Direct Line in Italy and Germany distributes to customers through the phone and internet, including price comparison websites (“PCWs”). The brand is known for its excellent customer service and value.
• Completed claims transformation for Motor and Home, extended ClaimCenter to Commercial Motor and Italy and laid the foundations for DLG Legal Services Limited
• Continued to develop Commercial and International, in particular full roll-out of eTrading and strong growth in Germany
• Return on tangible equity3 from ongoing operations of 16.0% for 2013 (2012: 11.5% and pro forma4 13.4%)
• 5.0% increase in final dividend per share to 8.4 pence per share and second special interim dividend of 4.0 pence per share taking total dividends for 2013 to 20.6 pence per share
We hold assets in excess of our expected liabilities in the form of capital, which is designed to absorb unexpected losses that might occur, as well as to meet regulatory capital requirements.
We are seeing that around one-in-five Direct Line new policies taken out by under 25s over the phone have selected telematics. This also allows feedback to customers on their driving, which is anticipated to reduce the likelihood of accidents and improve safety on our roads. This is a really positive step and will help with our ongoing campaign to the UK Government to contribute to an improvement in young driver safety. Our extensive data and large customer base mean we, alongside specialist partners, are well positioned to capitalise on this growing market. To date, we have gathered 22 million miles of customer data, giving us a more accurate picture of our customers, how they use their cars, and what cover is suitable for them. Once we have analysed this data over a period of time, we will have the ability to price and underwrite more accurately.
Notes: 1. See note 1 on page 2 2. See note 3 on page 2 3. See note 2 on page 2 4. See note 5 on page 3
Notes: 1. See note 1 on page 2 2. See note 2 on page 2 3. See note 6 on page 3
Aim We aim to operate an efficient and effective organisation and are targeting our total cost base2 for 2014 to be approximately £1,000 million.
Risk management tools: High Level Controls and System of Governance document ERM strategy
Meet all cash outflow requirements, including those that arise following a 1 in 200 year insurance, market or credit risk event.
• The development of our Own Risk and Solvency Assessment (“ORSA”) which supports the achievement of our strategic objectives
• The introduction of a risk culture which helps our understanding and measurement of how well risk is embedded within the Group
In addition, the requirement under Pillar III will result in additional reporting requirements both to the PRA and to external stakeholders. The Group continues to make progress to ensure all requirements will be met in line with developing best practice.
• Monitoring of cost savings to ensure they remain on track • The Chief Executive Officer owns and manages this risk
Insurance risk: underwriting and pricing We are subject to the risk that inappropriate business could be written (or not specifically excluded) and inappropriate prices charged.
Britain’s home insurance market size has been stable, but become more competitive, with new business premiums reducing in the year2. PCWs’ shares of sales are growing, albeit from a lower base than Motor, and have facilitated the growth of lesser known brands, as well as increasing price competitiveness. Retail banking distribution arms continue to review branch sales processes. Meanwhile, there is growth in the adoption of new technology by customers, including the use of mobile technology and online servicing. Providers are maximising customer value, increasing cross-selling activity and retention capabilities. A lack of mortgage demand has contributed to providers finding other routes to source new customers. In the flat housing market, the increase in the renter population is causing a decline in the demand for combined building and contents covers.
Gross written premium of £943.1 million declined by 4.6%, reflecting competitive market conditions. In-force policies fell by 12.3% since the start of the year, mainly as a result of the removal of Home Response3 policies (around 420,000) from certain packaged bank accounts no longer sold through partners. Excluding this effect, the underlying in-force policies were broadly similar year-on-year.
Recent insurance sector reforms, especially the ending of a requirement for policyholders to advise their insurer if they do not wish to renew their motor policies, together with the increase in PCWs, has increased the level of switching. This increases the potential market for Direct Line, while also increasing the number of our customers who shop around at renewal. Going forward, we expect growth in the number of customers accessing insurance products via smartphone and tablet devices.
Notes: 1. Instituto Nazionale di Statistica 2. Automobile Club Italia 3. Associazione Nazionale fra le Imprese Assicuratrici 4. Bundesministerium der Finanzen 5. Gesamtverband der Deutschen Versicherungswirtschaft
The fall in Motor in-force policies of 7.1% reflects the Group’s focus on maintaining its underwriting discipline in a competitive marketplace, particularly for new business. The reclassification of van business to Commercial (around 70,000 in-force policies) from 1 January 2013 represented 1.7 percentage points of the reduction.
In Motor, the 8.4 percentage points improvement in COR reflects management actions to improve the risk profile of the book as well as higher releases of reserves from prior years. Reserve releases of £291.9 million in 2013 were driven primarily by favourable bodily injury experience for recent accident years, partly attributable to better risk selection and benefits arising from the Group’s claims transformation programme. Assuming underlying claims trends continue, a significant contribution from prior-year reserve releases is currently expected in 2014, albeit at a lower level than in 2013. The current-year attritional loss ratio was in line with 2012.
Net realised and unrealised gains recognised in 2013 were £32.5 million compared with £82.5 million in 2012. Realised gains in 2012 reflected significant portfolio restructuring actions. Total realised gains at 31 December 2013 were £58.8 million net of deferred tax (2012: £158.8 million).
Run-off The Run-off segment made a profit of £63.6 million in 2013 compared with a profit of £6.1 million in 2012. Similar to the ongoing operations, the Run-off segment also benefited from higher prior-year reserve releases from the recognition of improved claims experience, in particular relating to large bodily injury claims. Going forward, it is currently expected that the Run-off segment will contribute positively to operating profit, albeit at a lower level than in 2013.
Notes: 1. Credit in Italy allows a maximum holding of €25.0 million of Buoni del Tesoro Poliennali, Italian government debt securities and as at 31 December 2013 this stood at £24.1 million.
2. Pfandbrief holdings in the German portfolio are overweight as a result of legacy holdings, which are in the process of being run down. 3. Awaiting investment into securitised credit and property (UK) 4. During the year the cash holdings for the International business was set to a minimum holding for liquidity purposes rather than as a percentage of AUM. 5. Asset allocation at 31 December 2013 includes investment portfolio derivatives, which have been netted and have a mark-to-market value of £39.8 million, split £37.7 million in corporate debt securities and £2.1 million in securitised credit (31 December 2012: £7.8 million in corporate debt securities). 6. Net of bank overdrafts and including term deposits with financial institutions with maturities in excess of three months.
Risk-based capital coverage ratio (adjusted for final and second special interim dividends) 148.7% 145.4%
Experience and qualifications Jane spent 12 years with KPMG, where she worked in the financial sector, becoming Director responsible for delivery of corporate governance, internal audit and risk management services in the North of England. Jane has also held executive roles including Director of Audit, and Risk and Governance Director at Aviva’s UK Life business. Jane is a graduate of the University of York with a degree in music and is a Fellow of the Institute of Chartered Accountants in England and Wales. Jane is 46. External appointments Jane is Chair of the Audit and Risk Committee and Non-Executive Director at Reclaim Fund Ltd and Chair of the Board Risk Committee and Non-Executive Director of Old Mutual Wealth Management Limited. She is an Independent Member of the Fairness Committee at ReAssure Ltd. Jane has her own financial sector consulting business, delivering audit, enterprise risk management and corporate governance advisory and consulting services to the financial sector. She is also a magistrate. Key strengths and contribution Jane has undertaken a number of senior roles in financial services, including in the UK life insurance sector, and has extensive experience of risk management, corporate governance and internal control. She also has extensive experience of developing and monitoring customer frameworks. This experience led to Jane’s appointment as Chair of the Board Risk and Corporate Social Responsibility Committees. She also provides a customer focus on the Board.
Notes: 1. Attendance is expressed as the number of meetings attended out of the number of meetings possible or applicable for the Director to attend. 2. Mark Catton resigned as a Director of the Board on 26 April 2013 and rejoined the Board on 1 October 2013. 3. Bruce Van Saun resigned as a Director of the Board on 1 October 2013.
4. Glyn Jones, Jane Hanson and Bruce Van Saun were each unable to attend a scheduled Board meeting during 2013 due to other commitments.
Governance review During 2013, the Board oversaw a review of the governance framework within which the Group operates, taking into account that the Company had listed on the London Stock Exchange and the shareholdings in the Company by RBS Group had decreased significantly.
In assessing the independence of each Director, we considered whether each was independent in character and judgement and particularly whether there were relationships or circumstances which were likely to affect his or her judgement.
In addition, the Company employs a process of reviewing independence from management and invites the declaration of any conflict of interest that could interfere with each Director’s ability to act in the best interests of the Group. UK company law allows the Board to authorise a situation in which there is, or may be, a conflict between the interests of the Group and the direct or indirect interests of a Director or between the Director’s duties to the Group and to another person. The Board has adopted procedures for ensuring that its powers to authorise conflicts operate effectively. For this purpose a register of conflicts, and of any authorisation of a conflict granted by the Board, is maintained by the General Counsel and Company Secretary and regularly reviewed by the Board. Mark Catton is a non-independent Non-Executive Director by virtue of being nominated for appointment to the Board by RBS Group, the Company’s largest shareholder. RBS Group has committed to the European Commission to sell Direct Line Group as a condition of its receipt of state aid in 2009. To comply with this requirement, RBS Group has reduced its shareholding in the Group to 28.5% and must divest its entire interest by the end of 2014.
• Experience and appreciation of businesses with customer service at their core (perceived as advantageous)
The selection procedure included a number of interviews and meetings with existing Board members. The Company also obtained a range of references for each candidate.
• Board environment and processes (including working relationships, Board papers and Board support).
Reports to the Board The Chair of the Committee submits a report to the subsequent scheduled meeting of the Board on the Committee’s work.
Following their review of actuarial best estimate and management best estimate reserves, the Committee proposes the respective reserves to the Board.
We may, however, put the audit out to tender at any time before this date. There are no contractual obligations restricting our choice of external auditor and no auditor liability agreement has been entered into. Equally, any recommendation to re-appoint Deloitte LLP as auditor of the Company is dependent on continued satisfactory performance.
• Overseeing preparations for changes in market, legal and regulatory environments, including emerging risks, the Group’s approach to periodic payment orders and preparations for Solvency II
What have we achieved? • Reviewed and challenged the following, receiving reports as standing agenda items: – significant risks and any other specific matters regarding the Group’s risks, received from the Chief Risk Officer and Risk and Compliance functions; – the High Level Controls and System of Governance document; – legal and regulatory issues; and
What will we be focusing on in 2014? In addition to its regular monitoring, challenge and oversight responsibilities, the focus for the Committee in 2014 is expected to include the following: • Finalising the appropriate combination of assets and the use of derivatives, if deemed appropriate, to back the Group’s long-term liabilities (PPOs) with the benefit of the November 2013 European agreement on Omnibus II (Solvency II)
Changes to the Board Mark Catton resigned from the Board on 25 April 2013 when RBS Group reduced its shareholding in Direct Line Group below 50%, whereupon RBS Group’s entitlement to nominate Directors under the Relationship Agreement with the Company reduced from two to one. Mr Catton rejoined the Board on 1 October 2013 when Bruce Van Saun resigned in order take up an appointment with RBS Group in America. As RBS Group are entitled to nominate a Director to the Board under the terms of their Relationship Agreement with the Company, it was not appropriate to engage an external search agency nor to use
The Board is also given the opportunity to understand the views of major shareholders through analysts’ reports and broker briefings.
• Individual performance will be reflected in employees’ reward through their salary and variable pay
• Awards will typically be made in the form of nil-cost options or conditional share awards which vest to the extent performance conditions are satisfied over a period of at least three years. Under the Plan rules, awards may also be settled in cash
• An annual limit of 10% of base salary per Executive Director has been set for the duration of this policy. The Committee will monitor the costs in practice and ensure that the overall costs do not increase by more than the Committee considers to be appropriate in all the circumstances
RBS legacy arrangements Both Executive Directors continue to hold unvested awards previously granted to them under the RBS Group LTIP 2011 and 2012 which are subject to performance conditions to be assessed by the RBS Group Remuneration Committee. These awards were granted to Paul Geddes and John Reizenstein at a time when they were divisional directors of RBS Group and will now be satisfied by the transfer of Company shares from RBS Group on vesting. The performance conditions for these awards relate to financial and operational performance against the strategic plan for Direct Line Group and effective risk management with, in the case of Paul Geddes only, 25% of vesting also dependent upon RBS Group performance. The 2012 awards also applied measures based on employee and customer satisfaction.
Selection of performance measures Annual Incentive Plan The AIP performance measures have been selected by the Committee to incentivise Executive Directors to achieve financial targets for the year as well as specific strategic and personal objectives. These measures are aligned with the key performance indicators that we use as a business to monitor performance against our strategic priorities, as shown on pages 20 and 21 of the Annual Report & Accounts.
• All employee share plans – the Committee considers it is important for all employees to have the opportunity to become shareholders in the Company. The HMRC-approved Buy-As-You-Earn plan in the UK and an International plan mirroring the UK plan for Italy were both launched during 2013. The International plan is being further rolled out to employees in Germany and the Committee expects this process to be completed in 2014. At year end, approximately 1,900 employees throughout the Group had signed up to these schemes
Notes: 1. The relevant percentages were calculated by reference to the salary paid over the financial year. 2. Based on vesting under the 2010 and expected vesting under the 2011 RBS legacy long-term incentive awards in respect of 2012 and 2013. 3. The 2012 figures represent the whole of 2012 and not simply the period from IPO.
3. 40% of the shares awarded to Paul Geddes under the DAIP in March 2013 vested during the financial year, consistent with the policy applying at RBS Group. 4. As at the date of this report the number of shares beneficially held by Paul Geddes and John Reizenstein had increased to 59,247 and 61,910 respectively. 5. Includes holdings of connected persons, as defined in sections 252-255 of the Companies Act. 6. Beneficial share interest includes participant shares held under the Share Incentive Plan.
The Company’s policy is to make awards twice a year following the announcement of the Group’s full and half-year results. The value of each grant of awards is set at 50% of the normal annual policy level, so that the total face value of awards to each Executive Director during the year equates to 200% of base salary, measured using an average share price prior to the date of grant.
The table below details the awards made to Paul Geddes and John Reizenstein under RBS Group plans which will vest in Company shares. No awards were granted, vested or lapsed during the year although the potential value of the 2011 LTIP has been included in the single figure of remuneration as described on page 93.
Dividends The Board is recommending a final dividend of 8.4 pence per share to shareholders, which, subject to shareholder approval, will be paid on 20 May 2014 to all holders of Ordinary Shares on the Register of members at close of business on 14 March 2014.
Following the IPO on 16 October 2012, the Ordinary Shares have a premium listing on the London Stock Exchange. As at the date of this report, 28.5% of the Company’s issued shares are held by The Royal Bank of Scotland Group plc.
Governmental regulation To comply with European Union (“EU”) state aid requirements, RBS Group agreed to cede control of Direct Line Group by the end of 2013 and divest its entire interest by the end of 2014. The initial minority tranche of the divestment of Direct Line Group, by way of a public flotation, was effected on 16 October 2012 and RBS Group ceded control of Direct Line Group on 13 March 2013 and reduced its shareholding further to 28.5% on 27 September 2013.
• the Parent Company financial statements are not in agreement with the accounting records and returns.
Our duty to read other information in the Annual Report Under International Standards on Auditing (UK and Ireland), we are required to report to you if, in our opinion, information in the Annual Report is: • materially inconsistent with the information in the audited financial statements; or
Profit for the year 312.8 184.3 Other comprehensive (loss) / income Items that will not be reclassified subsequently to profit or loss: Actuarial loss on defined benefit pension scheme 32 (6.9) (3.4) Tax relating to items not reclassified 1.5 0.6
Items that may be reclassified subsequently to profit or loss: Exchange differences on translation of foreign operations (4.9) (2.4) Fair value (loss) / gain on available-for-sale investments 28 (108.2) 109.9 Less: realised net gains on available-for-sale investments included in income statement 28 (25.7) (89.5) Tax relating to items that may be reclassified 33.9 1.3
Other comprehensive (loss) / income for the year net of tax (110.3) 16.5 Total comprehensive income for the year attributable to owners of the Company 202.5 200.8
Depreciation is charged to the income statement on a straight-line basis so as to write off the depreciable amount of property, plant and equipment over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and long leasehold buildings 50 years or the period of the lease if shorter
Scheme assets are measured at their fair value. Any surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). The current service cost and any past service costs together with the net interest on net pension liability or asset, is charged or credited to operating expenses. Actuarial gains and losses are recognised in full in the period in which they occur outside the income statement and presented in other comprehensive income under ‘Items that will not be reclassified subsequently to profit or loss’.
On a quarterly basis, the Group reviews whether there is any objective evidence that the direct investments in AFS debt securities are impaired based on the following criteria: • price performance of a particular AFS debt security, or group of AFS debt securities, demonstrating an adverse trend compared to the market as a whole; • adverse movements in the credit rating for corporate debt; • actual, or imminent, default on coupon interest or nominal; or
Prior to July 2011, the Group underwrote long-term insurance falling within the business classes of life and annuity and permanent health. From 6 July 2011 the Group ceased accepting new business. The products provided included mortgage life cover, fixed term cover with critical illness, over 50s life cover and the life cover associated with the creditor business underwritten by the Group’s general insurance business. Contracts were issued typically on a long-term basis, which means that the Group’s liability extended for a period ranging from five years up to 52 years. On 28 November 2013, the Life business was sold and liability was transferred away from the Group.
Interest rate risk The Group’s interest rate risk arises mainly from its debt, floating interest rate investments and assets and liabilities exposed to fixed interest rates.
In 2012, the Group issued £500 million of subordinated debt with a 30-year maturity and fixed rate coupon for the first 10 years. The cost of the fixed rate coupon has been hedged down to the three-month London Interbank Offered Rate (“LIBOR”) floating rate.
At 31 December 2013, the Group maintained exposure to US Dollar securities through its investments in US Dollar corporate bonds and US Dollar securitised credits. The foreign currency exposure of these investments is hedged by foreign currency forward contracts, maintaining a minimal unhedged (direct) currency exposure on these portfolios, as well as a low basis currency risk on the hedging.
Operating profit before restructuring and other one-off costs 347.7 106.2 46.5 9.5 16.6 526.5 63.6 590.1
All operations are in the UK except for International which operates in Italy and Germany. The reportable segment net assets do not represent the Group’s view of the capital requirements for its operating segments.
Reinsurance premium ceded: Premium payable (368.0) (365.4) Movement in reinsurance unearned premium reserve (5.0) 38.9 6. Investment return £m 2012 £m
The table below analyses the realised and unrealised derivatives included in investment return.
Note: 1. The UK Government enacted a reduction in the UK corporation tax rate from 24% to 23% effective from 1 April 2013 in the Finance Act 2012 and in the Finance Act 2013 enacted further reductions to 21% effective from 1 April 2014 and 20% effective from 1 April 2015. As a consequence the closing deferred tax assets and liabilities have been recognised at the tax rates expected to apply when the assets or liabilities are settled. The impact of these changes on the tax charge for the year is set out in the table above.
Rescue and other personal lines 3.0 11.9 493.4 (48.6) (67.0) (6.2)
Disposals – (69.5) Increase / (decrease) in fair value during the year 7.5 (4.8)
Investment properties were purchased during the year to provide an investment return over the long term in accordance with the Group’s investment strategy. These properties are managed, on behalf of the Group, by a property services company. The investment properties are measured at fair value which was arrived at on the basis of a valuation carried out at the balance sheet date by independent valuers.
The Group sold 100% of the share capital of Direct Line Life Insurance Company Limited on 28 November 2013. The fair value of the identifiable assets sold was £159.4 million (including cash and cash equivalents of £20.5 million) and the fair value of identifiable liabilities was £132.1 million. The total cash consideration received was £39.3 million generating a profit on disposal of £12.0 million. The Life business generated a gross earned premium of £35.9 million up to the point of sale (full year 2012: £46.6 million), a net earned premium of £14.6 million (full year 2012 £21.9 million) and operating profit of £7.6 million (full year 2012: £9.4 million).
There have been no defaults on any of the notes during the year. The Group has the option to defer interest payments on the notes but to date has not exercised this right. The aggregate fair value of subordinated dated notes as at 31 December 2013 is £625.4 million (2012: £597.6 million).
Direct Line Group Annual Report & Accounts 2013 154 30. Insurance liabilities, unearned premium reserve and reinsurance assets continued Net general insurance liabilities
Inflation rate 0.25% increase in inflation rate – 1.8 0.1 3.1 0.25% decrease in inflation rate – (1.8) (0.1) (3.0) Life expectancy 1 year increase in life expectancy 0.1 1.5 0.1 1.5 1 year decrease in life expectancy (0.1) (1.6) (0.1) (1.5)
RBS Group has indemnified Direct Line Group for all future costs in respect of RBS Group share-based awards made to Direct Line Group employees. All costs in respect of these share awards for Direct Line Group employees have since been borne by RBS Group.
Cash at bank 64.7 69.1 Short-term bank deposits – 28.8 Bank overdrafts (55.1) (90.9) Derivative financial assets 20.0 25.4 Derivative financial liabilities (18.5) (2.4) Term deposits 35.0 50.0 AFS debt securities 48.6 75.0
For the purposes of IAS 24 ‘Related party disclosures’, key management personnel comprise the Directors of the Company, Non-Executive Directors and members of the Executive Committee.
The aggregate fair value of subordinated dated notes at 31 December 2013 is £625.4 million (2012: £597.6 million).
The following transactions were carried out with related parties: Sale of services £m 2012 £m
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Funds set aside by the Group to meet the estimated cost of claims payments and related expenses that the Group considers will ultimately be required to be paid.
The loss ratio for the current accident year excluding the impact of movement of claims reserves relating to previous accident years and claims relating to weather events in the Home division.
Earnings per share The amount of the Group’s profit allocated to each Ordinary Share of the Company.