We had a successful 2016, absorbing a reduction in the discount rate applicable to personal injury lump sum damages awards to minus 0.75% and the Flood Re levy, while at the same time investing in the business and making progress on implementing our strategy. Our investments in our direct brands, competitiveness on price comparison websites and partnership capabilities are bearing fruit.
from 2014 to 2020 2. Hall & Partners 3. Deloitte Household and Motor Insurance Seminars 2016 4. Digital Market Magazine – How can the insurance industry retain existing customers?
5. Consumer Intelligence – Digital Insurance World 2016 6. ABI – Key facts 2016 7. Willis Towers Watson www.directlinegroup.com 7
Board and Committee membership changes Succession planning remains a key area of focus for the Board. In January 2016, Dr Richard Ward was appointed as our Senior Independent Director. Following Priscilla Vacassin’s retirement from the Board in March 2016, a number of changes were made to the chairmanship and membership of the Board’s Committees.
The Dialogue approach enables over 900 teams to discuss how they feel about the business, what’s working well and tackle what’s not quite right. ‘Say it like it is’ is a core value of ours; whether it’s through dialogue or through talking to our employee representative body and other representative groups.
We agreed an extension of our Home and Motor insurance partnership with Prudential for a further two years. As part of this, we will renew policies under the Prudential brand until 2019. We’ve also launched our first Affinity Partnership scheme to offer access to Churchill-branded Home and Motor policies to Prudential Group customers who do not currently have such insurance with us. This partnership demonstrates our ability to deliver tailored propositions to meet the needs of our partners and their customers.
Providing the tools for success The Connect programme was designed to challenge the mindset of our organisation and help our people with the skills they need to have real conversations with customers. The aim was to connect them to the vital role they play in supporting people through what can be difficult times.
Aim We aim to reduce our expense ratio during 2017, absorbing our investment in future capability. We also aim to deliver a lower commission ratio in 2017, normalised for major weather events.
We aim to improve this to achieve strong levels of customer loyalty and retention rates.
Risk management within risk appetite, which includes an assessment of capital strength, and acts as a gateway for the AIP awards and underpin for LTIP awards.
Overarching risk objective The Group recognises that its long-term sustainability depends on having sufficient economic capital to meet its liabilities as they fall due, thus protecting its reputation and the integrity of its relationship with policyholders and other stakeholders.
• Credit limits are set for each counterparty and we actively monitor credit exposures
• We are working to improve the performance of our IT systems while focusing on developing future systems capability. With significant change underway, we are continuing to monitor risks associated with our IT systems’ stability, cyber security, and the internal control environment
Rescue and other personal lines Highlights  In-force policies for Rescue reduced by 7.3% primarily as a result of lower partner volumes
 Gross written premium for Rescue and other personal lines increased by 1.7% to £400.8 million primarily due to Travel partnerships pricing
Note: 1. Rescue in-force policies have been revised to exclude partner post-accident vehicle recoveries
Commercial gross written premium increased by 3.0% to £499.8 million compared to 2015, reflecting growth in Commercial direct, particularly landlord and van products. Gross written premium for NIG and other increased by 1.7% compared to 2015 in part reflecting premium rate increases.
In 2016, operating profit from Ongoing operations was £403.5 million (pre-Ogden: £578.6 million; 2015: £520.7 million) primarily due to a lower underwriting result as the Group has reflected an increase in its claims reserves for the recent reduction in the Ogden discount rate, and lower investment returns. The underwriting profit was £70.1 million, (2015: £175.2 million), principally due to the recent reduction in the Ogden discount rate, which led to lower prior-year reserve releases from Ongoing operations of £266.7 million (2015: £378.9 million). This was partially offset by lower claims costs from major weather events. Expenses include higher non-cash impairments than in previous years of £39.3 million and the Flood Re levy of £24.1 million. Investment return was lower primarily due to a reduction in unrealised property gains.
Cash flow Net cash generated from operating activities before investment of insurance assets totalled £35.0 million (2015: £42.1 million). This reflected a decrease in cash generated from operations to £117.1 million (2015: £149.3 million), offset by lower taxes paid.
Profit for the year and return on tangible equity Profit for the year amounted to £278.8 million (pre-Ogden £452.6 million; 2015: £580.4 million), following the one-off gain on disposal of the Group’s International division in 2015 and lower underwriting profit as a result of the recent reduction in the Ogden discount rate, partially offset by an improvement in the underlying underwriting performance in 2016.
Note: 1. See glossary on page 189 and 190 and appendix A on page 191 www.directlinegroup.com 43
Investment risk is, in part, mitigated by the following characteristics of the investment portfolio:  All holdings within the short duration US Dollar high-yield portfolio have a credit rating of BB or B. The Group’s strategy does not generally permit any debt securities to be held below B–.
John was previously an Executive Director at the Co-operative Insurance Society, CIS General Insurance and The Co-operative Bank. He was Chief Financial Officer of these organisations between 2003 and 2007, and subsequently Managing Director, Corporate and Markets.
External appointments John is a Trustee and Director of Farm Africa. He is also an alternate representative of the Association of British Insurers on the Panel on Takeovers and Mergers.
Experience and qualifications Humphrey was previously Group Legal Director at RSA and is a solicitor with over 25 years’ experience. His experience includes advising on corporate and commercial matters, steering corporate transactions in the UK and internationally, managing legal risk, and dealing with corporate governance issues. Before joining RSA, he worked at the City law firm, Ashurst Morris Crisp. He is a graduate of the University of Oxford.
Experience and qualifications Simon was previously Group HR Director for O2, and responsible for all of Telefonica global digital businesses. Before this, he held various senior global HR roles at Diageo, including responsibility for Spain, Africa and several UK-based leadership positions. Before moving into HR, Simon held several commercial business roles in the fast-moving consumer goods and financial services sectors.
Non-Executive Directors Each Director brings different skills, experience and knowledge to the Company, with the NEDs bringing additional independent thought and judgement. All NEDs must be able to spend sufficient time in their roles to discharge their duties and responsibilities effectively. The letters of appointment for the Chairman and NEDs set out the time the Group anticipates that they will commit to their roles. This is at least three days a week for the Chairman and an average of three days a month for the other NEDs depending on business needs. The Nomination Committee reviews this time commitment, and each NED’s other commitments, annually.
Corporate Governance Corporate governance matters relating to: Director appointments; the operation of the Board; and the guidance provided to Directors.
Based on the responses to the questionnaire and resulting reports, the Directors are satisfied that the Board and its Committees operated effectively in 2016. The Directors are also satisfied that they made significant progress in areas for potential improvement identified in 2015.
Board approves High level governance framework, Risk Appetite, Group Policies and Regulatory Governance Map are set by the Board, following review by the Board Risk Committee.
Board Risk Committee approves Enterprise Risk Management Strategy and Framework is approved by the Board Risk Committee, following review by the Risk Management Committee (a committee comprised of Executives).
You can find an explanation from the Directors about their responsibility for preparing the financial statements in the Statement of Directors’ responsibilities on page 113. The Company’s External Auditor explains its responsibilities on page 121.
 A verification process, to ensure the content was factually accurate.
 Members of the Executive Committee reviewed drafts of the Annual Report & Accounts.
The Group operates a Three Lines of Defence model. You can find out more about this in the Risk management section on pages 26 to 29.
The Audit Committee’s main role and responsibilities are set out in written terms of reference and are available at www.directlinegroup.co.uk/termsofreference
It discussed the strength of the underlying assumptions with the Group’s External Auditor and independent external actuaries and concluded that, whilst the ABE appeared robust in the face of significant uncertainties about the long-term future, they were appropriate. It was satisfied that reserve margins held specifically for PPOs were proportionate and justified because not all risks could be captured in the actuarial analysis. The members sought and were given assurance that the additional costs of current and future PPOs from existing business cohorts were being recognised.
Remuneration During the year, the Committee and the Remuneration Committee held a joint meeting. This was to ensure the Group’s remuneration arrangements were still appropriate in the light of regulatory developments and did not encourage excessive risk-taking. As part of this review, the joint Committee also considered the Group’s preparedness for Solvency II regulations regarding remuneration. This followed published requirements, including how the Group would assess the performance of individuals in control functions.
Board Effectiveness Review In the three-year cycle recommended by the Code, 2016 was the year in which the Company should appoint an external facilitator to run the Board and Committee effectiveness review. The Nomination Committee scrutinised a list of potential external facilitators drawn up by the Company Secretary and recommended the appointment of Professor Rob Goffee of London Business School, whose field of expertise is organisational behaviour and leadership development. The Board subsequently approved his appointment as the external facilitator.
The Remuneration Committee held five scheduled meetings in 2016. Two sub-committee meetings were also held to approve the LTIP vesting and grants. Two additional meetings were held to discuss the remuneration policy. This table shows attendance at the scheduled meetings: Scheduled meetings
The Company continues to operate a Buy-As-You-Earn Share Incentive Plan (“SIP”) which is available to all eligible staff as a means of purchasing Company shares in an easy and tax efficient manner.
 Increase to the level of RoTE required for the March 2017 awards to vest from the current range of 14.5% to 17.5% to a range of 15.0% to 18.0% (with the range for the August 2017 awards to be confirmed at grant)
 2014 LTIP awards: Similarly, the 2016 figures reflect the expected vesting outcome figure for the RoTE portion of the awards granted under the LTIP in 2014 and expected to vest in March and August 2017 and the actual vesting under the TSR element of awards granted under the LTIP in March and August 2013.
Notes: 1. Appointed as Committee Chair with effect from 1 March 2016 having previously been a member of the Committee from September 2012 to September 2014 2. Committee Chair until she stepped down from the Board with effect from 1 March 2016
Implementing policy and pay outcomes relating to 2016 performance Single figure table (Audited)
% change: Dividend (£m), excluding 2015 special dividend relating to the sale of the International division 16y15y 4.
Options held arising from vesting in previous periods – – 261,941 – – – – 24,020
Financial Profit before tax 55% 55% Strategic Based on a basket of customer measures only, including
 40% based on relative TSR performance against the constituents of the FTSE 350 (excluding investment trusts) over a three-year performance period, starting on the date of grant. The starting and closing TSR will be averaged over a three-month period
Legal & General, Old Mutual, Phoenix Group, Prudential, RSA Insurance Group, Standard Life and companies of a similar size to DLG as appropriate; and
 When determining salary increases, the Committee will consider the factors outlined in this table under ‘Operation’. In any event, no increase will be made if it would take an Executive Director’s salary above £850,000 (the current median level of salaries for CEOs in the FTSE 100), as further increased by UK RPI from the date of approving this policy
 These may be financial, non-financial (Group, divisional or business line) and individual. Each year, at least 50% of the bonus is based on financial measures. The remainder of the bonus may be based on a combination of strategic, shared and individual performance measures
 Awards vest based on performance against financial and/or such other (including share return) measures, as set by the Committee, to be aligned with the Group’s long-term strategic objectives
 Executive Directors receive a benefits package generally set by reference to market practice in companies of a similar size and complexity, particularly FTSE 31-100 companies. Benefits currently provided include a company car or car allowance, private medical insurance, life insurance, health screening, and income protection
On-target Based on what the Director would receive if performance was on-target (excluding share price appreciation and dividends):  Fixed remuneration as above
Dividends The Group aims to generate long-term sustainable value for shareholders, while balancing operational, regulatory, rating agency and policyholder requirements. The Board has a progressive dividend policy for the Company. This aims to increase the dividend annually in real terms to reflect the Company’s cash-flow generation and long-term earnings potential.
Directors You can find the current Directors’ biographies on pages 50 to 51. All Directors will retire and be submitted for election and re-election at the 2017 AGM. This is in accordance with the UK Corporate Governance Code and the Articles of Association of the Company, which govern appointing and replacing Directors. The Directors listed on pages 50 and 51 were the Directors of the Company throughout the year apart from Dr Richard Ward, who was appointed as a Director on 18 January 2016, Priscilla Vacassin, who resigned as a Director on 1 March 2016 and Danuta Gray and Mike Holliday-Williams who were appointed as Directors of the Company on 1 February 2017.
Key observations: We completed our procedures on the impairment of the intangibles and have not identified any additional impairment. We have observed that the discount rate used was in the middle of a reasonable range and that the expected future cash flows were reasonable. In addition, we completed our controls testing and did not identify any significant control weaknesses.
Group materiality is used for setting audit scope and the assessment of uncorrected misstatements. Materiality is set for each significant component in line with the components proportion of the chosen benchmark. This is capped at the lower of 90% of Group materiality and the component materiality determined for a standalone audit. The main UK insurance trading entity, which makes up 100% of Group gross earned premium and 89% of Group statutory profit before tax, is scoped to a component materiality of £25.2m (2015: £24.8m).
Net cash generated from operating activities before investment of insurance assets 37 35.0 42.1 Cash generated from investment of insurance assets 37 827.4 503.1 Net cash generated from operating activities 862.4 545.2 Cash flows from investing activities Purchases of property, plant and equipment (49.9) (67.9) Purchases of intangible assets (80.8) (75.5) Proceeds on disposals of assets held for sale 5.1 7.1 Net cash flows from disposal of subsidiaries – 327.1 Net cash (used by) / generated from investing activities (125.6) 190.8 Cash flows from financing activities Dividends paid 15 (450.6) (666.0) Finance costs (38.3) (38.2) Purchase of employee trust shares (39.5) (17.8) Net cash used by financing activities (528.4) (722.0) Net increase in cash and cash equivalents 208.4 14.0 Cash and cash equivalents at the beginning of the year 902.4 898.2 Effect of foreign exchange rate changes – (9.8) Cash and cash equivalents at the end of the year 27 1,110.8 902.4
On 27 February 2017, the Ministry of Justice announced a new Ogden discount rate of minus 0.75% to become effective from 20 March 2017 and a review of the framework under which the rate is set with consultation to start before Easter 2017. The Group expects to fully participate in this consultation.
The provisions for PPOs have been categorised as either claims which have already been determined by the courts as PPOs (approved PPO claims provisions) or those expected to settle as PPOs in the future (anticipated PPOs). The Group is subject to estimation uncertainty on the propensity of large bodily claims to move from Ogden settled values to PPOs. The recent change in the Ogden discount rate is expected to reduce PPO propensity and these effects are recognised in the Group’s separate Ogden provisions. The estimates in the table above are based on historically observed propensity and therefore do not allow for any future changes in PPO propensity. Anticipated PPOs consist of both existing large loss case reserves including allowances for development and claims yet to be reported to the Group. Reinsurance is applied at claim level and the net cash flows are discounted for the time value of money. The discount rate is consistent with the long duration of the claims payments and the assumed future indexation of the claims payments.
Direct Line Group Annual Report & Accounts 2016 136 2. Critical accounting estimates and judgements continued 2.3 Fair value The Group has made the judgement that level 1 of the Group’s fair value hierarchy set out in note 40 will include only sovereign debt securities issued by members of the G1O group of countries within the Group’s AFS debt securities portfolio, with all other financial assets and liabilities carried at fair value included in level 2 as they are not considered to be quoted in a deeply liquid market.
The Group has also made the judgement that investment properties fall within level 3 of the Group’s fair value hierarchy (note 40) as the valuation model is driven predominantly by unobservable inputs, as although in part the valuations are compared to recent market transactions, they are adjusted for specific characteristics of each property including the size, location and condition by reference to the benchmark property transactions.
Reserve risk is controlled through a range of processes:  regular reviews of the claims, premiums and an assessment of the requirement for a liability adequacy provision for the main classes of business by the internal actuarial team;
The Group’s reserves are subject to the risk of retrospective changes in judicial conditions such as the change in the Ogden discount rate announced on the 27 February 2017. This is the discount rate set by the Lord Chancellor and used by courts to calculate lump sum awards in bodily injury cases. The rate has been 2.5% since 2001 and will change to minus 0.75% from 20 March 2017. The Group has calculated its estimated reserves based on the new rate which itself is uncertain depending on the outcome of the Government’s proposed consultation on the framework for setting the rate and on the frequency and timing of future changes.
Notes: 1. The sensitivities relating to an increase or decrease in the real discount rate used for PPOs illustrate a movement in the time value of money from the assumed level of 0.0%. 2. As at 31 December 2016 the Group has reserved at a discount rate of minus 0.75% (2015: 1.5%). With effect from 20 March 2017, the Ogden discount rate will be minus 0.75% (2015: 2.5%). 3. These sensitivities exclude the impact of taxation. 4. These sensitivities reflect one-off impacts at 31 December and should not be interpreted as a prediction.
Underwriting risk This is the risk that future claims experience on business written is materially different from the results expected, resulting in current year losses. The Group predominantly underwrites personal lines insurance including motor, residential property, roadside assistance, creditor, travel and pet business. The Group also underwrites commercial risks primarily for low-to-medium risk trades within the SME market. Contracts are typically issued on an annual basis which means that the Group’s liability usually extends for a 12 month period, after which the Group is entitled to decline to renew or can impose renewal terms by amending the premium or other policy terms and conditions such as the excess as appropriate.
Underwriting risk includes catastrophe risk, the risk of loss, or of adverse change in the value of the insurance liabilities resulting from significant uncertainty of pricing, underwriting and provisioning assumptions related to extreme or exceptional circumstances.
Direct Line Group Annual Report & Accounts 2016 150 4. Segmental analysis continued The table below analyses the Group’s revenue and results by reportable segment for the year ended 31 December 2016.
Note: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations.
Earnings attributable to owners of the Company arising from: Continuing operations 278.8 399.2 Discontinued operations – 181.2 Total Group 278.8 580.4 Weighted average number of Ordinary Shares (millions) 1,368.7 1,431.2 Effect of dilutive potential of share options and contingently issuable shares (millions) 13.1 17.8 Weighted average number of Ordinary Shares for the purpose of diluted earnings per share (millions) 1,381.8 1,449.0 Diluted earnings per share (pence): Continuing operations 20.2 27.6 Discontinued operations – 12.5 Total Group 20.2 40.1 17. Net assets per share and return on equity Net asset value per share is calculated as total shareholders’ equity divided by the number of Ordinary Shares at the end of the period excluding shares held by employee share trusts.
Note: 1. Reflects a 1% decrease in the profit for each year of the five-year plan.
Additional provision (4.2) (5.0) Release to income statement 7.4 17.5 23. Deferred acquisition costs 2016 £m 2015 £m
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 21.4 0.4 Designated as hedging instruments: Foreign exchange contracts (forwards)1 1.7 0.3 Interest rate swaps 56.6 18.9
35. Share-based payments The Group operates equity-settled, share-based compensation plans in the form of an LTIP, a Restricted Shares Plan, a DAIP and Direct Line Group Share Incentive Plans, including both the Free Share awards and a Buy-As-You-Earn Plan, details of which are set out below. All awards are to be satisfied using market purchased shares.
Liabilities held at fair value: Derivative liabilities (note 25) 45.1 – 45.1 – 45.1 Other financial liabilities: Subordinated liabilities (note 31) 539.6 – 625.0 – 625.0
Note: 1. In the year ended 31 December 2016, deferred tax liabilities of £0.1 million arose on the AFS revaluation reserve and £0.3 million on other temporary timing differences. Both of these amounts were charged to the statement of comprehensive income. There was no deferred tax asset or liability at 31 December 2015 or movement in the year ended 31 December 2015.
Interest receivable from subsidiary undertakings 47.9 47.5 Dividend income from subsidiary undertakings 780.6 671.0
 Search the list of unauthorised firms to avoid at www.fca.org.uk/consumers/scams
 If you change your bank account, inform the Registrar of your new account details immediately
 Be aware that the Company will never call you concerning investments. If you receive such a call from a person saying they represent the Group, please contact the Company Secretary immediately, by calling +44 (0)1132 920 667
RBS Group The Royal Bank of Scotland Group plc and its subsidiary companies. Reinsurance Contractual arrangements where the Group transfers part or all of the accepted insurance risk to another insurer. Reserves Funds that have been set aside to meet outstanding insurance claims and IBNR. Return on equity Return on equity is calculated by dividing the profit attributable to the owners of the Company by average ordinary shareholders’ equity for the period. Return on tangible equity (“RoTE”)
This shows underlying performance against a measure of equity that is more able to be compared with other companies.
Opening investment property 347.4 307.2 Opening financial investments 5,614.6 5,961.2 Opening cash and cash equivalents 963.7 880.4 Opening borrowings (61.3) (69.8) Opening derivatives liability2 (45.7) (27.8) Opening investment holdings 6,818.7 7,051.2 Closing investment property 20 329.0 347.4 Closing financial investments 26 5,147.0 5,614.6 Closing cash and cash equivalents 27 1,166.1 963.7