10. Remuneration policy for Executive Directors and other senior colleagues
To deliver its objective of creating real increases in shareholder value relative to the finance sector, the Group needs to attract and retain the most capable and committed people and create the right employment conditions and reward opportunities for them.

The remuneration policy for Executive Directors and their most senior colleagues is aligned with this objective. Accordingly, the focus of remuneration policy is not simply on salary but is on incentive plans that are aligned with the delivery of both operating plans and increases in shareholder value.

Therefore, for 2005 and (subject to review) for 2006, as was the case for 2002, 2003 and 2004:

• salary policy is set at around market median for the financial services sector;
• short term incentive plans are based on the delivery of annual operating plans; and
• long term incentive plans are focused on the creation of relative additional shareholder value. Participants do not receive any shares under the main plan unless the Group’s relative total shareholder return is above that of the finance sector as measured using the weighted average total shareholder return of a comparator group of companies. This long term plan is highly geared so that average performance (or worse) generates no reward but outstanding performance generates a high level of reward.

Other than as set out in Sections 10.3 and 10.4, there are no definitive plans, at present, to make any changes to this remuneration policy for 2005 and beyond. We have, however, committed to review our long term incentive plans in 2005 and we will review overall remuneration policy in the light of organisational needs, market positioning and the impending legislative pension changes.

In broad terms, for every £100 of target reward for Executive Directors, about £49 is guaranteed and £51 is performance contingent. Sustained exceptional performance can result in a further £59 of reward. Of the performance element of reward, between 25% and 35% is based solely on annual performance with the rest based on triennial performance or retention.

For remuneration purposes, roles in HBOS fall into one of ten Levels, 1-8, the HBOS Executive and the Executive Directors. The newly formed group of the HBOS Executive, together with the Executive Directors, comprises the most senior colleagues in the Group, about 25 colleagues in all, and is involved directly in major decisions taken by the Group and, in particular, the development of the Group’s strategy.

This report covers colleagues who fall into Level 8 and above, about 50 colleagues in all, but with emphasis on Directors. Appendix 2 gives broad details of remuneration arrangements for those in Levels 1-7.

10.1 Salary
Salary benchmarks are reviewed annually, taking account of information from independent sources on salary rates for comparable jobs in the finance sector and in other selected major listed companies. Actual salaries are normally reviewed annually in May but can be reviewed at any time. There is no automatic annual salary increase.

The benchmarking process is both extensive and rigorous. It is designed to ensure that the median salary policy adopted by the Committee demonstrably applies in practice. Specifically, the Committee considers data sourced from Hay Group, Towers Perrin and Watson Wyatt LLP; as well as data sourced from annual reports and accounts of other relevant companies. These include the “FTSE15” - seven companies bigger than and seven companies smaller than HBOS - together with other major banks, insurance companies and retailers.

Base salaries of the Executive Directors after the most recent review with effect from May 2004, and at 31 December 2004, were:

James Crosby £825,000, Mike Ellis £560,000 (retired 31 December 2004), Phil Hodkinson £440,000, Andy Hornby £610,000, Colin Matthew £440,000 and George Mitchell £565,000.

At the date of his appointment on 30 April 2004, and at 31 December 2004, Mark Tucker’s base salary was £560,000.

At 31 December 2004, the average salary for those in the HBOS Executive and Level 8 was £239,400; the upper quartile was £270,000 and the lower quartile was £200,000.

10.2 Incentive plan philosophy
The purpose of the incentive plans is to provide a direct link between each individual’s remuneration and three components of performance, namely their own, that of the division they work in and that of the Group, both annually and over the longer term.

All Executive Directors and a substantial majority of other senior colleagues participate in incentive plans which are Group-wide. Performance targets and levels of participation differ in order to align overall individual remuneration with the Group’s policy objectives outlined earlier. Different, market specific, arrangements exist for a small number of senior colleagues within the Group.

Payment of incentives, for Executive Directors and certain other individuals, is subject to the approval of the Committee. Except in certain circumstances in respect of initial periods of employment, it is the Committee’s policy that no Executive Director should have a contractual right to an incentive.

Incentive arrangements to apply during 2005 are set out below.

10.3 Short Term Incentive Plans
The levels of incentive payments are dependent on the extent to which participants achieve their operating plan objectives. In 2005, for Executive Directors, payment of the target incentive will require the achievement of targets which include earnings per share (‘EPS’) and return on equity (‘ROE’) and the attainment of a certain level of profit before tax and exceptional items (‘PBTE’). Examples of benchmark payment levels which apply for 2005 are as follows:

Category	Incentive as a % of salary
	Target	Maximum
Executive Directors	75	112.5
HBOS Executive	75	112.5
Level 8	60	90

The Committee, in setting targets for EPS, ROE and PBTE for 2005, will take account of the new International Financial Reporting Standards.

EPS, ROE and PBTE outcomes are reviewed by the Audit Committee for the purposes of determining outcomes under the plan.

The levels of incentives shown in the table on page 64 require participants to take their annual incentive in shares (the sharekicker facility referred to in Section 9) rather than in cash; to retain their shares for three years; and to remain in Group employment or to rank as a qualifying leaver during the three year period. The Committee believes that this feature clearly aligns the interests of participants and shareholders by encouraging participants to be both long term colleagues and long term shareholders, having first achieved stretching performance targets in relation to their operating plans. Participants may take their annual incentive in cash in which case the incentive is released at two-thirds of the level which would normally apply were the incentive taken in shares.

These incentive levels are higher than applied (excluding the special short term incentive) in 2004 when, for Executive Directors and Level 8 colleagues, the targets were 60% and 52.5% and the maxima were 90% and 78.75%, respectively. The Committee increased ongoing incentive levels to maintain HBOS’s competitive remuneration position in the financial services sector, in order to help attract and retain the most capable and committed Executive Directors and their most senior colleagues.

In relation to 2004, the outcomes for EPS, ROE and PBTE were, taken overall, slightly ahead of what were deliberately stretching targets set at the start of the year; and short term incentive outcomes were, therefore, slightly ahead of target levels.