The strategic priorities for the new ‘Insurance’ division are:

• Delivering profitable, market-led product propositions
• Increasing the proportion of business sold through the Lloyds Banking Group franchise whilst profitably growing independent financial adviser (IFA) sales
• Leveraging scale into new channels
• Improving service and operational efficiency
• Managing risk effectively and optimising capital management
• Attracting, developing and retaining the best people

Within the life assurance operations this will be achieved by developing strong and enduring relationships, developing market-led propositions and being easy to do business with. Scottish Widows’ products are distributed through the Lloyds TSB channels, independent financial advisers and other intermediaries, whilst Clerical Medical products are distributed through the HBOS channels, independent financial advisers and other intermediaries.

The General Insurance operations are targeting growing share in their chosen customer segments, developing key insurance partnerships, improving margins by better customer management and improving service and efficiency.

†The 2007 figures have been restated (see Summarised segmental analysis). The 2006 figures are as originally published.

*EEV basis.

♦Excluding volatility and insurance grossing.

Profit before tax, excluding volatility, increased by £38 million, or six per cent, to £635 million.

Life and pensions new business profit, on an IFRS basis and excluding volatility, increased by 46 per cent to £238 million, reflecting a higher volume of protection business and the development of an investment bond product which has resulted in a higher proportion of the new business written containing insurance features, which is therefore accounted for on an embedded value basis. Existing business profit decreased by 12 per cent, to £363 million, as an increase in expected profits from the existing business was more than offset by the adverse impact of changes in assumptions, principally reflecting an increase in long-term lapse assumptions.

During 2008, Scottish Widows has continued to make good progress in its key business priorities: to maximise bancassurance success; to profitably grow IFA sales; to improve service and operational efficiency; and to optimise capital management.

MAXIMISING BANCASSURANCE SUCCESS

During 2008, the value of Scottish Widows’ bancassurance new business premiums increased by four 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 OEICs through the wealth segment were particularly strong, offsetting a reduction in volumes through the mass market segment, where a reduction in the sales of equity-backed OEICs has been partly offset by strong sales of capital protected savings products. Sales of protection products also increased significantly reflecting the benefit of product enhancements during the year.

IFA SALES

Sales through the IFA distribution channel decreased by eight per cent, reflecting the general contraction in sales in the IFA market. Scottish Widows’ participation in the IFA market remains focused on achieving financial returns which meet the Company’s internal targets. Sales performance was strong in corporate pensions where an increase in volumes of 19 per cent was achieved whilst maintaining satisfactory margins and returns. Within individual pensions, sales of the Retirement Account, a capital efficient product with a more transparent charging structure, increased by 75 per cent benefiting from product enhancements introduced during the year. Sales of investment bonds reduced by 56 per cent, partly driven by changes in Capital Gains Tax regulations, but also reflecting the Company’s unwillingness to participate in markets which do not generate an economic return.

IMPROVING SERVICE AND OPERATIONAL EFFICIENCY

The business has made further improvements in service and operational efficiencies, and the benefits can be seen in a further reduction of three per cent in operating expenses, notwithstanding ongoing investment in product and distribution enhancements. In addition, the strength of Scottish Widows’ product and service proposition was recognised through an increased number of industry awards and ratings in 2008; the Company was voted best personal pensions provider, achieved two ‘5 star’ service awards and was rated highly for its strong e-commerce platform.

OPTIMISING CAPITAL MANAGEMENT

The capital position of Scottish Widows has remained robust despite recent market turbulence. Scottish Widows’ approach to capital management, including its investments and hedging strategy, has been successful in mitigating the impact of market shocks on its current capital base. Additionally, Scottish Widows’ capital management strategy is designed to generate sufficient free cash flow to fund new business and maintain dividend flow to the Group. Accordingly, Scottish Widows continues to focus on improving the capital efficiency of its products and identifying further opportunities to improve its capital position. The post-tax return on embedded value, on an EEV basis, increased to 11.4 per cent, partly reflecting a lower value of in-force business resulting from recent falls in investment markets. During 2008, £0.2 billion of capital was paid to the Group via the regular annual dividend payment, giving a total capital repatriation of over £3.8 billion since the beginning of 2005.

Present value of new business premiums (PVNBP)

	2008 £m	2007 £m	Change %
Life and pensions:
Protection	317	275	15
Creditor	680	685	(1)
Savings and Investments	437	913	(52)
Individual pensions	2,125	2,073	3
Corporate and other pensions	2,482	2,141	16
Retirement income	939	1,044	(10)
Managed fund business	217	486	(55)
Life and pensions	7,197	7,617	(6)
OEICs	2,897	2,807	3
Life, pensions and OEICs	10,094	10,424	(3)
Single premium business	7,346	8,375	(12)
Regular premium business	2,748	2,049	34
Life, pensions and OEICs	10,094	10,424	(3)
Bancassurance	4,247	4,096	4
Independent financial advisers	5,367	5,817	(8)
Direct	480	511	(6)
Life, pensions and OEICs	10,094	10,424	(3)

RESULTS ON A EUROPEAN EMBEDDED VALUE (EEV) BASIS

In addition to reporting under IFRS, the Group, as in previous reporting periods, provides supplementary financial reporting for Scottish Widows on an EEV basis.

Continuing businesses*

	2008 Life, pensions and OEICs £m		2007 Life, pensions and OEICs £m	Change %
New business profit	295		326	(10)
Existing business
– Expected return	321		296
– Experience variances	52		41
– Assumption changes	4		(32)
	377		305	24
Expected return on shareholders' net assets	146		166	(12)
Profit before tax, adjusted for capital repatriation*	818		797	3
Impact of capital repatriation to Group	–		21
Profit before tax*	818		818	–
New business margin (PVNBP)	2.9%		3.1%
Embedded value (period end) – continuing businesses	£4,932m		£5,365m
Post-tax return on embedded value*	11.4%		10.7%

*Excluding volatility and other items.

Adjusting for the impact of capital repatriation to Group, EEV profit before tax from the Group’s life, pensions and OEICs business increased by three per cent to £818 million in challenging market conditions.

New business profit fell by £31 million, or 10 per cent, to £295 million and the overall new business margin reduced to 2.9 per cent, from 3.1 per cent last year, primarily reflecting higher commission payable on OEIC products. In difficult trading conditions, life and pensions new business profit remained satisfactory with a continued focus on improving product profitability resulting in the new business margin increasing to 3.6 per cent (see Scottish Widows Investment Partnership).

Existing business profit increased by 24 per cent to £377 million. Expected return increased to £321 million driven by an increase in expected income from our annuity portfolio. The net impact of experience variances in both years is broadly comparable and reflects adverse lapse experience being more than offset by other favourable experience. The net impact of assumption changes in the current year is not significant and reflects a charge from more pessimistic lapse assumptions in life and pensions business which is broadly offset by favourable lapse assumptions in OEICs and other modelling changes. The expected return on shareholders’ net assets decreased by £20 million as a result of a lower volume of free assets, driven by lower investment markets.

Overall the post-tax return on embedded value increased to 11.4 per cent.

Profit before tax from Scottish Widows Investment Partnership (SWIP) increased to £42 million (2007: £41 million). The adverse impact on income of volatile equity and bond markets was more than offset by strong cost management. With the FTSE All-Share Index falling to levels not seen since 2003, SWIP’s assets under management decreased by £14.6 billion to £83.0 billion.

MOVEMENTS IN FUNDS UNDER MANAGEMENT

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

	2008 £bn	2007 £bn
Opening funds under management	102.7	105.7
Movement in Retail Funds
Premiums	11.2	11.7
Claims	(4.3)	(4.8)
Surrenders	(5.7)	(6.4)
Net inflow of business	1.2	0.5
Investment return, expenses and commission	(12.5)	2.4
Net movement	(11.3)	2.9
Movement in Institutional Funds
Lloyds TSB pension schemes	–	(5.7)
Other institutional funds	(0.8)	(0.6)
Investment return, expenses and commission	(2.5)	1.3
Net movement	(3.3)	(5.0)
Proceeds from sale of Abbey Life	–	1.0
Dividends and surplus capital repatriation	(0.2)	(1.9)
Closing funds under management	87.9	102.7
Managed by SWIP	83.0	97.6
Managed by third parties	4.9	5.1
Closing funds under management	87.9	102.7

Including assets under management within our UK Wealth Management and International Private Banking businesses, groupwide funds under management decreased by 10 per cent to £109 billion.

European Embedded Value reporting –
results for year ended 31 December 2008

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

Composition of EEV balance sheet

	31 December  2008  £m	31 December  2007  £m
Value of in-force business (certainty equivalent)	2,360	2,779
Value of financial options and guarantees	(90)	(53)
Cost of capital	(90)	(178)
Non-market risk	(57)	(61)
Total value of in-force business	2,123	2,487
Shareholders’ net assets	2,809	2,878
Total EEV of covered business	4,932	5,365

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

	Shareholders’ net assets £m		Value of in-force business £m		Total  £m
As at 1 January 2007	3,572		2,841		6,413
Total profit after tax
– Continuing businesses	580		102		682
– Discontinued businesses	81		5		86
Profit on disposal of Abbey Life (EEV basis)
– Sale proceeds	985		–		985
– Assets disposed	(474)		(461)		(935)
	511		(461)		50
Dividends	(1,866)		-		(1,866)
As at 31 December 2007	2,878		2,487		5,365
Total profit (loss) after tax	151		(364)		(213)
Dividends	(220)		–		(220)
As at 31 December 2008	2,809		2,123		4,932

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

	Required  capital  £m	Free  surplus  £m	Shareholders'  net assets £m
As at 1 January 2007	2,207	1,365	3,572
Total profit (loss) after tax
– Continuing businesses	(214)	794	580
– Discontinued businesses	(24)	105	81
Dividends	–	(1,866)	(1,866)
Disposal of Abbey Life (EEV basis)	(232)	743	511
As at 31 December 2007	1,737	1,141	2,878
Total (loss) profit after tax	(823)	974	151
Dividends	–	(220)	(220)
As at 31 December 2008	914	1,895	2,809

Summary income statement on an EEV basis – Continuing businesses

	2008  £m		2007   £m
New business profit	295		326
Existing business profit
– Expected return	321		296
– Experience variances	52		41
– Assumption changes	4		(32)
	377		305
Expected return on shareholders’ net assets	146		187
Profit before tax, excluding volatility and other items*	818		818
Volatility	(1,176)		(287)
Other items*	60		58
Total (loss) profit before tax	(298)		589
Taxation	85		(29)
Impact of Corporation tax rate change	–		122
Total (loss) profit after tax – continuing businesses	(213)		682

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

Breakdown of income statement between life and pensions, and OEICs – Continuing businesses

	Life and  pensions £m		OEICS  £m		Total  £m
2008
New business profit	258		37		295
Existing business
– Expected return	254		67		321
– Experience variances	40		12		52
– Assumption changes	(48)		52		4
	246		131		377
Expected return on shareholders’ net assets	138		8		146
Profit before tax*	642		176		818
New business margin (PVNBP)	3.6%		1.3%		2.9%
Post-tax return on embedded value*					11.4%
2007
New business profit	270		56		326
Existing business
– Expected return	245		51		296
– Experience variances	(2)		43		41
– Assumption changes	(92)		60		(32)
	151		154		305
Expected return on shareholders’ net assets	179		8		187
Profit before tax*	600		218		818
New business margin (PVNBP)	3.5%		2.0%		3.1%
Post-tax return on embedded value*					10.7%

*Excluding volatility and other items.

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 valuation of the Group’s annuity business has been affected by the recent upheaval in the capital markets which has caused a significant widening in corporate bond spreads. Based on available market analysis, an element of this widening in corporate bond spreads has been assessed as arising from an increase in the illiquidity premium. As a result, in 2008 the value of the in-force business asset for annuity business has been calculated after taking into account an estimate of the market premium for illiquidity derived using a portfolio of investment grade bonds with similar cash flow characteristics as the annuity liabilities.

For 2008, the risk-free rate assumed in valuing the non-annuity in-force business is the 15 year UK gilt yield. The risk free rate assumed in valuing the in-force asset for the annuity business is presented as a single risk free rate to allow easier comparison to the rate used for other business. That single risk free-free rate has been derived to give the equivalent value to the annuity book, had that book been valued using the UK gilt yield curve increased to reflect the illiquidity premium described above. The risk free rate used in valuing financial options and guarantees is defined as the spot yield derived from the UK gilt yield curve, in line with Scottish Widows’ FSA realistic balance sheet assumptions. The table below shows the range of resulting yields and other key assumptions.

	31 December 2008 %	31 Dec 2007 %
Risk-free rate (value of in-force non-annuity business)	3.74	4.65
Risk-free rate (value of in-force annuity business)	5.22	4.65
Risk-free rate (financial options and guarantees)	1.11 to 4.24	4.28 to 4.81
Retail price inflation	2.75	3.28
Expense inflation	3.50	4.18

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, recent lapse assumption experience has been collected over a period that has predominantly 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.

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.

SENSITIVTY 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 as the impact can be assumed to be reasonably symmetrical.

	Impact on EEV £m	Impact on new  business profit  before tax £m
2008 EEV/new business profit before tax
100 basis points reduction in risk-free rate1	186	6
10 per cent reduction in market values of equity assets2	(170)	n/a
10 per cent reduction in market values of property assets3	(25)	n/a
10 per cent reduction in expenses4	84	31
10 per cent reduction in lapses5	70	17
5 per cent reduction in annuitant mortality6	(56)	(2)
5 per cent reduction in mortality and morbidity (excluding annuitants)7	23	4
100 basis points increase in equity and property returns8	nil	nil
25 basis points increase in corporate bond spreads9	(59)	(4)
25 basis points decrease in illiquidity premium10	(97)	n/a

¹In 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.

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

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

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

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

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

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

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

⁹This sensitivity shows the impact of a 25 basis point increase in corporate bond yields and the corresponding reduction in market values. Government bond yields, the risk-free rate and illiquidity premia are all assumed to be unchanged.

¹⁰This sensitivity shows the impact of a 25 basis point reduction in the allowance for illiquidity premia. It assumes that the overall corporate bond spreads are unchanged and hence market values are unchanged. Government bond yields and the risk-free rate are both assumed to be unchanged.

In sensitivities (4) to (7) and (9) 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.

Profit before tax from our general insurance operations increased by £124 million, to £234 million, reflecting a £109 million reduction in claims due to the absence of the severe weather related claims experienced in 2007 and the continued benefits from ongoing investment in our claims processes.

Net operating income increased by £22 million, reflecting good increases in new and renewal home insurance premium income. New business premium income increased by nine per cent and continued investment in our pricing and business retention capabilities delivered four per cent growth in renewal earned premiums.

	2008 £m		2007† £m		Change %
Home insurance
Underwriting income (net of reinsurance)	441		418		6
Commission receivable	50		50
Commission payable	(78)		(77)		(1)
	413		391		6
Creditor insurance
Underwriting income (net of reinsurance)	163		164		(1)
Commission receivable	428		510		(16)
Commission payable	(494)		(574)		14
	97		100		(3)
Other
Underwriting income (net of reinsurance)	8		9		(11)
Commission receivable	71		88		(19)
Commission payable	(33)		(41)		20
Other	32		19		68
	78		75		4
Net operating income	588		566		4
Claims paid on insurance contracts (net of reinsurance)	(193)		(302)		36
Operating income, net of claims	395		264		50
Operating expenses	(161)		(154)		(5)
Profit before tax	234		110		113
Claims ratio	30%		49%
Combined ratio	76%		93%

†Restated, see Summarised segmental analysis. Within the above analysis, profit share receivable has been allocated across product groups, whereas it was previously allocated to other. Comparative figures have been restated accordingly.

Claims were £109 million lower, principally reflecting the absence of severe weather related claims experienced last year, which more than offset an increase of £15 million in payment protection insurance unemployment claims. Adjusting for the severe weather related claims, the claims ratio improved from 31 per cent to 30 per cent, reflecting continued benefits from ongoing investment in our claims processes and further efficiencies from improved process management.

General Insurance continues to make good progress against its key strategic initiatives:

GROWING SHARE IN OUR CHOSEN CUSTOMER SEGMENTS

Growth in total home insurance sales developed good momentum during 2008, with sales through the branch network increasing by nine per cent, supported by a positive customer reaction to our 5 Star Defaqto Rated home insurance product and strong claims service proposition.

DEVELOPING KEY INSURANCE PARTNERSHIPS

General Insurance continues to invest in the development of its Corporate Partnership distribution arrangements. New partnerships with Resolution Life, Reader’s Digest, Budget and Post Office Financial Services are expected to underpin further profit delivery over future years.

IMPROVING EFFICIENCY AND SERVICE

Investment in our claims processes continues to deliver improved service and efficiency, with a reduction in property claims ratios and recognition of our customer service teams at the European Call Centre Awards.

An ongoing review of our advertising expenditure and the introduction of further improvements to the targeting of promotional activity have led to further efficiencies, and the cost per product sale improving by 13 per cent.

We have also continued to focus on making our key processes easier for our customers to use. For the second year in succession our website www.lloydstsbinsurance.co.uk has been ranked as the best home insurance website by worldwide benchmarking organisation, Global Reviews. In addition, in October 2008 Defaqto recognised LloydsTSBCompare.com as the best car insurance price comparison site.