Our Italian business is focused primarily in the north of the country, distributing through a network of non-tied agents and brokers, and this year we continued to grow ahead of the market.
We did not get all our 2008 predictions right. The relatively large downward swing in interest rates, inflation and the relative weakness of Sterling was not forecast. The persistence of these trends has led us to go back to the original shareholder approved rate of return range for LTIP shares which we adjusted upwards on a voluntary basis last year. More generally, our philosophy of closely aligning management reward structures with the longer term interests of shareholders remains. The events of the past 12 months are certain to drive change in the structure and nature of reward for senior executives. Whatever these changes, we will maintain the strong link to performance and the focus on sustainability of results that underpin our existing culture.
Across the Group we have continued to take the right action on rate and expenses. We have achieved good growth in shareholders’ funds and our capital position remains healthy, with significant surpluses on both an economic and regulatory basis.
These results continue to demonstrate the positive impact of our tight operational and financial management and the benefit of the Group’s strong and diversified portfolio.
In May 2008, we announced plans to double the Scandinavian expense savings to £50m and achieve an expense ratio of around 14% by mid 2010. As a result of the actions we have already taken, we are well on our way to achieving both targets.
These markets remain attractive with good growth potential, and we are on track to meet our target of increasing Emerging Markets’ net written premiums to £1bn by the end of 2010.
We maintain a conservative reinsurance programme to minimise volatility in our earnings from large losses and catastrophe events.
Our balance sheet is strong, with shareholders’ funds increasing by 25% in 2008. We hold strong regulatory and economic capital surpluses, as well as sufficient capital to maintain our financial strength ratings and pursue our bolt on acquisition strategy.
£70M ADDITIONAL SAVINGS TO BE DELIVERED IN THE UK BY MID 2010 In February 2009, we announced a new UK expense savings target of £70m to be delivered by mid 2010. This will be achieved primarily through a reduction in headcount of 1,200, and together with other actions, we are targeting a UK expense ratio of around 14% by the end of 2012.
The 2007 acquisition of CNS marked a £37 million investment in our Canadian broker business and made us the largest general insurer in British Columbia and the sixth largest in Canada.
The UK market remains competitive, however, we are now starting to see early signs of positive rating trends. While we are beginning to see the impact of the economic downturn on premium volume with a slowdown in business activity in Commercial and lower mortgage originations and new car sales in Personal, this is expected to be partially offset by higher rates.
Net written premiums are up 11% to £6.5bn (4% on constant exchange), representing good underlying growth and the benefits of foreign exchange in International and Emerging Markets, and a disciplined approach in the UK.
Total gains will continue to be impacted by any further negative market movements in commercial property values as well as financial market volatility. If the FTSE 100 remains at around 4,000 throughout 2009, the value of the equity hedges is estimated to be £40m, while total impairments are estimated to be between £40m and £60m. The value of commercial property is expected to broadly track the IPD index, and as it stands today, we are not anticipating a positive contribution from total gains in 2009.
Customer service is of critical importance to us and our Canadian business embodies this. Johnson is the leader out of 750 blue chip organisations around the world for the CMAT customer relationship management assessment.
Climate change has continued to rise up the political agenda in 2008. As an insurer, any change in the intensity or frequency of extreme weather conditions is a significant issue.
Details of the directors’ service contracts and terms of appointment, together with their interests in the Company’s shares are shown in the remuneration report on pages 49 to 61 and are incorporated into this report by reference.
Corporate governance continued ensuring that both the Group CEO and his executive management team have appropriate objectives and that their performance against those objectives is reviewed. The Group CEO is responsible to the Board for the executive management of the Group and for liaising with the Chairman and keeping him informed on all material matters.
Remuneration policy principles The Committee’s remuneration policy is consistent with the high performance culture across the Group. The key principles which underpin the remuneration policy are: Total remuneration is set at a level which enables the recruitment, retention and motivation of high quality executive talent There is a strong and visible link between remuneration and performance Executive remuneration and shareholder interests are strongly aligned. This is reflected in the design of the LTIP, which provides a co-investment opportunity The observation of existing share ownership guidelines to further enhance the alignment of shareholder interests with those of executive directors Incentive arrangements are leveraged so that only exceptional performance attracts the highest levels of award A balance of short and long term performance is used, incorporating measures of financial performance, delivery of shareholder value and a robust assessment of personal contribution Remuneration policy and practice is transparent to shareholders That, where relevant, there is consideration of environmental, social and governance risks when determining remuneration for executive directors and senior managers to ensure that positive behaviours are reinforced.
Remuneration report continued the previous level of bonus provision was considerably below the median levels of opportunity provided to executive directors in the FTSE 100. Consequently, the Committee decided that, from 2009 the on target and maximum annual bonus opportunity would be increased from 66.5% of base salary at on target level, and 133% of base salary at a maximum level, to 90% of base salary at the on target level, and 180% of base salary as a maximum.
Bridget McIntyre’s termination arrangements Bridget McIntyre’s contract of employment was terminated by mutual consent, effective from 31 December 2008, when she stood down from the Board. The Committee approved termination payments that comprised an amount payable in lieu of notice, in line with the contractual entitlement, equivalent to one year’s base salary and bonus for 2008. No amount is payable in respect of a bonus for 2009. Awards made under ESOS and SMP vested prior to termination, and may be exercised within the time periods set out in the rules of the plans as they relate to leavers. Matching Share awards and Performance Share awards made under the LTIP will vest on a time pro rated basis (to 31 December 2008) on the normal vesting date, and remain subject to further pro rating for performance to the end of the relevant performance periods. All awards of voluntary and compulsory Deferred Shares will vest on the normal vesting date. An amount equivalent to 30% of base salary is payable in respect of pension contributions for the notice period. The balance comprises other contractual benefits.
The Company contributions paid in respect of executive directors who are members of Group defined contribution schemes, were as follows: Company Company contributions paid contributions paid in 2008 in 2007 £ £
Opinion In our opinion: The consolidated financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union, of the state of the Group’s affairs as at 31 December 2008 and of its profit for the year then ended The consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation The part of the remuneration report described as having been audited has been properly prepared in accordance with the Companies Act 1985 and The information given in the directors’ report is consistent with the consolidated financial statements.
Cash generated from continuing operations 31 137 66 Tax paid (101) (127) Interest received 632 587 Interest paid (107) (101) Dividends received 3 1 Pension asset reallocation funding (37) (86) Cashflows from discontinued operations – (37) Net cashflows from operating activities 527 303 Proceeds from sales or maturities of: Investment contracts 5,184 8,672 Investment property 3 18 Property and equipment 20 26 Intangible assets – 1 Investments in subsidiaries (net of cash disposed of) 30 78 (407) Investments in associates – 22 Purchase or settlement of: Investment contracts (5,528) (8,878) Investment property (10) (8) Property and equipment (64) (28) Intangible assets (72) (66) Investments in subsidiaries (net of cash acquired) 30 (25) (52) Investments in associates (32) (64) Cashflows from discontinued operations – 83 Net cashflows from investing activities (446) (681) Proceeds from issue of share capital 19 304 Purchase of shares from minorities – (616) Dividends paid to ordinary shareholders (172) (102) Dividends paid to preference shareholders (9) (9) Dividends paid to minority interests (8) (31) Net movement in long term borrowings – (25) Net movement in other borrowings (2) 293 Net cashflows from financing activities (172) (186) Net decrease in cash and cash equivalents and bank overdrafts (91) (564) Cash and cash equivalents and bank overdrafts at beginning of the year 1,538 2,040 Effect of exchange rate changes on cash and cash equivalents 167 62 Cash and cash equivalents and bank overdrafts at end of the year 17 1,614 1,538
Estimation of the fair value of financial assets and liabilities The methods and assumptions used by the Group in estimating the fair value of financial assets and liabilities are: For fixed maturity securities, fair values are generally based upon quoted market prices. Where market prices are not readily available, fair values are estimated using either values obtained from quoted market prices of comparable securities or estimated by discounting expected future cashflows using a current market rate applicable to the yield, credit quality and maturity of the investment For equity securities fair values are based upon quoted market prices If the market for a financial asset is not active, the Group establishes fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cashflow analysis and option pricing models For mortgage loans on real estate and collateral loans, fair values are estimated using discounted cashflow calculations based upon prevailing market rates For cash, short term investments, commercial paper, other assets, liabilities and accruals, carrying amounts approximate to fair values For notes, bonds, loans payable and loan capital, fair values are determined by reference to quoted market prices or estimated using discounted cashflow calculations based upon prevailing market rates. Loan capital is carried at amortised cost and, when different, fair value is shown in the relevant note. For borrowings that carry a variable rate of interest (other than loan capital), carrying values approximate to fair values For derivatives, fair values are generally based upon quoted market prices.
The provisions for claims outstanding, and related reinsurance recoveries, are discounted where there is a particularly long period from incident to claims settlement and where there exists a suitable claims payment pattern from which to calculate the discount. In defining those claims with a long period from incident to claims settlement, those categories of claims where the average period of settlement is six years
Operating segments Operating segments are identified on the basis of the regional structure of the Group. Internal reports about these segments are regularly reviewed by the Group Chief Executive Officer and by the Board of Directors to assess their performance and to allocate capital and resources.
Amendment to IAS 23 ‘Borrowing Costs’ (issued 29 March 2007) Interpretation IFRIC 13 ‘Customer Loyalty Programmes’ (issued 28 June 2007) Amendment to IFRS 2 ‘Share Based Payment’ (issued 17 January 2008) Amendments to IAS 32 ‘Financial Instruments: Presentation’ and IAS 1 ‘Presentation of Financial Statements – Puttable Financial Instruments and Obligations Arising on Liquidation’ (issued 14 February 2008) Improvements to IFRSs (issued 22 May 2008) Amendments to IFRS 1 and IAS 27 ‘Cost of an investment in a subsidiary, jointly controlled entity or associate’ (issued 22 May 2008) Interpretation IFRIC 15 ‘Agreements for the Construction of Real Estate’ (issued 3 July 2008) Interpretation IFRIC 16 ‘Hedges of a Net Investment in a Foreign Operation’ (issued 3 July 2008) Amendment to IAS 39 ‘Financial Instruments: Recognition and Measurement: Eligible Hedged Items’ (issued 31 July 2008) Interpretation IFRIC 17 ‘Distributions of Non cash Assets to Owners’ (issued 27 November 2008) Revised IFRS 1 ‘First Time Adoption of IFRS’ (issued 27 November 2008).
In addition to the inherent uncertainty of having to make provision for future events, there is also considerable uncertainty as regards the eventual outcome of the claims that have occurred by the balance sheet date but remain unsettled. This includes claims that may have occurred but have not yet been notified to the company and those that are not yet apparent to the insured.
The Group monitors the financial strength of its reinsurers, including those to whom risks are no longer ceded. Allowance is made in the financial position for non recoverability due to reinsurer default by requiring operations to provide, in line with Group standards, having regard to companies on the Group’s ‘Watch List’. The ‘Watch List’ is the list of companies whom the directors believe will not be able to pay amounts due to the Group in full.
Apart from the impact on derivative financial instruments covered below, the changes arise from retranslation of foreign subsidiaries’ balance sheets from their functional currencies into Sterling, with movements being taken through the currency translation reserve. These movements in exchange rates therefore have no impact on profit.
Derivatives The Group may use derivative financial instruments for the purpose of reducing its exposure to adverse fluctuations in interest rates, foreign exchange rates and equity price risk. The Group does not use derivatives to leverage its exposure to markets and does not hold or issue derivative financial instruments for speculative purposes. Forward contracts are used to reduce the risk of adverse currency movements on certain forecast future cash transactions and for structural hedging. The policy on use of derivatives is approved by the BRC.
Remaining life Fair value Notional principal amounts Less than One to More than one year five years five years 2008 2007 2008 2007 £m £m £m £m £m £m £m
The following table provides an indication of some of the single factor changes adopted within the Group.
With reference to sensitivity analysis within insurance risk, the Group has exposures to risks in each class of business within each operating segment that may develop and that could have a material impact upon the Group’s financial position. The geographical and insurance risk diversity within the Group’s portfolio of issued insurance policies makes it not possible to predict whether material development will occur and, if it does occur, the location and timing of such an occurrence.
The Group received its Individual Capital Guidance (based on its ICA submission) from the FSA in late 2007, which was not changed in 2008 and at the request of the FSA remains confidential. The ICA is a forward looking, economic assessment of the capital requirements of the Group based on its assessment of the risks to which it is exposed. The models used to determine the ICA have been integrated into the Group’s business processes and are used to enhance the management of the Group.
Notes to the financial statements continued 2. Net investment return A summary of the gross investment income, net realised and net unrealised gains/(losses) included in the income statement is given below.
At 31 December 2008 344 134 533 144 1,155 Accumulated amortisation At 1 January 2008 – 77 179 44 300 Amortisation charge – 8 54 12 74 Amortisation on disposals – – (4) – (4) Exchange adjustment – 27 13 1 41 At 31 December 2008 – 112 242 57 411 Net book amount at 31 December 2008 344 22 291 87 744
Cost At 1 January 2007 213 89 399 106 807 Additions and transfers 35 6 51 47 139 Disposals and transfers – – (9) (20) (29) Exchange adjustment 15 7 7 17 46 At 31 December 2007 263 102 448 150 963 Accumulated amortisation At 1 January 2007 – 65 145 45 255 Amortisation charge – 6 38 12 56 Amortisation on disposals – – (8) (20) (28) Exchange adjustment – 6 4 7 17 At 31 December 2007 – 77 179 44 300 Net book amount at 31 December 2007 263 25 269 106 663
Cost/valuation At 1 January 2007 298 320 618 Additions 7 21 28 Disposal of subsidiaries (4) – (4)
Ordinary Ordinary Capital Share- share share Treasury Preference Revaluation redemption Translation Retained holders’ Minority Total capital premium shares shares reserves reserve reserve earnings funds interests equity £m £m £m £m £m £m £m £m £m £m £m
Preference shareholders shall not have any right to receive notice of, attend, speak or vote at any general meeting of the Parent Company unless: The preferential dividend on such shares for the dividend payment period immediately prior to the issue of the notice is in arrears or if any arrears of deficiency of dividend in respect of any preceding period has not been paid in full A resolution is proposed varying the rights attached to preference shares, for the winding up of the Parent Company or for a reduction of capital in the Parent Company (in which case preference shareholders may only vote on such resolution) In such other circumstances as the directors may determine prior to the allotment of any preference shares.
Provision for unearned premiums 3,835 3,383 Provision for losses and loss adjustment expenses 11,220 10,344 Total insurance contract liabilities 15,055 13,727
Movement in surplus during the year: Surplus at 1 January 158 32 Total pension expense (52) (9) Employer contribution 123 168 Actuarial gains/(losses) 287 (28) Acquisition of subsidiary – 1 Exchange adjustment (10) (6) Pension and post retirement surplus 506 158 Deferred tax in respect of net pension and post retirement asset (143) (42) Net pension and post retirement surplus at 31 December 363 116
The following is a reconciliation of the Group’s pension schemes’ assets: Pension schemes’ assets at 1 January 5,244 4,870 Return on schemes’ assets (114) 383 Contributions by the employer 123 168 Contributions by schemes’ participants 2 2 Benefits paid (242) (226) Acquisition of subsidiary 2 14 Exchange adjustment 27 33 Pension schemes’ assets at 31 December 5,042 5,244
28. Hedge accounting The Group designates the loan capital denominated in Euros as a hedging instrument against the net investment in designated subsidiaries to reduce the foreign currency exchange risk. The book value of the hedging instrument at 31 December 2008 was £481m (2007: £365m). The fair value of the hedging instrument at 31 December 2008 was £459m (2007: £377m). The hedge ineffectiveness recognised in the income statement during 2008 is £nil (2007: £nil).
Net profit for the year before tax 480 63 Realised losses – 21 Foreign exchange loss 46 20 Dividends received (600) – Changes in operating assets/liabilities (13) (34) Cash generated from operations (87) 70