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Rating Action:

Moody's affirms Scottish Widows A2 insurance financial strength rating; outlook stable

19 December 2019

London , December 19, 2019 – Moody's Investors Service (Moody's) has today affirmed the A2 insurance financial strength rating and the Baa1(hyb) subordinated debt ratings of Scottish Widows Limited (SWL) which is owned by Lloyds Banking Group plc (Lloyds, A3 senior unsecured, negative). The outlook remains stable.

RATINGS RATIONALE

The affirmation of SWL's ratings reflects Moody's expectation that Scottish Widows Group (SWG, which together with wealth business forms Lloyds' insurance and wealth division) will maintain: (i) its very good market position in the UK life and pensions market; (ii) low product risk and good business diversification; (iii) a good level of profitability notwithstanding headwinds in the form of a very competitive UK Life and Pensions marketplace, very low interest rates and current uncertainty over the UK's economic outlook. Furthermore, SWL's ratings and outlook are not affected by the negative outlook on Lloyds (refer to "OUTLOOK" section).

With regard to its business profile, Moody's expects SWG, within UK life and pensions and non-life personal lines, to maintain its very good market position which continues to benefit from restructuring implemented in 2015 and by investment from Lloyds. SWG, which increased its life and pensions sales on a PVNBP (present value of new business premiums) basis by 45% and 14% at YE 18 and H1 19 respectively, has strong brand names and top three market shares in corporate pensions and home insurance. Furthermore, SWG has become an established bulk annuity writer and is growing its individual annuity and protection businesses. This should further diversify SWG's business which also benefits from low product risk with a significant proportion of unit-linked liabilities.

The affirmation also reflects the recent improvement in SWG's underlying earnings. At YE 18 and H1 19, Lloyds insurance and wealth division increased underlying profit by 3% and 41% to £927 million and £677 million respectively. Going forward, Moody's expects SWG's profitability to benefit from growth in new business income, operational efficiency gains and a reduced reliance on one-off items. Furthermore, SWG has been expanding higher operating margin business such as bulk annuities and protection which should help improve SWL's return on capital (ROC) which reduced to 5.8% at YE18 (YE17: 11%). However, short-term profitability will remain challenged in the context of a very competitive UK Life and Pensions marketplace which is further pressured by regulatory headwinds and of current uncertainty over the UK's economic outlook.

Moody's also expects SWG's economic capitalisation to remain broadly aligned with the overall rating level notwithstanding the very low interest rate environment. During 2019, SWG's Solvency II ratio (pre-interim dividend and excluding With Profits Funds) fell from 167% to 149%, negatively impacted by dividend payments of £350 million (£1.2 billion in 2018) and the fall in interest rates. While this is at the lower end of the range for UK peers, we believe that this is at least partly offset by a well-defined risk appetite and a risk management framework adequate to the business written. SWG upstreams to Lloyds capital in excess of a target having a reasonable buffer over solvency capital requirements in a one-in-ten-year stress scenario.

The upstreaming of dividends reduced SWL's shareholders' equity to £3.4 billion at YE 18 (YE 17: £4.8 billion) which was the main driver of the increase in SWL's adjusted financial leverage to 26.3% at YE 18 (YE 17: 21.9%). This level is still relatively low for the rating level although leverage increases if the non-SWL subordinated debt residing at the wider SWG level is included. SWL's earnings coverage has been volatile although good at around 7x on a 5-year average basis.

The reduction in equity has also increased SWL's high risk assets as a percentage of equity which was relatively high at 2.5-3x at YE18 although this is driven by with-profit assets the decline in value of which can be shared with policyholders. In collaboration with Lloyds, SWG been increasing its illiquid investments to enhance the yield on assets backing annuity liabilities as well as to improve duration matching. Moody's views these assets as having good quality although will continue to monitor concentration risks and potential investments in riskier asset classes.

OUTLOOK

The stable outlook on SWL's ratings reflects Moody's expectation that SWG's business profile will remain strong and that the momentum from the recent growth in earnings will overcome the headwinds facing the UK life industry. However, in the event of a "no-deal Brexit," UK life insurers, including SWL, would face increased risk of capital, revenue and profit deterioration, a credit negative.

Furthermore, SWL's ratings and outlook are unaffected by the negative outlook on Lloyds Banking Group plc given SWG's strong market position in the UK life market, its diversified business profile, its consistent upstreaming of dividends to Lloyds and regulatory protection as an insurance group.

However, SWG's linkages with Lloyds are significant, with the group providing funding for investments, a channel for acquiring customers, sourcing of illiquid assets and capital management. SWG continues to make progress on leveraging opportunities across Lloyds while extending its digital capabilities to deliver new propositions although Moody's believes it will take a number of years for the full potential to be realised.

WHAT COULD MOVE THE RATING UP/DOWN

The following factors could lead to an upgrade of SWL: 1) Material increase in market share within the UK life and pensions marketplace with no decline in profitability or capital adequacy and/or; 2) an improvement in underlying earnings resulting in return on capital consistently rising above 6% with no material deterioration in asset quality and/or; 3) SWG's Solvency II ratio (excluding With Profits funds) consistently above 165%.

Conversely, the following factors could lead to a downgrade: 1) A negative change in Lloyds' rating and/or; 2) A sustained meaningful decline in SWG's Solvency II ratio (excluding With Profits funds) and/or; 3) adjusted financial leverage consistently exceeding 35% or earnings coverage decreasing below 4x.

SUMMARY PROFILE OF AFFECTED GROUP

SWL, together with Lloyds' non-life insurance and wealth business, comprises Lloyds' insurance and wealth division which, as of June 2019, had £155 billion of assets under administration. SWL focuses on workplace, planning and retirement products together with individual and bulk annuities, and protection.

LIST OF AFFECTED RATINGS

The following ratings have been affirmed:

- Scottish Widows Limited's insurance financial strength rating A2

- Scottish Widows Limited's subordinated debt rating affirmed at Baa1(hyb)

The outlook on Scottish Widows Limited remains stable.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Life Insurers Methodology published in November 2019. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Dominic Simpson
VP-Sr Credit Officer
Financial Institutions Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London
United Kingdom
JOURNALISTS : 44 20 7772 5456
Client Service : 44 20 7772 5454

Simon Ainsworth
Associate Managing Director
Financial Institutions Group
JOURNALISTS : 44 20 7772 5456
Client Service : 44 20 7772 5454

Releasing Office :
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London, E14 5FA
United Kingdom
JOURNALISTS : 44 20 7772 5456
Client Service : 44 20 7772 5454

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