Business Context and Reporting Period
This Form 6-K filing by Lloyds TSB Group plc, dated November 22, 2006, announces the transition of its Scottish Widows subsidiary to European Embedded Value (EEV) reporting for supplementary financial information. While statutory accounts will continue under International Financial Reporting Standards (IFRS), the Group adopted EEV principles to improve transparency and comparability in its life assurance and investment businesses. The filing details the methodology, assumptions, and financial impact of this transition based on data for the year ended December 31, 2005.
Key Financial Metrics (Scottish Widows Supplementary Reporting)
The following metrics reflect the year ended December 31, 2005, under the new EEV basis compared to the previous Traditional Embedded Value (TEV) basis:
- New Business Profit Before Tax: GBP 254 million (EEV) vs. GBP 224 million (TEV), an increase of 13%.
- Profit Before Tax (excluding volatility and specific reserve adjustments): GBP 727 million (EEV) vs. GBP 616 million (TEV), an increase of 18%.
- Embedded Value (Year-End): GBP 6,386 million (EEV) vs. GBP 6,334 million (TEV), a 1% increase.
- Post-Tax Return on Embedded Value: 8.0% (EEV) vs. 6.8% (TEV).
- Statutory Impact: The transition has a negligible impact on statutory IFRS accounts, with the value of in-force business changing from GBP 2,922 million to GBP 2,921 million.
Material Changes Versus Prior Period
The primary material change is the shift in reporting methodology from TEV to EEV, which alters the timing of profit recognition and the scope of covered business.
- Scope Expansion: EEV reporting now includes retail Open Ended Investment Companies (OEICs) and managed fund business, which were excluded under TEV. This inclusion contributed significantly to the increase in new business profit.
- Risk Valuation: EEV explicitly values financial options and guarantees and includes a cost of capital for required capital, whereas TEV used a single risk discount rate. The cost of financial options and guarantees reduced the embedded value by GBP 193 million, while the inclusion of OEICs added GBP 456 million.
- Profit Timing: EEV recognizes profit earlier in the contract lifecycle compared to TEV, resulting in higher reported new business profit (GBP 254m vs GBP 123m under IFRS).
Guidance, Outlook, and Risks
Management Commentary: Management asserts that EEV provides a more appropriate measure of long-term value creation and economic value. The methodology was developed with consulting actuaries Tillinghast and audited by PricewaterhouseCoopers LLP, who issued an unqualified opinion on the supplementary information.
Outlook: The Group intends to report supplementary financial information on an EEV basis starting from the 2006 year-end. The impact on statutory accounts for 2006 is not expected to be material.
Risks and Contingencies: The filing includes standard forward-looking statement disclaimers regarding economic conditions, credit quality, market risks (interest rates, exchange rates, equity risk), and regulatory changes. Sensitivity analysis indicates that a 10% reduction in equity and property asset values would reduce EEV by GBP 240 million, while a 100 basis point reduction in risk-free rates would increase EEV by GBP 173 million.
Investor Verification Checklist
- Verify the reconciliation between IFRS statutory results and EEV supplementary results, noting the GBP 131 million difference in new business profit.
- Confirm the inclusion of retail OEICs and managed funds in the EEV covered business scope, which was not present in TEV.
- Review the sensitivity analysis regarding equity/property asset values and risk-free rates to understand valuation volatility.
- Note that the cost of capital adjustment is applied in supplementary EEV reporting but excluded from statutory accounts to maintain consistency with banking business treatment.
- Check the audit opinion from PricewaterhouseCoopers LLP confirming the EEV supplementary information complies with the 12 EEV Principles.