Report of the Board in relation to remuneration policy and practice For the year ended 31 December 2007
Dear Shareholder
I am delighted to introduce this, our sixth, HBOS Remuneration Committee Report for which we will be seeking approval from shareholders at our Annual General Meeting. It is my first report as Chair of the Committee. Brian Ivory, who had been Chair of the Committee since the establishment of HBOS, retired as a Non-executive Director and as Chair of the Committee immediately following the Annual General Meeting in April 2007.
Under Brian’s outstanding leadership, the Committee established the remuneration policy for our most senior colleagues (now about 240 in all) at the start of 2002. These principles are, we believe, as valid now as they were then and in broad terms are as follows:
- we have a median (mid-market) salary policy and manage actual salaries broadly up to this position;
- we set clear and tough targets linked absolutely to business plan performance under our short term incentive (‘STI’) schemes and we inform shareholders of our performance against those targets and the resulting STI outcomes;
- we operate ‘nowt for nowt’ long term incentive (‘LTI’) schemes: if we do no better than matching our competitor average in terms of returns for shareholders and no better than matching the retail prices index (‘RPI’) in terms of earnings per share growth (‘EPS’), our top 240 colleagues get no LTI payments;
- we deliver most of our incentive outcomes in HBOS shares and expect senior colleagues to maintain meaningful HBOS shareholdings; and
- we ensure that we have a clear correlation between overall reward, corporate performance and the interests of our shareholders, in both the short term and the long term.
We believe that we are at the forefront of our competitors in operating in such a robust and transparent remuneration environment.
As was the case a year ago, the Committee has undertaken an assessment of remuneration policy, on this occasion over 2002-2007. Its findings are much the same as a year ago: no need for any change in our remuneration principles; strong support for our policy and practice from shareholders generally; regular and supportive dialogue with our major shareholders; and belief that the incentives we provide create strong alignment with shareholders’ interests and the Group’s performance.
Specifically on that latter point, looking back over those six years since the inception of HBOS:
- our EPS has risen by 14% p.a. Although we have delivered double digit average annual EPS growth relative to the RPI, under the annual STI arrangements our payments have on average been only very slightly above target levels;
- under the total shareholder return (‘TSR’) LTI arrangements, we have outperformed our competitors on average by 2.4% p.a. HBOS’s absolute TSR over that period has been 13.4%. In terms of incentive outcomes we have made payments on average at about 75% of maximum levels; and
- over the first six full calendar years of HBOS (2002-2007) there were six triennial TSR LTI maturities. For the most recent arrangement covering 2005-2007, for the first time we did not outperform our competitors and therefore, in line with our ‘nowt for nowt’ remuneration policy, our TSR LTI payment to colleagues will be zero in March 2008.
Our expectation of meaningful HBOS shareholdings by colleagues is illustrated by the fact that, every year since 2002, all incentive outcomes earned by all Executive Directors have, at their choice, been taken in HBOS shares, rather than in cash.
As regular readers of our reports will know, we construct all our incentives so that all our colleagues have a very clear performance:reward link. It is one that is increasingly performance focused and longer term in nature as colleague seniority increases.
As we reported a year ago, our suite of incentive schemes for 2007 for our then top 215 colleagues consisted of two short term incentives (the first based on one year operational performance and the second focused on more sustained operational performance) and two long term incentives (the first based on the extent to which we improve EPS relative to the RPI and the second based on the extent to which we outperform our competitors in terms of TSR).
We do not intend to change the fundamental design of incentive schemes for 008 but we do intend to change how we set performance levels and reward opportunities.
Why? The dislocation in financial markets, prompted by the sub-prime mortgage financial crisis, which began in the United States, has created changes in many of the economies in which the Group operates, particularly in the UK. The Committee must ensure that, in what is anticipated to be a lower growth era, our incentives will continue to assist with the attraction, retention, engagement and motivation of all our colleagues.
We are therefore making some changes to the incentive schemes starting in 2008. Under our STI arrangements, we will continue to set really stretching targets but we will increase target incentives by a half. This greater emphasis on short term incentives reflects the challenge of setting robust long term performance targets in the current turbulent financial markets. Under our LTI arrangements, we will sustain target incentive payment opportunities but the performance targets for EPS and TSR have been altered so as to better align them with market and Group expectations. Details are set out in the main body of the report.
The Committee will review these incentive structures again before we launch the 2009 schemes, and that review will remain within our established remuneration principles described earlier in this letter.
During 2007, there were two other material changes.
Firstly, we amended the comparator group under the TSR LTI by increasing the weightings of the banks which have a predominantly UK domestic business profile and by decreasing the weightings of the banks which have built up a significant overseas business profile. This creates an overall comparator group profile which better matches that of HBOS.
Secondly, there were a number of changes in our Executive Director population. The individual arrangements are set out in the main body of the report.
In the full report which follows, we have produced transparent and extensive technical details, as we have done in the past.
We welcome questions and feedback from all shareholders on both the content and the transparency of the report.
We believe our remuneration policy is right for our shareholders and right for our colleagues. We encourage all shareholders to support this report at the Company’s forthcoming (2008) Annual General Meeting.
Karen Jones
Chair
Remuneration Committee
26 February 2008