TIDM40VY
RNS Number : 6656H
Scottish Widows Limited
07 April 2022
7 April 2022
SCOTTISH WIDOWS LIMITED
PUBLICATION OF THE ANNUAL REPORT AND ACCOUNTS FOR THE YEARED 31
DECEMBER 2021
Scottish Widows Limited has published its Annual Report and
Accounts for the year ended 31 December 2021 (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, UK-adopted
international accounting standards in conformity with the
requirements of the Companies Act 2006 have been followed, subject
to any material departures disclosed and explained in the financial
statements
-- make judgements 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 and Company financial statements which have been
prepared in accordance with UK-adopted international accounting
standards in conformity with the requirements of the Companies Act
2006, give a true and fair view of the assets, liabilities,
financial position and financial performance of the Group and
Company
-- the Group Strategic Report on pages 4 to 16, and the
Directors' Report on pages 17 to 23 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
Risks and uncertainties to our strategic plan, both positive and
negative, are considered by product through the planning process.
The following table describes the principal risks faced by the
Group. Further details on financial risks and how the Group
mitigates them can be found in note 36, as shown by the note
reference.
Financial risks
Principal
Risk Note reference Description
------------- -------------- ----------------------------------------------------------
Market risk 36(a) 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. External rates are outwith the Group's
control, so mitigation is via having sufficient
financial reserves to cover reduced earnings,
and using hedging strategies (see note 19).
Insurance 36(b) Insurance underwriting risk is defined as the
underwriting risk of adverse developments in the timing,
risk frequency and severity of claims for insured/underwritten
events and in customer behaviour, leading to
reductions in earnings and/or value. Specific
risks include mortality risk, morbidity risk
and persistency risk. In order to mitigate insurance
underwriting risk, the Group uses underwriting,
reinsurance, pricing-to-risk, claims management,
product design, policy wording, and demographics
to accurately assess mortality risk.
Credit risk 36(c) 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.
Credit risk is mitigated via the Credit Risk
Policy framework, which ensures exposures are
appropriately monitored and action taken where
necessary.
Capital risk 36(d) 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.
The business of the Group is regulated by the
PRA. The PRA specifies the minimum amount of
capital that must be held by the Company in
addition to its liabilities.
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 requires
it to hold capital in line with the stated risk
appetite for the business, which is to be able
to withstand high-severity stress events without
breaching the capital requirements. Capital
risk is managed via the Capital Risk Policy,
which includes tools and governance to monitor
capital requirements and assign capital accordingly.
Liquidity 36(e) 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). Liquidity risk is mitigated by applying
the Liquidity Risk Policy, which includes controls
to maintain liquidity at necessary levels.
Non-financial risks
Principal
Risk Description
-------------- --------------------------------------------------------------
Operational Operational risk is the risk of loss from inadequate or
risk failed internal processes, people and systems or from
external events. This includes risks around cyber and
information security, provision of external and internal
services, financial crimes, financial reporting risk,
fraud, IT systems, and security. Operational risk is managed
through an operational risk framework, including a Risk
and Control Self-Assessment (RCSA) process, and operational
risk policies.
The Group maintains a formal approach to operational risk
event escalation, whereby material events are identified,
captured and escalated. Root causes of events are determined,
and action plans put in place to ensure an optimum level
of control to keep customers and the business safe, reduce
costs, and improve efficiency.
Data risk Data risk is defined as the risk of failing to effectively
govern, manage and control data (including data processed
by third party suppliers), leading to unethical decisions,
poor customer outcomes, loss of value and mistrust. It
is present in all aspects of the business where data is
processed, both within the company and by third parties.
This risk is measured through a series of quantitative
and qualitative indicators, covering data governance,
data management, records management, data privacy and
ethics. Data risks and controls are monitored and governed
in line with an embedded risk management framework, which
involves identification, measurement, management, monitoring
and reporting.
Long term Risks arising from uncertainties in respect of the medium
impact of to long-term implications of the UK's exit from the EU
the UK's exit on trade, regulation and employment. The Group continues
from the EU to monitor the wider environment post EU exit, including
for market volatility. Scenario planning exercises are
performed as part of the business as usual, while contingency
plans are regularly reviewed for potential strategic,
operational and reputational impacts.
Climate risk The Group is exposed to climate risk through transition
and physical risks. The Group considers the impact of
climate risk as a risk driver on other risks types, such
as credit risk, market risk, and operational risk. Climate
risk is mitigated via the application of the Climate Risk
Policy, and actions taken to address other risk types.
In addition, as described in note 27, 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.
All such material matters are periodically reassessed, with the
assistance of external professional advisors where appropriate, to
determine the likelihood of the Group incurring a liability. In
those instances where it is concluded that it is more likely than
not that a payment will be made, a provision is established to
management's best estimate of the amount required at the relevant
balance sheet date. In some cases it will not be possible to form a
view, for example because the facts are unclear or because further
time is needed to properly assess the situation, and no provisions
are held in relation to such matters. However the Group does not
currently expect the final outcome of any such case to have a
material adverse effect on its financial position, operations or
cash flows.
36. 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 financial risks and the way in which
they are managed.
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 number 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.
36. Risk management (continued)
(a) 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.
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. This is
an economic hedge designed to mitigate the effects of the equity
market on profit
- 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 (as annuity rates are determined by interest
rates)
Below is an analysis of the carrying values 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 2021
Fair value hierarchy
Level 1 Level 2 Level 3 Total
GBPm GBPm GBPm GBPm
------------------------------------------- -------- ------- ------- --------
Investment properties - - 3,588 3,588
Contracts with reinsurers at
fair value through profit or
loss - 12,371 - 12,371
Shares and other variable yield
securities 116,066 4 526 116,596
Debt and other fixed/variable
income securities 11,129 27,639 224 38,992
Loans and advances to customers - - 9,395 9,395
Loans and advances to banks - 4,084 - 4,084
Derivative financial assets 43 2,543 257 2,843
------------------------------------------- -------- ------- ------- --------
Total assets 127,238 46,641 13,990 187,869
------------------------------------------- -------- ------- ------- --------
Derivative financial liabilities 63 2,445 - 2,508
Liabilities arising from non-participating
investment contracts - 45,035 - 45,035
Subordinated debt - 1,753 - 1,753
------------------------------------------- -------- ------- ------- --------
Total liabilities 63 49,233 - 49,296
------------------------------------------- -------- ------- ------- --------
For all financial assets held at amortised cost by the Group and
Company, carrying value is a reasonable approximation of fair
value. The fair value of subordinated debt is presented in note
29.
36. Risk management (continued)
(a) Market risk (continued)
Company As at 31 December 2021
Fair value hierarchy
Level 1 Level 2 Level 3 Total
GBPm GBPm GBPm GBPm
------------------------------------------- -------- ------- ------- --------
Investment properties - - 118 118
Contracts with reinsurers at
fair value through profit or
loss - 12,371 - 12,371
Shares and other variable yield
securities 130,261 - 581 130,842
Debt and other fixed/variable
income securities 7,334 7,033 809 15,176
Loans and advances to customers - - 8,910 8,910
Loans and advances to banks - 1,274 - 1,274
Deposits with cedants - 1,447 - 1,447
Derivative financial assets 17 2,446 257 2,720
------------------------------------------- -------- ------- ------- --------
Total assets 137,612 24,571 10,675 172,858
------------------------------------------- -------- ------- ------- --------
Derivative financial liabilities 54 2,375 - 2,429
Liabilities arising from non-participating
investment contracts - 45,016 - 45,016
Subordinated debt - 1,786 - 1,786
------------------------------------------- -------- ------- ------- --------
Total liabilities 54 49,177 - 49,231
------------------------------------------- -------- ------- ------- --------
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 2020
Fair value hierarchy
Level 1 Level 2 Level 3 Total
GBPm GBPm GBPm GBPm
------------------------------------------- -------- ------- ------- --------
Investment properties - - 3,324 3,324
Contracts with reinsurers 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
------------------------------------------- -------- ------- ------- --------
36. Risk management (continued)
(a) Market risk (continued)
Company As at 31 December 2020
Fair value hierarchy
Level 1 Level 2 Level 3 Total
GBPm GBPm GBPm GBPm
------------------------------------------- -------- ------- ------- --------
Investment properties - - 120 120
Contracts with reinsurers 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
------------------------------------------- -------- ------- ------- --------
Contracts with reinsurers 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 these types of contracts 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. Investment property is independently valued as
described in the Property section of this note below.
COVID-19
Markets in 2021 have been less volatile than in 2020 although
pandemic related sector uncertainties remain as well as new
inflationary pressures. Equity markets have risen over the last six
months increasing the value of collective investments and driving
the rise in value in the linked portfolio assets. The shape of the
risk-free interest rate curve has changed significantly during the
second half of 2021, with rising interest rates at the short end of
the curve but rate falls at the long end creating a more negatively
sloped GBP curve. Inflationary pressures have seen the short end of
the Retail Price Index (RPI) curves also rise sharply and become
more negatively sloped. The majority of the debt security and
illiquid credit asset positions have seen value declines as a
result of rising rates. Credit spread moves have been more subdued,
but with some steepening amongst investment grade ratings.
The following valuation methods and sensitivity of valuation
assumptions are applied to both the Group and the Company.
36. Risk management (continued)
(a) 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 GBP8.8 billion (2020: GBP9.1
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 into 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 GBP402
million (2020: GBP575 million) or increase it by GBP442 million
(2020: GBP454 million). The impact of alternative assumptions,
mainly related to credit spread and illiquidity premium
sensitivities would be -4.6 per cent (2020: -6.3 per cent) to base
in adverse scenario and +5.1 per cent (2020: +5.0 per cent) to base
in the favourable scenario. The skew observed in 2021 is less
pronounced than 2020 due to refinements in the interplay between
rating and sector spread uncertainty and changes in the dispersion
of base market data.
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 GBP327 million
(2020: GBP379 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 GBP20
million (2020: GBP21 million) or increase it by GBP17 million
(2020: GBP13 million). Impact of alternative assumptions on credit
spread, illiquidity premium and prepayment assumptions is -6.1 per
cent (2020: -5.5 per cent) to base in the adverse scenario and +5.2
per cent (2020: +3.5 per cent) to base in the favourable
scenario.
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 cashflow approach. The spread is derived using expert
judgement, supported by spreads in comparable LTM Mortgages against
changes in the expected performance of the underlying mortgage
portfolio. 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, Junior 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
assessed by reference to the current comparable lifetime mortgages
market, 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 (NNEG) for Lifetime Mortgages is valued
using a time-dependent Black-Scholes model. The value of NNEG is
GBP9 million (2020: GBP14 million).
Inputs in the valuation model include the gross interest rate
applicable to a notional portfolio of comparable 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 GBP162
million (2020: 176 million). December 2021 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
the notional portfolio rate assumption was 3.95 per cent to 4.30
per cent (2020: 3.50 per cent to 4.27 per cent).
36. Risk management (continued)
(a) Market risk (continued)
Securitised Lifetime Mortgages (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 (2020: GBP5 million) or increase it by GBP5 million (2020:
GBP9 million). The impact of alternative assumptions on credit
spread and illiquidity premium is -2.5 per cent (2020: -2.9 per
cent) to base in the adverse scenario and +3 per cent (2020: +5 per
cent) 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 the Company. The
loans are being warehoused with the intention to securitise in
2022.
The valuation methodology uses the same principles as that for
the securitised historical 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.
The base valuation of Originated Lifetime Mortgage is GBP123
million (2020: GBP16 million). December 2021 Valuation Uncertainty
calculations principally reflect uncertainty in the market rates
and acquisition costs of comparable notional portfolios and their
corresponding impact on the loan portfolio values. 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 GBP3 million (2020: GBP0.7
million) or increase it by GBP5 million (2020: GBP0.3 million). The
increase in this range year-on-year is due to the significant
increase of new loan origination throughout 2021. The range of
Notional Interest Rates as of December 2021 for the Favourable
scenario was 2.76 per cent to 3.41 per cent (2020: 2.48 per cent to
3.66 per cent) and for the Adverse Scenario was 2.99 per cent to
3.79 per cent (2020: 2.68 per cent to 4.18 per cent) compared to
Base case range of 2.93 per cent to 3.41 per cent (2020: 2.54 per
cent to 3.66 per cent).
ERM Public Securitisation
On 2 November 2021 the Company purchased a new public
securitisation of UK Lifetime Mortgages sponsored by RGA Americas
Reinsurance Company Ltd (RGA). The origination of the underlying
Lifetime Mortgages is by More2Life (M2L). The assets purchased are
GBP25 million of the Class A1 notes and GBP8 million of the Class
A2 notes.
The assets are classified as Level 3 and are included within
Asset Backed Securities. The valuation for the Class A1 notes as of
Dec 2021 was GBP26 million and the Class A2 notes valuation is GBP8
million. The valuation of these assets is provided by the lead
manager on a monthly basis.
Private Credit Funds
The Company holds investments in two private credit funds that
hold portfolios to European medium sized enterprises. 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 flows 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.
The fair value of Private Credit Funds is GBP456 million (2020:
GBP544 million) as valued by the fund manager. The effect of
applying reasonably possible alternative assumptions to the value
of these assets would be to decrease the fair value by GBP11
million (2020: GBP19 million) or increase it by GBP10 million
(2020: GBP3 million). For Pemberton European Mid-Market Debt Fund
II (E) (Pemberton), the impact of alternative assumptions on credit
spread and illiquidity premium is -2.5 per cent (2020: -2.0 per
cent) to base in the adverse scenario and 2.1 per cent (2020: 0 per
cent) to base in the favourable. The stable credit spread
environment has meant there is now a favourable scenario related to
these positions as compared to the fund managers pricing model.
For AgFe UK Real Estate Senior Debt Fund LP (AgFe), the fair
valuations are provided by the fund manager. For the assessment of
valuation uncertainty alternative assumptions on debt margin for
the underlying loans are applied, resulting in a -1.9 per cent
(2020: -5.9 per cent) to base in the adverse scenario and +1.9 per
cent (2020: +1.9 per cent) to base in favourable scenario.
36. Risk management (continued)
(a) Market risk (continued)
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 GBP359 million (2020:
GBP567 million). The effect of applying reasonably possible
alternative assumptions to the value of these assets would be to
decrease the fair value by GBP84 million (2020: GBP62 million) or
increase it by GBP23 million (2020: GBP20 million). The impact of
alternative assumptions is -23.3 per cent (2020: -10.9 per cent) to
base in the adverse scenario and +6.4 per cent (2020: +3.5 per
cent) to base in the favourable scenario.
Property
Investment properties are valued by external Chartered Surveyors
using industry standard techniques based on guidance from the Royal
Institute of Chartered Surveyors. The valuation methodology
includes an assessment of general market conditions and sector
level transactions and takes account of expectations of occupancy
rates, rental income and growth. Properties undergo individual
scrutiny using cash flow analysis to factor in the timing of rental
reviews, capital expenditure, lease incentives, dilapidation and
operating expenses; these reviews utilise both observable and
unobservable inputs.
The effect of applying reasonably possible alternative
assumptions to the value of these assets would be to decrease the
fair value by GBP14 million (2020: GBP21 million) or increase it by
GBP22 million (2020: GBP17 million).
36. Risk management (continued)
(a) Market risk (continued)
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).
Group
2021 2020
GBPm GBPm GBPm GBPm
-------------------------------------------- -------- ----------- ------- -----------
Assets Liabilities Assets Liabilities
Balance at 1 January 13,897 - 13,541 -
Transfers in 167 - 179 -
Transfers out (132) - (356) -
Purchases 842 - 756 -
Disposals (1,031) - (534) -
Net gains recognised within net gains
on assets and liabilities at fair
value through profit or loss in the
statement of comprehensive income 247 - 311 -
Balance at 31 December 13,990 - 13,897 -
-------------------------------------------- -------- ----------- ------- -----------
Total unrealised gains for the period
included in the statement of comprehensive
income for assets and liabilities
held at 31 December 215 - 692 -
-------------------------------------------- -------- ----------- ------- -----------
Company
2021 2020
GBPm GBPm GBPm GBPm
-------------------------------------- ------- ----------- ------- -----------
Assets Liabilities Assets Liabilities
Balance at 1 January 10,850 - 10,303 -
Transfers in 104 - 154 -
Transfers out (77) - (340) -
Purchases 810 - 676 -
Disposals (706) - (407) -
Net gains recognised within net gains
on assets and liabilities at fair
value through profit or loss in the
statement of comprehensive income (306) - 464 -
Balance at 31 December 10,675 - 10,850 -
-------------------------------------- ------- ----------- ------- -----------
Total unrealised gains for the period
included in the statement
of comprehensive income for assets
and liabilities held at 31 December (316) - 498 -
-------------------------------------- ------- ----------- ------- -----------
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.
36. Risk management (continued)
(a) 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
or loss, mainly due to the hedging result under falling and rising
markets respectively.
Profit/(loss) after
tax and equity
impact for the
year
2021 2020
GBPm GBPm
-------------------------------------------- ---------- ---------
10% (2020: 10%) decrease in equity prices 237 180
10% (2020: 10%) decrease in property prices (5) (5)
10% (2020: 10%) increase in equity prices (221) (157)
10% (2020: 10%) increase in property prices 4 3
-------------------------------------------- ---------- ---------
(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
35. 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.
36. Risk management (continued)
(a) Market risk (continued)
(ii) Interest rate risk (continued)
Impact on profit
after tax and equity
for the year
Restated*
2021 2020
GBPm GBPm
------------------------------------------------- -------- -------------
25 basis points (2020: 25 basis points) increase
in yield curves 5 40 *
25 basis points (2020: 25 basis points) decrease
in yield curves (9) (48) *
50 basis points (2020: 50 basis points) increase
in yield curves 8 72 *
50 basis points (2020: 50 basis points) decrease (104)
in yield curves (24) *
* Amount restated. See note 41 for details of the
restatement.
Interest Rate Benchmark Reform
During 2021, the Group has continued to manage its process to
transition to alternative benchmark rates under its Lloyds Banking
Group-wide IBOR Transition Programme and has delivered the core
changes required to its technology and business processes. Through
this programme, the Group has ensured that the most appropriate
benchmark rate is used for financial instruments impacted by the
IBOR reform and has managed the impacts and risks relating to
systems, processes, accounting and reporting. Most affected
financial instruments were transitioned to new benchmark rates
prior to 31 December 2021, with activity continuing to transition
or otherwise remove the exposure to LIBOR for the remainder. The
Group does not expect material changes to its risk management
approach and strategy as a result of interest rate benchmark
reform.
The material risks identified include the following:
Conduct and litigation risk
The Group may be exposed to conduct and litigation charges as a
direct result of inappropriate or negligent actions taken during
IBOR transition resulting in detriment to the customer. The Group
is working closely with its counterparties to avoid this
outcome.
Market risk
IBOR transition is expected to lead to changes in the Group's
market risk profile which will continue to be monitored and managed
within the appropriate risk appetites. The key change is expected
to be on the management of basis risk profile during the period
when alternative benchmark rates are referenced in contracts up to
the cessation of the in-scope IBOR index.
Credit risk
Clients may wish to renegotiate the terms of existing
transactions as a consequence of IBOR reform. This could lead to a
change in the credit risk exposure of the client depending on the
outcome of the negotiations. The Group will continue to monitor and
manage changes within the appropriate risk appetites.
Accounting risk
If IBOR transition is finalised in a manner that does not permit
the application of the reliefs introduced in the IFRS Phase 2
amendments, the financial instrument may be required to be
derecognised and a new instrument recognised.
Operational risk
Additional operational risks may arise due to the IBOR
transition programme impacting all businesses and functions within
the Group and leading to the implementation of changes to
technology, operations, client communication and the valuation of
in-scope financial instruments.
At 31 December 2021, the Group had the following significant
exposures impacted by interest rate benchmark reform which have yet
to transition to the replacement benchmark: Sterling LIBOR
non-derivative financial instruments at fair value through profit
or loss of GBP1,432 million, and sterling LIBOR interest rate
derivatives with contract/notional amount of GBP3,226 million. As
at December 2021, these Sterling LIBOR balances relate to contracts
that have not converted to a risk-free rate, for example where a
contract matures in 2022 and it is not in both parties' interests
to transition, or where both parties have not agreed to include
fallback provisions that would have effect when LIBOR ceases. In
both cases, these contracts will have both cash flows and
valuations determined on a 'synthetic' LIBOR basis for reporting
periods during 2022, unless they are transitioned to alternative
benchmark rates.
36. Risk management (continued)
(a) Market risk (continued)
(ii) Interest rate risk (continued)
Interest Rate Benchmark Reform (continued)
In respect of the Group's hedge accounting relationships, for
the purposes of determining whether:
a. a forecast transaction is highly probable
b. a hedge is expected to be highly effective in achieving
offsetting changes in fair value or cash flows attributable to the
hedged risk
c. 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 interest benchmark reform affects 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 (2020: nil) at 31 December 2021. The value of liabilities
designated in fair value hedges had a notional of GBP1.5 billion
(2020: GBP1.5 billion) at 31 December 2021.
At 31 December 2021, the notional amount of the hedging
instruments in hedging relationships to which these amendments
apply was GBP1.5 billion (2020: GBP1.5 billion).
(iii) Inflation risk
The Company's exposure to inflation risk on its liabilities
arises primarily from annuity contracts, where the benefit payments
are linked to an inflation index, and from the element of all
policyholder liabilities relating to the future expenses of
administering the in-force policies which are expected to increase
with higher inflation. This exposure is hedged through holding
appropriate assets, generally RPI linked swaps, such that the
change in value of the assets is broadly offsetting to the change
in value of the liabilities.
Within the Group, Scottish Widows Europe also hedges its
exposure to inflation from the liability to future expenses.
Residual risk remains after the hedges. For example due to caps
and floors to payments on some of the annuity liabilities and
differences in inflation measures between assets and liabilities
(e.g. RPI, CPI and salary growth).
The sensitivity below shows the expected impact of a 0.5 per
cent increase to inflation in all future years. This is a multiple
of the impact of one year's inflation increasing.
Impact on profit
after tax and equity
for the year
2021 2020
GBPm GBPm
-------------------------------- ----------- ----------
50 basis points increase in RPI 82 44
36. Risk management (continued)
(a) Market risk (continued)
(iiii) 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 SII capital
position.
Sensitivity analysis for the impact of a 10 per cent
depreciation of sterling against foreign currency shows a GBP(175)
million impact for 2021 on profit after tax and equity (2020:
GBP(117) 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
-- 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
(b) 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
-- 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 annuitant mortality rates
during 2020 and 2021, it is expected that current annuitant
mortality rates will revert to broadly the previous level in the
short term. The longer-term impacts of COVID-19 on future annuitant
mortality improvements remain unclear, however it is becoming clear
that the pandemic is likely to have a net negative impact so
smaller increases in life expectancy in the near future are now
reflected in assumptions. Mortality assumptions continue to be
updated annually, reflecting both historic experience and future
expectations so as further information becomes available it will be
incorporated in future assumptions. No additional provisions are
held in respect of annuitant mortality.
A provision is held in respect of morbidity products as the
reduced availability of medical screening has reduced critical
illness claims made in 2021. It is expected that this reduction
will be offset in 2022 as delayed claims arise.
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.
36. Risk management (continued)
(b) Insurance underwriting risk (continued)
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.
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. 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 and changes to the labour market have created
uncertainty over employment levels and, as a result, Workplace
pension contributions. This could negatively impact the value of
Workplace pensions. There is a provision held in relation to this
risk.
Further information on assumptions, changes in assumptions and
sensitivities in respect of insurance and participating investment
contracts is given in note 35.
36. Risk management (continued)
(c) 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 Asset and Liability Committee (IWALCO)
assists the Chief Investment Officer 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 IWALCO, 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.
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 S&P Global Ratings'
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.
36. Risk management (continued)
(c) Credit risk (continued)
Group As at 31 December 2021
BBB or
Total AAA AA A lower Not rated
GBPm GBPm GBPm GBPm GBPm GBPm
------------------------------ ------- ------ ------- ------- ------- ---------
Stage 1 assets
Cash and cash equivalents 228 1 - 203 24 -
Loans and receivables
at amortised cost 732 - - 384 - 348
Loss allowance - - - - - -
------------------------------ ------- ------ ------- ------- ------- ---------
Exposure to credit risk 960 1 - 587 24 348
Simplified approach
assets
Loans and receivables
at amortised cost 234 - - 31 - 203
Loss allowance (3) - - (2) - (1)
------------------------------ ------- ------ ------- ------- ------- ---------
Exposure to credit risk 231 - - 29 - 202
Assets at FVTPL
Contracts with reinsurers
at fair value through
profit or loss 12,371 - 12,328 - 43 -
Debt and other fixed/variable
income securities 38,992 2,320 15,020 9,901 11,725 26
Derivative financial
instruments 2,843 - 273 2,499 - 71
Loans and advances to
customers 9,395 67 295 5,799 2,583 651
Loans and advances to
banks 4,084 - 246 3,397 377 64
Other
Reinsurance contracts 729 - 616 113 - -
------------------------------ ------- ------ ------- ------- ------- ---------
Total 69,605 2,388 28,778 22,325 14,752 1,362
------------------------------ ------- ------ ------- ------- ------- ---------
Cash at bank, included with Stage 1 assets, is considered to
have low credit risk.
36. Risk management (continued)
(c) Credit risk (continued)
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 0 191 26 0
Loans and receivables
at amortised cost 775 - - 341 - 434
Loss allowance - - - - - -
------------------------------ ------- ------ ------- ------- ------- ---------
Exposure to credit risk 993 1 0 532 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
Contracts with reinsurers
at fair value through
profit or loss 19,549 - 19,230 0 314 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
------------------------------ ------- ------ ------- ------- ------- ---------
36. Risk management (continued)
(c) Credit risk (continued)
Company As at 31 December 2021
BBB or
Total AAA AA A lower Not rated
GBPm GBPm GBPm GBPm GBPm GBPm
------------------------------ ------- ---- ------- ------- ------ ---------
Stage 1 assets
Cash and cash equivalents 96 - - 73 24 (1)
Loans and receivables
at amortised cost 359 - - 357 - 2
Loss allowance - - - - - -
------------------------------ ------- ---- ------- ------- ------ ---------
Exposure to credit risk 455 - - 430 24 1
Simplified approach
assets
Loans and receivables
at amortised cost 224 - - 29 - 195
Loss allowance - - - - - -
------------------------------ ------- ---- ------- ------- ------ ---------
Exposure to credit risk 224 - - 29 - 195
Assets at FVTPL
Contracts with reinsurers
at fair value through
profit or loss 12,371 - 12,328 - 43 -
Debt and other fixed/variable
income securities 15,176 443 8,788 2,247 3,592 106
Derivative financial
instruments 2,720 - 264 2,437 - 19
Loans and advances to
customers 8,910 67 296 5,799 2,583 165
Loans and advances to
banks 1,274 - - 855 361 58
Deposits with cedants 1,447 - - - - 1,447
Other
Reinsurance contracts 736 - 623 113 - -
------------------------------ ------- ---- ------- ------- ------ ---------
Total 43,313 510 22,299 11,910 6,603 1,991
------------------------------ ------- ---- ------- ------- ------ ---------
Cash at bank, included with Stage 1 assets, is considered to
have low credit risk.
36. Risk management (continued)
(c) 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
Contracts with reinsurers
at fair value through
profit or 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
------------------------------ ------- ---- ------- ------- ------ ---------
Amounts classified as 'not rated' within contracts with
reinsurers at fair value through profit or loss principally relate
to an amount due from SWE which is 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.
Net credit exposure represents the exposure net of offsetting,
as defined in section 36(c)(iii).
36. Risk management (continued)
(c) Credit risk (continued)
Group 2021 2020
Maximum Maximum
exposure Net exposure exposure Net exposure
GBPm GBPm GBPm GBPm
-------------------------------------- --------- ------------ --------- ------------
Loans and receivables at amortised
cost 963 963 1,018 1,107
Investments at fair value through
profit or loss:
Contracts with reinsurers at fair
value through profit or loss 12,371 12,371 19,549 19,549
Debt securities 38,992 38,992 37,256 37,256
Derivative Financial Instruments 2,843 2,843 5,224 5,224
Loans and advances to customers 9,395 9,395 9,646 9,646
Loans and advances to banks 4,084 4,084 4,693 4,693
Reinsurance contracts 729 729 810 810
Cash and cash equivalents 228 228 218 218
-------------------------------------- --------- ------------ --------- ------------
At 31 December 69,605 69,605 78,414 78,503
-------------------------------------- --------- ------------ --------- ------------
Company 2021 2020
Maximum Maximum
exposure Net exposure exposure Net exposure
GBPm GBPm GBPm GBPm
------------------------------------- --------- ------------ --------- ------------
Loans and receivables at amortised
cost 583 583 615 615
Investments at fair value through
profit or loss:
Contracts with reinsurers at fair
value through profit or loss 12,371 12,371 19,549 19,549
Debt securities 15,176 15,176 16,677 16,677
Derivative Financial Instruments 2,720 2,720 5,132 5,132
Loans and advances to customers 8,910 8,910 9,095 9,095
Loans and advances to banks 1,274 1,274 1,468 1,468
Deposits with cedants 1,447 1,447 1,509 1,509
Reinsurance contracts 736 736 819 819
Cash and cash equivalents 96 96 95 95
------------------------------------- --------- ------------ --------- ------------
At 31 December 43,313 43,313 54,959 54,959
------------------------------------- --------- ------------ --------- ------------
Shareholder asset credit experience
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. In 2021 the net downgrades to
sub-investment grade totalled GBP7 million, this was a result of
GBP63 million of downgrades offset by total upgrades to investment
grade of GBP56 million. A total of 0.5 per cent of shareholder
assets are currently rated sub-investment grade.
The Group continues to have no direct exposure to Russia or
Ukraine in its shareholder asset portfolios. There is limited
indirect exposure in the corporate bond portfolio, but no material
impact is expected. There has been no immediate impact on credit
quality in the shareholder portfolio, however should a conflict
and/or sanctions persist, there will be increased risk of credit
deterioration due to macroeconomic pressures such as inflation or
increasing energy prices.
36. Risk management (continued)
(c) 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 2021 and 31 December 2020, the Group did not have
any significant concentration of credit risk with a single
counterparty or Group of counterparties where limits applied.
Regarding shareholder assets, the largest aggregated counterparty
exposure is 0.2 per cent (2020: 0.2 per cent) of the Group's total
assets.
The following table shows where the Group and Company has
concentrations of credit risk with counterparties sharing similar
features, specifically type of counterparty:
2021 2020
GBPm GBPm GBPm GBPm
----------------------------------------- ------ ------- ------ -------
Group Company Group Company
Trade and other receivables:
Amounts due from brokers 43 33 57 32
Amounts due from Group undertakings 403 361 375 364
Other receivables 517 189 586 219
Cash and cash equivalents with financial
institutions 228 96 218 95
----------------------------------------- ------ ------- ------ -------
Total 1,191 679 1,236 710
----------------------------------------- ------ ------- ------ -------
For other receivables, the largest single counterparty balance
is with policyholders, which totals GBP132 million for Group (2020:
GBP83 million) and GBP76 million for Company (2020: 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.
36. Risk management (continued)
(c) Credit risk (continued)
(ii) Collateral management (continued)
Collateral in respect of derivatives (continued)
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:
2021 2020
GBPm GBPm GBPm GBPm
---------------------------------- ------ ------- ------ -------
Group Company Group Company
Financial assets:
Investments at fair value through
profit or loss 1,326 1,326 1,483 1,483
Cash and cash equivalents 281 183 445 425
---------------------------------- ------ ------- ------ -------
Total 1,607 1,509 1,928 1,908
---------------------------------- ------ ------- ------ -------
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
GBP1,162 million (2020: GBP1,440 million) by the Group and GBP1,162
million (2020: GBP1,440 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 GBP463 million (2020: GBP868
million) and GBP390 million (2020: GBP821 million)
respectively.
Collateral in respect of Stock Lending
Stock lending activity has been suspended. Until the prior year,
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
(2020: GBP1 million) and by the Company is nil (2020: nil).
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 (2020: GBP1 million) by
the Group and nil (2020: nil) 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 (2020: nil) and nil (2020:
nil) respectively.
There were no defaults in respect of stock lending during the
year ended 31 December 2021 (2020: none) which required a call to
be made on collateral.
36. Risk management (continued)
(c) Credit risk (continued)
(ii) Collateral management (continued)
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 2021, 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 cumulatively in respect of Bulk Annuity business was
GBP1,314 million (2020: GBP1,436 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 (2020: nil). Total derivatives
presented in the balance sheet are shown in note 19.
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.
36. Risk management (continued)
(c) Credit risk (continued)
(iii) Offsetting (continued)
b) Repurchase and Reverse Repurchase Arrangements
(continued)
Group as at 31 December 2021
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 note Financial amounts
/ liabilities sheet 1) instruments Collateral permitted
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------- -------------- -------- ----------- ------------ ---------- ------------
Financial assets
OTC Derivatives 2,800 - 2,800 (963) (1,550) 287
ET Derivatives 43 - 43 (12) (33) (2)
Financial liabilities
OTC Derivatives (2,446) - (2,446) 962 1,458 (26)
ET Derivatives (62) - (62) 12 50 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
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 note Financial amounts
/ liabilities sheet 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) -
Financial liabilities
OTC Derivatives (4,562) - (4,562) 3,233 1,695 366
ET Derivatives (46) - (46) 29 17 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
36. Risk management (continued)
(c) Credit risk (continued)
(iii) Offsetting (continued)
b) Repurchase and Reverse Repurchase Arrangements
(continued)
Company as at 31 December 2021
Related amounts
where set off
not permitted
in the balance
sheet
(sub note 2)
Net amounts Potential
presented net amounts
Amounts in the if offset
Gross set off balance of related
amounts in the sheet amounts
of assets balance (sub note Financial permitted
/ liabilities sheet 1) instruments Collateral
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------- -------------- -------- ----------- ------------ ---------- ------------
Financial assets
OTC Derivatives 2,703 - 2,703 (942) (1,490) 271
ET Derivatives 17 - 17 (5) (13) (1)
Financial liabilities
OTC Derivatives (2,376) - (2,376) 942 1,437 3
ET Derivatives (53) - (53) 5 48 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
Company 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 note Financial amounts
/ liabilities sheet 1) instruments Collateral permitted
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 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
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
19.
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.
36. Risk management (continued)
(d) 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.
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
- to meet the requirements of the Schemes of Transfer
The capital management strategy is such that the integrated
insurance business (comprising 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 high-severity
stress events 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 reinsured 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 29).
36. Risk management (continued)
(d) Capital Risk (continued)
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.
Company
2021 2020
GBPm GBPm
------------------------------ ------ ------
Regulatory Capital held 6,930 7,434
SCR (unaudited) 4,314 5,226
Solvency II Ratio (unaudited) 180 % 149 %
------------------------------ ------ ------
The solvency position increased over 2021 due to recovery in the
markets and is expected to remain above risk appetite at 31
December 2021. Exposure of the solvency position to market
volatility continues to be actively monitored, in particular
relating to interest rates and credit assets. The credit 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.
(e) 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.
36. Risk management (continued)
(e) Liquidity risk (continued)
Non-participating contracts
For unit-linked products, portfolios are managed through
mandates which ensure that they are run within defined tolerances,
maintaining sufficient liquidity to carry out operations of the
portfolio without material disruption. Deferral clauses are
included in policyholder contracts to give time, when necessary, to
realise linked assets without being a forced seller. Redemptions
(other than on death, maturity or retirement) of units in certain
property-linked funds were deferred during 2020 due to material
uncertainty in the valuation of the underlying assets and were
unrestricted in 2021. As at 31 December 2021, there are no funds
subject to deferral (2020: one).
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.
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
2021
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 45,035 - 45,036 - - - -
External interests
in collective investment
vehicles 14,348 14,347 - - - - -
Derivatives held
for trading 2,508 - 42 73 40 223 2,547
Subordinated debt 1,753 - - - 93 1,094 1,420
Borrowings 1 - 1 - - - -
Lease liabilities 5 - - - - 1 71
Other financial
liabilities 1,717 298 1,408 4 9 - -
-------------------------- -------- --------- -------- ---------- ------- --------- --------
Total 65,367 14,645 46,487 77 142 1,318 4,038
-------------------------- -------- --------- -------- ---------- ------- --------- --------
36. Risk management (continued)
(e) Liquidity risk (continued)
Group As at 31 December Contractual cash flows
2020
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 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 8 - - - 1 2 77
Other financial
liabilities 2,214 229 1,961 15 9 - -
-------------------------- -------- --------- -------- ---------- ------- --------- --------
Total 59,793 12,849 40,460 96 262 1,913 5,170
-------------------------- -------- --------- -------- ---------- ------- --------- --------
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 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
2021 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 123,348 1,007 1,467 5,854 26,948 88,072
Non-participating investment
contracts 45,035 527 616 2,686 14,398 26,808
----------------------------- -------- -------- ------- ------- ------- -------
Group As at 31 December More
2020 (Restated*) 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 115,822 5,355 25,199 83,183
investment contracts * 853 * 1,232* * * *
Non-participating investment
contracts 38,448 469 537 2,363 11,510 23,569
----------------------------- -------- -------- ------- ------- ------- -------
* restated. See note 41 for details of restatement.
The 2020 Group figures for Insurance and participating
investment contracts have been adjusted to enhance the consistency
between the Group and Company maturity analysis.
36. Risk management (continued)
(e) Liquidity risk (continued)
Company As at 31 December Contractual cash flows
2021
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
---------------------------- -------- --------- -------- ---------- ------- --------- --------
Borrowings 1 - 1 - - - -
Liabilities arising
from non-participating
investment contracts 45,016 - 45,016 - - - -
Derivative financial
instruments 2,429 - 18 64 41 203 2,515
Subordinated debt 1,786 - - - 92 1,100 1,444
Other financial liabilities 1,505 272 1,235 - - - -
---------------------------- -------- --------- -------- ---------- ------- --------- --------
Total 50,737 272 46,270 64 133 1,303 3,959
---------------------------- -------- --------- -------- ---------- ------- --------- --------
Company As at 31 December Contractual cash flows
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
---------------------------- -------- --------- -------- ---------- ------- --------- --------
Borrowings 2 - 2 - - - -
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
---------------------------- -------- --------- -------- ---------- ------- --------- --------
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
2021 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 122,842 1,004 1,461 5,825 26,816 87,736
Non-participating investment
contracts 45,016 527 615 2,684 14,390 26,800
----------------------------- -------- -------- ------- ------- ------- -------
Company As at 31 December More
2020 (Restated*) 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 115,344 1,226 5,322 25,076 82,870
investment contracts * 850 * * * * *
Non-participating investment 38,433 2,361 11,504 23,563
contracts * 469 * 536 * * * *
----------------------------- --------- -------- ------- ------- ------- -------
* restated. See note 41 for details of restatement.
RELATED PARTY TRANSACTIONS
37. Related party transactions
(a) Ultimate parent and shareholding
The Group's immediate parent undertaking is SWG, a Company
registered in the United Kingdom. SWG 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. 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.
Group as at 31 December 2021 2021
Income Expenses Payable Receivable
during during at period at period
period period end end
GBPm GBPm GBPm GBPm
----------------------------- ------- -------- ---------- ----------
Relationship
Parent 13 (200) - 352
Other related parties 1,034 (1,634) (1,280) 2,150
----------------------------- ------- -------- ---------- ----------
Group as at 31 December 2020 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
----------------------------- ------- -------- ---------- ----------
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 GBP197
million (2020: GBP219 million) of shares in the ultimate parent
undertaking on the balance sheet, with associated transactions of
GBP(82) million (2020: GBP(90) million) during the year.
37. Related party transactions (continued)
(b) Transactions with other Lloyds Banking Group companies
(continued)
Company as at 31 December 2021 2021
Income Expenses Payable Receivable
during during at period at period
period period end end
GBPm GBPm GBPm GBPm
------------------------------- ------- -------- ---------- ----------
Relationship
Parent 13 (200) - 352
Subsidiary 222 (243) (1,623) 652
Other related parties 993 (1,495) (1,250) 1,989
------------------------------- ------- -------- ---------- ----------
Company as at 31 December 2020 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
------------------------------- ------- -------- ---------- ----------
Further, amounts relating to other related parties of GBP2,513
million due from OEICs investments were outstanding at 31 December
2021 (2020: GBP2,234 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 GBP216 million (2020: GBP(9) million) from OEIC investments.
Parent undertaking transactions relate to all reported
transactions and balances with SWG, 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.
There are no loss allowances on intercompany balances as the
risk of default is minimal.
(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:
2021 2021 2020 2020
GBPm GBPm GBPm GBPm
----------------------------- ----- ------- ----- -------
Group Company Group Company
Short-term employee benefits 5 5 5 5
Share-based payments 1 1 1 1
----------------------------- ----- ------- ----- -------
Total 6 6 6 6
----------------------------- ----- ------- ----- -------
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 (2020: GBP2 million).
There were no retirement benefits accruing to Directors (2020:
nil) under defined benefit pension schemes. Two Directors (2020:
two Directors) are paying into a defined contribution scheme. There
were no contributions paid to a pension scheme for qualifying
services (2020: 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.
37. 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 Lloyds Banking Group share-based
incentive schemes in respect of Directors qualifying services was
GBP1 million (2020: GBP1 million). During the year, one Director
exercised share options (2020: two Directors) and one Director
received qualifying service shares under long-term incentive
schemes (2020: two Directors). Movements in share options are as
follows:
2021 2020
million million
Options Options
------------------ ------- -------
Outstanding at 1
January 16 15
Granted 3 11
Exercised (2) (4)
Forfeited (3) (6)
Outstanding at 31
December 14 16
-------------------- ------- -------
Detail regarding the highest paid Director is as follows:
2021 2021 2020 2020
GBPm GBPm GBPm GBPm
--------------------------------- ----- ------- ----- -------
Group Company Group Company
Apportioned aggregate emoluments 1 1 1 1
Apportioned share-based payments 1 1 - -
The highest paid Director did exercise share options during the
year. (2020: 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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