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Name | Symbol | Market | Type |
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Scottish Wid 43 | LSE:40VY | London | Bond |
Price Change | % Change | Price | Bid Price | Offer Price | High Price | Low Price | Open Price | Traded | Last Trade | |
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0.00 | 0.00% | 0 | - |
TIDM40VY
RNS Number : 2962H
Scottish Widows Limited
23 March 2020
23 March 2020
SCOTTISH WIDOWS LIMITED
PUBLICATION OF THE ANNUAL REPORT AND ACCOUNTS FOR THE YEARED 31 DECEMBER 2019
Scottish Widows Limited has published its Annual Report and Accounts for the year ended 31 December 2019 (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 www.morningstar.co.uk/uk/NSM
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 the financial statements 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 financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and Company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by 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 applicable IFRSs as adopted by the European Union have been followed for the Group financial statements and IFRSs as adopted by the European Union have been followed for the Company financial statements, subject to any material departures disclosed and explained in the financial statements;
-- make judgments and accounting estimates that are reasonable and prudent; and
-- 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 IFRSs as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit of the Group and Company; and
- the Group strategic report on pages 4 to 7, and the Directors' Report on pages 8 to 10 include a fair review of the development and performance of the business and the position of the Group and Company, together with a description of the principal risks and uncertainties that it faces.
PRINCIPAL RISKS AND UNCERTAINTIES
Details of key risks are set out in note 38. Key risks include economic and political uncertainty alongside operational risk which is heightened by the current level of change being undertaken to execute our strategy. Risks and uncertainties to our strategic plan, both positive and negative, are considered by product through the planning process.
In addition, as described in note 28, during the ordinary course of business the Group is subject to complaints and threatened or actual legal proceedings (including class or Group action claims) brought by or on behalf of current or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the United Kingdom and overseas.
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.
38. Risk management
The principal activity of the Group 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 LBG network and direct sales. The Company also reinsures business with insurance entities external to the Group.
The Group assesses the relative costs and concentrations of each type of risk and material issues are escalated to the appropriate Insurance executive committees and onto the Board if required.
This note summarises these risks and the way in which the Group manages them.
(a) Governance framework
The Group is part of LBG, which has established a risk management function with responsibility for implementing the LBG risk management framework (with appropriate Insurance focus) within the Group.
This enterprise-wide risk management framework for the identification, assessment, measurement and management of risk covers the full spectrum of risks that the Group and Company are exposed to, with risks categorised according to an approved LBG risk language. This covers the principal risks faced by the Group, including the exposures to market, insurance underwriting, model risk, credit, capital, liquidity, regulatory & legal, conduct, people, governance and operational risks. The performance of the Group, its continuing ability to write business and the strategic management of the business depend on its ability to manage these risks.
Responsibility for setting and managing risk appetite and risk policy resides with the Board. Risks are managed in line with LBG and Insurance risk policies. The Board has delegated certain risk matters to the Insurance Risk Oversight Committee ("ROC") with operational implementation assigned to the Insurance and Wealth Risk Committee ("IWRC").
The risk management approach aims to ensure effective independent checking or "oversight" of key decisions by operating a "three lines of defence" model. The first line of defence is line management, who have direct accountability for risk decisions. The Risk function provides oversight and challenge and is the second line of defence. Internal Audit, the third line of defence, provide independent assurance to the Insurance Audit Committee and the Board that risks are recognised, monitored and managed within acceptable parameters.
Policy owners, identified from appropriate areas of the LBG and Insurance business, are responsible for drafting risk policies, for ensuring that they remain up-to-date and for facilitating any changes. Policies are subject to at least an annual review. Limits are prescribed within which those responsible for the day to day management of each Group company can take decisions. Line management are required to follow prescribed reporting procedures to the bodies responsible for monitoring compliance with policy and controlling the risks.
(b) Risk appetite
Risk appetite is the amount and type of risk that the Board prefers, accepts or wishes to avoid and is aligned to group and LBG strategy. The Board has defined a framework for the management of risk and approved a set of risk appetite statements that cover financial risks (capital, insurance underwriting, credit, market and liquidity), operational risks, people, conduct risks, regulatory & legal risks, model risk and governance risks. The risk appetite statements set limits for exposures to the key risks faced by the business. Risk appetite is reviewed at least annually by the Board. Executive owned Tier 2 and Tier 3 limits sit beneath Board owned risk appetite (Tier 1) and are managed and governed within the Insurance business.
Experience against Risk Appetite is reported monthly (by exception) to each meeting of IWRC and ROC. Copies are also supplied regularly to the Group's regulators as part of the close and continuous relationship. Reporting focuses on ensuring, and demonstrating to the Board, and their delegate the ROC that the Group is run in line with approved risk appetite. Any breaches of risk appetite require clear plans and timescales for resolution.
(c) Financial risks
The Group writes a variety of insurance and investment contracts which are subject to a variety of financial risks, as set out below. Contracts can be either single or regular premium and conventional (non-profit), With Profits or unit-linked in nature.
The Group is exposed to a range of financial risks through its financial assets, financial liabilities, assets arising from reinsurance contracts and liabilities arising from insurance and investment contracts. In particular, the key financial risk is that long-term investment proceeds are not sufficient to fund the obligations arising from its insurance and investment contracts. The most important components of financial risk are market, insurance underwriting, credit, capital and liquidity risk.
The Group manages these risks in a numbers of ways, including risk appetite assessment and monitoring of capital resource requirements. In addition, the Principles and Practices of Financial Management ("PPFMs") set out the way in which the With Profits business is managed. The Group also uses financial instruments (including derivatives) as part of its business activities and to reduce its own exposure to market risk and credit risk.
38. Risk management (continued) (c) Financial risks (continued)
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 ongoing 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.
38. Risk management (continued) (c) Financial risks (continued) (1) Market risk
Market risk is defined as the risk that our capital or earnings profile is affected by adverse market rates, in particular equity and credit spreads 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. Assets held in excess of the Best Estimate of Liabilities are managed in line with the policies of LBG to optimise shareholder risk and return; with the exception of some credit assets to support the bulk annuity proposition these assets are deemed to be safe assets.
-- 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.
-- Conventional non-profit liabilities are "close matched" as far as possible in relation to currency, nature and duration.
-- With Profits Funds are managed in line with the published PPFMs. Benchmarks and minimum and maximum holdings in asset classes are specified to allow limited investment management discretion whilst ensuring adequate diversification. Swaps and swaptions provide significant protection to the With Profits Funds from the effects of interest rate falls in respect of the cost of guaranteed annuity rates.
Below is an analysis of assets and liabilities at fair value through profit or loss and assets and liabilities for which a fair value is required to be disclosed, according to their fair value hierarchy (as defined in note 1 (d)).
Group As at 31 December 2019
Fair value hierarchy Level Level Level Total 1 2 3 GBPm GBPm GBPm GBPm Investment properties - - 3,523 3,523 Assets arising from reinsurance contracts held at fair value through profit or loss - 22,837 - 22,837 Shares and other variable yield securities 92,947 - 785 93,732 Debt and other fixed/variable income securities 11,878 20,205 283 32,366 Loans and advances to customers - - 8,804 8,804 Loans and advances to banks - 2,255 - 2,255 Derivative financial assets 45 3,777 146 3,968 Total assets 104,870 49,074 13,541 167,485 Derivative financial liabilities 36 3,409 - 3,445 Liabilities arising from non-participating investment contracts - 37,456 - 37,456 Subordinated debt - 1,795 - 1,795 Total liabilities 36 42,660 - 42,696 ------------------------------------------- ------- ------ ------ -------
For all financial instruments held at amortised cost by the Group and Company, carrying value is a reasonable approximation of fair value.
38. Risk management (continued) (c) Financial risks (continued) (1) Market risk (continued)
Company As at 31 December 2019
Fair value hierarchy Level Level Level Total 1 2 3 GBPm GBPm GBPm GBPm Investment properties - - 132 132 Assets arising from reinsurance contracts held at fair value through profit or loss - 22,837 - 22,837 Shares and other variable yield securities 100,727 28 848 101,603 Debt and other fixed/variable income securities 7,394 6,978 927 15,299 Loans and advances to customers - - 8,250 8,250 Loans and advances to banks - 1,203 - 1,203 Deposits with cedants - 1,507 - 1,507 Derivative financial assets 22 3,726 146 3,894 Transfer of Assets held for sale - - - - Total assets 108,143 36,279 10,303 154,725 Derivative financial liabilities 31 3,403 - 3,434 Liabilities arising from non-participating investment contracts - 37,455 - 37,455
Subordinated debt - 1,820 - 1,820 Total liabilities 31 42,678 - 42,709 ------------------------------------------- ------- ------ ------ -------
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 2018
Fair value hierarchy Level Level Level Total 1 2 3 GBPm GBPm GBPm GBPm Investment properties - - 3,729 3,729 Assets arising from reinsurance contracts held at fair value through profit or loss - 7,132 - 7,132 Shares and other variable yield securities 74,718 - 666 75,384 Debt and other fixed/variable income securities 10,819 19,962 252 31,033 Loans and advances to customers - - 7,845 7,845 Loans and advances to banks - 2,518 1 2,519 Derivative financial assets 90 3,028 39 3,157 Total assets 85,627 32,640 12,532 130,799 Derivative financial liabilities 132 2,587 - 2,719 Liabilities arising from non-participating investment contracts - 13,855 - 13,855 Subordinated debt - 1,769 - 1,769 Total liabilities 132 18,211 - 18,343 ------------------------------------------- ------ ------ ------ ------- 38. Risk management (continued) (c) Financial risks (continued) (1) Market risk (continued)
Company As at 31 December 2018
Fair value hierarchy Level Level Level Total 1 2 3 GBPm GBPm GBPm GBPm Investment properties - - 184 184 Assets arising from reinsurance contracts held at fair value through profit or loss - 7,132 - 7,132 Shares and other variable yield securities 84,876 84 681 85,641 Debt and other fixed/variable income securities 5,345 6,511 882 12,738 Loans and advances to customers - - 7,259 7,259 Loans and advances to banks - 1,470 - 1,470 Derivative financial assets 76 3,013 40 3,129 Transfer of Assets held for sale (2,051) - (114) (2,165) Total assets 88,246 18,210 8,932 115,388 Derivative financial liabilities 103 2,578 - 2,681 Liabilities arising from non-participating investment contracts - 13,825 - 13,825 Subordinated debt - 1,799 - 1,799 Total liabilities 103 18,202 - 18,305 ------------------------------------------- ------- ------ ----- -------
Assets arising from reinsurance contracts held at fair value through profit and loss are valued using the published price for the funds invested in. Participating investment contracts are not included above, on the basis that fair value and carrying value would not be materially different.
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(o).
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 and corporate debt instruments.
Private equity investments are valued using the financial statements of the underlying companies prepared by the general partners, adjusted for known cash flows since valuation and subject to a fair value review to take account of other relevant information. Property investment vehicles are valued based on the net asset value of the relevant Company which incorporates surveyors' valuations of property. Investment property is independently valued as described in note 17. Valuations are based on observable market prices for similar properties. Adjustments are applied, if necessary, for specific characteristics of the property, such as the nature, location, or condition of the specific asset. If such information is not available alternative valuation methods such as discounted cash flow analysis or recent prices in less active markets are used. Where any significant adjustments to observable market prices are required, the property would be classified as Level 3. Whilst such valuations are sensitive to estimates, it is believed that changing one or more of the assumptions to reasonably possible alternative assumptions would not change the fair value significantly.
The following valuation methods and sensitivity of valuation assumptions are applied to both the Group and the Company.
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 tree approach.
Unobservable inputs in the valuation model include an Illiquidity premium (2019 loan to bond spreads: 18.5bps to 51.5bps ) and Inferred spreads (2019 credit spreads: 73.1bps to 140.5bps ). The effect of applying reasonably possible alternative assumptions to the value of these loans would be to decrease the fair value by GBP332m (2018: GBP304m) or increase it by GBP345m (2018: GBP326m). There are no material interdependencies between the above assumptions.
38. Risk management (continued) (c) Financial risks (continued) (1) Market risk (continued)
Equity release mortgages - ERM SPV
A portfolio of Equity Release Mortgages is securitised through a Special Purpose Vehicle into a Senior Note (A Note) and a Junior Note (B Note).
The value of the B Note is determined using a discounted cash flow approach with a spread based judging movements in the spread for comparable instruments against the changes in expected performance of the underlying portfolio of mortgages. The value of the A Note is derived from the value of the underlying portfolio, the value of the B note and the value of the remaining contracts of the Special Purpose Vehicle. These notes are classified as Level 3 within debt securities due to the unobservable parameters required in the valuation of the B note and in the valuation of the portfolio of mortgages.
The equity release mortgages are valued using a discounted cash flow approach. Decrements (mortality, voluntary early repayment, entry into long-term care) are used to determine the incidence of cash flows. The discount rate is based on a risk free rate plus a spread with the spread assessed by reference to the market for new Equity Release Mortgages, after adjusting for the relative risks associated with this portfolio of loans and those of a notional portfolio of new mortgages. In the assessment of the value of the risks, the No Negative Equity Guarantee for Equity Release Mortgages is valued using a time-dependent Black-Scholes model at GBP14.7m as at 31 December 2019 (Dec 2018: GBP16.7m).
Inputs in the valuation model include the gross interest rate applicable to a notional portfolio of new Equity Release 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.
December 2019 Valuation Uncertainty calculations principally reflect uncertainty in the market rates for comparable notional portfolios and a range of decrement assumptions and their corresponding impacts on the value of the A Note and B Note. The range of notional portfolio rate assumptions was 3.26% to 4.94% (Dec 2018: 4.26% to 5.58%).
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 GBP6m (Dec 2018: GBP17m) or increase it by GBP12m (Dec 2018: GBP1m).
Private Credit Funds
SWL hold investments in two private credit funds that hold portfolios of loans to European medium-sized enterprises where loans are often backed by commercial real estate. The assets are classified as Level 3 and are included within equity securities. The underlying loan values, on which the investment values are based, are assessed by the fund manager on a discounted cash flow approach using spreads determined from the credit quality and illiquidity of the loans as compared to other credit assets. Our valuation uncertainty on these investments is assessed based on the valuation uncertainty characteristics of the underlying illiquid loans.
The effect of applying reasonably possible alternative assumptions to the value of these assets would be to decrease the fair value by GBP7m (Dec 2018: GBP6m) or increase it by GBP1m (Dec 2018: GBP2m).
Agricultural Loans - AMC 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 (Via Utility bonds as a proxy) and an incremental illiquidity premium as well as a prepayment cost of capital premium. The discount rate is based on a risk free rate plus a spread to compensate for the risks associated with the loans, which is determined on a portfolio level.
Unobservable inputs in the Agriculture valuation model include: Generic spreads based of Merrill Lynch pool of bonds (change of +14.0bps and 0bps to base), Illiquidity premium (2019 loan to bond spreads: 18.5bps to 51.5bps), and Utility Securities inferred spreads (2019 spreads: -4bps to -34bps) and prepayment rates (2019 rates: 0.11% to 0.13% for 1-5yrs and 0.14% for 5+ yrs).
The effect 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 GBP12m or increase it by GBP9m. There are no material interdependencies between the above assumptions.
38. Risk management (continued) (c) Financial risks (continued) (1) Market risk (continued)
Derivatives Unobservable inputs - Fair Value Hierarchy level 3
Complex derivatives can be transacted in order to hedge complex risks within other level 3 assets. Complex derivatives which have unobservable inputs, such as volatilities and correlations, in their valuation model 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 effect of applying reasonably possible alternative assumptions to the value of these assets would be to decrease the fair value by GBP26m (Dec 2018: GBP30m) or increase it by GBP1m (Dec 2018: nil).
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
2019 2018 GBPm GBPm GBPm GBPm Assets Liabilities Assets Liabilities Balance at 1 January 12,532 - 12,235 - Transfers in 421 - 703 - Transfers out (147) - (664) - Purchases 1,422 - 1,125 - Disposals (984) - (950) - Net gains recognised within net gains on assets and liabilities at fair value through profit or loss in the statement of comprehensive income 297 - 83 - Balance at 31 December 13,541 - 12,532 - Total unrealised gains for the period included in the statement of comprehensive income for assets and liabilities held at 31 December 245 - 32 - -------------------------------------------- ------ ----------- ------ -----------
Company
2019 2018 GBPm GBPm GBPm GBPm Assets Liabilities Assets Liabilities Balance at 1 January 8,932 - 8,756 - Transfers in 267 - 21 - Transfers out - - (85) - Purchases 1,355 - 953 - Disposals (649) - (521) - Assets held for sale - - (114) - Net gains recognised within net gains on assets and liabilities at fair value through profit or loss in the statement of comprehensive income 398 - (78) - Balance at 31 December 10,303 - 8,932 - Total unrealised gains for the period included in the statement of comprehensive income for assets and liabilities held at 31 December 340 - 20 - -------------------------------------- ------ ----------- ------ -----------
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.
38. Risk management (continued) (c) Financial risks (continued) (1) Market risk (continued) (i) Equity and property risk
The exposure of the Group's insurance and investment contract business to equity risk relates to financial assets and financial liabilities whose values will fluctuate as a result of changes in market prices other than from interest and foreign exchange fluctuations. This is due to factors specific to individual instruments, their issuers or factors affecting all instruments traded in the market. Accordingly, the Group monitors exposure limits both to any one counterparty and any one market.
From 2018, exposure to market risk has been managed by the implementation of unit matching and equity hedging to reduce the sensitivity of future dividend payments to market movements. Unit matching involves more effectively matching unit linked liabilities on a best-estimate view (as defined by Solvency regulations). This best-estimate view incorporates an allowance for expected future income and expenses, which are not fully allowed for under IFRS. As a result, this leads to a mismatch between IFRS statutory assets and liabilities in respect of market movements. For example, in the event of rising markets, a loss would now be recognised in the accounts as a result of this mismatch, which would be offset in the future due to higher income as fees are received.
The effect on the Group of changes in the value of investment property held in respect of investment contract liabilities due to fluctuations in property prices is negligible as any changes will be offset by movements in the corresponding liability.
The sensitivity analysis below illustrates how the fair value of future cash flows in respect of equities and properties, net of offsetting movements in insurance and investment contract liabilities, will fluctuate because of changes in market prices at the reporting date. The equity sensitivity includes the impact of unit matching and equity hedging which leads to a statutory profit, mainly due to the hedge payoff under falling markets.
Impact on profit after tax and equity for the year 2019 2018 GBPm GBPm 10% (2018: 10%) decrease in equity prices 131 140 10% (2018: 10%) decrease in property prices (5) (5) -------------------------------------------- ------------ --------- (ii) Interest rate risk
Interest rate risk is the risk that the value of future cash flows of a financial instrument will fluctuate because of changes in interest rates and the shape of the yield curve. Interest rate risk in respect of the Group's insurance and investment contracts arises when there is a mismatch in duration or yield between liabilities and the assets backing those liabilities.
The Group's interest rate risk policy requires that the maturity profile of interest-bearing financial assets is appropriately matched to the guaranteed elements of the financial liabilities.
A fall in market interest rates will result in a lower yield on the assets supporting guaranteed investment returns payable to policyholders. This investment return guarantee risk is managed by matching assets to liabilities as closely as possible. An increase in market interest rates will result in a reduction in the value of assets subject to fixed rates of interest which may result in losses, as a result of an increase in the level of surrenders, the corresponding fixed income securities have to be sold.
The effect of changes in interest rates in respect of financial assets which back insurance contract liabilities is given in note 37. 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.
Impact on profit after tax and equity for the year 2019 2018 GBPm GBPm 25 basis points (2018: 25 basis points) increase in yield curves 28 18 25 basis points (2018: 25 basis points) decrease in yield curves (34) (24) ------------------------------------------------- ----------- ---------- 38. Risk management (continued) (c) Financial risks (continued) (1) Market risk (continued) (iii) Foreign exchange risk
Foreign exchange risk relates to the effects of movements in exchange markets including changes in exchange rates.
The Group's foreign currency exposure is driven by holding financial instruments to hedge changes in future investment management fees resulting from exchange rate movements. These investment management fees are based on charges to policyholder funds invested in overseas equities. The hedges are placed by the Company to reduce foreign exchange exposure in the SWL SII capital position.
Sensitivity analysis for the impact of a 10% depreciation of sterling against foreign currency shows a GBP(131)m impact for 2019 on profit after tax and equity (2018: nil).
With the exception of these holdings, the overall risk to the Group is minimal due to the following:
-- The Group's principal transactions are carried out in pounds sterling;
-- The Group's financial assets are primarily denominated in the same currencies as its insurance and investment contract liabilities; and
-- Other than shareholder funds, all non-linked investments of the non-profit funds are in sterling or are currency matched. The effect on the Group of changes in the value of investments held in respect of investment contract liabilities due to fluctuations in foreign exchange rates is negligible as any changes will be offset by movements in the corresponding liability.
(2) Insurance underwriting risk
Insurance underwriting risk is defined as the risk of adverse developments in the timing, frequency and severity of claims for insured/underwritten events and in customer behaviour, leading to reductions in earnings and/or value.
The principal risk the Group faces under insurance contracts is that the actual claims and benefit payments exceed the amounts expected at the time of determining the insurance liabilities.
The nature of the Group's business involves the accepting of insurance underwriting risks which primarily relate to mortality, longevity, morbidity, persistency and expenses. When transacting new business, the Group underwrites policies to ensure an appropriate premium is charged for the risk or that the risk is declined.
The Group principally writes the following types of life insurance contracts:
-- Life assurance - where the life of the policyholder is insured against death or permanent disability, usually for pre-determined amounts;
-- Annuity products - where typically the policyholder is entitled to payments which cease upon death; and
-- Morbidity products - where the policyholder is insured against the risk of contracting a defined illness.
For contracts where death is the insured risk, the most significant factors that could increase the overall level of claims are epidemics or widespread changes in lifestyle, such as eating, smoking and exercise habits, resulting in earlier or more claims than expected. The possibility of a pandemic, for example one arising from influenza, 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.
For contracts with fixed and guaranteed benefits and fixed future premiums, there are no mitigating terms and conditions that significantly reduce the insurance underwriting risk accepted. For participating investment contracts, the participating nature of these contracts results in a significant portion of the insurance underwriting risk being shared with the policyholder.
Insurance underwriting risk is also affected by the policyholders' right to pay reduced or no future premiums, to terminate the contract completely, to exercise a guaranteed annuity option or, for bulk annuity business, for pensioners to exercise options following retirement. As a result, the amount of insurance underwriting risk is also subject to policyholder behaviour. On the assumption that policyholders will make decisions that are in their best interests, overall insurance underwriting risk will generally be aggravated by policyholder behaviour. For example, it is likely that policyholders whose health has deteriorated significantly will be less inclined to terminate contracts insuring death benefits than those policyholders who remain in good health.
The Group has taken account of the expected impact of policyholder behaviour in setting the assumptions used to measure insurance and investment contract liabilities.
38. Risk management (continued) (c) Financial risks (continued) (2) Insurance underwriting risk (continued)
The principal methods available to the Group to control or mitigate longevity, mortality and morbidity risk are through the following processes:
-- Underwriting (the process to ensure that new insurance proposals are properly assessed);
-- Pricing-to-risk (new insurance proposals would usually be priced in accordance with the underwriting assessment);
-- Demographics to accurately assess mortality risk; -- Claims management; -- Product design; -- Policy wording; and -- The use of reinsurance and other risk mitigation techniques.
Rates of mortality and morbidity are investigated annually based on the Group's recent experience. Future mortality improvement assumptions are set using the latest population data available. In addition, bulk annuity business pricing and valuation assumptions also consider underlying experience of the scheme where available. Where they exist, the reinsurance arrangements of each company in the Group are reviewed at least annually.
Persistency risk is the risk associated with the ability to retain long-term business and the ability to renew short-term business. The Group aims to reduce its exposure to persistency risk by undertaking various initiatives to promote customer loyalty. These initiatives are aimed both at the point of sale and through direct contact with existing policyholders, for example through annual statement information packs.
Further information on assumptions, changes in assumptions and sensitivities in respect of insurance and participating investment contracts is given in note 37.
(3) Credit risk
The risk that parties with whom we have contracted, fail to meet their financial obligations (both on and off balance sheet).
The Group accepts credit risk with a variety of counterparties through invested assets which are primarily used to back annuity business, cash in liquidity funds and bank accounts, derivatives and reinsurance. These are managed through a credit control framework which uses a tiered approach to set credit limits:
-- Tier 1: Credit limits are set by the Insurance Board as part of the overall Insurance Risk Appetite.
-- Tier 2: Insurance and Wealth Investment Strategy Committee ('IWISC') assists the IWISC Chair to set additional controls, sub limits and guidelines. These operate within the boundaries of the Board's Tier 1 Risk Appetite statements and are designed to assist the business with more efficient utilisation of higher level Board Risk Appetite statements in delivery of Insurance's investment strategy.
-- Tier 3: Insurance Credit approvers have individual personal delegated authorities from the Insurance Board to approve exposures to individual counterparties. Amounts above these delegated authorities require approval by the Insurance Board.
Group exposure limits are set for the maximum single name concentration, industry sector, country of risk and portfolio quality. In addition, each individual counterparty exposure requires a counterparty limit or is within the criteria of an approved sanction matrix.
Group exposures are reported on a monthly basis to the Insurance Shareholder Investment Management Committee ('ISIM') and semi-annually to IWISC, 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 LBG 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.
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued)
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 LBG Credit Risk Policy which set out the principles of the credit control framework outlined above.
Credit risk in respect of unit-linked funds and With Profits Funds is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for those funds.
The tables below analyse financial assets and reinsurance assets subject to credit risk exposure using Standard & Poor's rating or equivalent. For certain classes of assets, internally generated ratings have been used where external ratings are not available. This includes credit assets held in both shareholder and policyholder funds. No account is taken of any collateral held to mitigate the risk.
Group As at 31 December 2019
BBB or Total AAA AA A lower Not rated GBPm GBPm GBPm GBPm GBPm GBPm Stage 1 assets Cash and cash equivalents 276 1 17 204 48 6 Loans and receivables at amortised cost 483 - - 403 - 80 Loss allowance - - - - - - Exposure to credit risk 759 1 17 607 48 86 Simplified approach assets Loans and receivables at amortised cost 514 - - 22 - 492 Loss allowance (5) - - - - (5) Exposure to credit risk 509 - - 22 - 487 Assets at FVTPL Assets arising from reinsurance contracts held classified at fair value through profit and loss 22,837 - - 22,551 286 - Debt and other fixed/variable income securities 32,366 2,152 15,026 6,689 8,337 162 Derivative financial instruments 3,968 - 454 3,395 74 45 Loans and advances to customers 8,804 73 1,324 4,439 2,376 592 Loans and advances to banks 2,255 - 18 2,172 58 7 Other Reinsurance contracts 720 - 589 131 - - Total 72,218 2,226 17,428 40,006 11,179 1,379 ------------------------------ ------ ----- ------ ------ ------ ---------
Cash at bank, included with Stage 1 assets, is considered to have low credit risk.
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued)
Group As at 31 December 2018
BBB or Total AAA AA A lower Not rated GBPm GBPm GBPm GBPm GBPm GBPm Stage 1 assets Cash and cash equivalents 174 1 24 122 18 9 Loans and receivables at amortised cost 2,312 - - 1,789 - 523 Loss allowance - - - - - - Exposure to credit risk 2,486 1 24 1,911 18 532 Simplified approach assets Loans and receivables at amortised cost 362 - - 72 - 290 Loss allowance (6) - - (3) - (3) Exposure to credit risk 356 - - 69 - 287 Assets at FVTPL Assets arising from reinsurance contracts held classified at fair value through profit and loss 7,132 - - 7,111 21 - Debt and other fixed/variable income securities 31,033 2,423 13,261 7,034 8,156 159 Derivative financial instruments 3,157 - 322 2,413 333 89 Loans and advances to customers 7,845 72 945 4,774 1,418 636 Loans and advances to banks 2,519 - 540 448 110 1,421 Other Reinsurance contracts 728 - 555 172 1 - Total 55,256 2,496 15,647 23,932 10,057 3,124 ------------------------------ ------ ----- ------ ------ ------ --------- 38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued)
Company As at 31 December 2019
BBB or Total AAA AA A lower Not rated GBPm GBPm GBPm GBPm GBPm GBPm Stage 1 assets Cash and cash equivalents 98 - - 53 45 - Loans and receivables at amortised cost 411 - - 402 - 9 Loss allowance - - - - - - Exposure to credit risk 509 - - 455 45 9 Simplified approach assets Loans and receivables at amortised cost 208 - - 22 - 186 Loss allowance (2) - - - - (2) Exposure to credit risk 206 - - 22 - 184 Assets at FVTPL Assets arising from reinsurance contracts held classified at fair value through profit and loss 22,837 - - 22,551 286 - Debt and other fixed/variable income securities 15,299 591 9,065 2,792 2,605 246 Derivative financial instruments 3,894 - 452 3,347 74 21 Loans and advances to customers 8,250 73 1,324 4,439 2,376 38 Loans and advances to banks 1,203 - - 1,188 15 - Deposits with cedants 1,507 - - - - 1,507 Other Reinsurance contracts 726 - 595 131 - - Total 54,431 664 11,436 34,925 5,401 2,005 ------------------------------ ------ ---- ------ ------ ------ ---------
Cash at bank, included with Stage 1 assets, is considered to have low credit risk.
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued)
Company As at 31 December 2018
BBB or Total AAA AA A lower Not rated GBPm GBPm GBPm GBPm GBPm GBPm Stage 1 assets Cash and cash equivalents 41 - 7 21 13 - Loans and receivables at amortised cost 1,838 - - 1,797 - 41 Loss allowance - - - - - - Exposure to credit risk 1,879 - 7 1,818 13 41 Simplified approach assets Loans and receivables at amortised cost 358 - - 72 - 286 Loss allowance (2) - - (2) - - Exposure to credit risk 356 - - 70 - 286 Assets at FVTPL Assets arising from reinsurance contracts held classified at fair value through profit and loss 7,132 - - 7,111 21 - Debt and other fixed/variable income securities 12,738 652 7,059 2,552 2,237 238 Derivative financial instruments 3,129 - 311 2,409 333 76 Loans and advances to customers 7,259 72 945 4,774 1,417 51 Loans and advances to banks 1,470 - 13 38 17 1,402 Transferred to Assets held for sale (234) - - - - (234) Other Reinsurance contracts 728 - 555 172 1 - Total 34,457 724 8,890 18,944 4,039 1,860
------------------------------ ------ ---- ----- ------ ------ ---------
Amounts classified as "not rated" within assets arising from reinsurance contracts held principally relate to amounts due from other Group companies which are not rated by Standard & Poor's or an equivalent rating agency.
Expected credit losses are calculated using three key input parameters: the probability of default ("PD") (except for lifetime expected credit losses), the expected loss given default ("LGD") and the exposure at default ("EAD"). The probability of default and expected loss given default are determined using internally generated credit ratings. For lease receivables, the past due information is used to determine the expected loss given default.
Expected credit losses are measured on a collective basis for certain Groups of financial assets, such as control accounts, trade receivables and intercompany receivables, which are considered to be homogenous in terms of their risk of default.
Maximum credit exposure
The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss, which includes amounts held to cover unit-linked and With Profits Funds liabilities, is considered to be the balance sheet carrying amount.
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued) Group 2019 2018 Maximum Maximum exposure Offset Net exposure exposure Offset Net exposure GBPm GBPm GBPm GBPm GBPm GBPm Loans and receivables at amortised cost 997 - 997 2,674 - 2,674 Investments at fair value through profit or loss: Assets arising from reinsurance contracts held classified at fair value through profit and loss 22,837 - 22,837 7,132 - 7,132 Debt securities 32,366 - 32,366 31,033 - 31,033 Derivative Financial Instruments 3,968 - 3,968 3,157 - 3,157 Loans and advances to customers 8,804 - 8,804 7,845 - 7,845 Loans and advances to banks 2,255 - 2,255 2,519 - 2,519 Reinsurance contracts 720 - 720 728 - 728 Cash and cash equivalents 276 - 276 174 - 174 At 31 December 72,223 - 72,223 55,262 - 55,262 ------------------------------------- --------- ------ ------------ --------- ------ ------------ Company 2019 2018 Maximum Maximum exposure Offset Net exposure exposure Offset Net exposure GBPm GBPm GBPm GBPm GBPm GBPm Loans and receivables at amortised cost 619 - 619 2,196 - 2,196 Investments at fair value through profit or loss: Assets arising from reinsurance contracts held classified at fair value through profit and loss 22,837 - 22,837 7,132 - 7,132 Debt securities 15,299 - 15,299 12,738 - 12,738 Derivative Financial Instruments 3,894 - 3,894 3,129 - 3,129 Loans and advances to customers 8,250 - 8,250 7,259 - 7,259 Loans and advances to banks 1,203 - 1,203 1,470 - 1,470 Deposits with cedants 1,507 - 1,507 - - - Reinsurance contracts 726 - 726 728 - 728 Cash and cash equivalents 98 - 98 41 - 41 At 31 December 54,433 - 54,433 34,693 - 34,693 ------------------------------------- --------- ------ ------------ --------- ------ ------------ 38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued) (i) Concentration risk
Credit concentration risk
Credit concentration risk relates to the inadequate diversification of credit risk.
Credit risk is managed through the setting and regular review of counterparty credit and concentration limits on asset types which are considered more likely to lead to a concentration of credit risk. For other asset types, such as UK government securities or investments in funds falling under the Undertakings for Collective Investment in Transferable Securities "UCITS" Directive, no limits are prescribed as the risk of credit concentration is deemed to be immaterial. This policy supports the approach mandated by the PRA for regulatory reporting.
At 31 December 2019 and 31 December 2018, the Group did not have any significant concentration of credit risk with a single counterparty or Group of counterparties where limits applied. With the exception of Government bonds and UCITS funds, the largest aggregated counterparty exposure is 0.2% (2018: 1.0% of the Group's total assets).
Total GBPm Trade and other receivables: Amounts due from brokers 62 Amounts due from group undertakings 413 Other receivables 522 Cash and cash equivalents with financial institutions 276 Total 1,273 ------------------------------------------------------ -----
For other receivables, the largest single counterparty balance is with policyholders, which totals GBP91m.
Liquidity concentration risk
Liquidity concentration risk arises where the Group is unable to meet its obligations as they fall due or do so only at an excessive cost, due to over-concentration of investments in particular financial assets or classes of financial asset.
As most of the Group's invested assets are diversified across a range of marketable equity and debt securities in line with the investment options offered to policyholders it is unlikely that a material concentration of liquidity concentration could arise.
This is supplemented by active liquidity management in the Group, to ensure that even under stress conditions the Group has sufficient liquidity as required to meet its obligations. This is delegated by the Board to and monitored through the Insurance and Wealth Asset and Liability Committee (IWALCO), IWRC, ISIM and Banking and Liquidity Operating Committee (BLOC).
(ii) Collateral management
Collateral in respect of derivatives
The requirement for collateralisation of OTC derivatives, including the levels at which collateral is required and the types of asset that are deemed to be acceptable collateral, are set out in a Credit Support Annex (CSA), which forms part of the International Swaps and Derivatives Association (ISDA) agreement between the Company and the counterparty.
The CSA will require collateralisation where any net exposure to a counterparty exceeds the OTC counterparty limit, which must be established in accordance with the Derivatives Risk Policy (DRP). The aggregate uncollateralised exposure to any one counterparty must not exceed limits specified in the DRP. Where derivative counterparties are related, the aggregate net exposure is considered for the purposes of applying these limits.
Acceptable collateral is defined in each instance and must take into account the quality and appropriateness of the proposed collateral as well as being acceptable to the entity receiving the collateral. Collateral may include cash, corporate bonds, supranational debt and government debt.
Assets with the following carrying amounts have been pledged in accordance with the terms of the relevant CSAs entered into in respect of various OTC and other derivative contracts:
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued) 2019 2018 GBPm GBPm GBPm GBPm Group Company Group Company Financial assets: Investments at fair value through profit or loss 773 773 547 547 Cash and cash equivalents 369 369 378 378 Total 1,142 1,142 925 925 ---------------------------------- ----- ------- ----- -------
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 GBP1,191m (2018: GBP811m) by the Group and GBP1,191m (2018: GBP811m) 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.
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 GBP281m (2018: GBP259m) and GBP250m (2018: GBP259m) respectively.
Collateral in respect of Stock Lending
The Group and Company lend financial assets held in its portfolio to other institutions. The IWISC and its sub-committee Investment Management Operational Review Committee (IMOR) are responsible for setting the parameters of stock lending. Stock lending is permitted in accordance with the Insurance Stock Lending Policy. All stock lending takes 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 GBP4,137m (2018: GBP3,962m) and by the Company is GBP573m (2018: GBP831m).
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 GBP4,059m (2018: GBP4,232m) by the Group and GBP528m (2018: GBP873m) 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 GBP334m (2018: GBP622m) and GBP66m (2018: GBP109m) respectively.
There were no defaults in respect of stock lending during the year ended 31 December 2019 (2018: none) which required a call to be made on collateral.
Collateral in respect of Reverse Repurchase Agreement
The Group and Company entered into Reverse Repurchase Agreements whereby it purchased financial instruments with an agreement to resell them back to the counterparty at an agreed price. These transactions are in effect collateralised loans and are reported accordingly. The cash on loan is recognised as Loans and Receivables. The amount of cash on loan in this regard is GBP334m (2018: GBP622m) for the Group and GBP66m (2018: GBP109m) for Company.
The financial assets received as collateral are not recognised on the balance sheet as the counterparty retains all risks and rewards. The fair value of financial assets accepted as collateral amounted to is GBP349m (2018: GBP651m) for the Group and GBP69m (2018: GBP116m) for Company.
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued)
Collateral in respect of Repurchase Agreement
A repurchase agreement between the Company and Lloyds Bank Corporate Markets PLC was terminated in the year with the collateral pledged returned to the Company (2018: Collateral pledged GBP137m for Group and Company).
Collateral in respect of loans to related parties
In 2019 the Company terminated a GBP1,400m collateralised loan agreement with Lloyds Bank PLC and the collateral held was returned to the counterparty. (2018: value of loan GBP1,400m, collateral held GBP1,860m for Group and Company).
Collateral in respect of Bulk Annuity Business
Acceptable collateral is defined in each instance and must take into account the quality and appropriateness of the proposed collateral as well as being acceptable to the entity receiving the collateral. Collateral may include cash, corporate bonds, supranational debt and government debt.
During 2019, the Company purchased Bulk Annuity contracts which provide buy in and buy out solutions to defined benefit pension schemes. To enter into the transaction some trustees may seek collateral to cover the counterparty default scenario. Collateral pledged in respect of Bulk Annuity business was GBP1,471m (2018: GBP1,504m) for Group and Company.
(iii) Offsetting
The following tables show financial assets and liabilities which have been set off in the balance sheet and those which have not been set off but for which the Group and the Company has enforceable master netting agreements in place with counterparties. They include Derivatives, Repurchase and Reverse Repurchase arrangements.
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 (2018: nil). Total derivatives presented in the balance sheet are shown in note 20.
The "financial instruments" amounts in the tables below show the values that can be set off against the relevant derivatives asset and liabilities in the event of default under master netting agreements. In addition, the Group and the Company holds and provides cash and securities collateral in respect of derivative transactions to mitigate credit risks.
In the tables below, the amounts of derivative assets or liabilities presented are offset first by financial instruments that have the right of offset under master netting with any remaining amount reduced by the amount collateral.
b) Repurchase and Reverse Repurchase Arrangements
The Group and the Company participates in repurchase (repo) and reverse repurchase arrangements (reverse repo). The gross/net amount in the table shows the relevant assets that the Group and the Company has transferred to counterparties under these arrangements. Cash and non cash collateral is received by the Group and the Company for securities transferred. Cash collateral may be reinvested by the Group and Company through reverse repo against non cash collateral.
In the tables below, the amounts that are subject to repo and reverse repo are set off against the amount of collateral received according to the relevant legal agreements, showing the potential net amounts.
The actual fair value of collateral may be greater than amounts presented in the tables below in the case of over collateralisation.
38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued) b) Repurchase and Reverse Repurchase Arrangements (continued)
Group as at 31 December 2019
Related amounts where set off not permitted in the balance sheet (sub note 2) Net amounts presented Potential Amounts in the net amounts Gross set off balance if offset amounts in the sheet of related of assets balance (sub Financial amounts / liabilities sheet note 1) instruments Collateral permitted GBPm GBPm GBPm GBPm GBPm GBPm Financial assets OTC Derivatives 3,923 - 3,923 (2,352) (1,499) 72 ET Derivatives 45 - 45 (7) (38) - Reverse Repo 334 - 334 - (349) (15) Financial liabilities OTC Derivatives (3,409) - (3,409) 2,352 1,018 (39) ET Derivatives (36) - (36) 7 29 -
---------------------- -------------- -------- ----------- ------------ ---------- ------------
Group as at 31 December 2018
Related amounts where set off not permitted in the balance sheet (sub note 2) Net amounts presented Potential Amounts in the net amounts Gross set off balance if offset amounts in the sheet of related of assets balance (sub Financial amounts / liabilities sheet note 1) instruments Collateral permitted GBPm GBPm GBPm GBPm GBPm GBPm Financial assets OTC Derivatives 3,067 - 3,067 (2,681) (355) 31 ET Derivatives 89 - 89 (28) (61) - Repo 135 - 135 - (135) - Reverse Repo 622 - 622 - (622) - Financial liabilities OTC Derivatives (2,586) - (2,586) 2,681 (113) (18) ET Derivatives (132) - (132) 28 104 - ---------------------- -------------- -------- ----------- ------------ ---------- ------------ 38. Risk management (continued) (c) Financial risks (continued) (3) Credit risk (continued) b) Repurchase and Reverse Repurchase Arrangements (continued)
Company as at 31 December 2019
Related amounts where set off not permitted in the balance sheet (sub note 2) Gross Net amounts Potential amounts presented net amounts of assets Amounts in the if offset / liabilities set off balance of related in the sheet amounts balance (sub Financial permitted sheet note 1) instruments Collateral GBPm GBPm GBPm GBPm GBPm GBPm Financial assets OTC Derivatives 3,872 - 3,872 (2,352) (1,467) 53 ET Derivatives 22 - 22 (1) (20) 1 Reverse Repo 66 - 66 - (69) (3) Financial liabilities OTC Derivatives (3,403) - (3,403) 2,352 1,018 (33) ET Derivatives (31) - (31) 1 30 - ---------------------- -------------- -------- ----------- ------------ ---------- ------------
Company as at 31 December 2018
Related amounts where set off not permitted in the balance sheet (sub note 2) Gross Net amounts amounts presented Potential of assets Amounts in the net amounts / liabilities set off balance if offset in the sheet of related balance (sub Financial amounts sheet note 1) instruments Collateral permitted GBPm GBPm GBPm GBPm GBPm GBPm Financial assets OTC Derivatives 3,052 - 3,052 (2,681) (355) 16 ET Derivatives 76 - 76 (19) (57) - Repo 135 - 135 - (135) - Reverse Repo 109 - 109 - (109) - Financial liabilities OTC Derivatives (2,578) - (2,578) 2,682 (114) (10) ET Derivatives (103) - (103) 19 84 - ---------------------- -------------- -------- ----------- ------------ ---------- ------------
The following sub notes are relevant to the tables on this and the preceding page:
1. The value of net amounts presented in the balance sheet for derivatives comprises those derivatives held by the Group and the Company that are subject to master netting arrangements. Total derivatives presented in the balance sheet are shown in note 20.
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.
38. Risk management (continued) (c) Financial risks (continued) (4) Capital Risk
Capital risk is defined as the risk that the Group has a sub-optimal quantity or quality of capital or that capital is inefficiently deployed across the Group. The risk that:
-- the Group, or one of its separately regulated subsidiaries, has insufficient capital to meet its regulatory capital requirements;
-- the Group has insufficient capital to provide a stable resource to absorb all losses up to a confidence level defined in the risk appetite;
-- the Group loses reputational status by having capital that is regarded as inappropriate, either in quantity, type or distribution; and/or
-- the capital structure is inefficient.
The business of several of the companies within the Group is regulated by the PRA and the FCA. The PRA rules, which incorporate all Solvency II requirements, specify the minimum amount of capital that must be held by the regulated companies within the Group in addition to their insurance liabilities. Under the Solvency II rules, each insurance Company within the Group must hold assets in excess of this minimum amount, which is derived from an economic capital assessment undertaken by each regulated Company and the quality of capital held must also satisfy Solvency II tiering rules. This is reviewed on a quarterly basis by the PRA.
The Solvency II minimum required capital must be maintained at all times throughout the year. These capital requirements and the capital available to meet them are regularly estimated in order to ensure that capital maintenance requirements are being met.
The Group's objectives when managing capital are:
- to have sufficient capital to safeguard the Group's ability to continue as a going concern so that it can continue to provide returns for the shareholder and benefits for other stakeholders;
- to comply with the insurance capital requirements set out by the PRA in the UK;
- when capital is needed, to require an adequate return to the shareholder by pricing insurance and investment contracts according to the level of risk associated with the business written; and
- to meet the requirements of the Schemes of Transfer.
The capital management strategy is such that the integrated insurance business (comprising Scottish Widows Group Limited ("SWG") and its subsidiaries, including the Group) will hold capital in line with the stated risk appetite for the business, which is to be able to withstand a one in ten year stress event without breaching the capital requirements. At SWG level it is intended that all surplus capital above that required to absorb a one in ten year stress event will be distributed to LBG.
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 31).
The table below sets out the regulatory capital held at 31 December in each year for the Company on a Solvency II basis. The current year information is an estimate of the final result:
Company 2019 2018 GBPm GBPm Regulatory Capital held 7,724 7,944 ------------------------ ----- -----
All minimum regulatory requirements were met during the year.
(5) Liquidity risk
Liquidity risk is defined as the risk that the Group does not have sufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost.
Liquidity risk may result from either the inability to sell financial assets quickly at their fair values; or from an insurance liability falling due for payment earlier than expected; or from the inability to generate cash inflows as anticipated.
Liquidity risk has been analysed as arising from payments to policyholders (including those where payment is at the discretion of the policyholder) and non policyholder related activity (such as investment purchases and the payment of shareholder expenses).
38. Risk management (continued) (c) Financial risks (continued) (5) Liquidity risk (continued)
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 LBG Funding and Liquidity Policy. Liquidity risk in respect of each of the major product areas is primarily mitigated as follows:
Annuity contracts
Assets are held which are specifically chosen to correspond to the expectation of timing of annuity payments. Gilts, corporate bonds, loans and, where required, derivatives are selected to reflect the expected annuity payments as closely as possible and are regularly rebalanced to ensure that this remains the case in future.
With Profits contracts
For With Profits business, a portfolio of assets is held in line with investment mandates which will reflect policyholders' reasonable expectations.
Liquidity is maintained within the portfolio via the holding of cash balances and a substantial number of highly liquid assets, principally gilts, bonds and listed equities.
Non-participating contracts
For unit-linked products, portfolios are invested in accordance with unit fund mandates. Deferral clauses are included in policyholder contracts to give time, when necessary, to realise linked assets without being a forced seller. As at 31 December 2019, there are no funds under management subject to deferral (2018: none).
For non-linked products other than annuity contracts, backing investments are mostly held in gilts with minimal liquidity risk. Investments are arranged to minimise the possibility of being a distressed seller whilst at the same time investing to meet policyholder obligations. This is achieved by anticipating policyholder behaviour and sales of underlying assets within funds.
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.
38. Risk management (continued) (c) Financial risks (continued) (5) Liquidity risk (continued) Group As at 31 December Contractual cash flows 2019 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 37,456 - 37,456 - - - - External interests in collective investment vehicles 11,966 11,855 - - - - - Derivatives held for trading 3,445 - 16 67 110 677 2,872 Subordinated debt 1,795 - - - 112 1,128 1,465 Borrowings 3 - 3 - - - - Lease liabilities 197 - - - 2 7 188 Other financial liabilities 1,889 297 1,557 28 7 - - Total 56,751 12,152 39,032 95 231 1,812 4,525 -------------------------- -------- --------- -------- ---------- ------- --------- -------- Group As at 31 December Contractual cash flows 2018 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 13,855 - 13,855 - - - - External interests in collective investment vehicles 12,944 12,886 - - - - - Derivatives held for trading 2,719 - 10 98 128 340 2,823 Subordinated debt 1,769 48 - - 113 1,173 1,505 Borrowings 4 - 4 - - - - Other financial liabilities 2,331 260 1,884 28 159 - - Total 33,622 13,194 15,753 126 400 1,513 4,328 -------------------------- -------- --------- -------- ---------- ------- --------- --------
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 2019 Less than than 1-3 3-12 1-5 5 Total 1 month months months years years Maturity Analysis for liabilities arising from insurance and investment contracts GBPm GBPm GBPm GBPm GBPm GBPm Insurance and participating investment contracts 110,919 893 1,335 4,020 26,343 78,328 Non-participating investment contracts 37,456 334 360 1,596 8,077 27,089 ----------------------------- ------- -------- ------- ------- ------ ------ 38. Risk management (continued) (c) Financial risks (continued) (5) Liquidity risk (continued) Group As at 31 December More 2018 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 98,252 1,147 1,496 5,039 23,678 66,892 Non-participating investment contracts 13,855 308 258 1,056 4,534 7,699 ----------------------------- ------ -------- ------- ------- ------ ------ Company As at 31 Contractual cash flows December 2019 Less More Carrying No stated than 3-12 than amount maturity 1 month 1-3 months months 1-5 years 5 years Liabilities GBPm GBPm GBPm GBPm GBPm GBPm GBPm Liabilities arising from non-participating investment contracts 37,455 - 37,455 - - - - Derivative financial instruments 3,434 - 10 62 110 677 2,872 Subordinated debt 1,820 - - - 92 1,147 1,490 Other financial liabilities 1,422 313 1,109 - - - - Total 44,131 313 38,574 62 202 1,824 4,362 ------------------------ -------- --------- -------- ---------- ------- --------- -------- Company As at 31 December Contractual cash flows 2018 Less More Carrying No stated than 3-12 than amount maturity 1 month 1-3 months months 1-5 years 5 years Liabilities GBPm GBPm GBPm GBPm GBPm GBPm GBPm Liabilities arising from non-participating investment contracts 13,825 - 13,825 - - - - Derivative financial instruments 2,681 - 9 64 127 338 2,143 Subordinated debt 1,799 48 - - 92 1,194 1,536 Other financial liabilities 1,608 257 1,215 - 136 - - Total 19,913 305 15,049 64 355 1,532 3,679 ---------------------------- -------- --------- -------- ---------- ------- --------- --------
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 2019 Less than than 1-3 3-12 1-5 5 Total 1 month months months years years Maturity Analysis for liabilities arising from insurance contracts and investment contracts GBPm GBPm GBPm GBPm GBPm GBPm Insurance and participating investment contracts 110,599 882 1,313 5,458 25,903 77,042 Non-participating investment contracts 37,455 334 360 1,593 8,070 27,098 ----------------------------- ------- -------- ------- ------- ------ ------ 38. Risk management (continued) (c) Financial risks (continued) (5) Liquidity risk (continued) Company As at 31 December More 2018 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 96,117 1,125 1,464 4,922 23,166 65,440 Non-participating investment contracts 13,825 308 257 1,052 4,519 7,689 ----------------------------- ------ -------- ------- ------- ------ ------ - Non-financial risks
The Group faces a variety of non-financial risks through its operations and service provision. The Group manages these risks by following the embedded Risk Management Framework, which uses methodologies and systems consistent with those implemented across the Group. The various stages of the framework are:
Identification
-- Risks identified in products, processes, channels, customers and people -- Emerging risks
-- Changes to the risk profile through ongoing tracking, pricing reviews and monitoring of external factors
-- Change Management at project, programme or portfolio level
-- Implement Risk and Control Framework and standards, including loss estimation and provisioning
Measurement
-- Evaluate risk exposure vs appetite -- Modelling and stress testing, including Internal Model outputs -- Actual vs expected losses -- Scenario analysis -- Reverse stress testing
Management
-- Identify and operate controls -- Perform day-to-day control activities -- Ensure appropriate segregation of duties -- Control assessment and estimation of residual risk
-- Controls testing activities including Sarbanes-Oxley and Own Risk and Solvency Assessment (ORSA) review
-- Effectiveness reviews
Monitoring
-- Performance vs risk appetite -- Internal Model performance monitoring -- Risk metrics on for example products, processes, customer experience, service, retention -- Change portfolio -- Regulatory and external environment -- Quality checking -- Action management 38. Risk management (continued) (d) Non-financial risks (continued)
Reporting
-- Monthly Executive Risk Reporting presented through the corporate governance structure leads to top down review and challenge evidenced via the Insurance Consolidated Risk Report
-- Material Events escalation, including related actions -- ORSA reporting
The primary non-financial risk categories are:
Conduct risk
Conduct risk is defined as the risk of customer detriment across the customer lifecycle including: failures in product management, distribution and servicing activities; from other risks materialising, or other activities which could undermine the integrity of the market or distort competition, leading to unfair customer outcomes, regulatory censure, reputational damage or financial loss.
Governance risk
Governance risk is defined as the risk that the Group's organisational infrastructure fails to provide robust oversight of decision making and the control mechanisms to ensure strategies and management instructions are implemented effectively.
Model risk
The risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application and ongoing operation of Models and Ratings systems.
Operational risk
Operational risk is defined as the risk of loss from inadequate or failed internal processes, people and systems or from external events. As operational risk covers such a range of elements, there are secondary risk types within this area, including:
- Change risk
Change risk is defined as the risk that, in delivering its change agenda, the Group fails to ensure compliance with laws and regulation, maintain effective customer service and availability, and/or operate within the Group's risk appetite.
- Cyber and information security
The risk of financial loss, disruption or damage to the reputation of LBG from a malicious attack that impacts the confidentiality and/or integrity of electronic data or the availability of systems. The risk also to the security of information and data.
- Data management
The risk that the Group fails to effectively govern, manage and protect its data (or the data shared with Third Party Suppliers) impacting the Group's agility, accuracy, access and availability of data, ultimately leading to poor customer outcomes, loss of value to the Group and mistrust from regulators.
- External service provision
Failure in the provision of the formally agreed services (i.e. within the scope for the Group Service Provision Policy / supporting Procedures) which are required so Business Units meet their agreed deliverables.
- Financial crime
Financial crime is the risk of acts intended to bribe, corrupt, launder money, fund terrorist activity or circumvent sanctions intended for personal gain or to cause loss to another party, by customers/clients, suppliers, third parties or colleagues.
- Financial reporting risk
Financial reporting risk is defined as the risk that the Group suffers reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies, ineffective controls over business or finance processes impacting financial, prudential regulatory, and tax reporting, failure to manage the associated risks of changes in taxation rates, law, corporate ownership or structure and the failure to disclose timely and appropriate information in accordance with regulatory requirements.
- Fraud
The risk of acts of deception or omission intended for personal gain or to cause loss to another party, by customers/clients, third parties or colleagues,
- Internal service provision
The risk associated with the management of internal service arrangements.
38. Risk management (continued) (d) Non-financial risks (continued) - IT systems
The risk of failure in technology governance and the development, delivery and maintenance of effective IT solutions.
- Operational resilience risk
Operational resilience risk covers the risk that the Group fails to design resilience into business operations, underlying infrastructure and controls (people, process, technical) so that it is able to withstand external or internal events which could impact the continuation of operations, and fails to respond in a way which meets stakeholder expectations and needs when the continuity of operations is compromised.
- Physical security risk
The risk to the security of people and property (including damage (malicious or non-malicious) to LBG branches and buildings managed through Group Property).
- Sourcing
Sourcing risk covers the risk associated with the activity related to the agreement and management of services provided by third parties including outsourcing (excludes internal service arrangements).
People risk
People risk is defined as the risk that the Group fails to provide an appropriate colleague and customer centric culture, supported by robust regard and wellbeing policies and processes; effective leadership to manage colleague resources; effective talent and succession management; and robust control to ensure all colleague-related requirements are met.
Regulatory and legal risk
The risk of financial penalties, regulatory censure, criminal or civil enforcement action or customer detriment as a result of failure to identify, assess, correctly interpret, comply with, or manage regulatory and/or legal requirements.
(e) UK political uncertainties including EU exit
Following the UK's exit from the EU, significant negotiation is now required on the terms of the future trade agreement. As a result, the possibility of a limited or no deal at the end of the transition period remains and could manifest in prolonged business uncertainty across the UK, including the financial services sector. The continued lack of clarity over the UK's eventual relationship with the EU and other foreign countries, and ongoing challenges in the Eurozone, including weak growth raises additional uncertainty for the UK economic outlook. The Group's response to these risks and uncertainty is as follows:
-- Internal contingency plans recalibrated and regularly reviewed for potential strategic, operational and reputational impacts.
-- As part of LBG, engagement with politicians, officials, media, trade and other bodies to reassure our commitment to Helping Britain Prosper.
-- Committed investments for our new entity in the EU to ensure continuity of certain business activities, and contingency planning in relation to wider areas of impact
-- No deal EU exit outcome analysed to identify impacts and assess robustness of contingency plans.
-- Economic Risk
UK economic growth remains muted and the lack of clarity around an EU trade deal is likely to keep investment subdued. High levels of credit market liquidity have reduced spreads and weakened terms in some sectors, creating a potential under-pricing of risk and heightened risk of a market correction. The Group's response to these risks is as follows:
-- Internal contingency plans recalibrated and regularly reviewed for potential strategic, operational and reputational impacts, with a plan specifically for working through the potential impacts of the EU exit on the Group.
-- Wide array of risks considered in setting strategic plans.
-- Capital and liquidity are reviewed regularly through committees, ensuring compliance with risk appetite and regulatory requirements.
-- The Group has a robust through the cycle credit risk appetite, including individual limit guidelines, specific sector appetite statements and policies, and affordability and indebtedness controls at origination. In addition to ongoing focused monitoring, we conduct portfolio deep dives and larger exposure reviews. We have enhanced our use of early warning indicators including sector specific indicators.
Additionally, the more recent coronavirus outbreak and related global health issues are already starting to impact economies and markets. Whilst the ultimate impact is currently unknown, we are exploring the credit risk impact, with a focus on illiquid assets, noting we have little exposure to retail, automobiles and manufacturing loans.
RELATED PARTY TRANSACTIONS
39. Related party transactions (a) Ultimate parent and shareholding
The Group's immediate parent undertaking is Scottish Widows Group Limited, a Company registered in the United Kingdom. Scottish Widows Group Limited has taken advantage of the provisions of the Companies Act 2006 and has not produced consolidated financial statements.
The ultimate parent undertaking and controlling party is Lloyds Banking Group plc, which is the parent undertaking of the only group to consolidate these financial statements. Once approved, copies of the consolidated Annual Report and Accounts of Lloyds Banking Group plc 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 and balances with related parties
Transactions with other LBG 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.
2019 Income Expenses Payable Receivable during during at period at period period period end end GBPm GBPm GBPm GBPm Relationship Parent 15 (300) - 351 Other related parties 335 (822) (1,831) 2,275 2018 Income Expenses Payable Receivable during during at period at period period period end end GBPm GBPm GBPm GBPm Relationship Parent 15 (1,765) - 348 Other related parties 600 (894) (1,419) 3,213 ---------------------- ------- -------- ---------- ----------
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 GBP574m (2018: GBP476m) of shares in the ultimate parent undertaking on the balance sheet, with associated transactions of GBP(30)m (2018: GBP14m) during the year.
2019 Income Expenses Payable Receivable during during at period at period period period end end GBPm GBPm GBPm GBPm Relationship Parent 15 (300) - 351 Subsidiary 1,588 (88) (1,612) 662 Other related parties 335 (743) (1,826) 2,175 2018 Income Expenses Payable Receivable during during at period at period period period end end GBPm GBPm GBPm GBPm Relationship Parent 15 (1,765) - 348 Subsidiary 112 (193) (6) 671 Other related parties 522 (1,037) (2,376) 4,064 ---------------------- ------- -------- ---------- ----------
Further, amounts relating to other related parties of GBP3,418m due from OEICs investments were outstanding at 31 December 2019 (2018: GBP2,153m). 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 GBP330m (2018: GBP(139)m) from OEIC investments.
39. Related party transactions (continued) (b) Transactions and balances with related parties (continued)
Transactions with other LBG companies (continued)
Parent undertaking transactions relate to all reported transactions and balances with Scottish Widows Group Limited, the Group's immediate parent. Such transactions with the parent Company are primarily financing (through capital and sub-ordinated 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.
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:
2019 2019 2018 2018 GBPm GBPm GBPm GBPm Group Company Group Company Short-term employee benefits 7 7 8 8 Share-based payments 2 2 2 2 Total 9 9 10 10 ----------------------------- ----- ------- ----- -------
Included in short term employee benefits is the aggregate amount of emoluments paid to or receivable by Directors in respect of qualifying services of GBP3m (2018: GBP3m).
There were no retirement benefits accruing to Directors (2018: nil) under defined benefit pension schemes. Three Directors (2018: six Directors) are paying into a defined contribution scheme. There were no contributions paid to a pension scheme for qualifying services (2018: nil) for Group and Company.
Certain members of key management in the Group, including the highest paid Director, provide services to other companies within LBG. 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.
The aggregate amount of money receivable and the net value of assets received/receivable under share based incentive schemes in respect of Directors qualifying services was GBP1m (2018: GBP1m). During the year, two Director exercised share options (2018: 1 Directors) and three Directors received qualifying service shares under long term incentive schemes (2018: two Directors). Movements in share options are as follows:
2019 2018 GBPm GBPm Options Options Outstanding at 1 January 15 13 Granted 8 6 Exercised (4) (3) Forfeited (4) (1) Outstanding at 31 December 15 15 --------------------------- ------- -------
Detail regarding the highest paid Director is as follows:
2019 2019 2018 2018 GBPm GBPm GBPm GBPm Group Company Group Company Apportioned aggregate emoluments 2 2 2 2 Apportioned share-based payments 1 1 1 1
The highest paid Director did not exercise share options during the year. (2018: 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
This information is provided by RNS, the news service of the London Stock Exchange. RNS is approved by the Financial Conduct Authority to act as a Primary Information Provider in the United Kingdom. Terms and conditions relating to the use and distribution of this information may apply. For further information, please contact rns@lseg.com or visit www.rns.com.
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