Key highlights

• Strong profit performance. Profit before tax increased by 9 per cent to £1,056 million. Adjusting for the impact of surplus capital repatriation, profit before tax increased by 13 per cent.
• Good income growth and excellent cost control. Income, net of insurance claims and adjusting for the impact of surplus capital repatriation, increased by 7 per cent. Operating expenses decreased by 2 per cent.
• Good sales performance. 7 per cent increase in Scottish Widows’ present value of new business premiums. Strong progress in increasing bancassurance sales, up 20 per cent. Good performance in the sale of protection products, corporate pensions and retirement income products.
• Improved returns. On an EEV basis, the post-tax return on embedded value increased to 9.9 per cent. New business margin was robust at 3.1 per cent.
• Robust capital position. Scottish Widows continues to deliver improving capital efficiency and self-financing growth, and a further £1.9 billion of capital was repatriated to the Group during 2007.
• Increased weather related claims of £113 million, largely relating to the severe flooding in the UK in June and July, contributed to a 47 per cent reduction in profit before tax in General Insurance.
• Excellent performance in Scottish Widows Investment Partnership. Profit before tax increased by 52 per cent reflecting higher margins and improved mix of external business.

Results

*Excluding insurance grossing adjustment

Scottish Widows life, pensions and OEIC

Profit before tax increased by £183 million, or 26 per cent, to £884 million. The effect of surplus capital repatriation to the Group has been to reduce investment earnings by a total of £36 million in 2007. Adjusting 2006 for this, profit before tax increased by 33 per cent.

Life and pensions new business profit, on an IFRS basis and excluding volatility, reduced by 5 per cent to £163 million reflecting a change in the mix of investment products sold through the branch network towards non-embedded value accounted products. Total existing business profit grew by 43 per cent to £551 million, partly reflecting increased profits from the growing OEIC portfolio, improved cost management and a reduction in adverse assumption changes compared to 2006. The expected return on shareholders’ net assets increased by 43 per cent to £192 million as a result of a higher volume of free assets, driven by strong equity markets and the impact of regulatory changes in 2006, and a higher expected rate of return.

During 2007, Scottish Widows has continued to make strong progress in each of its key business priorities: to maximise bancassurance success; to profitably grow IFA sales; to improve service and operational efficiency; and to optimise capital management.

“During 2007, Scottish Widows has continued to make strong progress in each of its key business priorities.”

Maximising bancassurance success
In 2007, the value of Scottish Widows’ bancassurance new business premiums increased by 20 per cent, building on the success of the simplified product range for distribution through the Lloyds TSB branch network, Commercial Banking and Wealth Management channels. Sales of protection products were particularly strong. A new branch network creditor insurance and protection product, which replaced an externally provided creditor product, has led to the significant increase in protection sales during 2007. In addition, Scottish Widows launched a new protection product, ‘Protection for Life’ towards the end of 2006, which has performed very well. We have continued to deliver good sales of OEICs following the more than doubling of sales in 2006.

Profitably growing IFA sales
Sales through the IFA distribution channel increased by 2 per cent, following record A-day related sales levels in 2006. Scottish Widows has continued to focus on the more profitable business areas within the IFA market. Sales of savings and investment products were lower as we chose not to compete in areas which deliver unsatisfactory returns, although this was partly offset by good growth in OEIC sales. Corporate pensions volumes remained strong following excellent
growth last year and our managed fund business also showed good improvement.

Improving service and operational efficiency
The business has made continued improvements in service and operational efficiencies, and the benefits can be seen in a reduction of expenses by 2 per cent compared to prior year, notwithstanding the introduction of a number of new products. In addition, customer satisfaction is at its highest ever level. Scottish Widows received a number of awards for service quality and product innovation, including ‘Best Individual Pensions Provider’ at the Financial Adviser awards
whilst maintaining its top quartile position for lowest servicing and acquisition costs per policy.

Optimising capital management
Scottish Widows has maintained its strong focus on improving capital management. During 2007 Scottish Widows continued to deliver a more capital efficient product profile and improved internal rates of return. The post-tax return on embedded value, on an EEV basis, increased to 9.9 per cent, from 9.3 per cent last year. During 2007, £1.9 billion of capital was repatriated to the Group, giving a total capital repatriation of over £3.6 billion since the beginning of 2005.

Present value of new business premiums (PVNBP)

Results on a European Embedded Value (EEV) basis

Lloyds TSB continues to report under IFRS, however, in line with industry best practice, the Group provides supplementary financial reporting for Scottish Widows on an EEV basis. The Group believes that EEV represents the most appropriate measure of long-term value creation in life assurance and investment businesses.

Adjusting for the impact of capital repatriation, EEV profit before tax from the Group’s life, pensions and OEICs business increased by 11 per cent to £903 million.

New business profit fell by £20 million, or 6 per cent, to £326 million, largely reflecting the impact of a higher risk-free discount rate and changes in other economic assumptions applied to new business. This was however offset by a corresponding credit to the expected return on shareholders’ net assets.

Existing business profit increased by 9 per cent. Expected return decreased by 16 per cent to £337 million, primarily reflecting a lower shareholder benefit this year from the reduction in the value of realistic balance sheet liabilities and the impact of regulatory changes in 2006. Positive experience variances were driven by higher annuity profits from Abbey Life. Overall lapse experience was broadly in line with the Group’s expectations, as higher lapse experience in the life and pensions business was broadly offset by a favourable experience in OEICs. Assumption changes primarily reflect changes to the longer term lapse assumptions for both life and pensions business and OEICs. The expected return on shareholders’ net assets increased by £76 million, as a result of a higher volume of free assets, driven by strong equity markets and the impact of regulatory changes in 2006, and a higher expected rate of return

Overall the post-tax return on embedded value increased to 9.9 per cent from 9.3 per cent. Scottish Widows maintained a strong new business margin of 3.1 per cent. Individual new business product margins remained broadly stable. The overall new business margin fell by 50 basis points however, as a result of an adverse impact from a higher risk-free discount rate and changes in other economic assumptions applied to new business and the shift in product mix resulting from the insourcing of a new branch network creditor insurance and protection product. This product generates a lower new business margin, but delivers good levels of value for the Group.

Scottish Widows Investment Partnership

Pre-tax profit from Scottish Widows Investment Partnership (SWIP) increased by 52 per cent to £44 million, reflecting increased profitability resulting from higher margins and an improved mix of external business, a key strategic priority for SWIP. Over the last 12 months, SWIP’s assets under management decreased by £4.1 billion to £97.6 billion, reflecting the decision by the Trustees of the Lloyds TSB pension schemes to move £5.7 billion into external passive management. As a result, institutional funds under management reduced by £5.0 billion. The net movement in retail funds, net of expenses and commissions, was an increase of £2.9 billion.

Movements in funds under managemen

The following table highlights the movement in retail and institutional funds under management.

Including assets under management within our UK Wealth Management and International Private Banking businesses, Groupwide funds under management decreased by 3 per cent to £122.8 billion.

European Embedded Value reporting - results for year ended 31 December 2007

This section provides further details of the Scottish Widows EEV financial information.

Composition of EEV balance sheet

Reconciliation of opening EEV balance sheet to closing EEV balance sheet on covered business

Analysis of shareholders’ net assets on an EEV basis on covered business

Summary income statement on an EEV basis

* Other items represent amounts not considered attributable to the underlying performance of the business.

Breakdown of income statement between life and pensions, and OEICs

Economic assumptions

A bottom up approach is used to determine the economic assumptions for valuing the business in order to determine a market consistent valuation.

The risk-free rate assumed in valuing in-force business is 10 basis points over the 15 year gilt yield. In valuing financial options and guarantees the risk-free rate is derived from gilt yields plus 10 basis points, in line with Scottish Widows’ FSA realistic balance sheet assumptions. The table below shows the range of resulting yields and other key assumptions.

Non-market risk

An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk and the With Profit Fund these are asymmetric in the range of potential outcomes for which an explicit allowance is made.

Non-economic assumptions

Future mortality, morbidity, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and on management’s view of future experience. These assumptions are intended to represent a best estimate of future experience.

For OEIC business, the lapse assumption is based on recent experience which has been collected over a period that has coincided with favourable investment conditions. Management have used a best estimate of the long-term lapse assumption which is higher than indicated by this experience. In management’s view, the approach and lapse assumption are both reasonable.

Sensitivity analysis

The table below shows the sensitivity of the EEV and the new business profit before tax to movements in some of the key assumptions. The impact of a change in the assumption has only been shown in one direction other than for risk free rate. Where the impact has been shown only in one direction it can be assumed to be reasonably symmetrical.

¹ In this sensitivity the impact takes into account the change in the value of in-force business, financial options and guarantee costs, statutory reserves and asset values.

² The reduction in market values is assumed to have no corresponding impact on dividend yields.

³ The reduction in market values is assumed to have no corresponding impact on rental yields.

⁴ This sensitivity shows the impact of reducing new business maintenance expenses and investment expenses to 90 per cent of the expected rate.

⁵ This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.

⁶ This sensitivity shows the impact on our annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.

⁷ This sensitivity shows the impact of reducing mortality rates on non-annuity business to 95 per cent of the expected rate.

⁸ Under a market consistent valuation, changes in assumed equity and property returns have no impact on the EEV.

⁹ This sensitivity shows the impact of a 10 basis point increase in corporate bond yields and the corresponding reduction in market values. Government bond yields and the risk-free rate are assumed to be unchanged.

In sensitivities 4 to 7 assumptions have been flexed on the basis used to calculate the value of in-force business and the realistic and the statutory reserving bases. A change in risk discount rates is not relevant as the risk discount rate is not an input to a market consistent valuation.

General insurance

Profit before tax from our general insurance operations decreased by £115 million, to £128 million, largely as a result of a £113 million increase in weather related claims, primarily reflecting severe flooding in the UK in June and July. Net operating income decreased by 3 per cent whilst costs were reduced by 2 per cent.

Net operating income decreased by £16 million, or 3 per cent, as growth in home and loan protection income was more than offset by lower motor insurance income, increased reinsurance costs and the run-off from the legacy health portfolio. Our continued focus on improving operational efficiency and improving the effectiveness of our marketing spend has resulted in a £3 million, or 2 per cent, reduction in operating costs, whilst also continuing to improve processing efficiency.

Overall sales performance has been good with an 8 per cent increase in new business gross written premiums (GWP). Home insurance sales through the branch network continue to perform well with 14 per cent growth in new business GWP. We have, however, scaled back our participation in the distribution of home insurance through direct channels, as a result of the increasingly competitive pricing in that area of the market. During the year we continued to invest in product development, with loan protection and home insurance products both securing industry leading external quality ratings.

Income, net of claims, was £118 million lower, largely as a result of the increased extreme weather related claims, following a benign period in 2006. As a result, overall claims increased by £102 million, and key underwriting ratios were significantly affected with an increase in the claims ratio to 49 per cent, and an increase in the combined ratio to 93 per cent. Adjusting for the extreme weather related claims, the claims ratio improved, reflecting both a favourable claims experience in our home insurance underwriting and the impact of recent investment in improving the efficiency of our claims processing.

The business continues to invest in the development of its Corporate Partnership distribution arrangements and the performance of the Pearl business acquired in 2006 has exceeded our initial expectations.