under IFRS are similar to those followed by the
Group under UK GAAP, with the exception of the requirements to discount the expected cash flows at the original effective interest rate when determining the
provisioning requirement.
Netting (IAS 32)
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.
114 LLOYDS TSB GROUP
Notes to the group accounts
54 Adoption of International Financial Reporting Standards (continued)
Derivative financial instruments and hedging (IAS 39)
The Group enters into derivative contracts for both trading purposes and to hedge exposures arising from within the banking book. Under UK GAAP trading derivatives
were carried at fair value but hedging derivatives were accounted for on the same basis as the underlying hedged item, mainly on an accruals basis. IAS 39 requires
that all derivative contracts are carried at fair value on the Group’s balance sheet and movements in their fair value are reflected in the income statement except where
cash flow hedging is applied; this results in a mismatch between the accounting and the underlying economics where the Group has hedged its economic risk resulting
from the different treatment of the derivative and the underlying hedged position.
The Group has not changed the way it hedges its economic exposures as a result of the implementation of IFRS, but the Group seeks to mitigate the resulting income
statement volatility by the application of hedge accounting. Although the Group intends to mitigate the volatility arising from the requirement to fair value all derivatives
as far as possible, this will be a source of increased volatility in the income statement in 2005 and beyond.
Other non-derivative financial assets (IAS 39)
IAS 39 permits financial assets to be designated at the time of initial recognition as being held at fair value, with unrecognised gains or losses reported in the income
statement. Certain loans and advances and debt securities previously carried at amortised cost under UK GAAP have been designated as held at fair value through
profit or loss on adoption of IAS 39 and have been valued at their fair value at 1 January 2005.
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.
Insurance (IFRS 4, IAS 39, IAS 18)
IFRS 4 applies to contracts under which the insurer agrees to compensate the policyholder if a specified uncertain future event adversely affects the policyholder as
well as to investment contracts which entitle the holder to receive additional discretionary benefits depending on performance. For contracts within the scope of
IFRS 4, accounting practices are largely unchanged except for the modifications introduced by FRS 27 which is dealt with separately below.
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.
Life assurance (FRS 27)
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.
Equity to debt reclassification (IAS 32)
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.
Derecognition of financial liabilities (IAS 39)
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.
Changes to reconciliations published on 27 May 2005:
Except as noted below, the accounting policies adopted in the preparation of the 2005 results are unchanged from those disclosed in the Group’s announcement
setting out the effects of the implementation of IFRS and FRS 27 published on 27 May 2005.
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.
Comparative figures have also been restated to allow for deferred tax on properties acquired as part of a business combination and for the reclassification of certain
balance sheet items following revised interpretations of the requirements of IFRS. This has resulted in a reduction in shareholders’ equity although there is no effect
upon the Group’s income statement.
LLOYDS TSB GROUP 115
Notes to the group accounts
54 Adoption of International Financial Reporting Standards (continued)
The effect of these changes is set out below.
For the year ended 31 December 2004
Profit before tax
Taxation
Profit for the year
At 1 January 2004
Total assets
Shareholders’ equity
At 31 December 2004
Total assets
Shareholders’ equity
At 1 January 2005
Total assets
Shareholders’ equity
As previously
reported
£m
Value of in-force
business
£m
Other
adjustments
£m
3,495
(1,036)
2,459
253,477
10,644
282,985
11,150
291,997
9,572
(18)
18
–
1,468
–
1,450
–
870
–
–
–
–
(64)
(101)
(13)
(103)
(13)
(83)
Restated
£m
3,477
(1,018)
2,459
254,881
10,543
284,422
11,047
292,854
9,489
Restated consolidated balance sheet (reconciliation of equity) at 1 January 2004 (excludes effects of IAS 32, IAS 39 and IFRS 4)
Consolidation
UK Insurance
business
£m
GAAP
£m
New
entities
£m
Leasing
£m
Employee
benefits
£m
Software
£m
Unit
trusts
£m
Goodwill
£m
Dividend
£m
Other
£m
IFRS
£m
Assets
Cash and balances at central banks
Items in the course of collection from banks
Treasury bills and other eligible bills
Loans and advances to banks
Loans and advances to customers
Debt securities
Equity shares
Investment property
Goodwill
Value of in-force business
Intangible assets
Fixed assets
Other assets
Prepayments and accrued income
Long-term assurance business attributable to the shareholder
Long-term assurance assets attributable to the policyholders
1,195
1,447
539
15,547
135,251
28,669
458
–
2,513
–
–
3,918
3,998
1,918
6,481
–
–
–
4,948
(137)
16,896
24,972
3,551
–
4,347
–
138
1,203
–
(6,481)
50,078 (50,078)
–
–
–
1,649
1,178
318
244
–
–
–
–
–
416
–
–
–
–
–
–
–
(178)
–
–
–
–
–
–
(85)
15
–
–
–
Total assets
252,012
(641)
3,805
(248)
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
41
–
–
–
–
–
41
–
–
–
–
–
–
–
–
–
–
–
–
3
–
–
–
3
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,195
–
1,447
–
539
(2) 22,142
(1) 136,113
2
45,885
(59) 25,615
3,551
2,513
4,347
41
3,944
7,549
–
–
–
–
–
–
–
(27)
1,914
(1,918)
–
–
(91) 254,881
Equity and liabilities
Liabilities
Deposits from banks
Customer accounts
Items in course of transmission to banks
Debt securities in issue
Insurance contract liabilities
Unallocated surplus within insurance business
Other liabilities
Accruals and deferred income
Deferred tax liabilities
Other provisions
Retirement benefit obligations
Subordinated liabilities
Long-term assurance liabilities to policyholders
Total liabilities
Equity
Share capital
Share premium account
Other reserves
Retained profits
Shareholders’ equity
Minority interests
Total equity
Consolidation
UK Insurance
business
£m
GAAP
£m
New
entities
£m
Leasing
£m
Employee
benefits
£m
Software
£m
Unit
trusts
£m
Goodwill
£m
Dividend
£m
Other
£m
IFRS
£m
–
23,955
(1,995)
116,496
–
626
217
25,922
49,079
–
339
–
734
7,007
–
3,206
1,137
1,376
(186)
402
–
2,139
–
10,454
50,078 (50,078)
–
–
–
1,319
–
–
2,484
–
–
–
–
–
–
–
–
–
–
–
–
150
–
(155)
–
–
–
–
–
–
–
–
–
–
–
–
(42)
–
117
–
–
241,661
(753)
3,803
(5)
75
1,418
1,136
343
6,727
9,624
727
–
–
–
57
57
55
10,351
112
–
–
–
–
–
2
2
–
–
–
(241)
(241)
(2)
(243)
–
–
–
(75)
(75)
–
(75)
–
–
–
–
–
–
–
–
–
12
–
–
–
–
12
–
–
–
29
29
–
29
41
–
–
–
–
–
–
87
–
(25)
–
–
–
–
62
–
–
–
(59)
(59)
–
(59)
3
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
(1,314)
–
–
–
–
–
–
(8) 23,947
– 114,501
–
626
–
27,458
(51) 49,028
339
12,361
–
1,454
216
3,172
10,454
–
–
3,213
(3,206)
(849)
–
916
–
–
(1,314)
15 243,556
–
–
–
1,314
1,314
–
–
–
–
1,418
1,136
343
(106)
7,646
(106) 10,543
–
782
1,314
(106) 11,325
–
(91) 254,881
Total equity and liabilities
252,012
(641)
3,805
(248)
116 LLOYDS TSB GROUP
Notes to the group accounts
54 Adoption of International Financial Reporting Standards (continued)
Restated consolidated balance sheet (reconciliation of equity) at 31 December 2004 (excludes effects of IAS 32, IAS 39 and IFRS 4)
Consolidation
UK Insurance
business
£m
GAAP
£m
New
entities
£m
Leasing
£m
Employee
benefits
£m
Software
£m
Unit
trusts
£m
Goodwill
£m
Dividend
£m
Other
£m
IFRS
£m
1,078
1,462
92
–
–
–
23,565
5,836
154,240
(99)
25,194
17,794
215
28,072
–
3,160
2,425
–
–
4,181
3,273
2,573
–
4,363
–
133
–
6,781
(6,781)
54,764 (54,764)
–
–
–
2,447
1,339
498
(914)
616
–
–
–
–
–
–
–
2,435
717
–
–
–
–
(162)
–
–
–
–
–
–
(100)
14
–
–
–
279,843
149
4,703
(248)
Consolidation
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
28
–
–
–
–
–
28
–
–
–
–
–
–
–
–
–
–
–
–
3
–
–
–
3
–
–
–
–
–
–
–
–
44
–
–
–
–
–
–
–
44
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,078
1,462
92
31,848
– 155,318
(1) 43,485
(63) 27,310
–
–
–
–
(34)
2,571
(2,573)
–
–
3,776
2,469
4,363
28
4,180
9,013
–
–
–
(100) 284,422
UK Insurance
business
£m
GAAP
£m
New
entities
£m
Leasing
£m
Employee
benefits
£m
Software
£m
Unit
trusts
£m
Goodwill
£m
Dividend
£m
Other
£m
IFRS
£m
Assets
Cash and balances at central banks
Items in the course of collection from banks
Treasury bills and other eligible bills
Loans and advances to banks
Loans and advances to customers
Debt securities
Equity shares
Investment property
Goodwill
Value of in-force business
Intangible assets
Fixed assets
Other assets
Prepayments and accrued income
Long-term assurance business attributable
to the shareholder
Long-term assurance assets attributable
to the policyholders
Total assets
Equity and liabilities
Liabilities
Deposits from banks
Customer accounts
Items in course of transmission to banks
Debt securities in issue
Insurance contract liabilities
Unallocated surplus within insurance business
Accruals and deferred income
Other liabilities
Deferred tax liabilities
Other provisions
Retirement benefit obligations
Subordinated liabilities
Total liabilities
Equity
Share capital
Share premium account
Other reserves
Retained profits
Shareholders’ equity
Minority interests
Total equity
39,738
–
122,062
(2,254)
631
–
–
–
–
27,217
208
1,345
–
–
52,350
1,362
3,866
6,619
1,473
417
2,231
10,252
–
2,127
1,276
(206)
–
–
–
–
–
3,356
–
–
–
–
–
–
–
–
–
–
–
–
183
(159)
–
–
–
–
–
–
–
–
–
–
–
–
17
–
(112)
–
–
269,270
99
4,701
24
(95)
1,419
1,145
343
7,070
9,977
596
10,573
–
–
–
13
13
37
50
–
–
–
–
–
2
2
–
–
–
(268)
(268)
(4)
(272)
–
–
–
95
95
–
95
–
Long-term assurance liabilities to policyholders
54,764 (54,764)
Total equity and liabilities
279,843
149
4,703
(248)
–
–
–
–
–
–
–
–
9
–
–
–
–
9
–
–
–
19
19
–
19
28
–
–
–
–
–
–
–
56
(16)
–
–
–
–
40
–
–
–
(37)
(37)
–
(37)
3
–
–
–
–
–
–
–
–
3
–
–
–
–
3
–
–
–
41
41
–
41
44
–
–
–
–
–
–
–
(15) 39,723
3 119,811
–
–
631
28,770
(61) 52,289
–
1,362
(3,866)
–
(1,315)
3,890
14,916
–
–
–
–
–
(899)
1,704
–
211
956
3,075
–
–
10,252
–
(1,315)
8 272,744
–
–
–
1,315
1,315
–
–
–
–
1,419
1,145
343
(108)
8,140
(108) 11,047
–
631
1,315
(108) 11,678
–
(100) 284,422
LLOYDS TSB GROUP 117
Notes to the group accounts
54 Adoption of International Financial Reporting Standards (continued)
Restated consolidated income statement (reconciliation of profit) for the year ended 31 December 2004 (excludes effects of IAS 32, IAS 39 and IFRS 4)
Interest income
Interest expense
Net interest income
Other finance income
Insurance premium income
Fees and commission income
Fees and commission expense
Net fee and commission income
Dealing profits
Net trading income
Increase in value of long-term assurance business
Other operating income
Total income
Insurance claims
Total income, net of insurance claims
Administrative expenses
Depreciation of property, plant and equipment
Amortisation of goodwill
Total operating expenses
Trading surplus
Impairment losses on loans and advances
Amounts written off fixed asset investments
Profit and loss on disposal of businesses
Profit before tax
Taxation
Profit for the year
Profit attributable to minority interests
Profit attributable to equity shareholders
Consolidation
UK Insurance
business
£m
GAAP
£m
New
entities
£m
Leasing
£m
Employee
benefits
£m
Software
£m
Unit
trusts
£m
Goodwill
£m
Other
£m
IFRS
£m
10,395
(5,475)
4,920
39
554
3,124
(744)
2,380
271
170
55
225
–
5,516
(16)
(95)
(111)
–
–
4,663
715
688
(715)
202
9,567
9,780
(224)
(9,408)
9,343
372
(4,284)
(589)
(44)
(395)
(12)
–
(4,917)
(407)
4,426
(866)
(52)
(15)
3,493
(1,004)
2,489
68
2,421
2,489
(35)
–
–
–
(35)
(8)
(43)
–
(43)
(43)
125
(162)
(37)
–
–
(52)
(10)
(62)
–
109
–
5
15
–
15
(2)
–
–
(2)
13
–
–
–
13
(12)
1
1
–
1
(2)
–
(2)
–
–
(38)
5
(33)
–
–
–
16
(19)
–
(19)
2
(15)
–
(13)
(32)
–
–
–
(32)
4
(28)
(1)
(27)
(28)
–
–
–
(39)
–
–
–
–
–
–
–
–
(39)
–
(39)
14
–
–
14
(25)
–
–
–
(25)
12
(13)
–
(13)
(13)
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
10
(22)
–
(12)
(12)
–
–
–
(12)
4
(8)
–
(8)
(8)
–
–
–
–
–
31
–
31
–
–
–
–
31
–
31
–
–
–
–
31
–
–
–
31
(9)
22
–
22
22
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
44
44
44
–
–
–
44
(3)
41
–
41
41
19
10,707
(15)
(5,597)
4
–
–
5
–
5
(271)
264
–
(54)
5,110
–
6,070
3,054
(844)
2,210
–
5,036
–
857
(52) 19,283
10
(9,622)
(42)
9,661
(4)
(4,659)
–
–
(638)
–
(4)
(5,297)
(46)
4,364
–
52
(6)
–
(2)
(2)
(1)
(1)
(2)
(866)
–
(21)
3,477
(1,018)
2,459
67
2,392
2,459
118 LLOYDS TSB GROUP
Notes to the group accounts
54 Adoption of International Financial Reporting Standards (continued)
Restated consolidated balance sheet (reconciliation of equity) at 1 January 2005 (includes effects of IAS 32, IAS 39 and IFRS 4)
Restated
31 December
2004
£m
Reclassi-
fications
£m
Effective
interest
rates
£m
Impair-
ment
£m
Offset Derivatives
£m
£m
Available-
for-sale
£m
Insurance
£m
Debt/
equity
£m
Other
£m
1 January
2005
£m
Assets
Cash and balances at central banks
Items in the course of collection from banks
Treasury bills and other eligible bills
Trading securities and other financial assets at fair value
1,078
1,462
92
–
–
(92)
through profit or loss
Derivative financial instruments
Loans and advances to banks
Loans and advances to customers
Debt securities
Equity shares
Available-for-sale financial assets
Investment property
Goodwill
Value of in-force business
Intangible assets
Fixed assets
Other assets
Total assets
Equity and liabilities
Liabilities
Deposits from banks
Customer accounts
Items in course of transmission to banks
Derivative financial instruments and
other trading liabilities
Liabilities to customers under investment contracts
Debt securities in issue
Insurance contract liabilities
Unallocated surplus within insurance business
Other liabilities
Deferred tax liabilities
Other provisions
Retirement benefit obligations
Subordinated liabilities
Total liabilities
Equity
Share capital
Share premium account
Other reserves
Retained profits
Shareholders’ equity
Minority interests
Total equity
(337)
108
(314)
6,287
–
–
–
–
–
3
–
–
–
–
–
–
–
–
–
–
3,956
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
25
438
–
95
–
–
–
–
–
–
–
–
–
–
–
175
33
–
–
–
–
–
(910)
–
–
–
–
–
–
–
–
–
(45)
–
–
–
–
–
–
–
–
(1,603)
–
–
291
56,865
4,869
–
31,848
155,318
43,485 (43,485)
27,310 (27,310)
14,385
3,776
2,469
4,363
28
4,180
9,013
–
–
–
–
–
(4,869)
(137)
284,422
26
(26)
(314) 10,243
(177)
33
(1,357)
39,723
119,811
631
–
(36)
–
5,943
16,354
28,770
–
52,289 (16,354)
1,362
–
14,916
(5,940)
1,704
211
3,075
10,252
272,744
1,419
1,145
343
8,140
11,047
631
11,678
–
59
–
–
26
–
–
–
–
–
–
–
–
(13)
–
–
–
–
–
–
(45)
10
–
–
–
–
–
–
–
–
–
–
–
–
(93)
–
–
–
–
6,287
–
3,956
–
–
–
–
–
–
–
–
–
(48)
(93) 10,243
–
–
–
22
22
–
22
–
–
–
(221)
(221)
–
(221)
–
–
–
–
–
–
–
–
127
–
435
–
(42)
–
–
(784)
(82)
–
–
361
15
–
–
–
(192)
(192)
–
(192)
–
–
–
–
7
–
790
(936)
416
(568)
–
–
–
(291)
–
–
–
(1,066)
(1,066)
–
–
–
–
–
–
–
–
–
5
–
–
–
5
–
–
28
–
28
–
28
33
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,078
1,462
–
–
–
(5) 56,840
–
–
9,263
31,851
5 161,162
–
–
–
–
–
–
–
–
4
14,593
3,776
2,469
2,760
28
4,180
3,392
4 292,854
–
39,723
173 126,349
–
–
–
–
–
–
(37)
(51)
–
–
631
10,334
16,361
28,728
36,725
426
8,526
925
270
3,075
550
550
48
11,211
133 283,284
–
–
–
–
–
–
–
–
(129)
(129)
–
1,419
1,145
371
6,554
9,489
81
Total equity and liabilities
284,422
26
(26)
(314) 10,243
(177)
–
(550)
(1,066)
(550)
(129)
9,570
(1,357)
–
4 292,854
LLOYDS TSB GROUP 119
Notes to the group accounts
55 Future developments
The following pronouncements will be relevant to the Group but were not effective at 31 December 2005 and have not been applied in preparing these financial
statements.
Pronouncement
Nature of change
Effective date
*IFRS 7 Financial Instruments: Disclosures
Amendment to IAS 39 Financial Instruments:
Recognition and Measurement and IFRS 4
Insurance Contracts – Financial Guarantee
Contracts
Amendment to IAS 39 Financial Instruments:
Recognition and Measurement – The Fair Value
Option
Amendment to IAS 19 Employee Benefits –
Actuarial Gains and Losses, Group Plans and
Disclosures
*Amendment to IAS 1 Presentation of Financial
Statements – Capital Disclosures
IFRIC Interpretation 4 Determining Whether an
Arrangement Contains a Lease
Consolidates the current financial instruments
disclosures into a single standard and requires
more detailed qualitative and quantitative
disclosures about exposure to risks arising from
financial instruments.
Requires issued financial guarantee contracts to
be accounted for as financial instruments unless
the issuer has previously asserted that the
contracts are regarded as insurance contracts and
has accounted for them as such.
Restricts the fair value option for financial
instruments to certain situations, including when
doing so results in more relevant information
because it eliminates or reduces a measurement
or recognition inconsistency or where a group of
financial instruments is managed and evaluated
on a fair value basis in accordance with a
documented strategy.
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.
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.
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.
Annual periods beginning on or after 1 January
2007
Annual periods beginning on or after 1 January
2006
Annual periods beginning on or after 1 January
2006
Annual periods beginning on or after 1 January
2006
Annual periods beginning on or after 1 January
2007
Annual periods beginning on or after 1 January
2006
The full impact of these accounting changes is being assessed by the Group; none of these pronouncements are expected to cause any material adjustments to the
financial statements. The Group has not yet made a final decision as to whether it will apply in the 2006 financial statements those pronouncements marked (*) in
the table above.
56 Approval of the financial statements
The consolidated financial statements were approved by the directors of Lloyds TSB Group plc on 23 February 2006.
120 LLOYDS TSB GROUP
Report of the independent auditors on the
parent company financial statements
To the members of Lloyds TSB Group plc
We have audited the parent company financial statements of Lloyds TSB Group plc for the year ended 31 December 2005 which comprise the balance sheet, the
cash flow statement, the statement of changes in equity and the related notes. These parent company financial statements have been prepared under the accounting
policies set out therein. We have also audited the information in the directors’ remuneration report on pages 46 to 57 that is described as having been audited.
We have reported separately on the consolidated financial statements of Lloyds TSB Group plc for the year ended 31 December 2005.
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.
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.
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.
Basis of audit opinion
We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes
examination, on a test basis, of evidence relevant to the amounts and disclosures in the parent company financial statements and the part of the directors’
remuneration report to be audited. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the parent
company financial statements, and of whether the accounting policies are appropriate to the Company’s circumstances, consistently applied and adequately
disclosed.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence
to give reasonable assurance that the parent company financial statements and the part of the directors’ remuneration report to be audited are free from material
misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information
in the parent company financial statements and the part of the directors’ remuneration report to be audited.
Opinion
In our opinion:
• the parent company financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union as applied in accordance with the
provisions of the Companies Act 1985, of the state of the parent company’s affairs as at 31 December 2005 and cash flows for the year then ended; and
• 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.
PricewaterhouseCoopers LLP
Chartered Accountants and Registered Auditors
Southampton, England
23 February 2006
LLOYDS TSB GROUP 121
Note
2005
£ million
2004
£ million
7
7
2
3
4
4
5
6
5,589
1,723
21
7,333
188
131
164
107
590
5,589
1,723
15
7,327
–
155
76
208
439
7,923
7,766
1,420
1,170
2,055
4,645
1,502
1,502
5
1,692
79
1,776
3,278
7,923
1,419
1,145
1,996
4,560
1,358
1,358
7
1,741
100
1,848
3,206
7,766
Parent company balance sheet
at 31 December 2005
Assets
Non-current assets:
Investment in subsidiaries
Loans to subsidiaries
Deferred tax assets
Current assets:
Derivative financial instruments
Other assets
Amounts due from subsidiaries
Cash and cash equivalents
Total assets
Equity and liabilities
Capital and reserves:
Share capital
Share premium account
Retained profits
Total equity
Non-current liabilities:
Subordinated liabilities
Current liabilities:
Current tax liabilities
Amounts owed to subsidiaries
Other liabilities
Total liabilities
Total equity and liabilities
The accompanying notes are an integral part of the parent company financial statements.
The directors approved the parent company accounts on 23 February 2006.
Maarten A van den Bergh
Chairman
J Eric Daniels
Group Chief Executive
Helen A Weir
Group Finance Director
122 LLOYDS TSB GROUP
Parent company statement of changes in equity
Balance at 1 January 2004 (note 8)
Profit for the year*
Dividends
Purchase/sale of treasury shares
Employee share option schemes:
– value of employee services
– proceeds from shares issued
Balance at 31 December 2004 (note 8)
Adjustments on transition to IAS 32 and IAS 39
Restated balance at 1 January 2005 (note 8)
Profit for the year*
Dividends
Purchase/sale of treasury shares
Employee share option schemes:
– value of employee services
– proceeds from shares issued
Balance at 31 December 2005
Share capital
and premium
£ million
2,554
–
–
–
–
10
2,564
–
2,564
–
–
–
–
26
Retained
profit
£ million
1,953
1,928
Total
£ million
4,507
1,928
(1,913)
(1,913)
9
19
–
1,996
30
2,026
1,898
9
19
10
4,560
30
4,590
1,898
(1,914)
(1,914)
(2)
47
–
(2)
47
26
2,590
2,055
4,645
* No income statement has been shown for the parent company, as permitted by section 230 of the Companies Act 1985.
LLOYDS TSB GROUP 123
Parent company cash flow statement
for the year ended 31 December 2005
Profit before tax
Profit on disposal of subsidiary
Dividend income
Fair value adjustment
Change in other assets
Change in other liabilities
Tax paid
Net cash used in operating activities
Cash flows from investing activities:
Disposal of businesses, net of cash disposed
Net cash generated by investing activities
Cash flows from financing activities:
Dividends received from subsidiaries
Dividends paid to equity shareholders
Proceeds from issue of ordinary shares and transactions in own shares held in respect of
employee share schemes
Net cash generated by financing activities
Change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Cash and cash equivalents comprise cash and amounts due from banks with a maturity of less than three months.
The accompanying notes are an integral part of the parent company financial statements.
2005
£ million
1,882
–
(1,913)
9
(72)
(44)
12
2004
£ million
1,894
(1)
(1,913)
–
–
(24)
(122)
(126)
(166)
–
–
1
1
1,913
(1,914)
1,913
(1,913)
26
25
(101)
208
107
11
11
(154)
362
208
124 LLOYDS TSB GROUP
Notes to the parent company accounts
1 Accounting policies
The parent company has applied International Financial Reporting Standards (‘IFRS’) as adopted by the European Union (EU) in its financial statements for the year
ended 31 December 2005.
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.
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.
2 Deferred tax assets
The movement in the net deferred tax asset is as follows:
At 1 January
Restatement on implementation of IAS 32, IAS 39 and IFRS 4
At 1 January – restated
Income statement credit
Amount credited to equity in respect of employee share schemes
At 31 December
2005
£m
15
(12)
3
2
16
21
2004
£m
6
6
9
–
15
With effect from 1 January 2005 the Company implemented the requirements of IAS 39 ‘Financial instruments: Recognition and Measurement’. As a result, certain
financial assets and liabilities valued at amortised cost are now carried at fair value with a consequential adjustment being made to the deferred tax balance.
The deferred tax assets relate to temporary timing differences.
3 Amounts due from subsidiaries
These comprise short-term lending to subsidiaries, repayable on demand. The fair values of amounts owed by subsidiaries are equal to their carrying amounts. No
provisions have been recognised in respect of amounts owed by subsidiaries.
4 Share capital and share premium
Details of the Company’s share capital and share premium account are as set out in notes 42 and 43 to the consolidated accounts.
5 Retained profits
At 1 January 2004
Profit for the year
Dividends
Purchase/sale of treasury shares
Employee share option schemes: value of employee services
At 31 December 2004
Adjustments on implementation of IAS 32 and IAS 39
Restated balance at 1 January 2005
Profit for the year
Dividends
Purchase/sale of treasury shares
Employee share option schemes: value of employee services
At 31 December 2005
£m
1,953
1,928
(1,913)
9
19
1,996
30
2,026
1,898
(1,914)
(2)
47
2,055
LLOYDS TSB GROUP 125
Notes to the parent company accounts
6 Subordinated liabilities
Undated subordinated loan capital*
6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 §
Dated subordinated loan capital
81/2% Subordinated Bonds 2006
91/8% Subordinated Bonds 2011
57/8% Subordinated Guaranteed Bonds 2014 (c750 million)
Total subordinated loan capital
2005
£m
497
250
149
606
1,005
1,502
2004
£m
497
250
149
462
861
1,358
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 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.
§ At the callable date the coupon on these bonds will be reset by reference to the applicable five year benchmark gilt rate.
7 Related party transactions
Key management personnel
The key management personnel of the Group and parent company are the same. The relevant disclosures are given in note 49 to the consolidated financial
statements.
Investment in subsidiaries
At 1 January 2005 and 31 December 2005
£m
5,589
The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of
Lloyds TSB Group plc, are:
Lloyds TSB Bank plc
Cheltenham & Gloucester plc
Lloyds TSB Commercial Finance Limited
Lloyds TSB Leasing Limited
Lloyds TSB Private Banking Limited
The Agricultural Mortgage Corporation PLC
Lloyds TSB Offshore Limited
Lloyds TSB Scotland plc
Lloyds TSB General Insurance Limited
Scottish Widows Investment Partnership Group Limited
Abbey Life Assurance Company Limited
Lloyds TSB Insurance Services Limited
Lloyds TSB Asset Finance Division Limited
Black Horse Limited
Scottish Widows plc
Scottish Widows Annuities Limited
† Indirect interest
Country of
registration/
incorporation
England
England
England
England
England
England
Jersey
Scotland
England
England
England
England
England
England
Scotland
Scotland
Percentage
of equity
share capital
and voting
rights held
100%
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
100%†
Nature of business
Banking and financial services
Mortgage lending and retail investments
Credit factoring
Financial leasing
Private banking
Long-term agricultural finance
Banking and financial services
Banking and financial services
General insurance
Investment management
Life assurance
Insurance broking
Consumer credit, leasing and related services
Consumer credit, leasing and related services
Life assurance
Life assurance
The country of registration/incorporation is also the principal area of operation for each of the above subsidiaries except as follows:
Lloyds TSB Bank plc operates principally in the UK but also through branches in Belgium, Dubai, Ecuador, Gibraltar, Hong Kong, Japan, Luxembourg, Malaysia,
Monaco, Netherlands, Paraguay, Singapore, Spain, Switzerland, Uruguay and the USA.
Amounts owed by subsidiaries:
At 1 January and 31 December
2005
£m
1,723
2004
£m
1,723
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.
Related party information in respect of other related party transactions is given in note 49 to the consolidated financial statements.
126 LLOYDS TSB GROUP
Notes to the parent company accounts
8 Adoption of International Financial Reporting Standards
The impact for the parent company in respect of the accounting for dividends, derivatives and hedging instruments is the same as for the Group, as set out in note 54
to the consolidated accounts.
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).
Set out below are explanations and reconciliations showing the effect of the adoption of IFRS upon the parent company’s previously published financial information.
Restated parent company balance sheet (reconciliation of equity) at 1 January 2004 (excludes the effect of IAS 32 and IAS 39)
UK
GAAP
£m
Reclassifi-
cations
£m
Investment in
subsidiaries
£m
Dividends
£m
Other
£m
Investment in subsidiaries
Loans to subsidiaries
Deferred tax asset
Other assets
Amounts due from subsidiaries
Cash and cash equivalents
Total assets
Share capital
Share premium account
Revaluation reserve
Retained profits
Total equity
Subordinated liabilities
Current tax liabilities
Other liabilities
Amounts owed to subsidiaries
Dividend payable
Total liabilities
Total equity and liabilities
10,753
1,723
–
88
1,387
362
14,313
1,418
1,136
4,687
2,383
9,624
1,356
–
106
1,913
1,314
4,689
14,313
–
–
–
–
–
–
–
–
–
–
–
–
–
5
(5)
–
–
–
–
(5,164)
–
–
–
–
–
–
–
–
–
(1,314)
–
(5,164)
(1,314)
–
–
(4,687)
(477)
(5,164)
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
(1,314)
(1,314)
–
–
6
41
–
–
47
–
–
–
47
47
–
–
–
–
–
–
Restated parent company balance sheet (reconciliation of equity) at 31 December 2004 (excludes the effect of IAS 32 and IAS 39)
UK
GAAP
£m
Reclassifi-
cations
£m
Investment in
subsidiaries
£m
Dividends
£m
Other
£m
Investment in subsidiaries
Loans to subsidiaries
Deferred tax assets
Other assets
Amounts due from subsidiaries
Cash and cash equivalents
Total assets
Share capital
Share premium account
Revaluation reserve
Retained profits
Total equity
Subordinated liabilities
Current tax liabilities
Other liabilities
Amounts owed to subsidiaries
Dividend payable
Total liabilities
Total equity and liabilities
11,080
1,723
–
97
1,390
208
14,498
1,419
1,145
5,014
2,399
9,977
1,358
–
107
1,741
1,315
4,521
14,498
–
–
9
(9)
–
–
–
–
–
–
–
–
–
7
(7)
–
–
–
–
(5,491)
–
–
–
–
–
–
–
–
–
(1,314)
–
(5,491)
(1,314)
–
–
(5,014)
(477)
(5,491)
–
–
–
1
1
–
–
–
–
–
–
–
–
–
–
(1,315)
(1,315)
–
–
6
67
–
–
73
–
–
–
73
73
–
–
–
–
–
–
IFRS
£m
5,589
1,723
6
129
73
362
7,882
1,418
1,136
–
1,953
4,507
1,356
5
101
1,913
–
3,375
IFRS
£m
5,589
1,723
15
155
76
208
7,766
1,419
1,145
–
1,996
4,560
1,358
7
100
1,741
–
3,206
(5,164)
(1,314)
47
7,882
(5,491)
(1,314)
73
7,766
LLOYDS TSB GROUP 127
Notes to the parent company accounts
8 Adoption of International Financial Reporting Standards (continued)
Restated parent company balance sheet (reconciliation of equity) at 1 January 2005 (includes the effect of IAS 32 and IAS 39)
Restated
31 December
2004
£m
Derivatives
£m
Investment in subsidiaries
Loans to subsidiaries
Deferred tax assets
Derivative financial instruments
Other assets
Amounts due from subsidiaries
Cash and cash equivalents
Total assets
Share capital
Share premium account
Retained profits
Total equity
Subordinated liabilities
Current tax liabilities
Other liabilities
Amounts owed to subsidiaries
Total liabilities
Total equity and liabilities
5,589
1,723
15
–
155
76
208
7,766
1,419
1,145
1,996
4,560
1,358
7
100
1,741
3,206
7,766
–
–
(12)
208
(37)
–
–
159
–
–
30
30
155
–
(26)
–
129
159
1 January
2005
£m
5,589
1,723
3
208
118
76
208
7,925
1,419
1,145
2,026
4,590
1,513
7
74
1,741
3,335
7,925
9 Approval of the financial statements and other information
The parent company financial statements were approved by the directors of Lloyds TSB Group plc on 23 February 2006.
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.
128 LLOYDS TSB GROUP
Forward looking statements
Information for shareholders
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
to events and depend upon
circumstances that will occur in the future.
relate
Examples of such forward looking statements
include, but are not limited to, projections or
expectations of profit attributable to shareholders,
provisions, economic profit, dividends, capital
structure or any other financial items or ratios;
statements of plans, objectives or goals of
Lloyds TSB Group or its management; statements
about the future trends in interest rates, stock
market levels and demographic trends and any
impact on Lloyds TSB Group; statements
concerning any future UK or other economic
environment or performance including in particular
any such statements included in this annual
strategic goals,
report;
competition,
and
consolidation or technological developments in the
financial services industry and statements of
assumptions underlying such statements.
statements about
dispositions
regulation,
interest
inflation,
internationally;
Factors that could cause actual results to differ
materially from the plans, objectives, expectations,
estimates and intentions expressed in such forward
looking statements made by Lloyds TSB Group or
on Lloyds TSB Group’s behalf include, but are not
limited to, general economic conditions in the UK
and
rate,
exchange rate, market and monetary fluctuations;
changing demographic developments, adverse
weather and similar contingencies outside the
Lloyds TSB Group’s control; inadequate or failed
internal or external processes, people and systems;
terrorist acts and other acts of war or hostility and
responses to those acts; changes in laws,
regulations or taxation; changes in competition and
pricing environments; the ability to secure new
customers and develop more business from
existing customers;
to achieve
value-creating mergers and/or acquisitions
at the appropriate time and prices and the success
of the Lloyds TSB Group in managing the risks
of the foregoing.
the ability
Lloyds TSB Group plc may also make or disclose
written and/or oral forward looking statements in
reports filed with or furnished to the Securities and
Exchange Commission (‘SEC’), Lloyds TSB Group
plc’s annual review, proxy statements, offering
circulars, prospectuses, press releases and other
written materials and in oral statements made by
the directors, officers or employees of Lloyds TSB
Group plc to third parties, including financial
analysts. The
looking statements
contained in this annual report are made as of the
date hereof, and Lloyds TSB Group undertakes
no obligation to update any of its forward
looking statements.
forward
Analysis of shareholders
at 31 December 2005
Size of shareholding
1 – 99
100 – 499
500 – 999
1,000 – 4,999
5,000 – 9,999
10,000 – 49,999
50,000 – 99,999
100,000 – 999,999
1,000,000 and over
Number
74,538
385,662
284,434
139,327
19,883
13,888
720
981
504
919,937
Financial calendar 2006
24 February
Shareholders
Number of ordinary shares
Results for 2005 announced
%
8.10
41.92
30.92
15.15
2.16
1.51
0.08
0.11
0.05
Millions
2.5
128.4
185.9
269.1
135.1
248.9
48.5
330.5
4,253.7
%
0.04
2.29
3.32
4.81
2.41
4.44
0.87
5.90
75.92
8 March
Ex-dividend date for 2005 final dividend
10 March
Record date for final dividend
5 April
Final date for joining or leaving the dividend
reinvestment plan for the final dividend
3 May
100.00
5,602.6*
100.00
Final dividend paid
* Includes 698 million shares (12.46%) registered in the names of some 812,000 individuals. 227 million shares (4.05%) are held by
over 78,000 staff and Group pensioners, or on their behalf by the trustee of the staff shareplan scheme.
11 May
Substantial shareholdings
Individual Savings Accounts (ISAs)
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.
Share price information
In addition to listings in the financial pages of the
press, the latest price of Lloyds TSB shares on the
London Stock Exchange can be obtained by
telephoning 0906 877 1515. These telephone
calls are charged at 55p per minute, including VAT.
Visit www.londonstockexchange.com for details.
Share dealing facilities
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.
For telephone dealing, the current rate for both
purchases and sales is 0.5%: minimum £20. For
full details, contact Lloyds TSB Registrars on:
0870 850 0852.
For postal dealing,
the current rate for both
purchases and sales is 0.75%: no minimum. For
full details, contact Lloyds TSB Registrars on:
0870 242 4244.
American Depositary Receipts (ADRs)
Lloyds TSB shares are traded in the USA through
an NYSE-listed sponsored ADR facility, with The
Bank of New York as the depositary. The ADRs are
traded on the New York Stock Exchange under the
symbol LYG. The CUSIP number is 539439109
and the ratio of ADRs to ordinary shares is 1:4.
For details contact: The Bank of New York,
Investor Services, PO Box 11258, Church Street
S t a t i o n , N e w Yo r k , N Y 1 0 2 8 6 - 1 2 5 8 .
Telephone: 888 BNY ADRS (US toll free),
international callers: +1 212 815 3700.
Alternatively visit www.adrbny.com or email
shareowners@bankofny.com
The Company provides a facility for investing in
Lloyds TSB shares through an ISA. For details
contact Retail Investor Operations, Lloyds TSB
Registrars, The Causeway, Worthing, West Sussex
BN99 6UY. Telephone 0870 242 4244.
Corporate responsibility
A copy of the Group’s corporate responsibility
report may be obtained by writing to Corporate
R e s p o n s i b i l i t y, L l o y d s T S B G r o u p p l c ,
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.
The Better Payment Practice Code
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.
Shareholder enquiries
The Company’s share register is maintained by
Lloyds TSB Registrars, The Causeway, Worthing,
West Sussex BN99 6DA. Telephone 0870 600
3990; textphone 0870 600 3950.
Contact them if you have enquiries about your
Lloyds TSB shareholding, including those
concerning the following matters:
• change of name or address
• loss of share certificate, dividend warrant or tax
voucher
• obtaining a form for dividends to be paid directly
to your bank or building society account (tax
vouchers will still be sent to your registered
address unless you request otherwise)
• obtaining details of the dividend reinvestment
plan which enables you to use your cash
dividends to buy Lloyds TSB shares in the market
• requesting copies of the report and accounts in
alternative formats for shareholders with
disabilities.
Lloyds TSB Registrars operates a web based
enquiry and portfolio management service
for shareholders. Visit www.shareview.co.uk
for details.
Annual general meeting in Glasgow
2 August
Results for half-year to 30 June 2006 announced
9 August
Ex-dividend date for 2006 interim dividend
11 August
Record date for interim dividend
6 September
Final date for joining or leaving the dividend
reinvestment plan for the interim dividend
4 October
Interim dividend paid
Head office
25 Gresham Street
London EC2V 7HN
Telephone +44 (0)20 7626 1500
Registered office
Henry Duncan House
120 George Street
Edinburgh EH2 4LH
Registered in Scotland no 95000
Internet
www.lloydstsb.com
Registrar
Lloyds TSB Registrars
The Causeway
Worthing
West Sussex BN99 6DA
Telephone 0870 600 3990
Textphone 0870 600 3950
Overseas +44 (0)121 415 7047
Designed by Starling Design/The Team
Printed in the UK by Royle Corporate Print who are ISO 9001 and
ISO 14001 accredited, on paper sourced from sustainable managed
forests and made using the elemental chlorine free process at a Mill
which is ISO 14001 and Eco-management Audit system accredited.
LLOYDS TSB GROUP 129
Building our business
Annual Report and Accounts
2005
L
l
o
y
d
s
T
S
B
G
r
o
u
p
p
l
c
A
n
n
u
a
l
R
e
p
o
r
t
a
n
d
A
c
c
o
u
n
t
s
2
0
0
5