TIDM40VY
RNS Number : 4895T
Scottish Widows Limited
25 March 2021
25 March 2021
SCOTTISH WIDOWS LIMITED
PUBLICATION OF THE ANNUAL REPORT AND ACCOUNTS FOR THE YEARED 31
DECEMBER 2020
Scottish Widows Limited has published its Annual Report and
Accounts for the year ended 31 December 2020 (the "Accounts") which
will shortly be available on the Scottish Widows website at
www.scottishwidows.co.uk Copies of the Accounts have also been
submitted to the National Storage Mechanism and will shortly be
available for inspection at
https://data.fca.org.uk/#/nsm/nationalstoragemechanism
ADDITIONAL INFORMATION REQUIRED BY THE DISCLOSURE AND
TRANSPARENCY RULES ("DTR")
The information below is extracted from the Accounts and
constitutes the material required by DTR 6.3.5 to be communicated
to the media in unedited full text through a Regulatory Information
Service. This material is not a substitute for reading the full
Accounts and is provided solely for the purposes of complying with
DTR 6.3.5. Page numbers and cross-references in the extracted
information below refer to page numbers and cross-references in the
Accounts.
STATEMENT OF DIRECTORS' RESPONSIBILITIES
The Directors are responsible for preparing the Annual Report
and Accounts in accordance with applicable law and regulation.
Company law requires the Directors to prepare financial
statements for each financial year. Under that law, the Directors
have prepared the Group and Company financial statements in
accordance with international accounting standards in conformity
with the requirements of the Companies Act 2006. Additionally, the
Financial Conduct Authority's Disclosure Guidance and Transparency
Rules require the Directors to prepare the Group financial
statements in accordance with international financial reporting
standards adopted pursuant to Regulation (EC) No 1606/2002 as it
applies in the European Union. Under Company law the Directors must
not approve the financial statements unless they are satisfied that
they give a true and fair view of the state of affairs of the Group
and Company and of the profit or loss of the Group and Company for
that period. In preparing the financial statements, the Directors
are required to:
-- select suitable accounting policies and then apply them consistently
-- state whether for the Group and Company, international
accounting standards in conformity with the requirements of the
Companies Act 2006 and, for the Group, international financial
reporting standards adopted pursuant to Regulation (EC) No
1606/2002 as it applies in the European Union have been followed,
subject to any material departures disclosed and explained in the
financial statements
-- make judgments and accounting estimates that are reasonable and prudent
-- prepare the financial statements on the going concern basis
unless it is inappropriate to presume that the Group and Company
will continue in business
The Directors are also responsible for safeguarding the assets
of the Group and Company and hence for taking reasonable steps for
the prevention and detection of fraud and other irregularities.
The Directors are responsible for keeping adequate accounting
records that are sufficient to show and explain the Group and
Company's transactions and disclose with reasonable accuracy at any
time the financial position of the Group and Company and enable
them to ensure that the financial statements comply with the
Companies Act 2006 and, as regards the Group financial statements,
Article 4 of the IAS Regulation.
The Directors are responsible for the maintenance and integrity
of the Company's website. Legislation in the United Kingdom
governing the preparation and dissemination of financial statements
may differ from legislation in other jurisdictions. A copy of the
financial statements is placed on our website
www.scottishwidows.co.uk.
Each of the Directors whose names are listed on page 3 confirms
that, to the best of their knowledge:
-- The Group financial statements, which have been prepared in
accordance with international accounting standards in conformity
with the requirements of the Companies Act 2006 and in accordance
with international financial reporting standards adopted pursuant
to Regulation (EC) No 1606/2002 as it applies in the European Union
and the Company financial statements which have been prepared in
accordance with international accounting standards in conformity
with the requirements of the Companies Act 2006
-- the Group strategic report on pages 4 to 15, and the
Directors' Report on pages 16 to 20 include a fair review of the
development and performance of the business and the position of the
Group and Company, together with a description of the principal
risks and uncertainties that it faces
PRINCIPAL RISKS AND UNCERTAINTIES
Details of key risks are set out in note 37. Key risks include
economic and political uncertainty alongside operational risk which
is heightened by the current level of change being undertaken to
execute our strategy. Risks and uncertainties to our strategic
plan, both positive and negative, are considered by product through
the planning process. The following table describes the key risks
faced by the Group. Further details on these risks and how the
Group mitigates them can be found in note 37, as shown by the note
reference.
Key Risk Note reference Description
----------------- -------------- ---------------------------------------------------------
Market risk 37(c)(1) Market risk is the risk that the Group's capital
or earnings profile is affected by adverse market
rates. Of particular importance to the Group
are equity, credit default spreads, interest
rates and inflation for assets backing insurance
business.
Insurance 37(c)(2) Risks are transferred from policyholders to
underwriting the Group through writing insurance business.
risk These include mortality risk, morbidity risk
and persistency risk.
Credit risk 37(c)(3) Credit risk is the risk that parties with whom
we have contracted, fail to meet their financial
obligations. The Group is subject to credit
risk through a variety of counterparties through
invested assets which are primarily used to
back annuity business, cash in liquidity funds
and bank accounts, derivatives and reinsurance.
Capital risk 37(c)(4) Capital risk is the risk that the Group has
a sub-optimal quantity or quality of capital
or that capital is inefficiently deployed across
the Group. Capital, which includes regulatory
capital for the Company and regulated subsidiaries,
comprises all components of equity and subordinated
debt.
In addition to ensuring that the Company maintains
sufficient regulatory capital to meet Solvency
II capital requirements (based on a one in 200
year event),
the Group's capital management strategy, as
part of the integrated insurance business (see
note 37(c)(4)) requires it to hold capital in
line with the stated risk appetite for the business,
which is to be able to withstand a one in ten
year stress event without breaching the capital
requirements.
Liquidity 37(c)(5) Liquidity risk is the risk that the Group does
risk not have sufficient financial resources to meet
its commitments as they fall due, or can only
secure them at excessive cost. The Group is
exposed to liquidity risk from payments to policyholders
and non- policyholder related activity, such
as investment purchases and the payment of shareholder
expenses).
Operational 37(d) Operational risk is the risk of loss from inadequate
risk or failed internal processes, people and systems
or from external events.
Economic risk 37(e), 37(f) The Group faces economic and political uncertainty
and UK political arising from the impact of Covid-19, as well
uncertainties as the need to continue monitoring developments
following the adoption of the UK / EU TCA.
In addition, as described in note 28, during the ordinary course
of business the Group is subject to complaints and threatened or
actual legal proceedings (including class or Group action claims)
brought by or on behalf of current or former employees, customers,
investors or other third parties, as well as legal and regulatory
reviews, challenges, investigations and enforcement actions, both
in the United Kingdom and overseas.
37. Risk management
The Group is a part of Lloyds Banking Group. The principal
activity is the undertaking of ordinary long-term insurance and
savings business and associated activities in the United Kingdom.
The Group offers a wide range of life insurance products such as
annuities, pensions, whole life, term life and investment type
products through independent financial advisors, the Lloyds Banking
Group network and direct sales. The Company also reinsures business
with insurance entities external to the Group.
This note summarises the risks associated with the activities of
the Company and the way in which they are managed.
(a) Governance framework
Lloyds Banking Group has established a Risk function with
responsibility for implementing the Lloyds Banking Group risk
management framework (with appropriate Insurance focus) within the
Group.
The risk management approach aims to ensure effective
independent checking or 'oversight' of key decisions by operating a
'three lines of defence' model. The first line of defence is line
management, who have direct accountability for risk decisions. The
Risk function provides oversight and challenge and is the second
line of defence. Internal Audit, the third line of defence, provide
independent assurance to the Insurance Audit Committee and the
Board that risks are recognised, monitored and managed within
acceptable parameters.
This enterprise-wide risk management framework for the
identification, assessment, measurement and management of risk
covers the full spectrum of risks that the Group and Company are
exposed to, with risks categorised according to an approved Lloyds
Banking Group risk language. This covers the principal risks faced
by the Group, including the exposures to market, insurance
underwriting, model risk, credit, capital, liquidity, regulatory
and legal, conduct, people, governance and operational risks. The
Group assesses the relative costs and concentrations of each type
of risk and material issues are escalated to the appropriate
Insurance executive committees and onto the Board if required. The
performance of the Group, its continuing ability to write business
and the strategic management of the business depend on its ability
to manage these risks.
Responsibility for setting and managing risk appetite and risk
policy resides with the Board. Risks are managed in line with
Lloyds Banking Group and Insurance risk policies. The Board has
delegated certain risk matters to the Insurance Risk Oversight
Committee with operational implementation assigned to the Insurance
and Wealth Risk Committee (IWRC).
Policy owners, identified from appropriate areas of Lloyds
Banking Group and the Insurance and Wealth Division, are
responsible for drafting risk policies, ensuring they remain
up-to-date and for facilitating any changes. Policies are subject
to at least an annual review. Limits are prescribed within which
those responsible for the day-to-day management of each Company
within the Group can take decisions. Line management are required
to follow prescribed reporting procedures to the bodies responsible
for monitoring compliance with policy and controlling the
risks.
In response to the contingency planning requirements for
Covid-19, daily Risk Surgeries were put in place establishing a
control amendment process to support colleagues to continue to
serve customers and to maintain the operation of business
processes. A key aim of the Risk Surgery and control amendment
process is to take reasonable steps to ensure that all changes to
current ways of working (including operational home working),
operational processes or customer treatment is robustly risk
assessed and reviewed by the appropriate risk SMEs across the three
lines of defence. The changes implemented helped to manage
operational and conduct risks e.g. enhancements to the contribution
holiday process to support Longstanding Pension customers during
the Covid-19 crisis and Individual Annuities quote guarantee period
extension. Following the success of the Risk Surgeries, these will
continue beyond Covid-19 and are part of our ongoing governance
activity. In addition, through the Group's incident management
process, we managed key business continuity factors such as absence
levels, productivity, IT stability, strategic change activity,
regulatory focus, supplier performance and health and safety
measures.
(b) Risk appetite
The Board has approved a risk appetite framework that covers
Customer Risk, Strategy and Brand Risk and Financial Risks.
Risk appetite is the amount and type of risk that the Board
prefers, accepts or wishes to avoid and is aligned to Group
strategy. The risk appetite statements set limits for exposures to
the key risks faced by the business.
Risk appetite is reviewed at least annually by the Board.
Executive owned Tier 2 and Tier 3 limits sit beneath Board owned
risk appetite (Tier 1) and are managed and governed within the
Insurance and Wealth Division.
Experience against Risk Appetite is reported monthly (by
exception) to each meeting of IWRC and ROC. Copies are also
supplied regularly to the Group's regulators as part of the close
and continuous relationship. Reporting focuses on ensuring, and
demonstrating to the Board, and their delegate the ROC that the
Group is run in line with approved risk appetite. Any breaches of
risk appetite require clear plans and timescales for
resolution.
37. Risk management (continued)
(c) Financial risks
The Group writes a variety of insurance and investment contracts
which are subject to a variety of financial risks, as set out
below. Contracts can be either single or regular premium and
conventional (non-profit), With Profits or unit-linked in
nature.
The Group is exposed to a range of financial risks through its
financial assets, financial liabilities, assets arising from
reinsurance contracts and liabilities arising from insurance and
investment contracts. In particular, the key financial risk is that
long-term investment proceeds are not sufficient to fund the
obligations arising from its insurance and investment contracts.
The most important components of financial risk are market,
insurance underwriting, credit, capital and liquidity risk.
The Group manages these risks in a numbers of ways, including
risk appetite assessment and monitoring of capital resource
requirements. In addition, the Principles and Practices of
Financial Management (PPFMs) set out the way in which the With
Profits business is managed. The Group also uses financial
instruments (including derivatives) as part of its business
activities and to reduce its own exposure to market risk and credit
risk.
For With Profits business, subject to minimum guarantees,
policyholders' benefits are influenced by the smoothed investment
returns on assets held in the With Profits Funds. The smoothing
cushions policyholders from daily fluctuations in investment
markets. This process is managed in accordance with the published
PPFMs.
The financial risks arising from providing minimum guaranteed
benefits are borne in the With Profits Funds, but the Group bears
financial risk in relation to the possibility that in extreme
market conditions the With Profits Funds might be unable to bear
the full costs of the guarantees. The amount of the guaranteed
benefits increases as additional benefits are declared and
allocated to policies.
For unit-linked business, policyholders' benefits are closely
linked to the investment returns on the underlying funds. In the
short-term, profit and equity are therefore largely unaffected by
investment returns on assets in internal unit-linked funds as any
gains or losses will be largely offset by changes in the
corresponding insurance and investment contract liabilities,
provided that there is appropriate matching of assets and
liabilities within these funds. However, any change in the market
value of these funds will have an indirect impact on the Group and
Company through the collection of annual management and other fund
related charges. As markets rise or fall, the value of these
charges rises or falls correspondingly.
For non-participating business, the principal market risk is
interest rate risk, which arises because assets and liabilities may
exhibit differing changes in market value as a result of changes in
interest rates. Asset and liability matching is used to mitigate
the impact of changes in interest rates where the difference is
material.
Financial assets and financial liabilities are measured on an
on-going basis either at fair value or at amortised cost. The
summary of significant accounting policies (note 1) describes how
the classes of financial instruments are measured and how income
and expenses, including fair value gains and losses, are
recognised.
The timing of the unwind of the deferred tax assets and
liabilities is dependent on the timing of the unwind of the
temporary timing differences, arising between the tax bases of the
assets and liabilities and their carrying amounts for financial
reporting purposes, to which these balances relate.
The sensitivity analyses given throughout this note are based on
a change in an assumption while holding all other assumptions
constant. In practice, this is unlikely to occur as changes in some
of the assumptions may be correlated, for example changes in
interest rates and changes in market values. The sensitivity
analysis presented also represents management's assessment of a
reasonably possible alternative in respect of each sensitivity,
rather than worst case scenario positions.
(1) Market risk
Market risk is defined as the risk that our capital or earnings
profile is affected by adverse market rates, in particular equity,
credit default spreads, interest rates and inflation in Insurance
business.
Investment holdings within the Group are diversified across
markets and, within markets, across sectors. Holdings of individual
assets are diversified to minimise specific risk and large
individual exposures are monitored closely. For assets held with
unit-linked funds, investments are only permitted in countries and
markets which are sufficiently regulated and liquid.
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
Market risk policy is dependent on the nature of the funds in
question, and can be broadly summarised as follows:
-- Assets held in shareholder funds are invested in money-market
funds, gilts, loans and investment grade bonds to match regulatory
capital requirements. The balance of the shareholder fund assets is
managed in line with the policies of Lloyds Banking Group to
optimise shareholder risk and return. This includes suitable use of
derivatives to minimise shareholder risk
-- Unit-linked assets are invested in accordance with the nature
of the fund mandates. "Unit matching" is adopted on a significant
proportion of unit-linked business, under which sufficient units
are created to cover Solvency II technical provisions. An equity
hedging programme has also been established in respect of the
unit-linked business that is not subject to unit matching
-- Conventional non-profit liabilities are 'close matched' as
far as possible in relation to currency, nature and duration
-- With Profits Funds are managed in line with the published
PPFMs. Benchmarks and minimum and maximum holdings in asset classes
are specified to allow limited investment management discretion
whilst ensuring adequate diversification. Swaps and swaptions
provide significant protection to the With Profits Funds from the
effects of interest rate falls in respect of the cost of guaranteed
annuity rates
Below is an analysis of assets and liabilities at fair value
through profit or loss and assets and liabilities for which a fair
value is required to be disclosed, according to their fair value
hierarchy (as defined in note 1 (d)).
Group As at 31 December 2020
Fair value hierarchy
Level Level Level Total
1 2 3 GBPm
GBPm GBPm GBPm
------------------------------------------- ------- ------ ------ ---------
Investment properties - - 3,324 3,324
Assets arising from reinsurance
contracts held at fair value
through profit or loss - 19,549 - 19,549
Shares and other variable yield
securities 94,188 164 605 94,957
Debt and other fixed/variable
income securities 12,802 24,267 187 37,256
Loans and advances to customers - - 9,646 9,646
Loans and advances to banks - 4,693 - 4,693
Derivative financial assets 56 5,040 128 5,224
------------------------------------------- ------- ------ ------ -------
Total assets 107,046 53,713 13,890 174,649
------------------------------------------- ------- ------ ------ -------
Derivative financial liabilities 47 4,562 - 4,609
Liabilities arising from non-participating
investment contracts - 38,448 - 38,448
Subordinated debt - 1,892 - 1,892
------------------------------------------- ------- ------ ------ -------
Total liabilities 47 44,902 - 44,949
------------------------------------------- ------- ------ ------ -------
For all financial instruments held at amortised cost by the
Group and Company, carrying value is a reasonable approximation of
fair value.
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
Company As at 31 December 2020
Fair value hierarchy
Level Level Level Total
1 2 3 GBPm
GBPm GBPm GBPm
------------------------------------------- ------- ------ ------ ---------
Investment properties - - 120 120
Assets arising from reinsurance
contracts held at fair value
through profit or loss - 19,549 - 19,549
Shares and other variable yield
securities 107,067 152 665 107,884
Debt and other fixed/variable
income securities 8,106 7,729 842 16,677
Loans and advances to customers - - 9,095 9,095
Loans and advances to banks - 1,468 - 1,468
Deposits with cedants - 1,509 - 1,509
Derivative financial assets 39 4,965 128 5,132
Total assets 115,212 35,372 10,850 161,434
------------------------------------------- ------- ------ ------ -------
Derivative financial liabilities 40 4,550 - 4,590
Liabilities arising from non-participating
investment contracts - 38,433 - 38,433
Subordinated debt - 1,923 - 1,923
------------------------------------------- ------- ------ ------ -------
Total liabilities 40 44,906 - 44,946
------------------------------------------- ------- ------ ------ -------
For all financial instruments held at amortised cost by the
Group and Company, carrying value is a reasonable approximation of
fair value.
Group As at 31 December 2019
Fair value hierarchy
Level Level Level Total
1 2 3 GBPm
GBPm GBPm GBPm
------------------------------------------- ------- ------ ------ ---------
Investment properties - - 3,523 3,523
Assets arising from reinsurance
contracts held at fair value through
profit or loss - 22,837 - 22,837
Shares and other variable yield
securities 92,947 - 785 93,732
Debt and other fixed/variable
income securities 11,878 20,205 283 32,366
Loans and advances to customers - - 8,804 8,804
Loans and advances to banks - 2,255 - 2,255
Derivative financial assets 45 3,777 146 3,968
------------------------------------------- ------- ------ ------ -------
Total assets 104,870 49,074 13,541 167,485
------------------------------------------- ------- ------ ------ -------
Derivative financial liabilities 36 3,409 - 3,445
Liabilities arising from non-participating
investment contracts - 37,456 - 37,456
Subordinated debt - 1,795 - 1,795
------------------------------------------- ------- ------ ------ -------
Total liabilities 36 42,660 - 42,696
------------------------------------------- ------- ------ ------ -------
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
Company As at 31 December 2019
Fair value hierarchy
Level Level Level Total
1 2 3 GBPm
GBPm GBPm GBPm
------------------------------------------- ------- ------ ------ ---------
Investment properties - - 132 132
Assets arising from reinsurance
contracts held at fair value
through profit or loss - 22,837 - 22,837
Shares and other variable yield
securities 100,727 28 848 101,603
Debt and other fixed/variable
income securities 7,394 6,978 927 15,299
Loans and advances to customers - - 8,250 8,250
Loans and advances to banks - 1,203 - 1,203
Deposits with cedants - 1,507 - 1,507
Derivative financial assets 22 3,726 146 3,894
Total assets 108,143 36,279 10,303 154,725
------------------------------------------- ------- ------ ------ -------
Derivative financial liabilities 31 3,403 - 3,434
Liabilities arising from non-participating
investment contracts - 37,455 - 37,455
Subordinated debt - 1,820 - 1,820
------------------------------------------- ------- ------ ------ -------
Total liabilities 31 42,678 - 42,709
------------------------------------------- ------- ------ ------ -------
Assets arising from reinsurance contracts held at fair value
through profit and loss are valued using the published price for
the funds invested in. Fair values have not been disclosed for
participating investment contracts. There is currently no agreed
definition of fair valuation for DPFs applied under IFRS and
therefore the range of possible fair values of these contracts
cannot be measured reliably.
The derivative securities classified as Level 2 above have been
valued using a tri-party pricing model as determined by the Pricing
Source Agreement between Investment Manager(s) and the Third-Party
Administrator (State Street). Further detail on valuation is given
in note 1(n).
Assets classified as Level 3 include portfolios of illiquid
loans and advances to customers, investments in private debt funds
and private equity assets, investment properties, investments in
asset-backed securities, derivatives and corporate debt
instruments.
Private equity investments are valued using the financial
statements of the underlying companies prepared by the general
partners, adjusted for known cash flows since valuation and subject
to a fair value review to take account of other relevant
information. Property investment vehicles are valued based on the
net asset value of the relevant Company which incorporates
surveyors' valuations of property. Investment property is
independently valued as described in note 17. Valuations are based
on observable market prices for similar properties. Adjustments are
applied, if necessary, for specific characteristics of the
property, such as the nature, location, or condition of the
specific asset. If such information is not available alternative
valuation methods such as discounted cash flow analysis or recent
prices in less active markets are used. Where any significant
adjustments to observable market prices are required, the property
would be classified as Level 3. Whilst such valuations are
sensitive to estimates, it is believed that changing one or more of
the assumptions to reasonably possible alternative assumptions
would not change the fair value significantly.
Covid-19
The current year has experienced a period of major market
turbulence, increased volatility and greater illiquidity whilst
risk free interest rates have fallen to near historical lows. The
effects of the Covid-19 pandemic, and the related actions of
central banks and governments, have had uneven impacts across
different assets and notably between industry segments. There has
been a sustained recovery in equity prices and corporate credit
spreads since the initial market shock, however the worsening
credit environment has started to have some effect on corporate
bond and loan ratings. The Company's assessment for the range of
valuation uncertainty has increased 24% between year ends
principally due to greater market illiquidity although all
valuation methods and models have remained effective.
The following valuation methods and sensitivity of valuation
assumptions are applied to both the Group and the Company.
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
Loan assets
Loans classified as Level 3 within debt securities are valued
using a discounted cash flow model. The discount rate comprises
market observable interest rates, a risk margin that reflect loan
credit ratings and calibrated to weighted average life on borrower
level using sector bond spread curves for each rating, and an
incremental illiquidity premium that is estimated by reference to
historical spreads at origination on similar loans where available
and established measures of market liquidity. Libor tenor and base
rate options are valued by comparing the current tenor with the
lowest tenor option (basis swap approach). Prepayment options are
valued using a monthly time step binomial lattice approach.
The base valuation of loans is GBP9.1 billion (2019: GBP8.2
billion). The unobservable inputs in the valuation model include
the credit spread and specifically the illiquidity premium of loans
compared to bonds and the spread adjustments due to the specific
credit characteristics of the borrower. The impact of current
economic conditions on the valuation of the loan portfolio has been
taken in to account in the year end valuation. The impact of
applying reasonably possible alternative assumptions to the value
of these loans would be to decrease the fair value by GBP575
million (2019: GBP332 million) or increase it by GBP454 million
(2019: GBP345 million). The impact of alternative assumptions,
mainly related to credit spread and illiquidity premium
sensitivities is -6.3% (2019: -4.1%) to base in adverse scenario
and +5.0% (2019: +4.2%) to base in the favourable scenario.
Agricultural Loans - Agriculture SPV
A portfolio of agricultural loans is securitised through a
Special Purpose Vehicle into a Senior Note (A Note) and a Junior
Note (E Note). These notes are classified as Level 3 within debt
securities. The underlying agricultural loans are valued using a
discounted cash flow approach. The discount rate comprises market
observable interest rates, a risk margin that reflect underlying
loan credit ratings, a spread to represent the risks associated
with the Agricultural sector and an incremental illiquidity premium
including additional spread for prepayment uncertainty.
The unobservable input in the valuation model is principally the
credit spread including the illiquidity premium of loans compared
to mortgages, the spread adjustments relevant to the Agricultural
sector and the credit profile of the borrowers and the notes issued
from the securitisation.
The base valuation of Agricultural loans is GBP379 million
(2019: GBP376 million). The impact of applying reasonably possible
alternative assumptions to the valuation of the loans and senior
note would be to decrease the fair value of the SPV by GBP21
million (2019: GBP12 million) or increase it by GBP13 million
(2019: GBP9 million). Impact of alternative assumptions on credit
spread, illiquidity premium and prepayment assumptions is -5.5%
(2019: -3.1%) to base in the adverse scenario and +3.5% (2019:
+2.3%) to base in the favourable scenario. The capital repayment
holiday option is a new option in response to the onset of the
Covid-19 pandemic, it did not though have a significant impact on
the valuation of Agricultural loans.
Securitised Lifetime Mortgages
A portfolio of historical Lifetime Mortgages is securitised
through a Special Purpose Vehicle into a Senior Note (A Note) and a
Junior Note (B Note).
The value of the B Note is determined using a discounted cash
flow approach with a spread based judging movements in the spread
for comparable instruments against the changes in expected
performance of the underlying portfolio of mortgages.
The value of the A Note is derived as a balancing item from the
value of the underlying portfolio less the value of the B note and
expenses. These notes are classified as Level 3 within debt
securities due to the unobservable parameters required in the
valuation of the Senior Note, B note and in the valuation of the
portfolio of mortgages.
These lifetime mortgages are valued using a discounted cash flow
approach. Decrements (mortality, voluntary early repayment, entry
into long-term care) are used to determine the incidence of cash
flows. The discount rate is based on a risk free rate plus a spread
with the spread assessed by reference to the market for new
Lifetime Mortgages, after adjusting for the relative risks
associated with this portfolio of mortgages and those of a notional
portfolio of new mortgages. In the assessment of the value of the
risks, the No Negative Equity Guarantee for Lifetime Mortgages is
valued using a time-dependent Black-Scholes model. The value of
NNEG is GBP14 million (2019: GBP15 million).
Inputs in the valuation model include the gross interest rate
applicable to a notional portfolio of new Lifetime Mortgages, risk
free rates, residential property volatilities, property valuation
haircuts and settlement lags as well as decrement assumptions on
mortality, voluntary early repayment and entry into long-term
care.
The base valuation of Securitised Lifetime Mortgages is GBP176
million. December 2020 Valuation Uncertainty calculations reflects
uncertainty in the market rates for comparable notional portfolios
as well as decrement assumptions and their impacts on the value of
the A Note and B Note. The range of notional portfolio rate
assumptions was 3.50% to 4.27% (2019: 3.26% to 4.94%).
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
The effect of applying the aforementioned reasonably possible
alternative assumptions in line with the ranges disclosed above on
the A & B Notes would be to decrease the fair value by GBP5
million (2019: GBP6 million) or increase it by GBP9 million (2019:
GBP12 million). The impact of alternative assumptions on credit
spread and illiquidity premium is -2.9% (2019: -3.3%) to base in
the adverse scenario and +5% (2019: +6.6%) to base in the
favourable scenario.
Originated Lifetime Mortgages
New Lifetime Mortgage Loans have been originated by Lloyds
Banking Group Retail since April 2020 on behalf of SWL. The loans
are being warehoused with the intention to securitise.
The valuation methodology uses the same principles as that for
the securitised mortgages. The mortgages are valued using a
discounted cash flow approach. Decrements (mortality, voluntary
early repayment, entry into long-term care) are used to determine
the incidence of cash flows. The discount rate includes an
illiquidity spread by reference to the market for new Lifetime
Mortgages, after adjusting for the relative risks associated with
this portfolio of mortgages and those of a notional portfolio of
new mortgages. The model for originated mortgages utilises a
Jarrow-Yildirim model, which is a variant of the Black-Scholes
mechanism, and an Economic Scenario generator in determining the No
Negative Equity Guarantee. The model also includes additional
features and factors that are pertinent to recently originated
mortgages as compared those that are more mature.
Inputs to the valuation model include the Notional Portfolio
updated monthly, risk free rates, swaption volatilities for the
Economic Scenario generator, residential property volatilities,
property valuation haircuts, settlement delay as well as decrement
assumptions on mortality, voluntary early redemption and entry into
long-term care.
The base valuation of Originated Life Time Mortgage is GBP16
million (2019: nil). December 2020 Valuation Uncertainty
calculations principally reflect uncertainty in the market rates
for comparable notional portfolios, prepayment scenarios and for
the recognition of types of acquisition costs and their
corresponding impact on the loan portfolio. The range of Notional
Interest Rates as of December 2020 for the Favourable scenario was
2.48% to 3.66% and for the Adverse Scenario was 2.68% to 4.18%
compared to Base case range of 2.54% to 3.66%. The effect of
applying the aforementioned reasonably possible alternative
assumptions in line with the ranges disclosed above on the loans
would be to decrease the fair value by GBP0.7 million or increase
it by GBP0.3 million.
Private Credit Funds
SWL hold investments in two private credit funds that hold
portfolios of loans to European medium-sized enterprises where
loans are often backed by commercial real estate. The assets are
classified as Level 3 and are included within equity securities.
The underlying loan values, on which the investment values are
based, are assessed by the fund manager on a discounted cash flow
approach using spreads determined from the credit quality and
illiquidity of the loans as compared to other credit assets. Our
valuation uncertainty on these investments is assessed based on the
valuation uncertainty characteristics of the underlying illiquid
loans.
Private equity base value at GBP544 million (2019: GBP614
million). The effect of applying reasonably possible alternative
assumptions to the value of these assets would be to decrease the
fair value by GBP19 million (2019: GBP7 million) or increase it by
GBP3 million (2019: GBP1 million). For Pemberton European
Mid-Market Debt Fund II (E) (Pemberton), the impact of alternative
assumptions on credit spread and illiquidity premium is -2.0%
(2019: -1.2%) to base in the adverse scenario and 0% (2019: 0%) to
base in the favourable. For AgFe UK Real Estate Senior Debt Fund LP
(AgFe), an alternative approach is used incorporating alternative
assumptions on debt margin for the underlying loans, resulting in a
-5.9% (2019: -0.9%) to base in the adverse scenario and +1.9%
(2019: +0.5%) to base in favourable scenario.
Derivatives with Unobservable inputs
Derivatives are used to hedge interest rate and inflation risks.
Where complex risks arise in other assets or liabilities, these
hedging derivatives can be complex and have unobservable inputs
such as volatilities, correlations and basis differences to vanilla
derivatives. In these cases, the complex derivatives are assessed
as level 3.
Favourable and adverse scenarios are determined by stressing
unobservable inputs into the valuation models, with reference to
the valuations of the instruments they hedge where appropriate, in
order to generate a plausible range of fair values that different
market participants might apply
The base valuation of Derivatives is GBP128 million (2019:
GBP146 million). The effect of applying reasonably possible
alternative assumptions to the value of these assets would be to
decrease the fair value by GBP17 million (2019: GBP26 million) or
increase it by GBP1 million (2019: GBP1 million). The impact of
alternative assumptions is -13.8% (2019: -17.5% to base in the
adverse scenario and +1.1% (2019: +0.8%) to base in the favourable
scenario.
The table below shows movements in the assets and liabilities
measured at fair value based on valuation techniques for which any
significant input is not based on observable market data (Level 3
only).
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
Group
2020 2019
GBPm GBPm GBPm GBPm
-------------------------------------------- ------ ----------- ------ -------------
Assets Liabilities Assets Liabilities
Balance at 1 January 13,541 - 12,532 -
Transfers in 179 - 421 -
Transfers out (356) - (147) -
Purchases 756 - 1,422 -
Disposals (534) - (984) -
Net gains recognised within net gains
on assets and liabilities at fair
value through profit or loss in the
statement of comprehensive income 311 - 297 -
Balance at 31 December 13,897 - 13,541 -
-------------------------------------------- ------ ----------- ------ -----------
Total unrealised gains for the period
included in the statement of comprehensive
income for assets and liabilities
held at 31 December 692 - 245 -
-------------------------------------------- ------ ----------- ------ -----------
Company
2020 2019
GBPm GBPm GBPm GBPm
-------------------------------------- ------ ----------- ------ -------------
Assets Liabilities Assets Liabilities
Balance at 1 January 10,303 - 8,932 -
Transfers in 154 - 267 -
Transfers out (340) - - -
Purchases 676 - 1,355 -
Disposals (407) - (649) -
Assets held for sale - - - -
Net gains recognised within net gains
on assets and liabilities at fair
value through profit or loss in the
statement of comprehensive income 464 - 398 -
Balance at 31 December 10,850 - 10,303 -
-------------------------------------- ------ ----------- ------ -----------
Total unrealised gains for the period
included in the statement
of comprehensive income for assets
and liabilities held at 31 December 498 - 340 -
-------------------------------------- ------ ----------- ------ -----------
Total gains or losses for the period included in the statement
of comprehensive income, as well as total gains or losses relating
to assets and liabilities held at the reporting date, are presented
in the statement of comprehensive income, through net gains/losses
on assets and liabilities at fair value through profit or loss.
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
(i) Equity and property risk
The exposure of the Group's insurance and investment contract
business to equity risk relates to financial assets and financial
liabilities whose values will fluctuate as a result of changes in
market prices other than from interest and foreign exchange
fluctuations. This is due to factors specific to individual
instruments, their issuers or factors affecting all instruments
traded in the market. Accordingly, the Group monitors exposure
limits both to any one counterparty and any one market.
From 2018, exposure to market risk has been managed by the
implementation of unit matching and equity hedging to reduce the
sensitivity of future dividend payments to market movements. Unit
matching involves more effectively matching unit linked liabilities
on a best-estimate view (as defined by Solvency regulations). This
best-estimate view incorporates an allowance for expected future
income and expenses, which are not fully allowed for under IFRS. As
a result, this leads to a mismatch between IFRS statutory assets
and liabilities in respect of market movements. For example, in the
event of rising markets, a loss would now be recognised in the
accounts as a result of this mismatch, which would be offset in the
future due to higher income as fees are received.
The effect on the Group of changes in the value of investment
property held in respect of investment contract liabilities due to
fluctuations in property prices is negligible as any changes will
be offset by movements in the corresponding liability.
The sensitivity analysis below illustrates how the fair value of
future cash flows in respect of equities and properties, net of
offsetting movements in insurance and investment contract
liabilities, will fluctuate because of changes in market prices at
the reporting date. The equity sensitivity includes the impact of
unit matching and equity hedging which leads to a statutory profit,
mainly due to the hedge payoff under falling markets.
Impact on profit
after tax and equity
for the year
2020 2019
GBPm GBPm
-------------------------------------------- ------------ -----------
10% (2019: 10%) decrease in equity prices 180 131
10% (2019: 10%) decrease in property prices (5) (5)
-------------------------------------------- ------------ ---------
(ii) Interest rate risk
Interest rate risk is the risk that the value of future cash
flows of a financial instrument will fluctuate because of changes
in interest rates and the shape of the yield curve. Interest rate
risk in respect of the Group's insurance and investment contracts
arises when there is a mismatch in duration or yield between
liabilities and the assets backing those liabilities.
The Group's interest rate risk policy requires that the maturity
profile of interest-bearing financial assets is appropriately
matched to the guaranteed elements of the financial
liabilities.
A fall in market interest rates will result in a lower yield on
the assets supporting guaranteed investment returns payable to
policyholders. This investment return guarantee risk is managed by
matching assets to liabilities as closely as possible. An increase
in market interest rates will result in a reduction in the value of
assets subject to fixed rates of interest which may result in
losses, as a result of an increase in the level of surrenders, the
corresponding fixed income securities have to be sold.
The effect of changes in interest rates in respect of financial
assets which back insurance contract liabilities is given in note
36. The effect on the Group of changes in the value of investments
held in respect of investment contract liabilities due to
fluctuations in market interest rates is negligible as any changes
will be offset by movements in the corresponding liability.
The sensitivity analysis below illustrates how the fair value of
future cash flows in respect of interest-bearing financial assets,
net of offsetting movements in insurance and investment contract
liabilities, will fluctuate because of changes in market interest
rates at the reporting date.
37. Risk management (continued)
(c) Financial risks (continued)
(1) Market risk (continued)
(ii) Interest rate risk (continued)
Impact on profit
after tax and equity
for the year
2020 2019
GBPm GBPm
------------------------------------------------- ------------ -----------
25 basis points (2019: 25 basis points) increase
in yield curves 43 28
25 basis points (2019: 25 basis points) decrease
in yield curves (51) (34)
50 basis points (2019: 50 basis points) increase
in yield curves 79 51
50 basis points (2019: 50 basis points) decrease
in yield curves (111) (75)
Interest Rate Benchmark Reform
For the purposes of determining whether:
-- a forecast transaction is highly probable
-- hedged future cash flows are expected to occur
-- a hedge is expected to be highly effective in achieving
offsetting changes in fair value or cash flows attributable to the
hedged risk
-- an accounting hedging relationship should be discontinued
because of a failure of the retrospective effectiveness test
The Group assumes that the interest rate benchmark on which the
hedged risk or the cash flows of the hedged item or hedging
instrument are based is not altered by uncertainties resulting from
interest rate benchmark reform. In addition, for a fair value hedge
of a non-contractually specified benchmark portion of interest rate
risk, the Group assesses only at inception of the hedge
relationship and not on an ongoing basis that the risk is
separately identifiable and hedge effectiveness can be
measured.
The Group is exposed to the Sterling LIBOR interest rate
benchmarks in respect of a fair value hedge. The value of assets
designated in fair value hedges had a notional of nil (2019: nil)
at 31 December 2020. The value of liabilities designated in fair
value hedges had a notional of GBP1.5 billion (2019: GBP1.5
billion) at 31 December 2020.
At 31 December 2020, the notional amount of the hedging
instruments in hedging relationships to which these amendments
apply was GBP1.5 billion (2019: GBP1.5 billion).
The Group is managing the process to transition to alternative
benchmark rates as part of Lloyds Banking Group's Group-wide IBOR
Transition Programme. This programme has developed an
implementation plan for new products and a transition plan for
legacy products. The programme also encompasses the associated
impacts on systems, processes, accounting and reporting and
includes dealing with the impact on hedge accounting relationships
of the transition to alternative reference rates.
(iii) Foreign exchange risk
Foreign exchange risk relates to the effects of movements in
exchange markets including changes in exchange rates.
The Group's foreign currency exposure is driven by holding
financial instruments to hedge changes in future investment
management fees resulting from exchange rate movements. These
investment management fees are based on charges to policyholder
funds invested in overseas equities. The hedges are placed by the
Company to reduce foreign exchange exposure in the SWL SII capital
position.
Sensitivity analysis for the impact of a 10 per cent
depreciation of sterling against foreign currency shows a GBP(117
million) impact for 2020 on profit after tax and equity (2019:
GBP(131 million)).
With the exception of these holdings, the overall risk to the
Group is minimal due to the following:
-- The Group's principal transactions are carried out in pounds sterling
-- The Group's financial assets are primarily denominated in the
same currencies as its insurance and investment contract
liabilities; and
-- Other than shareholder funds, all non-linked investments of
the non-profit funds are in sterling or are currency matched. The
effect on the Group of changes in the value of investments held in
respect of investment contract liabilities due to fluctuations in
foreign exchange rates is negligible as any changes will be offset
by movements in the corresponding liability
37. Risk management (continued)
(c) Financial risks (continued)
(2) Insurance underwriting risk
Insurance underwriting risk is defined as the risk of adverse
developments in the timing, frequency and severity of claims for
insured/underwritten events and in customer behaviour, leading to
reductions in earnings and/or value.
The principal risk the Group faces under insurance contracts is
that the actual claims and benefit payments exceed the amounts
expected at the time of determining the insurance liabilities.
The nature of the Group's business involves the accepting of
insurance underwriting risks which primarily relate to mortality,
longevity, morbidity, persistency and expenses. When transacting
new business, the Group underwrites policies to ensure an
appropriate premium is charged for the risk or that the risk is
declined.
The Group principally writes the following types of life
insurance contracts:
-- Life assurance - where the life of the policyholder is
insured against death or permanent disability, usually for
pre-determined amounts
-- Annuity products - where typically the policyholder is
entitled to payments which cease upon death; and
-- Morbidity products - where the policyholder is insured
against the risk of contracting a defined illness
For contracts where death is the insured risk, the most
significant factors that could increase the overall level of claims
are epidemics or widespread changes in lifestyle, such as eating,
smoking and exercise habits, resulting in earlier or more claims
than expected. The occurrence of a pandemic, such as the one
arising from Covid-19 in 2020, is regarded as a potentially
significant mortality risk. For contracts where survival is the
insured risk, the most significant factor is continued improvement
in medical science and social conditions that would increase
longevity.
Despite an unprecedented spike in mortality rates over 2020 due
to the Covid-19 pandemic, it is expected that current mortality
rates will revert to broadly the previous level. The longer-term
impacts of Covid-19 on future mortality improvements remain
unclear, with limited data available to date to support any change
to the assumptions. The mortality assumptions disclosed therefore
do not include any allowance for Covid-19. Mortality assumptions
are updated annually, reflecting both historic experience and
future expectations. Therefore as further information becomes
available it will be incorporated in future assumptions.
A provision is held in respect of life assurance and to reflect
that fact that a short-term spike in mortality claims is expected.
A provision is also held in respect of morbidity products as the
reduced availability of medical screening has reduced critical
illness claims made in 2020. It is expected that this reduction
will be offset in 2021 as delayed claims arise. Increased mortality
on annuity contracts reduces the payments made and so no provision
is necessary for these.
For contracts with fixed and guaranteed benefits and fixed
future premiums, there are no mitigating terms and conditions that
significantly reduce the insurance underwriting risk accepted. For
participating investment contracts, the participating nature of
these contracts results in a significant portion of the insurance
underwriting risk being shared with the policyholder.
Insurance underwriting risk is also affected by the
policyholders' right to pay reduced or no future premiums, to
terminate the contract completely, to exercise a guaranteed annuity
option or, for bulk annuity business, for pensioners to exercise
options following retirement. As a result, the amount of insurance
underwriting risk is also subject to policyholder behaviour. On the
assumption that policyholders will make decisions that are in their
best interests, overall insurance underwriting risk will generally
be aggravated by policyholder behaviour. For example, it is likely
that policyholders whose health has deteriorated significantly will
be less inclined to terminate contracts insuring death benefits
than those policyholders who remain in good health.
The Group has taken account of the expected impact of
policyholder behaviour in setting the assumptions used to measure
insurance and investment contract liabilities.
37. Risk management (continued)
(c) Financial risks (continued)
(2) Insurance underwriting risk (continued)
The principal methods available to the Group to control or
mitigate longevity, mortality and morbidity risk are through the
following processes:
-- Underwriting (the process to ensure that new insurance proposals are properly assessed)
-- Pricing-to-risk (new insurance proposals would usually be
priced in accordance with the underwriting assessment)
-- Demographics to accurately assess mortality risk
-- Claims management
-- Product design
-- Policy wording
-- The use of reinsurance and other risk mitigation techniques
Rates of mortality and morbidity are investigated annually based
on the Group's recent experience. Future mortality improvement
assumptions are set using the latest population data available. In
addition, bulk annuity business pricing and valuation assumptions
also consider underlying experience of the scheme where available.
Where they exist, the reinsurance arrangements of each Company in
the Group are reviewed at least annually.
Persistency risk is the risk associated with the ability to
retain long-term business and the ability to renew short-term
business. The Group aims to reduce its exposure to persistency risk
by undertaking various initiatives to promote customer loyalty.
These initiatives are aimed both at the point of sale and through
direct contact with existing policyholders, for example through
annual statement information packs.
Covid-19 has resulted in a significant negative shock to the
global economy. This is expected to result in increased levels of
redundancies. Consequently, it is expected that there will be
reduced premium income for contracts in the Workplace and Savings
business as premiums are directly linked to the policyholders'
employment. A provision is held in respect of this risk.
Further information on assumptions, changes in assumptions and
sensitivities in respect of insurance and participating investment
contracts is given in note 36.
(3) Credit risk
The risk that parties with whom we have contracted, fail to meet
their financial obligations (both on and off balance sheet).
The Group accepts credit risk with a variety of counterparties
through invested assets which are primarily used to back annuity
business, cash in liquidity funds and bank accounts, derivatives
and reinsurance. These are managed through a credit control
framework which uses a tiered approach to set credit limits:
-- Tier 1: Credit limits are set by the Insurance Board as part
of the overall Insurance Risk Appetite
-- Tier 2: Insurance Investment Strategy Committee (IISC)
assists the IISC Chair to set additional controls, sub limits and
guidelines. These operate within the boundaries of the Board's Tier
1 Risk Appetite statements and are designed to assist the business
with more efficient utilisation of higher level Board Risk Appetite
statements in delivery of Insurance's investment strategy
-- Tier 3: Insurance Credit approvers have individual personal
delegated authorities from the Insurance Board to approve exposures
to individual counterparties. Amounts above these delegated
authorities require approval by the Insurance Board
Group exposure limits are set for the maximum single name
concentration, industry sector, country of risk and portfolio
quality. In addition, each individual counterparty exposure
requires a counterparty limit or is within the criteria of an
approved sanction matrix.
Group exposures are reported on a monthly basis to the Insurance
Shareholder Investment Management Committee (ISIM) and
semi-annually to IISC, and other senior committees. Any exceptions
to limits must be approved in advance by the relevant authority
that owns that limit, and any unapproved excesses notified to that
authority as a breach.
A core part of the invested asset portfolio which backs the
annuity business is invested in loan assets. These have
predominately been purchased from Lloyds Banking Group although the
Group has also started originating new business. All loan assets
are assessed and monitored using established robust processes and
controls.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
Reinsurance is primarily used to reduce insurance risk. However,
it is also sought for other reasons such as improving
profitability, reducing capital requirements and obtaining
technical support. In addition, reinsurance is also used to offer
policyholders access to third-party funds via Investment Fund Links
which we are unable to provide through other means. The Group's
reinsurance strategy is to reduce the volatility of profits through
the use of reinsurance whilst managing the insurance and credit
risk within the constraints of the risk appetite limits.
The Group has reinsurance on all significant lines of business
where mortality, morbidity or property risks exceed set retention
limits. This does not, however, discharge the Group's liability as
primary insurer. If a reinsurer fails to pay a claim for any
reason, the Group remains liable for the payment to the
policyholder. All new material reinsurance treaties are subject to
Board approval and reinsurance arrangements are reviewed annually
to ensure that the reinsurance strategy is being achieved.
Reinsurance for Investment Fund Links is not assessed as a
counterparty exposure for the Group since with invested assets
matching liabilities, any loss to the Group would only be the
result of operational failures of internal controls and as such it
is outside of the credit control framework described above.
Shareholder funds are managed in line with the Insurance Credit
Risk Policy and the wider Lloyds Banking Group Credit Risk Policy
which set out the principles of the credit control framework
outlined above.
Credit risk in respect of unit-linked funds and With Profits
Funds is largely borne by the policyholders. Consequently, the
Group has no significant exposure to credit risk for those
funds.
The tables below analyse financial assets and reinsurance assets
subject to credit risk exposure using Standard & Poor's rating
or equivalent. For certain classes of assets, internally generated
ratings have been used where external ratings are not available.
This includes credit assets held in both shareholder and
policyholder funds. No account is taken of any collateral held to
mitigate the risk.
Group As at 31 December 2020
BBB or
Total AAA AA A lower Not rated
GBPm GBPm GBPm GBPm GBPm GBPm
------------------------------ ------ ----- ------ ------ ------ -----------
Stage 1 assets
Cash and cash equivalents 218 1 - 191 26 -
Loans and receivables
at amortised cost 775 - - 341 - 434
Loss allowance - - - - - -
------------------------------ ------ ----- ------ ------ ------ ---------
Exposure to credit risk 993 1 - 532 26 434
Simplified approach
assets
Loans and receivables
at amortised cost 250 - - 54 - 196
Loss allowance (7) - - (3) - (4)
------------------------------ ------ ----- ------ ------ ------ ---------
Exposure to credit risk 243 - - 51 - 192
Assets at FVTPL
Assets arising from
reinsurance contracts
held classified at fair
value through profit
and loss 19,549 - 19,230 - 314 5
Debt and other fixed/variable
income securities 37,256 2,036 16,831 8,602 9,756 31
Derivative financial
instruments 5,224 - 636 4,426 90 72
Loans and advances to
customers 9,646 76 266 6,131 2,570 603
Loans and advances to
banks 4,693 - 213 4,440 3 37
Other
Reinsurance contracts 810 - 810 - - -
------------------------------ ------ ----- ------ ------ ------ ---------
Total 78,414 2,113 37,986 24,182 12,759 1,374
------------------------------ ------ ----- ------ ------ ------ ---------
Cash at bank, included with Stage 1 assets, is considered to
have low credit risk.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
Group As at 31 December 2019
BBB or
Total AAA AA A lower Not rated
GBPm GBPm GBPm GBPm GBPm GBPm
------------------------------ ------ ----- ------ ------ ------ -----------
Stage 1 assets
Cash and cash equivalents 276 1 17 204 48 6
Loans and receivables
at amortised cost 483 - - 403 - 80
Loss allowance - - - - - -
------------------------------ ------ ----- ------ ------ ------ ---------
Exposure to credit risk 759 1 17 607 48 86
Simplified approach
assets
Loans and receivables
at amortised cost 514 - - 22 - 492
Loss allowance (5) - - - - (5)
------------------------------ ------ ----- ------ ------ ------ ---------
Exposure to credit risk 509 - - 22 - 487
Assets at FVTPL
Assets arising from
reinsurance contracts
held classified at fair
value through profit
and loss 22,837 - - 22,551 286 -
Debt and other fixed/variable
income securities 32,366 2,152 15,026 6,689 8,337 162
Derivative financial
instruments 3,968 - 454 3,395 74 45
Loans and advances to
customers 8,804 73 1,324 4,439 2,376 592
Loans and advances to
banks 2,255 - 18 2,172 58 7
Other
Reinsurance contracts 720 - 589 131 - -
------------------------------ ------ ----- ------ ------ ------ ---------
Total 72,218 2,226 17,428 40,006 11,179 1,379
------------------------------ ------ ----- ------ ------ ------ ---------
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
Company As at 31 December 2020
BBB or
Total AAA AA A lower Not rated
GBPm GBPm GBPm GBPm GBPm GBPm
------------------------------ ------ ---- ------ ------ ------ -----------
Stage 1 assets
Cash and cash equivalents 95 - - 69 26 -
Loans and receivables
at amortised cost 383 - - 382 - 1
Loss allowance - - - - - -
------------------------------ ------ ---- ------ ------ ------ ---------
Exposure to credit risk 478 - - 451 26 1
Simplified approach
assets
Loans and receivables
at amortised cost 236 - - 54 - 182
Loss allowance (4) - - (3) - (1)
------------------------------ ------ ---- ------ ------ ------ ---------
Exposure to credit risk 232 - - 51 - 181
Assets at FVTPL
Assets arising from
reinsurance contracts
held classified at fair
value through profit
and loss 19,549 - 19,230 - 314 5
Debt and other fixed/variable
income securities 16,677 514 9,741 2,714 3,561 147
Derivative financial
instruments 5,132 - 606 4,385 90 51
Loans and advances to
customers 9,095 76 266 6,131 2,570 52
Loans and advances to
banks 1,468 - - 1,437 - 31
Deposits with cedants 1,509 - - - - 1,509
Other
Reinsurance contracts 819 - 819 - - -
------------------------------ ------ ---- ------ ------ ------ ---------
Total 54,959 590 30,662 15,169 6,561 1,977
------------------------------ ------ ---- ------ ------ ------ ---------
Cash at bank, included with Stage 1 assets, is considered to
have low credit risk.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
Company As at 31 December 2019
BBB or
Total AAA AA A lower Not rated
GBPm GBPm GBPm GBPm GBPm GBPm
------------------------------ ------ ---- ------ ------ ------ -----------
Stage 1 assets
Cash and cash equivalents 98 - - 53 45 -
Loans and receivables
at amortised cost 411 - - 402 - 9
Loss allowance - - - - - -
------------------------------ ------ ---- ------ ------ ------ ---------
Exposure to credit risk 509 - - 455 45 9
Simplified approach
assets
Loans and receivables
at amortised cost 208 - - 22 - 186
Loss allowance (2) - - - - (2)
------------------------------ ------ ---- ------ ------ ------ ---------
Exposure to credit risk 206 - - 22 - 184
Assets at FVTPL
Assets arising from
reinsurance contracts
held classified at fair
value through profit
and loss 22,837 - - 22,551 286 -
Debt and other fixed/variable
income securities 15,299 591 9,065 2,792 2,605 246
Derivative financial
instruments 3,894 - 452 3,347 74 21
Loans and advances to
customers 8,250 73 1,324 4,439 2,376 38
Loans and advances to
banks 1,203 - - 1,188 15 -
Deposits with cedants 1,507 - - - - 1,507
Transferred to Assets
held for sale - - - - - -
Other
Reinsurance contracts 726 - 595 131 - -
------------------------------ ------ ---- ------ ------ ------ ---------
Total 54,431 664 11,436 34,925 5,401 2,005
------------------------------ ------ ---- ------ ------ ------ ---------
Amounts classified as 'not rated' within assets arising from
reinsurance contracts held principally relate to amounts due from
other Group companies which are not rated by Standard & Poor's
or an equivalent rating agency.
Expected credit losses are calculated using three key input
parameters: the probability of default (PD) (except for lifetime
expected credit losses), the expected loss given default (LGD) and
the exposure at default (EAD). The probability of default and
expected loss given default are determined using internally
generated credit ratings. For lease receivables, the past due
information is used to determine the expected loss given
default.
Expected credit losses are measured on a collective basis for
certain Groups of financial assets, such as control accounts, trade
receivables and intercompany receivables, which are considered to
be homogenous in terms of their risk of default.
Maximum credit exposure
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, which includes amounts held to cover unit-linked
and With Profits Funds liabilities, is considered to be the balance
sheet carrying amount.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
Group 2020 2019
Maximum Maximum
exposure Net exposure exposure Net exposure
GBPm GBPm GBPm GBPm
----------------------------------- --------- ------------ --------- --------------
Loans and receivables at amortised
cost 1,018 1,107 997 997
Investments at fair value through
profit or loss:
Assets arising from reinsurance
contracts held classified at fair
value through profit and loss 19,549 19,549 22,837 22,837
Debt securities 37,256 37,256 32,366 32,366
Derivative Financial Instruments 5,224 5,224 3,968 3,968
Loans and advances to customers 9,646 9,646 8,804 8,804
Loans and advances to banks 4,693 4,693 2,255 2,255
Reinsurance contracts 810 810 720 720
Cash and cash equivalents 218 218 276 276
----------------------------------- --------- ------------ --------- ------------
At 31 December 78,414 78,503 72,223 72,223
----------------------------------- --------- ------------ --------- ------------
Company 2020 2019
Maximum Maximum
exposure Net exposure exposure Net exposure
GBPm GBPm GBPm GBPm
----------------------------------- --------- ------------ --------- --------------
Loans and receivables at amortised
cost 615 615 619 619
Investments at fair value through
profit or loss:
Assets arising from reinsurance
contracts held classified at fair
value through profit and loss 19,549 19,549 22,837 22,837
Debt securities 16,677 16,677 15,299 15,299
Derivative Financial Instruments 5,132 5,132 3,894 3,894
Loans and advances to customers 9,095 9,095 8,250 8,250
Loans and advances to banks 1,468 1,468 1,203 1,203
Deposits with cedants 1,509 1,509 1,507 1,507
Reinsurance contracts 819 819 726 726
Cash and cash equivalents 95 95 98 98
----------------------------------- --------- ------------ --------- ------------
At 31 December 54,959 54,959 54,433 54,433
----------------------------------- --------- ------------ --------- ------------
Covid-19
The Group invests in a non-cyclical and high quality portfolio
of assets, and regarding shareholder assets, the majority of these
are used to match against long-term annuity liabilities. The bonds,
loans and gilts in which the Group invests have an average rating
of A and are well diversified. All shareholder assets are subject
to continued assessment for the impact of Covid-19. Since 1 January
2020 downgrades to sub-investment grade across loans and bonds were
GBP99 million, with a total of 0.5 per cent of shareholder assets
rated sub-investment grade.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
(i) Concentration risk
Credit concentration risk
Credit concentration risk relates to the inadequate
diversification of credit risk.
Credit risk is managed through the setting and regular review of
counterparty credit and concentration limits on asset types which
are considered more likely to lead to a concentration of credit
risk. For other asset types, such as UK government securities or
investments in funds falling under the Undertakings for Collective
Investment in Transferable Securities (UCITS) Directive, no limits
are prescribed as the risk of credit concentration is deemed to be
immaterial. This policy supports the approach mandated by the PRA
for regulatory reporting.
At 31 December 2020 and 31 December 2019, the Group did not have
any significant concentration of credit risk with a single
counterparty or Group of counterparties where limits applied. With
the exception of government bonds and UCITS funds, the largest
aggregated counterparty exposure is 0.20 per cent (2019: 0.20 per
cent) of the Group's total assets).
Total
GBPm
------------------------------------------------------ -------
Trade and other receivables:
Amounts due from brokers 57
Amounts due from Group undertakings 375
Other receivables 586
Cash and cash equivalents with financial institutions 218
------------------------------------------------------ -----
Total 1,236
------------------------------------------------------ -----
For other receivables, the largest single counterparty balance
is with policyholders, which totals GBP83 million.
Liquidity concentration risk
Liquidity concentration risk arises where the Group is unable to
meet its obligations as they fall due or do so only at an excessive
cost, due to over-concentration of investments in particular
financial assets or classes of financial asset.
As most of the Group's invested assets are diversified across a
range of marketable equity and debt securities in line with the
investment options offered to policyholders it is unlikely that a
material concentration of liquidity concentration could arise.
This is supplemented by active liquidity management in the
Group, to ensure that even under stress conditions the Group has
sufficient liquidity as required to meet its obligations. This is
delegated by the Board to and monitored through the Insurance and
Wealth Asset and Liability Committee (IWALCO), IWRC, ISIM and
Banking and Liquidity Operating Committee (BLOC).
(ii) Collateral management
Collateral in respect of derivatives
The requirement for collateralisation of OTC derivatives,
including the levels at which collateral is required and the types
of asset that are deemed to be acceptable collateral, are set out
in a Credit Support Annex (CSA), which forms part of the
International Swaps and Derivatives Association (ISDA) agreement
between the Company and the counterparty.
The CSA will require collateralisation where any net exposure to
a counterparty exceeds the OTC counterparty limit, which must be
established in accordance with the Derivatives Risk Policy (DRP).
The aggregate uncollateralised exposure to any one counterparty
must not exceed limits specified in the DRP. Where derivative
counterparties are related, the aggregate net exposure is
considered for the purposes of applying these limits.
Acceptable collateral is defined in each instance and must take
into account the quality and appropriateness of the proposed
collateral as well as being acceptable to the entity receiving the
collateral. Collateral may include cash, corporate bonds,
supranational debt and government debt.
Assets with the following carrying amounts have been pledged in
accordance with the terms of the relevant CSAs entered into in
respect of various OTC and other derivative contracts:
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
(ii) Collateral management (continued)
Collateral in respect of derivatives (continued)
2020 2019
GBPm GBPm GBPm GBPm
-------------------------- ----- ------- ----- ---------
Group Company Group Company
Financial assets:
Investments at fair value
through profit or loss 1,483 1,483 773 773
Cash and cash equivalents 445 425 369 369
-------------------------- ----- ------- ----- -------
Total 1,928 1,908 1,142 1,142
-------------------------- ----- ------- ----- -------
Collateral pledged in form of financial assets, is continued to
be recognised in the balance sheet as the Group and Company retains
all risks and rewards of the transferred assets. The Group and the
Company has the right to recall any collateral pledged provided
that this is replaced with alternative acceptable assets. The
counterparty has right to repledge or sell the collateral in the
absence of default by the Group and Company.
Cash collateral pledged where the counterparty retains the risks
and rewards is derecognised from the balance sheet and a
corresponding receivable is recognised for its return.
Where the Group and Company receives collateral in form of
financial instruments for which the counterparty retains all risks
and rewards, it is not recognised in the balance sheet. The fair
value of financial assets accepted as collateral for OTC
derivatives but not recognised in the balance sheet amounts to
GBP1,440 million (2019: GBP1,191 million) by the Group and GBP1,440
million (2019: GBP1,191 million) by the Company, all of which is
permitted to be sold or repledged in the absence of default.
However the policy of the Group and Company is not to repledge
assets, and hence no collateral was sold or repledged by the Group
or Company during the year or in the prior year. Non-cash
collateral received during the year was made up of high quality
government Bonds such as UK Gilts and Treasury Bills, with the
exception of one asset which was a Corporate bond.
Where the Group and Company receives collateral in form of cash,
it is recognised in the balance sheet along with a corresponding
liability to repay the amount of collateral received within other
financial liabilities. The amount of cash collateral received by
the Group and Company amounts to GBP868 million (2019: GBP281
million) and GBP821 million (2019: GBP250 million)
respectively.
Collateral in respect of Stock Lending
Stock lending activity has discontinued during the year. Until
this year and in prior years, the Group and Company lent financial
assets held in its portfolio to other institutions. The IISC and
its sub-committee Investment Management Operational Review
Committee (IMOR) were responsible for setting the parameters of
stock lending. Stock lending is permitted in accordance with the
Insurance Stock Lending Policy. All stock lending took place on an
open/call basis, enabling the loan to be recalled at any time
within the standard settlement terms of the market concerned.
The financial assets lent do not qualify for derecognition as
the Group and Company retains all risks and rewards of the
transferred assets except for the voting rights. The aggregate
carrying value of securities on loan by the Group is GBP1 million
(2019: GBP4,137 million) and by the Company is nil (2019: GBP573
million).
It is the Group's and Company's practice to obtain collateral in
stock lending transactions. The accepted collateral can include
cash, equities, certain bonds and money-market instruments. On a
daily basis, the fair value of collateral is compared to the fair
value of stock on loan. The value of collateral must always exceed
the value of stock on loan.
Where the Group and Company receives collateral in form of
financial instruments for which counterparty retains all risks and
rewards, it is not recognised in the balance sheet. The fair value
of financial assets accepted as collateral but not recognised in
the balance sheet amounts to GBP1 million (2019: GBP4,059 million)
by the Group and nil (2019: GBP528 million) by the Company. The
Group and the Company is not permitted to sell or repledge the
collateral in the absence of default.
Where the Group and Company receives collateral in form of cash,
it is recognised in the balance sheet along with a corresponding
liability to repay the amount of collateral received within other
financial liabilities. The amount of cash collateral received by
the Group and Company amounts to nil (2019: GBP334 million) and nil
(2019: GBP66 million) respectively.
There were no defaults in respect of stock lending during the
year ended 31 December 2020 (2019: none) which required a call to
be made on collateral.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
(ii) Collateral management (continued)
Collateral in respect of Reverse Repurchase Agreement
Reverse Repurchase Agreements were closed during the year. In
previous years, the Group and Company entered into Reverse
Repurchase Agreements whereby it purchased financial instruments
with an agreement to resell them back to the counterparty at an
agreed price. These transactions are in effect collateralised loans
and are reported accordingly. The cash on loan is recognised as
Loans and Receivables. The amount of cash on loan in this regard is
nil (2019: GBP334 million) for the Group and nil (2019: GBP66
million) for Company.
The financial assets received as collateral were not recognised
on the balance sheet as the counterparty retains all risks and
rewards. The fair value of financial assets accepted as collateral
amounted to is nil (2019: GBP349 million) for the Group and nil
(2019: GBP69 million) for Company.
Collateral in respect of Bulk Annuity Business
Acceptable collateral is defined in each instance and must take
into account the quality and appropriateness of the proposed
collateral as well as being acceptable to the entity receiving the
collateral. Collateral may include cash, corporate bonds,
supranational debt and government debt.
During 2020, the Company purchased Bulk Annuity contracts which
provide buy in and buy-out solutions to defined benefit pension
schemes. To enter into the transaction some trustees may seek
collateral to cover the counterparty default scenario. Collateral
pledged in respect of Bulk Annuity business was GBP1,436 million
(2019: GBP1,471 million) for Group and Company.
(iii) Offsetting
The Group and Company are not offsetting under master netting
arrangements. Financial assets and liabilities are offset in the
statement of financial position when the Group and/or Company has a
legally enforceable right to offset and has the intention to settle
the asset and liability on a net basis, or to realise the asset and
settle the liability simultaneously.
a) Derivatives
The derivative assets and liabilities in the tables below
consist of OTC and exchange traded (ET) derivatives. The value of
gross/net amounts for derivatives in the table below comprises
those that are subject to master netting arrangements. The right to
set off balances under these master netting agreements or to set
off cash and securities collateral only arises in the event of non
payment or default and, as a result, these arrangements do not
qualify for offsetting under IAS 32. As a result no amount has been
set off in the balance sheet (2019: nil). Total derivatives
presented in the balance sheet are shown in note 20.
The 'financial instruments' amounts in the tables below show the
values that can be set off against the relevant derivatives asset
and liabilities in the event of default under master netting
agreements. In addition, the Group and the Company holds and
provides cash and securities collateral in respect of derivative
transactions to mitigate credit risks.
In the tables below, the amounts of derivative assets or
liabilities presented are offset first by financial instruments
that have the right of offset under master netting with any
remaining amount reduced by the amount collateral.
b) Repurchase and Reverse Repurchase Arrangements
The Group and the Company participates in repurchase (repo) and
reverse repurchase arrangements (reverse repo). The gross/net
amount in the table shows the relevant assets that the Group and
the Company has transferred to counterparties under these
arrangements. Cash and non cash collateral is received by the Group
and the Company for securities transferred. Cash collateral may be
reinvested by the Group and Company through reverse repo against
non cash collateral.
In the tables below, the amounts that are subject to repo and
reverse repo are set off against the amount of collateral received
according to the relevant legal agreements, showing the potential
net amounts.
The actual fair value of collateral may be greater than amounts
presented in the tables below in the case of over
collateralisation.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
(iii) Offsetting (continued)
b) Repurchase and Reverse Repurchase Arrangements (continued)
Group as at 31 December 2020
Related amounts
where set off
not permitted
in the balance
sheet
(sub note 2)
Net amounts
presented Potential
Amounts in the net amounts
Gross set off balance if offset
amounts in the sheet of related
of assets balance (sub Financial amounts
/ liabilities sheet note 1) instruments Collateral permitted
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------- -------------- -------- ----------- ------------ ---------- --------------
Financial assets
OTC Derivatives 5,169 - 5,169 (3,233) (2,225) (289)
ET Derivatives 55 - 55 (29) (26) -
Reverse Repo - - - - - -
Financial liabilities
OTC Derivatives (4,562) - (4,562) 3,233 1,695 366
ET Derivatives (46) - (46) 29 17 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
Group as at 31 December 2019
Related amounts
where set off
not permitted
in the balance
sheet
(sub note 2)
Net amounts
presented Potential
Amounts in the net amounts
Gross set off balance if offset
amounts in the sheet of related
of assets balance (sub Financial amounts
/ liabilities sheet note 1) instruments Collateral permitted
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------- -------------- -------- ----------- ------------ ---------- --------------
Financial assets
OTC Derivatives 3,923 - 3,923 (2,352) (1,499) 72
ET Derivatives 45 - 45 (7) (38) -
Repo - - - - - -
Reverse Repo 334 - 334 - (349) (15)
Financial liabilities
OTC Derivatives (3,409) - (3,409) 2,352 1,018 (39)
ET Derivatives (36) - (36) 7 29 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
(iii) Offsetting (continued)
b) Repurchase and Reverse Repurchase Arrangements (continued)
Company as at 31 December 2020
Related amounts
where set off
not permitted
in the balance
sheet
(sub note 2)
Gross Net amounts Potential
amounts presented net amounts
of assets Amounts in the if offset
/ liabilities set off balance of related
in the sheet amounts
balance (sub Financial permitted
sheet note 1) instruments Collateral
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------- -------------- -------- ----------- ------------ ---------- --------------
Financial assets
OTC Derivatives 5,093 - 5,093 (3,233) (2,185) (325)
ET Derivatives 39 - 39 (26) (13) -
Reverse Repo - - - - - -
Financial liabilities
OTC Derivatives (4,550) - (4,550) 3,233 1,689 372
ET Derivatives (40) - (40) 26 14 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
Company as at 31 December 2019
Related amounts
where set off
not permitted
in the balance
sheet
(sub note 2)
Gross Net amounts
amounts presented Potential
of assets Amounts in the net amounts
/ liabilities set off balance if offset
in the sheet of related
balance (sub Financial amounts
sheet note 1) instruments Collateral permitted
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------- -------------- -------- ----------- ------------ ---------- --------------
Financial assets
OTC Derivatives 3,872 - 3,872 (2,352) (1,467) 53
ET Derivatives 22 - 22 (1) (20) 1
Repo - - - - - -
Reverse Repo 66 - 66 - (69) (3)
Financial liabilities
OTC Derivatives (3,403) - (3,403) 2,352 1,018 (33)
ET Derivatives (31) - (31) 1 30 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
The following sub notes are relevant to the tables on this and
the preceding page:
1. The value of net amounts presented in the balance sheet for
derivatives comprises those derivatives held by the Group and the
Company that are subject to master netting arrangements. Total
derivatives presented in the balance sheet are shown in note
20.
37. Risk management (continued)
(c) Financial risks (continued)
(3) Credit risk (continued)
(iii) Offsetting (continued)
b) Repurchase and Reverse Repurchase Arrangements (continued)
2. The Group and the Company enters into derivative transactions
with various counterparties which are governed by industry standard
master netting agreements. The Group and the Company holds and
provides cash and securities collateral in respective of derivative
transactions covered by these agreements. The right to set off
balances under these master netting agreements or to set off cash
and securities collateral only arises in the event of non-payment
or default and, as a result, these arrangements do not qualify for
offsetting under IAS 32.
(4) Capital Risk
Capital risk is defined as the risk that the Group has a
sub-optimal quantity or quality of capital or that capital is
inefficiently deployed across the Group. The risk that:
-- the Group, or one of its separately regulated subsidiaries,
has insufficient capital to meet its regulatory capital
requirements
-- the Group has insufficient capital to provide a stable
resource to absorb all losses up to a confidence level defined in
the risk appetite
-- the Group loses reputational status by having capital that is
regarded as inappropriate, either in quantity, type or
distribution
The business of several of the companies within the Group is
regulated by the PRA and the FCA. The PRA rules, which incorporate
all Solvency II requirements, specify the minimum amount of capital
that must be held by the regulated companies within the Group in
addition to their insurance liabilities. Under the Solvency II
rules, each insurance Company within the Group must hold assets in
excess of this minimum amount, which is derived from an economic
capital assessment undertaken by each regulated Company and the
quality of capital held must also satisfy Solvency II tiering
rules. This is reviewed on a quarterly basis by the PRA.
The Solvency II minimum required capital must be maintained at
all-times throughout the year. These capital requirements and the
capital available to meet them are regularly estimated in order to
ensure that capital maintenance requirements are being met.
The Group's objectives when managing capital are:
- to have sufficient capital to safeguard the Group's ability to
continue as a going concern so that it can continue to provide
returns for the shareholder and benefits for other stakeholders
- to comply with the insurance capital requirements set out by the PRA in the UK
- when capital is needed, to require an adequate return to the
shareholder by pricing insurance and investment contracts according
to the level of risk associated with the business written; and
- to meet the requirements of the Schemes of Transfer
The capital management strategy is such that the integrated
insurance business (comprising Scottish Widows Group Limited (SWG)
and its subsidiaries, including the Group) will hold capital in
line with the stated risk appetite for the business, which is to be
able to withstand a one in ten year stress event without breaching
the capital requirements. At SWG level it is intended that all
surplus capital above that required to absorb a one in ten year
stress event will be distributed to Lloyds Banking Group.
Capital support arrangements are in place for SWUTM and SWAS,
which are provided by the Company. These irrevocable guarantees
will come into effect on the occurrence of a material operational
risk event impacting their respective capital positions. In
addition for SWAS only, these arrangements will also come into
effect on the occurrence of a material reinsurance fund default
event impacting its capital position. The Company has made these
arrangements to provide sufficient capital to meet the regulatory
capital adequacy and internal capital surplus requirements of these
subsidiaries if such events occur.
The Company's capital comprises all components of equity,
movements in which are set out in the statement of changes in
equity and includes subordinated debt (note 30).
The table below sets out the regulatory capital held
(specifically, eligible own funds, allowing for any year-end
foreseeable dividend, available to cover the solvency capital
requirement) at 31 December in each year for the Company on a
Solvency II basis. The current year information is an estimate of
the final result:
37. Risk management (continued)
(c) Financial risks (continued)
(4) Capital Risk (continued)
Company
2020 2019
GBPm GBPm
------------------------ ----- -------
Regulatory Capital held 7,434 7,724
------------------------ ----- -----
The solvency position reduced over 2020 due to the impacts of
the Covid-19 pandemic, but remains above risk appetite at 31
December 2020. The pandemic may impact credit assets further in
2021 and the Company continues to actively monitor and manage its
credit asset portfolio. This portfolio is average 'A' rated, well
diversified and non-cyclical, with less than 1 per cent invested in
sub investment grade or unrated assets.
All minimum regulatory requirements were met during the
year.
(5) Liquidity risk
Liquidity risk is defined as the risk that the Group does not
have sufficient financial resources to meet its commitments as they
fall due, or can only secure them at excessive cost.
Liquidity risk may result from either the inability to sell
financial assets quickly at their fair values; or from an insurance
liability falling due for payment earlier than expected; or from
the inability to generate cash inflows as anticipated.
Liquidity risk has been analysed as arising from payments to
policyholders (including those where payment is at the discretion
of the policyholder) and non policyholder related activity (such as
investment purchases and the payment of shareholder expenses).
In order to measure liquidity risk exposure the Group's
liquidity is assessed in a stress scenario. Liquidity risk is
actively managed and monitored to ensure that, even under stress
conditions, the Company and Group has sufficient liquidity to meet
its obligations and remains within approved risk appetite.
Liquidity risk appetite considers two time periods; three month
stressed outflows are required to be covered by primary liquid
assets; and one-year stressed outflows are required to be covered
by primary and secondary liquid assets. Primary liquid assets are
gilts or cash, and secondary liquid assets are corporate bonds. The
stressed outflows also make allowance for the increased collateral
that needs to be posted under derivative contracts in stressed
conditions. Liquidity risk is actively managed and monitored to
ensure that, even under stress conditions, the Group has sufficient
liquidity to meet its obligations and remains within approved risk
appetite.
Liquidity risk is managed in line with the Insurance Liquidity
Risk Policy and the wider Lloyds Banking Group Funding and
Liquidity Policy. Liquidity risk in respect of each of the major
product areas is primarily mitigated as follows:
Annuity contracts
Assets are held which are specifically chosen to correspond to
the expectation of timing of annuity payments. Gilts, corporate
bonds, loans and, where required, derivatives are selected to
reflect the expected annuity payments as closely as possible and
are regularly rebalanced to ensure that this remains the case in
future.
With Profits contracts
For With Profits business, a portfolio of assets is held in line
with investment mandates which will reflect policyholders'
reasonable expectations.
Liquidity is maintained within the portfolio via the holding of
cash balances and a substantial number of highly liquid assets,
principally gilts, bonds and listed equities.
Non-participating contracts
For unit-linked products, portfolios are invested in accordance
with unit fund mandates. Deferral clauses are included in
policyholder contracts to give time, when necessary, to realise
linked assets without being a forced seller. As at 31 December
2020, there are no funds under management subject to deferral
(2019: none).
For non-linked products other than annuity contracts, backing
investments are mostly held in gilts with minimal liquidity risk.
Investments are arranged to minimise the possibility of being a
distressed seller whilst at the same time investing to meet
policyholder obligations. This is achieved by anticipating
policyholder behaviour and sales of underlying assets within
funds.
37. Risk management (continued)
(c) Financial risks (continued)
(5) Liquidity risk (continued)
Shareholder funds
For shareholder funds, liquidity is maintained within the
portfolio via the holding of cash balances and a substantial number
of highly liquid assets, principally gilts and bonds.
The following tables indicate the timing of the contractual cash
flows arising from the Group and Company's financial liabilities,
as required by IFRS 7. The table is based on the undiscounted cash
flows of financial liabilities based on the earliest date on which
the Group and Company are obliged to pay. The table includes both
interest and principal cash flows.
Liquidity risk in respect of liabilities arising from insurance
contracts and participating investment contracts has been analysed
based on the expected pattern of maturities as permitted by IFRS 4
rather than by contractual maturity. A maturity analysis of
liabilities arising from non-participating investment contracts
based on expected contract maturities is also given as it is
considered that this analysis provides additional useful
information in respect of the liquidity risk relating to contracts
written by the Group and Company.
Group As at 31 December Contractual cash flows
2020
Liabilities Carrying No stated Less 1-3 months 3-12 1-5 years More
amount maturity than months than
1 month 5 years
GBPm GBPm GBPm GBPm GBPm GBPm GBPm
-------------------------- -------- --------- -------- ---------- ------- --------- ----------
Liabilities arising
from non-participating
investment contracts 38,448 - 38,448 - - - -
External interests
in collective investment
vehicles 12,620 12,620 - - - - -
Derivatives held
for trading 4,609 - 49 81 139 837 3,673
Subordinated debt 1,892 - - - 113 1,074 1,420
Borrowings 2 - 2 - - - -
Lease liabilities 80 - - - 1 2 77
Other financial
liabilities 2,214 229 1,961 15 9 - -
-------------------------- -------- --------- -------- ---------- ------- --------- --------
Total 59,865 12,849 40,460 96 262 1,913 5,170
-------------------------- -------- --------- -------- ---------- ------- --------- --------
Group As at 31 December Contractual cash flows
2019
Carrying No stated Less 1-3 months 3-12 1-5 years More
amount maturity than months than
Liabilities 1 month 5 years
GBPm GBPm GBPm GBPm GBPm GBPm GBPm
-------------------------- -------- --------- -------- ---------- ------- --------- ----------
Liabilities arising
from non-participating
investment contracts 37,456 - 37,456 - - - -
External interests
in collective investment
vehicles 11,966 11,855 - - - - -
Derivatives held
for trading 3,445 - 16 67 110 677 2,872
Subordinated debt 1,795 - - - 112 1,128 1,465
Borrowings 3 - 3 - - - -
Lease liabilities 197 - - - 2 7 188
Other financial
liabilities 1,889 297 1,557 28 7 - -
-------------------------- -------- --------- -------- ---------- ------- --------- --------
Total 56,751 12,152 39,032 95 231 1,812 4,525
-------------------------- -------- --------- -------- ---------- ------- --------- --------
The contractual cash flow analysis set out above has been based
on the earliest possible contractual date, regardless of the
surrender penalties that might apply and has not been adjusted to
take account of such penalties.
37. Risk management (continued)
(c) Financial risks (continued)
(5) Liquidity risk (continued)
An analysis of the contractual cash flows in respect of
insurance and investment contract liabilities by expected contract
maturity, on a discounted basis, is shown below:
Group As at 31 December More
2020 Less than
than 1-3 3-12 1-5 5
Total 1 month months months years years
Maturity Analysis for
liabilities arising from
insurance and investment
contracts GBPm GBPm GBPm GBPm GBPm GBPm
----------------------------- ------- -------- ------- ------- ------ --------
Insurance and participating
investment contracts 115,965 866 1,257 3,964 25,702 84,176
Non-participating investment
contracts 38,448 469 537 2,363 11,510 23,569
----------------------------- ------- -------- ------- ------- ------ ------
Group As at 31 December More
2019 Less than
than 1-3 3-12 1-5 5
Total 1 month Months months years years
Maturity Analysis for
liabilities arising from
insurance and investment
contracts GBPm GBPm GBPm GBPm GBPm GBPm
----------------------------- ------- -------- ------- ------- ------ --------
Insurance and participating
investment contracts 110,919 893 1,335 4,020 26,343 78,328
Non-participating investment
contracts 37,456 334 360 1,596 8,077 27,089
----------------------------- ------- -------- ------- ------- ------ ------
Company As at 31 Contractual cash flows
December 2020
Less More
Carrying No stated than 3-12 than
amount maturity 1 month 1-3 months months 1-5 years 5 years
Liabilities GBPm GBPm GBPm GBPm GBPm GBPm GBPm
Liabilities arising
from non-participating
investment contracts 38,433 - 38,433 - - - -
Derivative financial
instruments 4,590 - 40 71 138 837 3,673
Subordinated debt 1,923 - - - 92 1,100 1,444
Other financial
liabilities 1,972 229 1,743 - - - -
------------------------ -------- --------- -------- ---------- ------- --------- --------
Total 46,920 229 40,218 71 230 1,937 5,117
------------------------ -------- --------- -------- ---------- ------- --------- --------
37. Risk management (continued)
(c) Financial risks (continued)
(5) Liquidity risk (continued)
Company As at 31 December Contractual cash flows
2019
Less More
Carrying No stated than 3-12 than
amount maturity 1 month 1-3 months months 1-5 years 5 years
Liabilities GBPm GBPm GBPm GBPm GBPm GBPm GBPm
Liabilities arising
from non-participating
investment contracts 37,455 - 37,455 - - - -
Derivative financial
instruments 3,434 - 10 62 110 677 2,872
Subordinated debt 1,820 - - - 92 1,147 1,490
Other financial liabilities 1,422 313 1,109 - - - -
---------------------------- -------- --------- -------- ---------- ------- --------- --------
Total 44,131 313 38,574 62 202 1,824 4,362
---------------------------- -------- --------- -------- ---------- ------- --------- --------
The contractual cash flow analysis set out above has been based
on the earliest possible contractual date, regardless of the
surrender penalties that might apply and has not been adjusted to
take account of such penalties.
An analysis of liabilities arising from insurance and investment
contracts by expected contract maturity, on a discounted basis, is
shown below:
Company As at 31 December More
2020 Less than
than 1-3 3-12 1-5 5
Total 1 month months months years years
Maturity Analysis for
liabilities arising from
insurance contracts and
investment contracts GBPm GBPm GBPm GBPm GBPm GBPm
----------------------------- ------- -------- ------- ------- ------ --------
Insurance and participating
investment contracts 115,487 851 1,227 5,329 25,107 82,972
Non-participating investment
contracts 38,433 469 536 2,361 11,504 23,563
----------------------------- ------- -------- ------- ------- ------ ------
(d) Non-financial risks
The Group faces a variety of non-financial risks through its
operations and service provision. The Group manages these risks by
following the embedded Risk Management Framework, which uses
methodologies and systems consistent with those implemented across
the Group. The various stages of the framework are:
Identification
-- Risks identified in products, processes, channels, customers and people
-- Emerging risks
-- Changes to the risk profile through on-going tracking,
pricing reviews and monitoring of external factors
-- Change Management at project, programme or portfolio level
-- Implement Risk and Control Framework and standards, including
loss estimation and provisioning
Measurement
-- Evaluate risk exposure vs appetite
-- Modelling and stress testing, including Internal Model outputs
-- Actual vs expected losses
-- Scenario analysis
-- Reverse stress testing
37. Risk management (continued)
(d) Non-financial risks (continued)
Management
-- Identify and operate controls
-- Perform day-to-day control activities
-- Ensure appropriate segregation of duties
-- Control assessment and estimation of residual risk
-- Controls testing activities including Sarbanes-Oxley and Own
Risk and Solvency Assessment (ORSA) review
-- Effectiveness reviews
Monitoring
-- Performance vs risk appetite
-- Internal Model performance monitoring
-- Risk metrics on for example products, processes, customer experience, service, retention
-- Change portfolio
-- Regulatory and external environment
-- Quality checking
-- Action management
Reporting
-- Monthly Executive Risk Reporting presented through the
corporate governance structure leads to top down review and
challenge evidenced via the Insurance Consolidated Risk Report
-- Material Events escalation, including related actions
-- ORSA reporting
The primary non-financial risk categories are:
Conduct risk
Conduct risk is defined as the risk of customer detriment across
the customer lifecycle including: failures in product management,
distribution and servicing activities; from other risks
materialising, or other activities which could undermine the
integrity of the market or distort competition, leading to unfair
customer outcomes, regulatory censure, reputational damage or
financial loss.
Governance risk
Governance risk is defined as the risk that the Group's
organisational infrastructure fails to provide robust oversight of
decision-making and the control mechanisms to ensure strategies and
management instructions are implemented effectively.
Model risk
The risk of financial loss, regulatory censure, reputational
damage or customer detriment, as a result of deficiencies in the
development, application and on-going operation of Models and
Ratings systems.
Operational risk
Operational risk is defined as the risk of loss from inadequate
or failed internal processes, people and systems or from external
events. As operational risk covers such a range of elements, there
are secondary risk-types within this area, including:
- Change risk
Change risk is defined as the risk that, in delivering its
change agenda, the Group fails to ensure compliance with laws and
regulation, maintain effective customer service and availability,
and/or operate within the Group's risk appetite.
37. Risk management (continued)
(d) Non-financial risks (continued)
Operational risk (continued)
- Cyber and information security
The risk of financial loss, disruption or damage to the
reputation of Lloyds Banking Group from a malicious attack that
impacts the confidentiality and/or integrity of electronic data or
the availability of systems. The risk also to the security of
information and data.
- Data management
The risk that the Group fails to effectively govern, manage and
protect its data (or the data shared with Third-Party Suppliers)
impacting the Group's agility, accuracy, access and availability of
data, ultimately leading to poor customer outcomes, loss of value
to the Group and mistrust from regulators.
- Financial crime
Financial crime is the risk of acts intended to bribe, corrupt,
launder money, fund terrorist activity or circumvent sanctions
intended for personal gain or to cause loss to another party, by
customers/clients, suppliers, third parties or colleagues.
- Financial reporting risk
Financial reporting risk is defined as the risk that the Group
suffers reputational damage, loss of investor confidence and/or
financial loss arising from the adoption of inappropriate
accounting policies, ineffective controls over business or finance
processes impacting financial, prudential regulatory, and tax
reporting, failure to manage the associated risks of changes in
taxation rates, law, corporate ownership or structure and the
failure to disclose timely and appropriate information in
accordance with regulatory requirements.
- Fraud
The risk of acts of deception or omission intended for personal
gain or to cause loss to another party, by customers/clients, third
parties or colleagues,
- Internal service provision
The risk associated with the management of internal service
arrangements.
- IT systems
The risk of failure in technology governance and the
development, delivery and maintenance of effective IT
solutions.
- Operational resilience risk
Operational resilience risk covers the risk that the Group fails
to design resilience into business operations, underlying
infrastructure and controls (people, process, technical) so that it
is able to withstand external or internal events which could impact
the continuation of operations, and fails to respond in a way which
meets stakeholder expectations and needs when the continuity of
operations is compromised.
- Physical security risk
The risk to the security of people and property (including
damage (malicious or non-malicious) to
Lloyds Banking Group branches and buildings managed through
Group Property).
- Sourcing
Sourcing risk covers the risk associated with the activity
related to the agreement and management of services provided by
third parties including outsourcing (excludes internal service
arrangements).
People risk
People risk is defined as the risk that the Group fails to
provide an appropriate colleague and customer-centric culture,
supported by robust regard and wellbeing policies and processes;
effective leadership to manage colleague resources; effective
talent and succession management; and robust control to ensure all
colleague-related requirements are met.
37. Risk management (continued)
(d) Non-financial risks (continued)
Regulatory and legal risk
The risk of financial penalties, regulatory censure, criminal or
civil enforcement action or customer detriment as a result of
failure to identify, assess, correctly interpret, comply with, or
manage regulatory and/or legal requirements.
(e) UK political uncertainties including EU exit
The UK / EU Trade and Cooperation Agreement means a disorderly
Brexit has been avoided. While the TCA contains limited, high-level
provisions on financial services, further detail is expected to
emerge during this year, and the Group will continue to monitor
developments closely. In advance of the UK leaving the EU, a
European subsidiary (SWE) was created to ensure continuity of
certain insurance business for EEA customers. As a result of
Brexit, some customers' bank accounts have had to be closed,
meaning these customers will need to set up alternative payment
arrangements to continue other Group products and services,
including savings, investments and insurance cover. Measures have
been put in place to support affected customers, although to date
customer responses remain low. The Group continues to monitor the
wider post-Brexit environment, including for market volatility.
Scenario planning exercises are performed as part of business as
usual, while contingency plans have been recalibrated and are
regularly reviewed for potential strategic, operational and
reputational impacts.
(f) Economic Risk
UK economic growth is muted due to impacts from the Covid-19
pandemic and political uncertainty. High levels of credit market
liquidity have reduced spreads and weakened terms in some sectors,
creating a potential under-pricing of risk and heightened risk of a
market correction. The Group's response is:
-- The Group has a robust through the cycle credit risk
appetite, including individual limit guidelines, specific sector
appetite statements and policies, and affordability and
indebtedness controls at origination. In addition to on-going
focused monitoring, we conduct portfolio deep dives and larger
exposure reviews. We have enhanced our use of early warning
indicators including sector specific indicators
-- Capital and liquidity are reviewed regularly through
committees, ensuring compliance with risk appetite and regulatory
requirements
-- Internal contingency plans recalibrated and regularly
reviewed for potential strategic, operational and reputational
impacts
-- Wide array of risks considered in setting strategic plans
Additionally, the Covid-19 outbreak and related global health
issues are impacting economies and markets. More detail is given in
respect of market risk (note 37 (c) (1)), insurance underwriting
risk (note 37 (c) (2)), credit risk (note 37 (c) (3)) and capital
risk (note 37 (c) (4)).
RELATED PARTY TRANSACTIONS
38. Related party transactions
(a) Ultimate parent and shareholding
The Group's immediate parent undertaking is Scottish Widows
Group Limited, a Company registered in the United Kingdom. Scottish
Widows Group Limited has taken advantage of the provisions of the
Companies Act 2006 and has not produced consolidated financial
statements.
The ultimate parent undertaking and controlling party is Lloyds
Banking Group which is the parent undertaking of the only group to
consolidate these financial statements. Once approved, copies of
the consolidated Annual Report and Accounts of Lloyds Banking Group
may be obtained from Lloyds Banking Group's head office at 25
Gresham Street, London EC2V 7HN or downloaded via
www.lloydsbankinggroup.com.
(b) Transactions with other Lloyds Banking Group companies
In accordance with IAS 24 'Related Party Disclosures',
transactions and balances between Group companies have been
eliminated on consolidation and have not been reported as part of
the consolidated financial statements.
The Group has entered into transactions with related parties in
the normal course of business during the year.
2020
Income Expenses Payable Receivable
during during at period at period
period period end end
GBPm GBPm GBPm GBPm
---------------------- ------- -------- ---------- ------------
Relationship
Parent 14 (560) - 348
Other related parties 403 (848) (1,671) 2,762
---------------------- ------- -------- ---------- ----------
2019
Income Expenses Payable Receivable
during during at period at period
period period end end
GBPm GBPm GBPm GBPm
---------------------- ------- -------- ---------- ------------
Relationship
Parent 15 (300) - 351
Other related parties 335 (822) (1,831) 2,275
---------------------- ------- -------- ---------- ----------
The Company has entered into transactions with related parties
in the normal course of business during the year. Holdings by the
Group, including consolidated OEIC investments, give rise to GBP219
million (2019: GBP574 million) of shares in the ultimate parent
undertaking on the balance sheet, with associated transactions of
GBP(90) million (2019: GBP(30) million) during the year.
38. Related party transactions (continued)
(b) Transactions with other Lloyds Banking Group companies (continued)
2020
Income Expenses Payable Receivable
during during at period at period
period period end end
GBPm GBPm GBPm GBPm
---------------------- ------- -------- ---------- ------------
Relationship
Parent 14 (560) - 348
Subsidiary 352 (233) (1,679) 675
Other related parties 386 (713) (1,651) 2,650
---------------------- ------- -------- ---------- ----------
2019
Income Expenses Payable Receivable
during during at period at period
period period end end
GBPm GBPm GBPm GBPm
---------------------- ------- -------- ---------- ------------
Relationship
Parent 15 (300) - 351
Subsidiary 1,588 (88) (1,612) 662
Other related parties 335 (743) (1,826) 2,175
---------------------- ------- -------- ---------- ----------
Further, amounts relating to other related parties of GBP2,234
million due from OEICs investments were outstanding at 31 December
2020 (2019: GBP3,418 million). The above balances are unsecured in
nature and are expected to be settled in cash.
Included within the consolidated statement of comprehensive
income were net (expense)/income amounts related to other parties
of GBP(9) million (2019: GBP330 million) from OEIC investments.
Parent undertaking transactions relate to all reported
transactions and balances with Scottish Widows Group Limited, the
Group's immediate parent. Such transactions with the parent Company
are primarily financing (through capital and subordinated debt),
provision of loans and payment of dividends.
Transactions with other related parties (which includes
Subsidiary and Other categories above) are primarily in relation to
operating and employee expenses.
(c) Transactions between the Group and entity employing key management
Key management personnel are those persons having authority and
responsibility for planning, directing and controlling the
activities of the Company which, for the Company, are all Directors
and Insurance and Wealth Executive Committee (IWEC) members. Key
management personnel, as defined by IAS 24, are employed by a
management entity, transactions with this entity are as
follows:
Key management compensation:
2020 2020 2019 2019
GBPm GBPm GBPm GBPm
----------------------------- ----- ------- ----- ---------
Group Company Group Company
Short-term employee benefits 5 5 7 7
Share-based payments 1 1 2 2
----------------------------- ----- ------- ----- -------
Total 6 6 9 9
----------------------------- ----- ------- ----- -------
Included in short-term employee benefits is the aggregate amount
of emoluments paid to or receivable by Directors in respect of
qualifying services of GBP2 million (2019: GBP3 million).
There were no retirement benefits accruing to Directors (2019:
nil) under defined benefit pension schemes. Two Directors (2019:
three Directors) are paying into a defined contribution scheme.
There were no contributions paid to a pension scheme for qualifying
services (2019: nil) for Group and Company.
Certain members of key management in the Group, including the
highest paid Director, provide services to other companies within
Lloyds Banking Group. In such cases, for the purposes of this note,
figures have been included based on an apportionment to the Group
of the total compensation earned.
38. Related party transactions (continued)
(c) Transactions between the Group and entity employing key management (continued)
The aggregate amount of money receivable and the net value of
assets received/receivable under share-based incentive schemes in
respect of Directors qualifying services was one (2019: GBP1
million). During the year, two Director exercised share options
(2019: two Directors) and two Directors received qualifying service
shares under long-term incentive schemes (2019: three Directors).
Movements in share options are as follows:
2020 2019
GBPm GBPm
Options Options
--------------- ------- ---------
Outstanding at
1 January 15 15
Granted 11 8
Exercised (4) (4)
Forfeited (6) (4)
Outstanding at
31 December 16 15
----------------- ------- -------
Detail regarding the highest paid Director is as follows:
2020 2020 2019 2019
GBPm GBPm GBPm GBPm
--------------------------------- ----- ------- ----- ---------
Group Company Group Company
Apportioned aggregate emoluments 1 1 2 2
Apportioned share-based payments - - 1 1
The highest paid Director did not exercise share options during
the year. (2019: The highest paid Director did exercise share
options during the year).
Further details of the above can also be obtained by contacting
Secretariat, Insurance, Lloyds Banking Group plc, Level 7 Block E,
Port Hamilton, 69 Morrison Street, Edinburgh EH3 8YF.
LEI NUMBER: 549300ZT0RVWCG8T4L55
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END
FR GCGDXGSDDGBU
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March 25, 2021 05:53 ET (09:53 GMT)
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