Strategic report 2 Group highlights 4 Group at a glance 6 Market overview 8 Business model 10 Chairman’s statement 12 Chief Executive Officer’s review 14 Our strategy 24 Our key performance indicators 26 Risk management 30 Corporate social responsibility 34 Operating review 38 Finance review
Governance 48 Chairman’s introduction 50 Board of Directors 52 Executive Committee 53 Corporate governance report 64 Committee reports 82 Directors’ remuneration report 110 Directors’ report
Financial statements 114 Contents 115 Independent Auditor’s report financial statements 127 Notes to the consolidated financial statements 179 Parent Company financial statements 182 Notes to the Parent Company financial statements
Our strategy supports our aspiration to be the leading personal and small business general insurer in the UK. Our customers are at the centre of everything we do, as we remain focused on protecting an ever-changing Britain.
Building our brands by offering more Find out more on page 22 www.directlinegroup.com 1
Notes: 1. Results for the years ended 31 December 2015 and 31 December 2014 are based on continuing operations and exclude discontinued operations 2. See glossary on pages 189 and 190 and Alternative performance measures (“APM”) in Appendix A on page 191 and Appendix B – Proforma results on page 194 presents the Group’s results excluding the recent impact of the Ogden discount rate reduction 3. The Board is proposing a final dividend of 9.7 pence per share, making a total regular dividend for 2016 of 14.6 pence per share
• Combined operating ratio1 from Ongoing operations of 97.7% (pre-Ogden3: 91.8%; 2015: 94.0%), increased as a result of the reduction in the Ogden discount rate, partially offset by improved current-year underwriting performance and favourable weather claims. Adjusted for normal weather and before the Ogden discount rate change, the combined operating ratio was 93.5%, towards the lower end of the target range of 93% to 95%
• Invested in innovation, including partnership with PSA Peugeot Citroën for telematics extended for 4 more years, introducer role developed with Tesla, and MOVE_UK project brought into data collection stage
We have multiple brands, products and distribution channels. Each enables our customers to choose the right cover to protect their cars, homes, holidays, businesses and pets.
Direct Line has maintained its brand heritage by selling products direct to customers exclusively by phone and internet. We target customers with a high affinity to the brand, and focus on providing a fast and straightforward service.
NIG is our specialist commercial insurance brand. We sell our products through brokers, including an in-house intermediary that arranges RBS1 and NatWest commercial insurance.
Green Flag is our roadside rescue and recovery provider. We sell it as a standalone service and an additional optional product alongside motor insurance.
Motor We are Britain’s leading personal motor insurer measured by in-force policies1, mainly represented through our highly recognised brands Direct Line, Churchill and Privilege, and also through our partners. We insure around one in six insured cars on the road in the UK, representing 3.9 million in-force policies.
Home We are Britain’s leading personal home insurer measured by in-force policies1. We reach our customers by selling home insurance products through our brands, Direct Line, Churchill and Privilege, and our partners – RBS, NatWest and Prudential.
We protect commercial businesses through our brands, NIG, Direct Line for Business and Churchill, and through our partners RBS and NatWest. NIG sells its products exclusively through brokers operating across the UK. Direct Line for Business provides business, van and landlord insurance products direct to customers. Churchill sells business, landlord and van products direct to customers and through price comparison websites (“PCWs”).
Combined operating ratio £149.1m Operating profit £834.4m Gross written premium 3.4m In-force policies
Combined operating ratio £166.7m Operating profit £400.8m Gross written premium 7.9m In-force policies
Rescue and other personal lines We are one of the leading providers of rescue and other personal lines insurance in the UK2,3 with 7.9 million in-force policies. This includes providing roadside assistance and recovery for customers through Green Flag, the UK’s third-largest roadside recovery provider2. We also offer customers protection for their pets and holidays and are the second largest travel and the third largest pet insurer respectively3.
Innovative companies offer partnership possibilities New technology has the power to create feature-rich insurance apps and systems that can analyse vast amounts of data. These developments support the possibility of more tailored insurance products, as underwriting techniques evolve. Such innovations are being partly driven by InsureTech and FinTech companies, who are creating opportunities for partnerships with established insurers. However, given the amount of private and confidential information being generated, cyber security remains an increasing focus for the insurance industry.
Changing habits offer opportunities and challenges The new sharing economy is changing the way we live. Insurance products must change to reflect this. For example, we will need more innovative products than traditional buildings and contents insurance, as communal living and short-term rentals grow in popularity. Change will also affect motor insurance, where increasingly autonomous cars may lead to significant reductions in severe crashes and injuries and change the profile of claims. In the long term, the industry will need to consider how best to provide cover as risk shifts from the driver to the vehicle.
The pace of change remains rapid Insurance regulation has continued to evolve over the past year with a reduction in the personal injury discount rate, Flood Re, the Enterprise Bill, Solvency II, an Insurance Premium Tax increase and new FCA renewal legislation being implemented. The UK’s vote to leave the European Union adds significant regulatory uncertainty. The Bank of England’s decision to cut the base rate to 0.25% has reduced insurers’ investment returns with impacts on industry profitability.
84% of consumers would use one insurer for all of their insurance needs if quality customer service and low prices were available5 1.8 million
The average bodily injury claim cost following an accident is6 connected cars in the UK in 20161 £10,955 £5.8bn one-off impact to the industry due to the personal injury discount rate reduction7
Notes: 1. Statista – Number of connected cars in the United Kingdom (UK)
We hold assets that exceed our expected liabilities as capital to allow us to absorb any unexpected losses that might occur. We maintain a buffer that significantly exceeds our regulatory capital requirements.
We aim to make it easy for our customers to access our products, and to give them what they are looking for. We want to make sure they have appropriate cover to protect against the unexpected.
Each brand provides products for one or more insurance segments: motor, home, rescue, pet, travel and commercial. By tailoring the mix of distribution channels for each product, we seek to offer customers a blend of brands, products and services that best suit their needs.
Our shareholders are a big part of our business model. They invest in the business wanting to achieve a good level of return. So we aim to give our shareholders value by generating sustainable business profits. We reinvest part of this profit in the business, or add to capital and, where appropriate, distribute the rest to shareholders as dividends.
We ensure our products meet regulatory standards and that customers understand what they are buying from us. We also aim to price our policies accurately and invest our assets appropriately to minimise potential losses.
In 2016, the Group delivered profit before tax of £353.0 million (2015: £507.5 million). Before the reduction in the Ogden discount rate to minus 0.75%, profit before tax was £570.3 million. We achieved this resilient result through our continued focus on the value, service and brand propositions offered to our customers, on operating efficiency and on underwriting discipline in competitive markets.
Dividends We aim to increase the dividend annually in real terms, under our progressive dividend policy (see page 110). This aim reflects the potential of the Company’s cash-flow generation and long-term earnings. We are recommending a final regular dividend of 9.7 pence per share. If approved, the total regular dividend of 14.6 pence per share will represent 5.8% growth on 2015’s regular dividend (13.8 pence per share), which is consistent with this policy.
In addition, we paid a special interim dividend of 10.0 pence per share in September 2016. The Board’s ability to return a dividend to shareholders is against the backdrop of a challenging economic environment following the UK’s EU membership referendum and the recent reduction in the Ogden discount rate. Whilst the day-to-day operations remain unaffected, the Group continues to monitor the consequences of the devaluation of Sterling, inflation, uncertain financial markets and the Ogden discount rate reduction.
The Group achieved a return on tangible equity (“RoTE”) of 14.2% for 2016. However, a decrease of 9.4% (2015: an increase of 39.9%) in the share price over the year to 369.4 pence (2015: 407.5 pence) at 31 December 2016, together with dividend payments, provided a total shareholder return (“TSR”) of minus 1% for the year (2015: 46.9%), which is reflected in the long-term incentive plan (“LTIP”) outcome for 2016. This follows three consecutive years of outperformance versus the benchmark (FTSE 350 excluding
Leadership Your Board seeks to ensure that decisions are of the highest standard. It challenges strategic proposals, performance delivery and management responsibilities. See page 53.
Effectiveness The effectiveness of your Board’s and its Committees’ performance is considered annually in an effectiveness review. See page 59.
Accountability Your Board provides shareholders with an assessment of the Group’s position and prospects. We monitor and review the effectiveness of the Group’s risk management and internal control systems. See pages 26 and 61.
investment trusts) meaning that shareholders, since the initial public offering in 2012 (“IPO”), have received a TSR of 188% compared to the FTSE350 (excluding investment trusts) of 48%. Since the IPO, the Group has delivered good results each year, enabling the Board to declare cumulative dividends, including special interim dividends, equivalent to approximately 72% of the IPO share price.
Regulation, conduct and culture We maintain active relationships with our regulators through constructive two way dialogue. Your Board promotes the Group’s culture and oversees the Group’s conduct policy, which aims to ensure that we achieve good customer outcomes and that our employees behave with integrity. We also have a Code of Business Conduct which sets out standards that our employees are required to observe. We recognise that opportunities always exist to improve the services offered to our customers; and your Board has encouraged a range of customer experience initiatives which are designed to deliver increased levels of customer satisfaction.
On 1 February 2017, I was delighted to welcome Danuta Gray as a Non-Executive Director and Mike HollidayWilliams as an Executive Director to the Board. Danuta brings executive and non-executive experience from her previous roles in a number of sectors, including financial services. Mike’s appointment reflects the importance of the Personal Lines business to the Group. Your Board will benefit from closer interaction with the Personal Lines business and from the expertise that Mike will bring to the Board. My introduction to the Corporate Governance report and the Nomination Committee report provide further information on these changes.
Employees I would also like to thank our employees for their hard work, initiative and commitment to our mission. Their positive energy and dedication in supporting our customers helped our business progress in 2016, and has put us in a strong position for the future.
What do you believe will be the risks, opportunities and challenges in 2017? As 2016 has shown, no one can predict the future. Everything from the unpredictability of the weather, combatting new types of fraud such as cyber attacks, the uncertainties of Brexit and the change to the Ogden discount rate means we all have to remain vigilant.
In terms of regulation, we’ve actively lobbied Government to make whiplash claims more efficient for customers and ourselves. If we reduce costs, we can be in a position to pass on savings to customers, so we hope the Government consultation will produce effective reform for the industry.
How do you feel the Group is progressing towards its goal to make insurance much easier and better value for our customers? The fact our brands are growing is evidence that we’re doing the right thing. In a market that people believed was commoditised and only about cheap prices, growing the Direct Line brand is the ultimate accolade. It shows customers still value great products and service too.
Our TV advertising helps show where we believe our propositions differentiate us from our competitors. Our people have also received training on how to better understand and empathise with customers to help meet their needs appropriately.
Alongside this, we have improved both the sales and claims processes for our customers. Improving the digital journey through mobile devices, allowing customers to use their smartphones on more aspects of their claims and enabling customers to amend their policies with no additional fees are just a few ways we’re making Direct Line much easier and better value for our customers.
Direct Line for Business has also seen strong growth, with policy numbers rising by 6.4% over the year. We have ambitions of ensuring the Company can do more for businesses in the future.
However, a second and more dangerous view I hear is that nothing will change. We believe technology will make cars much safer and improve driver experiences. Usage, ownership, prices, and how people choose to buy cars and insurance will evolve. So, while I feel the market will remain large, what it means to be an insurer can be expected to change profoundly.
Reducing accidents can only be a good thing. I lost my best friend in an accident so I’m absolutely behind it. Technology might change how our business is configured. The market may get smaller, so we’ll need to win more of it. If we have the right attitude; consider all the opportunities; and remain experts at using data, helping our customers, and finding new partners, I believe we can grow our market share.
Supporting this are internal initiatives such as our diversity network alliance, external schemes such as the 2016 Women in Finance charter, and several other associations that I am proud we have joined. These are all helping us to chip away at the ‘male, pale, stale’ image of insurance.
Every day, I see evidence of people bringing all of themselves to work – I think this is because we are diverse, and value the individuality and the unique strengths of each person. This is backed up by our Dialogue results, where 90% of our colleagues say that they feel they can be themselves at work.
This is important as it ensures we have the most talented teams and truly represent the ever changing Britain we look to protect. I believe this further helps our people genuinely care about their actions, whether that’s in the way they treat our customers, or how they help other parts of the Company to be efficient and effective. Although there is even more we can do in this area, diversity is something that unites and defines us. Not only in the conventional sense, but also through striving to have a powerful combination of people, with a rich diversity of experience and thinking.
We continue to invest in our key enablers to help grow and strengthen these pillars, which we believe will help us with our ambitions of growing sustainably and delivering at least a 15% RoTE.
The strength of our Direct Line brand is not limited to the personal lines sector, with more small businesses looking for reliable and easy to use direct insurance, Direct Line for Business continued to grow strongly in the year, highlighting the value of this brand asset.
Our effectiveness on PCWs via the Churchill and Privilege brands has also increased, particularly in Home as we improved the customer journey. This contributed to strong new sales growth through this channel.
Our Churchill brand was strengthened with the launch of our ‘Lollipoppers’ campaign and we have recruited new Lollipop men and women nationwide. We also relaunched our Churchill Motor free rescue campaign, differentiating this brand and leveraging our Rescue capabilities at the same time.
Our Green Flag brand continued to perform well. Green Flag’s app was enhanced with Green Flag ‘Alert Me’ and ‘Rescue Me’, providing the capability for rescue customers to monitor the health of their car and to improve their rescue experience.
Our objectives for 2017 Continue to build the Direct Line brand presence, offering a differentiated and valued service and proposition not available on PCWs. Further leverage our ‘Direct’ capabilities with our small to medium-sized enterprise (“SME”) commercial customers and maintain our competitiveness on PCWs.
The Group increased the number of accident repair centres it owns to 18 in 2016 strengthening its ability to control indemnity spend and improve customer experience.
Maximise existing growth opportunities while creating and driving future areas of value We aim to remain a leading competitor in our chosen markets by providing quality propositions and value for money. Where there are opportunities, we will look to launch new and exciting products and services. These will aim to put us at the forefront of disruptive market changes.
How we performed in 2016 We continued to build on our strong market position by identifying and investing in market developments we believe can contribute to future growth.
We are working with Tesla to understand the role advanced technology and driving aids can play in enhancing road safety and therefore insurance. In 2017, Tesla became an introducer appointed representative to be able to refer customers to Direct Line to insure their Tesla.
In 2016, we formed a partnership called MOVE_UK with the UK government, technology providers and car manufacturers to accelerate the development, market readiness and deployment of Automated Driving Systems (“ADS”). With ADS systems observing and recording in the background while MOVE_UK vehicles are driven normally, this is a unique opportunity to learn how ADS technology would respond in real life situations.
In Commercial, we are looking to further leverage our strong Direct Line brand and direct marketing capabilities to disrupt the small commercial customer segment.
We aim to harness the power of technology to make things easier for our customers and our people. By implementing integrated systems that are flexible and efficient, over time we aim to reduce costs while improving customer interactions such as self-service. We also enjoy a wealth of data from being a major insurer for a number of years, which we can use to make our business better for our customers.
How we performed in 2016 The ongoing areas of focus include developing future capability, and managing risks associated with IT systems’ stability and cyber security. Technology remains at the heart of our operations and the focus is on upgrading our IT systems and capabilities, aimed at improving the digital offering, customer experience and operational efficiency. While progress has been made in each of these three areas, implementation and integration of a range of new IT systems is inherently complex and challenging. We remained focused on adopting the right capabilities and will take the time necessary to do so.
We have made progress improving the performance of the core infrastructure during the year, supporting our people in performing their roles more effectively.
In addition, we launched a new graduate scheme and apprentice recruitment drive to build a stronger organic talent pool.
Our objectives for 2017 We have a range of new initiatives to build on our people strategy focused on developing a high performance culture based on diversity, continuous training and a focus on the customer.
Our risk and capital management policy seeks to maintain an appropriate level of capital and solvency for the risk appetite agreed by the Board to support our business, while aiming to grow dividends annually in real terms.
How we performed in 2016 During 2016, we received approval from the PRA to use the Group’s PIM, successfully concluding a multi-year project. We have embedded this model at the centre of the risk management framework and now use it to report our Solvency II capital coverage.
We were well prepared for the UK’s referendum on leaving the European Union (“EU”) and have actively managed the impacts from the subsequent volatile financial markets. We are a UK-based business underwriting risk within the UK, and the day-to-day operations remain largely unaffected. We continue to monitor the consequences of the devaluation of Sterling and uncertain financial markets.
Our objectives for 2017 We aim to further embed the use of our internal model within the business and operational decision making. We recognise the strategic value and competitive advantage strong risk management can provide and continue to work to drive ownership of risk management across the Group.
Building a culture of great service In order to constantly improve our customer experience we are investing in training and development for our people.
Preparing for the roads of the future This year we kicked off a partnership called MOVE_UK with Government, technology providers, and car manufacturers to accelerate the development, market readiness and deployment of Automated Driving Systems (ADS). Planning for the future of our business is vital so that we continue to provide customers with a service that fits their needs.
Testing tomorrow’s cars The three-year project is one of the first of its kind in the UK and aims to develop a new method for validating ADS and a data resource that will help us analyse and prepare for the impact of ADS on three-year vehicle insurance.
Direct Line committing to providing a plumber within 3 hours day or night was an industry first
Available when our customers need us The commitment to a plumber arriving in such a short time frame is a first for the insurance industry. For water leaks that can be contained by turning off the water supply, Direct Line will still ensure an emergency plumber is sent to the property at a time convenient for the householder.
Read more about our rewards for performance on page 82. For definitions, see the glossary on pages 189 and 190
Performance See Finance review page 42 See Finance review page 42 See Finance review page 42 See Finance review page 39
Link to Directors’ remuneration We base the Long-Term Incentive Plan (“LTIP”) awards partly on RoTE over a three-year performance period.
Notes: 1. See glossary on pages 189 and 190 and APM in appendix A on page 191 2. See note 3 on page 2
Definition The cost of doing business, including paying our people, marketing expenses, and spending on infrastructure and IT. This includes the costs we incur handling claims, but excludes any commissions we pay to brokers or partners, and restructuring and other one-off costs.
A measure to show the level of capital held compared to the level that is required, accounting for the risks we face.
We target capital coverage to the Board’s risk appetite range of 140% to 180% of our SCR. We also aim to maintain a rating in the ‘A’ range from our credit rating agencies.
Performance See Finance review page 40 See Finance review pages 45 and 46 Customer claims experience programmes and improved propositions have contributed to an increase in our overall brand score.
Link to Directors’ remuneration Costs are considered and form part of the gateway measures for the AIP awards.
Managing risk in line with our strategy Management, and ultimately the Board, are responsible for developing our strategy. Our strategic planning process aims to ensure we have developed clear objectives and targets, and identified the actions needed to deliver them, including the management of risks. These clear objectives are consistent with our overall long-term ambition of sustainable growth and at least a 15% RoTE delivered within our risk appetite. To find out more about our strategy, see page 14.
The Group’s governance structure is set out in more detail in the corporate governance section.
Our business is risk. So to ensure our strategy’s success, we must manage risk effectively and efficiently.
Our Enterprise Risk Management Strategy and Framework This section sets out, at a high level, our approach to setting risk strategy and the Enterprise Risk Management Framework (“ERMF”) for managing risks. It documents the high-level principles and practices to achieve appropriate risk management standards and demonstrates the inter-relationships between components of the ERMF – see diagram.
The Board approves our strategy, risk appetite and policies, and the Board Risk Committee (“BRC”) approves the ERMF.
Our risk culture Our risk culture underpins our business and decision-making, and helps us embed a robust approach to managing risk. Our risk culture is demonstrated in the understanding and business-wide use of the risk management systems and processes and through risk-aware decision-making. The Board is committed to promoting a culture of high standards of corporate governance, business integrity, ethics, and professionalism in all our activities. An annual assessment of risk behaviours and attitudes (“ARBA”) is undertaken jointly by the Risk function and Group Audit and considers a range of factors influencing risk culture.
Principal risks and uncertainties We assess robustly the principal risks facing us. Principal risks are defined as having a residual risk impact of £40 million or more on profit before tax or net asset value on a one-in-200 years basis, accounting for customer, financial and reputational impacts. We believe our risk profile remained broadly unchanged over the last year.
• We estimate technical reserves using various actuarial and statistical techniques. Management’s best estimate of total reserves is set at not less than the actuarial best estimate
• Third parties review our reserves • Underwriting guidelines are set for all transacted business, and pricing refined by analysing comprehensive data • Catastrophe and motor excess of loss reinsurance limits our exposure to events and large losses • We invest in enhanced external data to analyse and mitigate exposures • We have set reserves using the latest data and trends. In particular, the recent decision to reduce the Ogden discount rate has been reflected in the estimate of reserves www.directlinegroup.com 27
The risk of loss resulting from fluctuations in the credit standing of issuers of securities, counterparties and any debtors to which we are exposed. See pages 141 to 146.
• We only purchase reinsurance from reinsurers with at least an ‘A–’ rating
• We have appropriate operational processes and systems, including detection systems for fraudulent claims
• Our risk management system is designed to enable us to capture risk information in a robust and consistent way
The risks leading to reputational damage, regulatory or legal censure, fines or prosecutions, and other types of non-budgeted operational risk losses associated with our conduct and activities.
• We maintain a constructive and open relationship with our regulators
• Our risk-based monitoring is designed to ensure we use our resources effectively
• We have a strong culture of considering customers’ perspectives; delivering the right outcomes for our customers is central to how we operate
Emerging risks Our definition of emerging risks is newly developing or changing risks that are often difficult to quantify, but may materially affect our business. We have further defined emerging risks as highly uncertain risks that are external to our business. We record emerging risks within an Emerging Risk Register. We report these to the Risk Management Committee and BRC for them to review, challenge, approve and feed into the Board’s strategic planning process. Our emerging risks processes aim to: • achieve ‘first mover advantage’ by recognising risks and associated opportunities early; • reduce the uncertainty and volatility of our business’ results; and
UK economy The UK could enter a prolonged period of reduced growth following its referendum vote on EU membership, potentially reducing insurance sales and the value of our investment portfolio. Equally, the uncertainty surrounding the nature and outcome of the Article 50 negotiations could have various implications. In addition, whilst our operations are based mainly in the UK, we have monitored and will continue to monitor actual and potential implications including: changes to the value of Sterling which impact claims and non-claims supplier costs; volatility in currency exposures and hedging costs; inflation; recruitment and retention of people; potential changes to direct and indirect tax; and the impact on our capital position.
• We run an annual strategy and 5-year planning process which considers our performance, competitor positioning and strategic opportunities
We consider brand, reputational and political risk within the drivers of other risk types, such as regulatory and conduct, operational and strategic risks.
Approach Our Corporate Social Responsibility (“CSR”) strategy helps us put society’s interests at the heart of our business. The strategy has four strands. As shown in the graphic, they are ‘Helping to make our society safer’, ‘Proud to be here’, ‘Recognised as part of our communities’ and ‘Reduce, Reuse and Recycle’.
We manage our strategy through our CSR Advisory Group, which comprises senior managers from across the business. Our sustainability team supports the Advisory Group. Individual members of our Executive Committee are accountable for each strand of the strategy. The CSR Committee’s role is to oversee our approach. See page 72.
To help us understand, prioritise, and respond to the sometimes competing needs of our different stakeholders across society, we partner with several leading CSR organisations.
You can find more details of our approach on the Group’s website at www.directlinegroup.com, including our CSR Charter, policy framework, performance against last year’s targets, and targets for 2017.
We recognise that our products, services and operations affect our many stakeholders so we seek to make our society safer for everyone. Our current focus is on road safety. We believe we can responsibly use our expertise and experience to reduce deaths and life changing injuries on Britain’s roads.
In response, we have set ourselves the ambitious goal of cutting deaths in the first 1,000 miles to zero across the UK. We will, of course, need to work with many other stakeholders to achieve this goal.
To find out more about our CSR Committee, see page 72
While progressing our broad Corporate Social Responsibility strategy, we have increased our focus on road safety as the area where we have some of the clearest and strongest expertise in the UK. We are using our position as Britain’s leading car insurer to try to inspire a generation of safer young drivers and make a radical and measurable change to the level of young driver deaths.
The biggest barrier to addressing this issue is that young drivers often feel immune to the risks. Our goal of inspiring a generation of safe and careful drivers sits at odds with many of the motivations of new drivers. Young drivers, especially young men, can be pro-risk and competitive. From our surveys, we found that many believe that ‘most people drive faster than the speed limit’ and that ‘good driving means travelling as fast as you can’. To change behaviour, we must change this perspective.
We are working with various reward partners, including Boost and Virgin Experience. Shotgun offers rewards which are attractive to a 17 to 25 year old demographic. Our research showed we needed a range of reward options that appealed to different tastes and to both urban and more rural users.
To launch the app we used the same leading-edge thinking that won Direct Line a coveted Institute of Practitioners in Advertising Gold award for Effectiveness. The Shotgun launch represented a departure from traditional advertising, in a bid to engage the target audience using channels that are relevant. This moves the topic of road safety into a more social space, with a particular focus on personal platforms like Instagram, You Tube and Snapchat. The strategy was to create content in a range of formats, based on creative ideas that resonate with the audience. These were seeded with carefully chosen partners to build saliency and drive momentum. They are also quite a bit edgier than our traditional marketing messages.
We put in place a communication plan for a diverse range of audiences – young drivers, of course, were central but also their parents as well as our own employees. Making sure we capture all of these groups is critical. For our staff, our approach has been to create awareness, build understanding and drive engagement across the business. We want our people to be proud of our shared belief that the know-how and power of Direct Line can be a real force for good in the UK. We also want our employees to become active advocates for this initiative in their local communities right across the country.
From our research and testing, we know we can engage with this vulnerable audience and change both their attitudes to driving and materially improve their driving behaviour, making a real change in their chances of being killed or injured on the roads.
During 2017, we are focusing on delivering against this objective. We will run a series of attitudinal research studies to track our users’ attitude to driving. In addition, the Shotgun app will give us a rich source of data allowing us to measure improvements to driving performance over time.
Road safety partners During 2016, we worked with various partners to highlight a range of road safety issues.
Department for Transport We continue to engage proactively with the Department for Transport on various topics, including telematics technology, driverless cars and road safety policy.
We communicate the details of a carbon management programme through the Carbon Disclosure Project. Throughout 2016, 100% of the Group’s electricity was purchased on a green tariff.
Proud to be here Our people strategy supports our business strategy, ensuring we have capable, skilled and engaged people that can help make insurance easier and better value for our customers.
Diversity, inclusion and human rights We continue to work towards an environment based on meritocracy and inclusion, where every employee can achieve their full potential, whatever their background or situation.
Examples of activities include: • 780 employees manning our call centres to take pledges for appeals such as Stand Up to Cancer, Comic Relief and Children in Need; • supporting national appeals such as the World’s Biggest Coffee Morning in aid of Macmillan and raising funds during Movember for various men’s health charities; and
Our Employee Opinion Survey revealed that 33% of staff volunteered or fundraised in company time last year. Our target for 2017 is to at least maintain this high level of engagement.
You can find the ratio of female-to-male employees at 31 December 2016 in the charts below.
Recognised as part of our communities We believe that our people’s feelings about working for the Group are linked to our reputation in the community and we therefore try to align our approach to giving more generally with their interests.
 Gross written premium increased by 9.4% with own brands increasing by 9.3%
Performance Motor in-force policies increased by 4.5% during 2016, driven primarily by own brands. Overall, Motor gross written premium increased by 9.4% in comparison to 2015.
Motor average written premiums1 increased by 6.3% in 2016 compared with an average increase of 5.2% in 2015. As demonstrated by the improving current-year loss ratio, the Group was able to continue to write business at attractive margins, as a result of successful pricing and a slightly improved risk mix. Claims inflation remained at the top of the Group’s long-term expectation of 3%-5%, driven by higher damage costs.
The current-year attritional loss ratio improved by 0.9 percentage points to 84.1% (2015: 85.0%). Excluding the impact of the recent reduction in the Ogden discount rate, the current-year attritional loss ratio for Motor was 83.3% an improvement of 1.7 percentage points compared to 2015. Growth in average premiums, coupled with improving claims trends in large bodily injury, were partially offset by higher than expected damage inflation and the Group’s investment in new business growth.
 Gross written premium was 3.7% lower primarily due to partnerships, while own brands reduced by 0.9%
 Operating profit improved by 51.7 percentage points to £166.7 million reflecting lower claims from major weather events
The current-year attritional loss ratio, excluding claims costs from major weather events, was 2.0 percentage points higher than 2015. This was predominantly driven by a greater proportion of new business sales compared to 2015 and an increase in claims inflation.
The expense ratio at 21.7% was 1.9 percentage points higher than in 2015 primarily due to the Flood Re levy. The commission ratio at 22.6% was 1.7 percentage points higher than in 2015 as profit share due to partners was higher as a result of the improved loss ratio performance.
Operating profit of £166.7 million improved by 51.7 percentage points benefitting from lower claims costs from major weather events and higher than expected prior-year reserve releases.
The Group continued with its planned digital and proposition investment in the successful RBS Home and Private Insurance relationship. This will enable the Group to offer RBS customers tailored products consistent across distribution channels.
The Group agreed an extension of its Home and Motor insurance partnership with Prudential for a further two years. As part of this, policies will be renewed under the Prudential brand until 2019. The Group also launched its first affinity partnership scheme to offer access to Churchill-branded Home and Motor policies for Prudential Group customers who do not currently have such insurance with the Group. This partnership demonstrates the Group’s ability to deliver tailored propositions to meet the needs of partners and their customers.
Outlook The market remained competitive in 2016, although with some signs of premium inflation on new business, following several years of significant deflation.
There is evidence that claims inflation has been increasing and has continued to run ahead of premium inflation. The focus remains on balancing margin and volume with a view to delivering sustainable long term value.
Performance In-force policies for Rescue reduced by 7.3% to 3.6 million in comparison to the prior year through lower partner volumes. The reduction in in-force policies for other personal lines of 2.8% across 2016 primarily reflected lower packaged bank account volumes.
The Group continues to support RBS with rescue and travel products sold to packaged account customers. The provision of these services beyond the current contract term is subject to a market review, in which the Group is participating.
Highlights  Commercial in-force policies grew by 3.1% with Direct Line for Business growth of 6.4%
Regulatory The Insurance Act went live in August 2016 with changes applied to all of our product wordings across Commercial along with new processes in the claims area to ensure alignment to the principles of the Act. 2017 will bring changes from the Enterprise Act and the Commercial division is well placed to support these changes.
to £3,274.1m (2015: £3,152.4m), driven by growth in Motor and Home own brand in-force policies (up 4.3%)
 The Group’s estimated Solvency II capital coverage ratio4 post-dividend is 165%, above the middle of the Group’s risk appetite range of 140% – 180% (pre-dividend: 174%)
 5.4% increase in final dividend per share to 9.7 pence per share (2015: 9.2 pence). Total dividends per share for 2016, including special interim dividend of 10.0 pence per share paid in September 2016 following the approval of the Group’s partial internal model, of 24.6 pence per share (2015: 50.1 pence)
Investment income yield1,2 2.5% 2.4% Investment return1,2 2.6% 2.9% Basic earnings per share (pence) 20.4 27.9 Adjusted diluted earnings per share1,2 (pence) 21.2 26.6 Return on tangible equity1,2 14.2% 18.5% Net asset value per share (pence) 184.7 192.2 Tangible net asset value per share (pence) 147.4 153.8 Dividend per share
Underwriting profit 70.1 175.2 Investment return 168.1 194.7 Instalment and other operating income 165.3 150.8 Operating profit 403.5 520.7
In-force policies – Ongoing operations (thousands) At 31 December 2016 2015
Other personal lines 4,234 4,356 Rescue and other personal lines 7,880 8,288 Direct Line for Business 433 407 NIG and other 242 248
Total in-force policies for Ongoing operations during 2016 reduced by 1.6% to 15.8 million (31 December 2015: 16.1 million). The fall primarily related to partner volumes in Home and Rescue and other personal lines. Motor in-force policies grew by 4.5% and Commercial by 3.1% across the period. Own brands in-force policies during 2016 grew by 4.3% including a 5.3% increase in Motor.
Home total 834.4 866.3 Of which Nationwide and Sainsbury’s 215.5 221.2
Gross written premium of £3,274.1 million increased by 3.9% compared with 2015 (£3,152.4 million) primarily relating to an increase in Motor own brands.
Underwriting profit (£ million) 70.1 175.2 Loss ratio 60.9% 59.5% Commission ratio 11.5% 10.9% Expense ratio 25.3% 23.6%
The increase in the commission ratio of 0.6 percentage points to 11.5% primarily reflected higher payments to partners, particularly in Home, following lower claims costs as a result of prior-year reserve releases and major weather events.
Loss ratio current-year attritional 84.1% 47.8% 66.0% 66.3% 69.2% Loss ratio – prior-year reserve releases (9.2%) (9.3%) (4.4%) (11.0%) (8.9%) Loss ratio – major weather events – Home2 n/a 2.2% n/a n/a 0.6%
Loss ratio current-year attritional 85.0% 45.8% 63.5% 75.5% 69.4% Loss ratio – prior-year reserve releases (21.4%) (5.0%) (3.6%) (12.8%) (13.0%) Loss ratio – major weather events – Home2 n/a 10.7% n/a n/a 3.1%
The movement in the current-year attritional loss ratio is a key indicator of underlying accident year performance as it excludes prior-year reserve movements and claims from major weather events. The Group’s current-year attritional loss ratio improved by 0.2 percentage points to 69.2% in 2016 (2015: 69.4%) with improvements in Motor and Commercial partially offset by a deterioration in Home and Rescue and other personal lines. Excluding the impact of the recent reduction in the Ogden discount rate, the current-year attritional loss ratio for Ongoing operations improved to 68.8% in 2016. By division, the COR improved in Home and Commercial, mainly as a result of benign weather compared to 2015. The COR deteriorated in Motor due to the recent Ogden discount rate change and an intangible asset impairment charge of £39.3 million. Prior-year reserve releases for Motor were significantly lower at £123.5 million (2015: £266.8 million), including a £139.8 million charge in respect of the recent Ogden discount rate change. Home prior-year reserve releases increased to £75.9 million (2015: £41.9 million) due to some favourable development from the storms in late 2015.
For the year ended 31 December 2015 Net insurance claims 4 794.8 435.1 231.6 275.8 1,737.3
Consequently, the Group’s expense ratio increased to 25.3% (2015: 23.6%). Excluding the impairment charge and Flood Re levy the expense ratio would have been 23.2%. The reduction in claims handling expenses was largely due to lower staff costs and other operating costs being allocated to claims and a reduction in claims handling provision.
Instalment and other operating income – Ongoing operations £m 2015 £m
The investment income yield in 2016 was 2.5%, an increase on the yield achieved in 2015. Actions to diversify the portfolio including investment in commercial real estate loans, subordinated financial debt and global credit, have helped offset yield pressure from low UK interest rates. The Group currently forecasts an investment income yield of 2.4% for 2017 on the basis of current market conditions given the continuing low interest rate environment.
All divisions were profitable in 2016, with Home and Commercial reporting significant improvements in operating profit compared to 2015. This was partially offset by a decrease in Motor, due to the recent reduction in the Ogden discount rate and a higher level of intangible asset impairments, and in Rescue and other personal lines.
Operating profit – Ongoing operations 403.5 520.7 Run-off 26.6 73.1 Restructuring and other one-off costs (39.9) (48.7) Operating profit 390.2 545.1 Finance costs (37.2) (37.6) Profit before tax 353.0 507.5
Profit from discontinued operations, net of tax – 181.2 Profit after tax 278.8 580.4
Restructuring and other one-off costs Restructuring and other one-off costs for 2016 of £39.9 million (2015: £48.7 million) primarily reflected the costs associated with the exit of the Group’s Bristol property and relocating to a smaller site. Over the four-year period 2015 to 2018, the Group expects cumulative restructuring and other one-off costs to be substantially offset by the operating profit from the Run-off segment.
Discontinued operations On 29 May 2015, the Group completed the sale of its International division, which comprised its Italian and German operations, to Mapfre, S.A. Accordingly, this division is treated as discontinued operations. The gain on disposal of £167.1 million is included in profit from discontinued operations of £181.2 million in 2015. Operating profit for 2015 includes £29.9 million of realised net gains on divisional available-for-sale (“AFS”) investments reclassified through the income statement on disposal. Further details on discontinued operations are presented in note 5 to the consolidated financial statements, see page 152.
Earnings per share Basic earnings per share was 20.4 pence (2015: 27.9 pence) reflecting the decrease in profit after tax.
Adjusted diluted earnings per share1 from Ongoing operations were 21.2 pence (2015: 26.6 pence) reflecting the decrease in operating profit.
The net cash used by investing activities of £125.6 million (2015: £190.8 million generated from investing activities) the movement primarily reflects the proceeds on sale of discontinued operations in 2015.
Reserving Financial management includes the central aspect of estimating claims reserves. Uncertainty is an inherent part of insurance, and requires judgement when assessing claims liabilities.
Note: 1. See glossary on page 189 and 190 and appendix A on page 191
Finance costs Finance costs remained stable at £37.2 million (2015: £37.6 million).
RoTE was 14.2% due to lower profit after tax as a result of the reduction in the Ogden discount rate (pre-Ogden: 20.2%; 2015: 18.5%).
Overall, cash and cash equivalents increased by £208.4 million (2015: £14.0 million increase) across the year to £1,110.8 million (31 December 2015: £902.4 million).
Financial management Accessing sufficient funding as liabilities fall due is central to the Group’s long-term sustainability. The Group’s integrity and brand reputation for customers and other stakeholders relies on this sustainability. The Group’s key financial management risks are reserving for insurance liabilities, and market risk connected to the investment portfolio.
The Group considers the class of business, the length of time to notify a claim, the validity of the claim against a policy, and the claim value. Claims reserves could settle at a range of outcomes, and settlement certainty increases over time. However, for bodily injury claims, the uncertainty is greater due to the length of time taken to settle these claims. Annuity payments for injured parties also increase this uncertainty.
Looking forward, the Group expects to continue to set its initial management best estimate for future accident years conservatively. Over time, the proportion of the Group’s underwriting profit attributable to current year is expected to increase, including due to targeted improvements in the expense and commission ratio. Assuming current claims trends continue, the contribution from prior-year reserve releases is expected to remain significant, albeit it is expected to reduce over time.
Total Ongoing 3,062.1 3,220.2 Run-off 326.2 382.4 Total Group 3,388.3 3,602.6
Reinsurance The objectives of the Group’s reinsurance strategy are to reduce the volatility of earnings, facilitate effective capital management, and transfer risk outside the Group’s risk appetite. This is achieved by transferring risk exposure through various reinsurance programmes:  Catastrophe reinsurance to protect against an accumulation of claims arising from a natural peril event. The retained deductible is at £150 million, and cover is purchased annually on 1 July, up to a modelled one-in-200 year loss event of £1,250 million (2015: £1,350 million).
 Motor reinsurance to protect against a single or an accumulation of large claims which renews on 1 January. The retained deductible is at an indexed level of £1 million per claim, providing a substantial level of protection against large motor bodily injury claims.
These arrangements are intended to ensure that the Group complies with applicable laws and regulations, and meets its obligations as a contributor of taxes and a collector of taxes on behalf of the tax authorities; and manages its tax affairs efficiently, claiming reliefs and other incentives, where appropriate.
Investment portfolio The investment strategy is designed to deliver several objectives, which are summarised below:  To ensure there is sufficient liquidity available within the investment portfolio to meet stressed liquidity scenarios determined by the Risk function
 To match PPO and non-PPO liabilities in an optimal manner
Decisions were taken to exit securitised credit during Q3 2016. In addition the Group sold two investment properties in 2016.
 The investment property portfolio consists presently of 24 UK-based properties. The Group’s strategy does not permit any overseas holdings. The portfolio is predominantly based in the South East and invested mainly in the prime (rather than secondary) sector of the market.
Asset and liability management The following table summarises the Group’s high level approach to asset and liability management.
At 31 December 2016, total investment holdings of £6,581.0 million were 3.5% lower than at 31 December 2015, reflecting dividends paid offset by operating cash flows. Total debt securities were £4,724.5 million (31 December 2015: £5,194.4 million), of which 6.1% were rated as ‘AAA’ and a further 63.8% were rated as ‘AA’ or ‘A’. The average duration at 31 December 2016 of total debt securities was 2.3 years (31 December 2015: 2.3 years).
 The infrastructure debt portfolio is made up of UK assets only, which are purchased via the secondary market post the construction phase of the project concerned. The portfolio is weighted heavily towards social infrastructure with 89% of the year-end portfolio invested in projects across this sector (36% in healthcare, 48% in education and 5% in other).
Solvency II Solvency II is the new solvency framework implemented on 1 January 2016 as the capital adequacy regime for the European insurance industry. It established a set of EU-wide capital requirements and risk management standards with the aim of increasing protection for policyholders. The Group is regulated by the PRA on both a Group basis and, for the Group’s principal underwriter, U K Insurance Limited (“UKI”), on a solo basis.
At 1 January 2016, the Group (including UKI) assessed its capital requirements using the standard formula. UKI had its IECM approved for use by the PRA in June 2016, and this now forms part of a Group-wide PIM, which has been in use from the same date.
In its results, the Group has estimated its Solvency II own funds, SCR and Solvency II capital coverage ratio as at 31 December 2016. The Group will formally submit its final Solvency II Solvency Financial Condition Report (“SFCR”) in May 2017 to the PRA, and expects to continue to update the assumptions and implement model changes until then. Therefore, the final estimates may differ from those presented in this report.
Motor premium rate reduction of 10% (14 pts) One-off catastrophe loss equivalent to the 1990 storm (9 pts) One-off catastrophe loss based on extensive flooding of the River Thames (9 pts) 100bps increase in credit spreads (8 pts) 100bps decrease in interest rates (7 pts)
Solvency capital requirement (£ billion) 1.42 1.37 Capital surplus above solvency capital requirement (£ billion) 0.92 1.14 Capital coverage ratio post- dividend 165% 184%
Tier 1 capital before foreseeable dividends 1.81 2.04 Foreseeable dividends (0.13) (0.20)
Own funds as at 1 January 2016 2.47 Change in risk margin from Group standard formula basis to Group PIM at 1 January 2016 (0.09) Ogden discount rate impact (0.19) Mark to market movement 0.12 Capital generation 0.49 Capital expenditure (0.12) Capital distribution (0.34) Own funds as at 31 December 2016 2.34
Shareholders’ equity 2,521.5 2,630.0 Financial debt  subordinated guaranteed dated notes 539.6 521.1 Total capital employed 3,061.1 3,151.1 Financial-leverage ratio1 17.6% 16.5%
Credit ratings Standard & Poor’s and Moody’s Investors Service provide insurance financial-strength ratings for UKI. UKI is currently rated ‘A’ (strong) with a stable outlook by Standard & Poor’s, and ‘A2’ (good) with a stable outlook by Moody’s.
For 2017, the Group targets achieving a COR in the range of 93% to 95% for Ongoing operations, assuming a normal annual level of claims from major weather events and no further change to the Ogden discount rate. In addition, the Group reiterates its ongoing target of achieving at least a 15% RoTE.
Paul Geddes John Reizenstein Chief Executive Officer Chief Financial Officer 6 March 2017 6 March 2017 www.directlinegroup.com 47
The Corporate Governance report sets out the Direct Line Group framework, which we believe enables effective decision making and management of the risks in the markets in which we operate. Matters Reserved for the Board and the role of the Board’s Committees are core elements of this framework. The Corporate Governance and Committee reports highlight the areas of focus, challenge and supervision for the Board and its Committees during 2016.
Succession planning and Board changes Succession planning has been an area of focus for the Board in 2016. The Board recognises the importance of succession planning and understands the need to have leaders who reflect the Group’s culture and values. Gender diversity is also considered an important matter by the Board and its Nomination Committee. The Board has female representation of 30% and the Board remains committed to improving this position when the appropriate opportunity arises.
Effectiveness and Evaluation As Chairman, my objective is to develop and lead an effective Board for the benefit of our shareholders. In 2014 and 2015, we evaluated the performance of the Board and its
Business practices We shall engage in honest, professional and ethical conduct and maintain effective procedures to prevent confidential information being misused.
Dealing with customers We shall treat customers fairly, openly and honestly, and operate an effective complaints process to address any perceived departure from these standards.
Committees internally. During 2016, our Board evaluation was externally facilitated by Professor Rob Goffee of London Business School. The review focused on the Board’s role and composition; the relevance, flow and quality of information, and the Non-Executive Directors’ balance of knowledge, skills and expertise. The findings have equipped us to continue to improve the leadership of the Group. You can find further details on page 59.
Executive Remuneration The debate in the UK over Executive remuneration remains a valid topic for discussion and continuous evaluation. The Group’s remuneration policy remains aligned with our strategic priorities and the interests of our shareholders. As required by legislation, the policy will be put forward for adoption by shareholders at our forthcoming AGM. Details of the consultation process undertaken by the Remuneration Committee can be reviewed on page 80 and the revised remuneration policy proposed is detailed on pages 100 to 109.
Our shareholders Communication with shareholders is extremely important to us. By maintaining dialogue with you, we aim to ensure that your concerns are met and our objectives are understood. I would like to thank you for your support and look forward to discussing the Group’s progress with you at our forthcoming AGM on 11 May 2017.
Take ownership Treat it like it’s OUR business; take the initiative, if you can see a better way, go and make a difference; take decisions, be accountable for your actions in whatever role you perform; take responsibility for your personal development and performance.
Dealing with suppliers of goods and services and business partnerships We shall maintain the highest possible standards of integrity in business relationships with suppliers and partners by treating them honestly and with respect, and avoiding compromising offers of gifts and hospitality.
External appointments Danuta is interim Chairman of Aldermore Group plc, a Non-Executive Director and Chairman of the Remuneration Committee of PageGroup plc, a Non-Executive Director and Chairman of the Remuneration Committee of Old Mutual plc, a Non-Executive Director of PaddyPower Betfair plc and a Non-Executive Member of the Defence Board of the UK Ministry of Defence.
Experience and qualifications Mike is Managing Director, Personal Lines. He joined Direct Line in 2014 and has over 10 years’ insurance industry experience. He was previously Chief Executive Officer of RSA Group’s Scandinavian businesses, Codan A/S and Trygg-Hansa, and before that UK Managing Director of Personal Lines at RSA, responsible for the MORETH>N, Partnerships and the Broker businesses. Before joining RSA, Mike had many general management, marketing and customer growth roles across several industries including the energy, telecoms and retail sectors. He started his career at WHSmith plc, before moving to various Centrica-owned businesses, including British Gas and Onetel.
Biography Sebastian is Chair of the Corporate Social Responsibility Committee. He has extensive experience in retail and consumer practice at large groups; and has a detailed understanding of the UK consumer markets, products and brands. Sebastian was previously Chief Executive Officer of Synergy Insurance Services Limited and subsequently gained wide retail experience as Strategy Director responsible for developing and implementing the turnaround strategy at Mothercare.
Biography Andrew is Chair of the Audit Committee and Investment Committee and was Senior Independent Director until 18 January 2016. He has performed various senior roles in the financial services and insurance industries. Additionally, he has insight into corporate governance developments and best practice in financial reporting. In 2009, Andrew retired from Legal & General Group plc, where he was the Group Finance Director. He is a Fellow of the Institute of Chartered Accountants in England and Wales.
Biography John is Chief Financial Officer. He has extensive City and financial services experience, spending more than 20 years in investment banking with UBS and Goldman Sachs.
Biography Dr Richard Ward is Senior Independent Director. He was Chief Executive of Lloyd’s of London, from 2006 to 2013. Richard previously worked for over ten years at the London-based International Petroleum Exchange, the second largest energy trading exchange, re-branded ICE Futures, as both Chief Executive Officer and ViceChairman. He has extensive insurance industry experience and insight into prudential regulation.
Prior to the International Petroleum Exchange, Richard held a range of senior positions at British Petroleum and was Head of Marketing & Business Development for energy derivatives worldwide at Tradition Financial Services.
External appointments Richard is Executive Chairman of Cunningham Lindsey and Non-Executive Chairman of Brit Syndicates Ltd. He also serves as a member of the PRA Practitioner Panel, Bank of England.
Paul Geddes chairs the Executive Committee. In addition to Paul Geddes, Mike Holliday-Williams and John Reizenstein, the committee comprises the following: Jonathan Greenwood, Managing Director of Commercial (joined 2000)
Experience and qualifications Jonathan has previously held roles at HBOS, MBNA and Pinnacle and has over 30 years’ insurance and financial services industry experience. He joined the Group as Product and Pricing Director for UK partnerships. After the Group acquired Churchill, Jonathan became Commercial Director and then Managing Director of the Group’s household and life businesses. Jonathan was appointed Managing Director of Commercial in 2009.
Experience and qualifications José was previously Global Chief Risk Officer and Group Chief Actuary at HSBC Insurance. Before joining HSBC, José worked for Zurich Insurance, first in its London Market Operations, then as Chief Actuary International Business Division (Asia, Latin America and Africa) and lastly as Chief Actuary in the UK. José is a Mathematics graduate from Brunel University and a Fellow of the Institute of Actuaries.
Experience and qualifications Steve was previously Director of Strategic and Technical Claims at RSA. He has over 20 years’ insurance industry experience, including roles as Director of Claims and Customer Service at Capita, and as Director of Operations at AMP. He became Chief Operating Officer in 2016, having previously been the Managing Director of Claims, Business Services and Technology Services. Steve holds an MBA from the University of Reading, and is Chairman of the Motor Insurers’ Bureau and Insurance Database Services Limited.
Further details of how the Company applied the Code’s principles and complied with its provisions can be found on the following pages of this report and the Directors’ remuneration report:  Leadership – page 53
Board composition As at the date of this report, the Board comprised the Chairman, who was independent when appointed to the Board; the CEO; CFO; the Managing Director of Personal Lines; and six independent Non-Executive Directors (“NEDs”), including the SID. The current Directors served throughout all of 2016, except for Richard Ward, who was appointed on 18 January 2016 and Danuta Gray and Mike HollidayWilliams who were appointed on 1 February 2017. Priscilla Vacassin retired from the Board on 1 March 2016.
The Board also held seven additional meetings. The additional meetings were ad hoc or Board sub-committee meetings, including meetings to receive recommendations from the Nomination Committee on Board and Committee changes, and strategic matters. The Board also held an annual strategy day in June 2016.
Structure of the Board The diagrams on the following page summarise the responsibilities of the Chairman, the CEO, the Board and the Board Committees. The Board has established six Committees to help discharge its responsibilities. Each Committee plays a vital role in helping to ensure the Board operates efficiently and considers matters appropriately. Further details on the roles and responsibilities of the Board Committees, along with the activities undertaken during the period, are contained in the Committee reports on pages 64 to 81.
Biographical details of the Executive Directors and Executive Committee members are shown on pages 50 to 52.
 Supervises the Group’s operations, helping to ensure it is effectively managed, that prudent controls are in place, and that risks are assessed and managed appropriately.
 Sets the Group’s strategy, and monitors management’s performance and progress against the strategic aims and objectives.
Executive Committee Paul Geddes, Chief Executive Officer  Sets performance targets.
 Monitors key objectives and commercial plans to help achieve the Group’s targets.
 Considers reports on operational matters that are material to the Group or have cross business implications.
 Oversees and advises the Board on the Group’s current and potential future risk exposures, and its strategic approach to managing risk.
 Provides oversight and advice on how the Group conducts its business responsibly, including matters relating to environmental, employee engagement and wellbeing, community involvement, and ethics.
 Provides oversight of how the Group develops its investment strategy.
 Reviews the Board’s structure, size, composition, and balance of skills, experience, independence and expertise.
 Oversees the level and structure of remuneration arrangements for senior executives, approves share incentive plans, and recommends them to the Board and shareholders.
The Chief Executive Officer The Board is ultimately responsible for the Company’s success. The Board has, however, authorised Paul Geddes, the CEO, to manage the Group’s day-to-day operations and deliver its strategic objectives.
Senior Independent Director: Acts as a sounding board for the Chairman and an intermediary for the other Directors when necessary. Available to shareholders if they have any concerns they cannot resolve through normal channels. Leads the Chairman’s performance evaluation annually.
Non-Executive Directors: Responsible for objectively and constructively challenging management. Use their wider business experience to help develop the Group’s strategy. NEDs are initially appointed for a term of three years. The Nomination Committee recommends potential new NEDs to the Board for appointment. The Board then considers and approves each appointment. All Directors are subject to election or re-election annually at the Company’s AGM. You can find the standard terms and conditions of the NED appointments at www.directlinegroup.com. Further details of NEDs letters of appointment are on page 108 of the Directors’ remuneration report.
Effectiveness Matters Reserved for the Board The Board recognises that to ensure the long-term success of the Company, certain specific matters should be reserved for the consideration and decision of the Board either alone or following review and recommendation by its Committees. Other matters are delegated by the Board to its Committees and to the Executive Directors. In addition to the Schedule of Matters Reserved, each Board Committee has written terms of reference defining its role and the authority delegated to it by the Board. The decisions specifically reserved for approval by the Board are set out in the Schedule of Matters Reserved for the Board, and are summarised in the diagram below.
 Major changes to the Group’s corporate structure, including material acquisitions and disposals of shares.
Corporate governance matters  The Group’s corporate governance and regulatory compliance frameworks.
 Major capital projects, investments and contracts that are either materially strategic or above the CEO’s delegated authority.
Board activities during 2016 The activities undertaken by the Board in 2016 to promote the long-term success of the Company are focused on its role as the leadership and decision forum for the Group.
Financial performance and investor relations, including: setting financial plans, annual budgets and key performance indicators (“KPIs”), and monitoring the Group’s results against them; considering the Group’s reserving position; approving financial results for publication; agreeing the Group’s dividend policy; and reviewing broker reports on the Group alongside feedback from investor meetings.
Risk management, regulatory and other related governance, including: reviewing and agreeing the Group’s Policies; setting risk appetites; approving the Own Risk & Solvency Assessment (“ORSA”); approving major changes to the Group’s internal model and seeking to ensure that the Group complies with all regulatory requirements.
The co-ordination of the Board meeting content is managed by the Chairman, supported by the CEO and Company Secretary, primarily using a forward agenda planner.
In addition to routine business the Board considers and discusses key issues that impact on the business as they arise.
The chart below details some of the specific topics discussed during 2016: The CEO and CFO spend a considerable amount of time with the different business units ensuring that the Board’s aims are being correctly disseminated throughout the Group, and that colleagues’ views and opinions are reported back to the Board. In addition the NEDs meet with key management outside of the Board and Committee fora to get a wider view of the Group’s activities.
The main Board training and development activities in the year under review included:  Training on topics including: Solvency II matters; the Group’s investment risk appetite; cyber risk and security; PPOs, complaints handling; and marketing and branding.
 Internal training workshops on: the Senior Insurance Managers Regime; anti-bribery and corruption and competition law; the Group’s IECM; and the application of the pricing actuarial basis for Personal Lines Motor.
 Regular reports from the Investor Relations team regarding institutional investors and analysts.
Board effectiveness review In accordance with the principles and provisions of the Code, the Board’s intended practice is to conduct a thorough review of the effectiveness of the performance of the Directors, the Board as a whole and its Committees on an annual basis, with the input of an external facilitator at least once every three years. The 2016 Board effectiveness review was facilitated by an external consultant, Professor Rob Goffee of London Business School, who is independent and has no other connection with the Company.
The 2016 process commenced with the Nomination Committee planning the scope of the evaluation. The Committee considered a shortlist of external evaluators for approval by the Board. The selected evaluator discussed the process with the Chairman and the Company Secretary and agreed the questions to be put to Board members and a number of executives who regularly attend Board and/or Committee meetings.
All of the Company’s Executive and Non-Executive Directors, the Company Secretary and the other respondents completed a questionnaire and then held one-to-one interviews with the facilitator. Professor Goffee discussed his report initially with the Chairman and Company Secretary and presented it to the Board in January 2017.
The review focused on: Role & organisation The role of the Board, including Board and Committee structure and composition; the number and frequency of meetings; and Directors’ responsibilities.
Directors’ expertise and experience; training; the behaviour of, and interaction between, the Non-Executive and Executive Directors; Non-Executive Directors’ time commitment; and access to key executives below Board level.
The findings of the effectiveness review were discussed by the Board as a whole in January 2017.
Whilst the findings of Professor Goffee’s report were positive, the Board will focus during 2017 on a number of areas with the objective of improving its, and its Committees’, effectiveness. These include: making better use of Non-Executive Directors’ expertise in the strategic planning cycle; refreshing the Board’s skills and experience through Board succession planning; and enhancing the Board’s approach to monitoring major business initiatives.
The Group’s governance framework is detailed in the High Level Control and System of Governance Framework document. The Board reviews this document annually. The core elements of the Governance Framework are the:  Matters Reserved for the Board and the Board Committees’ Terms of Reference.
 Executive Governance Framework, which outlines how each business function is governed and details the authority delegated to Executive Committee members.
Risk Management Committee approves The Executive Governance Framework is developed by Executives and approved by the Risk Management Committee.
To do this, the Company Secretary maintains a register of conflicts, and any conflicts that the Board has authorised. The Board reviews this register at each scheduled Board meeting.
The Company believes in the benefits of diversity. At the date of this report, of the Board’s ten members, three are women. However, while the Board will strive to consider diversity when choosing new members, it is committed to appointing the most appropriate candidates.
The CSR Committee considers diversity as part of its ‘Proud to be here’ work stream. This is to ensure the Group’s talent pipeline remains diverse to meet future requirements. The Group provides mentoring schemes and associated training and development programmes for high-potential candidates. You can find numerical data relating to the gender diversity of the Board, senior managers and employees in the CSR report on page 33.
During the year, the Group signed up to the Women in Finance Charter. This Charter reflects the Government’s, as well as the Group’s aspiration, to see gender balance at all levels across financial services firms.
Nomination Committee On behalf of the Board, the Nomination Committee assesses the NEDs’ independence, skills, knowledge and experience as part of its annual review of each Director’s performance. The Board concluded that every current NED was independent, continued to contribute effectively, and demonstrated they were committed to the role. Andrew Palmer has served on the Board since March 2011. At the Chairman’s request, he has agreed to continue to serve as a Director and a resolution for his re-election as a Director will be proposed to the 2017 AGM. In accordance with the Code, the extension of Mr Palmer’s term of appointment beyond six years has been the subject of a particularly rigorous review. The Board is satisfied that he remains independent, that he continues to make a significant contribution to the proceedings of the Board and its Committees and that the extension of his term of appointment will provide valuable continuity as work on refreshing the Board progresses.
 The Board has delegated responsibility to the Audit Committee to oversee the management of the relationship with the Company’s External Auditor. You can find details of the Audit Committee’s role, activities and relationship with the External Auditor in the Committee report on pages 64 to 67.
Responsibility for preparing the Annual Report & Accounts The Board is responsible for giving shareholders a fair, balanced and understandable assessment of the Company’s position and prospects. The Board is also responsible for maintaining adequate accounting records and ensuring compliance with statutory and regulatory obligations.
 The Company’s Disclosure Committee reviewed an advanced draft of the Annual Report & Accounts.
Risk management and internal control systems The Board is responsible for the Group’s risk management and internal control systems. It has complied with the Code by establishing a continuous process for identifying, evaluating and managing the principal risks the Group faces.
The Board, with the assistance of the BRC and the Audit Committee as appropriate, monitored the Company’s risk management and internal control systems that have been in place throughout the year under review, and reviewed their effectiveness. The monitoring and review covered all material controls, including financial, operational and compliance controls. The Board and its Committees are overseeing the ongoing work intended to improve the performance across the board of the Group’s IT systems, including focusing on risks relating to IT systems’ stability, cyber security and the internal control environment.
The Board was also supported in its review of the annual Control Environment Certification process. As part of this, each directorate self-assessed its risks and whether its key controls were adequate and effective. The Risk and Group Audit functions reviewed and challenged these findings. The Group then combined the overall findings into a Group-level assessment, which the CEO approved. The system reported on the controls’ nature and effectiveness, and other management processes that manage these risks.
Assessing principal risks The Board is responsible for determining the nature and extent of the risks that it is willing to take to achieve its strategic objectives. The Directors confirm that they robustly assessed the principal risks facing the Company, including risks that would threaten its business model, future performance, solvency or liquidity. You can find a description of these risks, and their management or mitigation, on pages 27 to 29.
The Executive Directors meet frequently with investors and inform the Board about shareholder views. This gives Directors the opportunity to discuss governance and strategy with shareholders. The Chairman, SID and NEDs are available to attend meetings with major shareholders at their request.
Annual General Meeting The Board sees the Company’s AGM as a good opportunity for private shareholders to talk directly with the Board. All shareholders can attend the AGM if they wish. All Directors attended the AGM in 2016.
At the AGM, the CEO presents the Group’s financial results. The Chairman then invites shareholders to ask questions about the meeting’s business, before proposing the AGM’s formal business. All Directors will be put forward for re-election at the AGM. The Chairman, the Committee Chairs and the remaining Directors and members of the Executive Committee are also available to talk with shareholders at the end of the meeting.
 During the year the Ministry of Justice published a consultation regarding the assessment of soft tissue injury for bodily injury claims. The Committee reviewed and challenged management’s assessment of the impact of the proposed new process on both claims experience and operating costs.
The Committee’s main responsibilities are to:  monitor the integrity of the Group’s financial statements and any other formal announcement relating to its financial performance.
Committee composition, skills and experience and meetings in the year The Committee comprises three independent NEDs: Andrew Palmer, Jane Hanson and Clare Thompson. You can find their biographical information on pages 50 and 51. In line with the 2016 amendments to the Code, the Audit Committee as a whole is deemed to have competence relevant to the insurance and financial services sectors in which the Group operates.
All Committee members are members of the Institute of Chartered Accountants in England and Wales. They also have recent and relevant financial experience, enabling them to contribute diverse expertise to the Committee’s proceedings. To keep their skills current and relevant, in addition to Board training, members of the Committee have received training during the period on matters including PPOs, reserving processes and the Solvency II balance sheet.
The table below shows attendance at the scheduled meetings: Scheduled meetings
The Chair reports on matters dealt with at each scheduled Committee meeting to the subsequent scheduled Board meeting.
The Committee reviewed trends in the claims experience versus industry experience to assess the Group’s performance in these complex cases. It concluded that the Group’s experience was broadly consistent with the market and that its claims handling approach to settling PPOs was appropriately reflected in reserving. It challenged, and was satisfied with, the data collection process and methods for ensuring accuracy.
Main activities during the year At every scheduled Committee meeting, the Committee receives reports on financial reporting, reserves, internal controls and Group Audit. You can find out more about this in the following sections.
Valuation of investments not held at fair value – The Committee considered reports on the judgements applied to the carrying value of the Group’s investments and the basis for the valuation.
Change and IT – The Committee considered major change projects and IT controls.
During 2016, the Committee received regular reports on the FRCF and the testing of it. Part of those reports focused on control deficiencies and the mitigating actions taken.
The Committee provides oversight of Group Audit’s work and seeks to ensure it adopts industry best practice appropriately. The Group Head of Audit’s primary reporting line is to the Chair of the Committee. The secondary reporting line, for day-to-day administration, is to the CFO. Group Audit provides the Committee with independent and objective reports on the adequacy and effectiveness of the Group’s governance, risk management and internal controls. The Committee approves Group Audit’s annual plan and receives quarterly reports detailing internal audit activity, key findings, management responses, and proposed action plans. Group Audit also monitors that these actions are completed. The Committee also approves the Group Audit Charter.
During the year, the Committee discussed the position on its external audit services contract and examined a number of options regarding the timing of tendering for the external audit, including the mandatory rotation of the Group’s audit firm, taking into account the Code and the reforms of the audit market by the Competition and Markets Authority and the EU. This included whether it was appropriate to tender the external audit contract for the year ending 31 December 2018. The Company has complied with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014.
Note: 1. The relevant affiliates are U K Insurance Limited and Churchill Insurance Company Limited
The Committee approves annual plans for reviews of reserves, informed by emerging internal and external issues.
It also considers an appropriate balance between internal and external actuarial review. Consultants appointed to provide actuarial reviews of reserves are subject to approval by the Committee. The external actuarial review of reserves requiring most judgement was carried out by PricewaterhouseCoopers LLP for the Directors of the Company and its relevant affiliates1.
During the year, the Committee assessed whether the Group Audit function was effective and concluded that it was. This included the Committee satisfying itself that the Group Audit function has the appropriate resources.
The CEO, CFO, Chief Risk Officer (“CRO”), Group Financial Controller and Head of External Reporting are invited to attend Audit Committee meetings. The Actuarial Director, external actuarial advisers, External Auditor and Group Head of Audit are also invited to attend meetings and meet privately with the Audit Committee, in the absence of management. The Chief Operating Officer is also invited to attend appropriate sections of Audit Committee meetings.
External audit The Committee is responsible for overseeing the External Auditor and agreeing the audit fee. This also involves approving the scope of the External Auditor’s annual plan.
A number of factors were taken into account, including anticipated business changes, regulatory developments such as the implementation of Solvency II and the approval of the Group’s use of its own Internal Model, the expected new insurance accounting standard for implementation in 2021 and the appointment of a new audit partner by Deloitte LLP (“Deloitte”) during 2016, following the normal audit partner rotation process. The Committee concluded that it was not appropriate to tender the external audit contract for the 2018 year end and, subject to continued effective performance by Deloitte, would review the position again early in 2017. At that point a decision will be made whether to tender the external audit contract for the year ended 31 December 2019 or defer until a later date. The current audit partner is Colin Rawlings who was appointed in advance of the 2016 audit. Colin has had no interaction with the Financial Reporting Council’s Corporate Reporting Review team.
There are no contractual obligations restricting the Company’s choice of external auditor and no auditor liability agreement has been entered into. Equally, any recommendation to reappoint Deloitte as auditor of the Company depends on continued satisfactory performance.
During the year, the Committee approved fees of £0.4 million to Deloitte for services unrelated to audit work. The following is a breakdown of fees paid to Deloitte for the year ended 31 December 2016.
The non-audit fee of £0.4 million related to audit assurance services and services provided in reviewing the Company’s remuneration policy, tax advisory services and an IT project.
 The Committee reviewed an assessment of risk behaviours and attitudes undertaken jointly by the Risk function and Group Audit, which covered areas including: tone from the top; decision making; and risk management. The Committee challenged the outputs of the assessment and ensured the appropriateness of the actions identified. The Committee commended the progress made to embed and to demonstrate positive culture and behaviours in risk management.
 The Committee scrutinised the Pricing Control Framework, and challenged the Group’s risk appetite for pricing events. The Committee reviewed the outputs of reviews undertaken by Group Audit and an external consultancy firm regarding the effectiveness and sustainability of controls within the Pricing function. The Committee ensured that management undertook sufficient root cause analysis and read across of the pricing events. The small number of pricing issues were non-material and not systemic and the Committee was satisfied with the robustness of the control environment within the Pricing function and the level of management focus.
 review and recommend the ORSA process and report to the Board.
 review the Group’s procedure for detecting internal and external fraud.
Committee composition, skills and experience and meetings in the year The Committee comprises three independent NEDs: Jane Hanson, Andrew Palmer and Richard Ward. You can find their biographical information on pages 50 and 51.
 With cyber security becoming an increasingly important area of focus for companies, the Committee closely monitored and challenged activities in relation to IT risks, controls and resilience. The Committee reviewed the outputs from system penetration testing and reviews of risk management and information security, and challenged the first and second lines of defence on the adequacy of the remediation planning and the assessment of the materiality of the issues raised. The Committee was satisfied with progress made in the continuing development of the IT control environment and with the oversight of the IT risks and controls by the second line of defence.
Responsibilities of the Board Risk Committee The Committee is responsible for oversight and challenge of the Group’s current and potential future risk exposures, and its strategic approach to managing risk. The Committee recommends risk appetite and tolerance levels to the Board, and supports the Board in promoting a risk-aware culture across the Group.
Having spent 2015 preparing for the implementation of Solvency II, the Committee’s focus in 2016 was on providing oversight of the process leading up to the Group’s approval from the PRA for the use of its PIM and on the calculation of the SCR using the Group’s IECM. During the year, the Committee received detailed presentations from management on the underlying assumptions around the IECM and reviewed how the model had been constructed. The Committee challenged both the Group’s Solvency II and IECM submission, including:  IECM uses, particularly in relation to investment matters and the setting of the Group’s capital risk appetite under Solvency II.
 The IECM validation framework, scope and process, including satisfying itself that independent validation was focused on the most appropriate areas and there was sufficient coverage in specific areas.
 The Group’s SCR, including the key assumptions and dependencies within the calculation methodology such as diversification, expert judgements, parameterisation, sensitivity testing and the selection of the catastrophe model used in the IECM.
The Committee received regular reports regarding the three strategic risk appetite statements: maintain capital adequacy; stable and efficient access to funding and liquidity; and maintain stakeholder confidence. The Committee monitored the Group’s exposure against these appetites and the lower level risk appetite statements, and assessed the drivers that affect its risk appetite status. The Committee reviewed and questioned the justification regarding the assessment of certain risks and the robustness of management action plans to address areas close to or outside tolerance. Having regard to the extent of change being executed by management, the Committee closely monitored change risk.
The Committee monitored the Group’s risk management and internal control systems, and reviewed their effectiveness. This covered all material risks, including financial, operational and compliance; reviewing the net risk position after the operation of controls; and considered the effectiveness of any associated mitigating actions and compensating controls.
Customer The Group puts the customer at the heart of its business, by endeavouring to deliver on its commitments and ensure that fairness is a natural outcome of what the Group does. The Committee reviewed and challenged reports relating to the Group’s conduct towards its customers, to try to ensure appropriate customer outcomes, the meeting of reasonable customer expectations and to determine that the Group was operating within its defined conduct risk appetite, as set by the Board.
Conduct and regulatory risk During the year, the Committee considered the Group’s compliance with regulatory requirements including conduct and financial crime. In particular, the Committee reviewed and challenged the effectiveness and level of embedding of the Group’s Conduct Risk Management Framework and the Group’s approach to complaints reporting under the Financial Conduct Authority’s (“FCA”) new definitions. The Committee also reviewed the Group’s Regulatory Governance Map and received updates on regulatory interactions, particularly with the FCA and the PRA.
Additionally, the Committee reviewed and challenged the outputs from conduct and compliance assurance reviews. Following feedback from the Committee, the assurance plan was revised to comprise a monitoring plan and a separate thematic assurance plan. The Committee also requested that the documentation underpinning the assurance reviews be sufficiently robust from a governance and regulatory perspective.
Operational risk The Committee continues to oversee the development of IT controls, including risks relating to IT systems’ stability, cyber security and the internal control environment. The Committee assessed the level of prevention, protection and detection in relation to cyber risk and the residual risk for each of the IT control areas, taking into account any compensating controls and/or mitigating actions. The Committee questioned the impact of system stability issues in relation to customer and conduct metrics, including call abandonment rates. The Committee also reviewed the proposed IT risk appetite statements.
The Committee reviewed and challenged the stress and scenario testing plan, and examined the outputs of the reverse stress tests undertaken in relation to climate change and change risk.
The Committee monitored and challenged the outputs from reviews of the effectiveness and level of embeddedness of the Group’s Conduct Risk Management Framework, in particular the findings of the reviews undertaken by the Risk function, Group Audit and an external consultancy firm. Challenges from the Committee included a need for more emphasis on fostering good customer outcomes and greater ownership of risk management by the first line of defence. The Committee probed management on the activities undertaken and planned in relation to culture, and commended the activity being undertaken by the Customer Conduct Committee, which included a rolling regular monthly assessment against each of the FCA’s themes on culture. The Committee was satisfied that the Group’s Conduct Risk Management Framework was appropriate to enable the identification and escalation of conduct risks facing the Group, and to subsequently manage and mitigate those risks.
The Committee received regular reports on the Group’s actions to prevent financial crime, including reviewing of the Annual Financial Crime Report and the Annual Anti-Bribery and Corruption Report.
The Committee considered the Group’s broader operational risk control environment and commissioned reviews by the Risk function on controls relating to major third party suppliers and the execution of pricing changes. The Committee reviewed the issues encountered with the Group’s third party suppliers, and challenged the depth and coverage of the assurance approach and whether the monitoring was appropriately robust in relation to the suppliers.
Financial risk At each meeting, the Committee monitored the Group’s performance against capital risk appetite through the CRO’s report. Committee members considered risks in the strategic plan against risk appetite. During the year Committee members also reviewed and challenged the ORSA report and subsequently recommended the report for approval to the Board. Questions on the ORSA included those in relation to stress testing of the strategic plan, distribution risk, internal model validation activity and contingent management actions.
Whistleblowing The Committee reviews arrangements by which employees may, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters (“Whistleblowing”). The Committee also reviews reports relating to Whistleblowing to ensure arrangements are in place for the proportionate and independent investigation of such matters and for appropriate follow-up action. Group Audit undertook an audit in the first quarter of 2016 which concluded that the Whistleblowing process was adequately designed, operating effectively and met the new regulatory requirements.
Additional information To help discharge its duties, the Committee has unrestricted access to management and external advisers. It is satisfied that during 2016 it received sufficient, reliable and timely information to perform its responsibilities effectively.
The Committee also invites the Director of Group Regulatory Risk and Compliance, Director of Financial Risk and Enterprise Risk Director to appropriate sections of its meetings.
The Board Risk Committee’s effectiveness A formal and rigorous annual evaluation of the Committee’s performance and effectiveness was undertaken during the year. Professor Rob Goffee of London Business School facilitated this effectiveness review, and prepared a report based on responses from Committee members and other stakeholders to a questionnaire and interview. After reviewing and discussing the report, the Committee concluded that it was operating effectively and has access to sufficient resources to perform its duties.
 At the Committee’s request, the Group’s CSR Manager and Head of Investments met with a number of the Group’s external asset managers to understand their attitudes towards responsible investment. All were able to demonstrate clear evidence of their own CSR credentials as well as their approach to incorporating environmental, social and governance factors into their investment processes.
The Committee also considers: diversity and inclusion in the workplace; employee engagement and wellbeing; community engagement activities; and environmental matters.
The Head of Public Affairs and Sustainability, and CSR Manager are invited to attend CSR Committee meetings. As executive sponsors of the strands of the CSR strategy, the Managing Director of Personal Lines, the Chief Operating Officer and the Managing Director of Commercial attend appropriate sections of Committee meetings.
 As a result, the Committee’s principal focus was on “Shotgun”, the CSR initiative designed with the ambitious goal of reducing young driver deaths in their first 1,000 miles of driving to zero. The case study on page 73 shows the scrutiny and interest of the Committee in this initiative.
The Committee comprised two independent NEDs, Sebastian James and Jane Hanson, Paul Geddes, CEO, and Simon Linares, Group Human Resources Director. You can find their biographical information on pages 50 to 52.
Sebastian James (Chair) 3 of 3 100% Paul Geddes 3 of 3 100% Jane Hanson 3 of 3 100% Simon Linares12 2 of 2 100% Angela Morrison12 1 of 1 100% Notes: 1. Attendance is expressed as the number of scheduled meetings attended out of the number of such meetings possible or applicable to attend 2. Angela Morrison stepped down from the Committee prior to the meeting on 28 July 2016. Simon Linares was appointed to the Committee at the start of the same meeting
The Committee examined the communications brief, particularly the advertising and use of social media. The Committee was especially interested in maximising the reach and power of the app, and in making sure that the marketing was appropriate and powerful and made use of all appropriate channels (focused on the digital and social channels).
The Committee reviewed the evaluation framework and provided feedback on the effectiveness measures, including in relation to attitudes, behaviours and impacts. A key area of the Committee’s focus was to challenge the robustness of the development and testing to ensure the product was launched successfully and functioning as intended.
 Proud to be here: Simon Linares, Group Human Resources Director.
 Being recognised as part of our communities: Jon Greenwood, MD Commercial.
Helping to make our society safer During the year, the Committee received progress updates at each meeting on Shotgun. The Committee also received reports on the project to sponsor lollipop people for schools (Lollipoppers). You can find further details on the Shotgun manifesto in the CSR report on page 30.
Proud to be here The primary objective of this strand was to improve employee engagement in order to support a key enabler of the Group’s 2016 strategy. The KPIs for this element are linked to the People Strategy and focus on employee engagement and wellbeing.
Reduce, Reuse and Recycle This strand of the strategy considers energy use, waste management and resource use within the Group’s operations and environmental and social matters in the Group’s supply chain. The Committee reviewed the key objectives related to reducing greenhouse gas emissions, diverting waste from landfill, and challenged the targets, including the new targets for waste recycling across the Group’s accident and repair centres. The Committee encouraged management to pursue their proposed initiative relating to the use of reconditioned automotive parts in order to reduce embedded energy usage, waste and landfill.
 As part of management’s drive to deliver a cost-effective investment operating model, the Committee has scrutinised a proposal from management to bring certain UK investment grade credit assets in house. The Committee challenged whether the Investment team was in a position to manage in-house a wider range of holdings before approving this initiative.
 With the compression in UK yields following the vote to leave the EU, the Committee was concerned to ensure investment discipline remained paramount within new asset classes still being invested to full allocations and investment income budgeting continued to be based on conservative assumptions. The Committee received a presentation from the external asset manager responsible for the CRE loans portfolio and reviewed the assumptions underpinning management’s projections of investment income over 2017-20. In both cases, the Committee was satisfied with responses received to questions raised at respective presentations.
 Following the implementation of Solvency II, the Committee wanted to understand: (a) how well management was planning for, and resourcing, the additional reporting on assets and derivatives required under Pillar III; and (b) whether there was sufficient evidence of application of the Prudent Person Principle (“PPP”) to investment activities. Following review the Committee was satisfied that appropriate levels of delegation to management had been put in place; and that management were robustly reviewing investment and risk against the PPP guidelines.
 monitor the results from investment activities, namely adequacy of financial results delivered, compliance with agreed risk tolerances and external service provider performance. The Committee also ensures that any material breaches are reported to the BRC.
Andrew Palmer was appointed Chair of the Committee as of 1 March 2016. This appointment was part of the changes to the Committees that were announced on 16 February 2016.
 consider and approve material changes to the risk framework that underpins investment activity, and any proposals to change the operating model. This typically relates to how outsource service providers are used.
The CEO, CFO, CRO, Director of Investment Management and Treasury, and Director of Financial Risk are invited to attend Committee meetings.
The Chair reports on matters dealt with at each Committee meeting to the subsequent scheduled Board meeting.
In preparation for the UK’s EU membership referendum, the Committee met economists from a major financial institution in April 2016 to obtain an independent third party view of the likely economic consequences of a vote to either remain in, or leave, the EU. In addition, the Committee requested an update from management regarding preparations in advance of the vote. The Committee concluded that preparations, including plans to ensure access to liquidity to meet customer payments, and to support collateral calls, were well developed. In the period following the vote, management updated both the Board and the Committee on market conditions, and in particular the impact of Sterling’s depreciation against both the US Dollar and the Euro on collateral calls for open foreign exchange forward positions.
Monitoring investment activity and performance The Committee monitored the performance of investments every quarter. It also received reports from the Director of Investment Management and Treasury on various matters. These included: key market developments; financial results from investment activity; investment performance versus benchmark for internally and externally managed portfolios; operational performance by the custodian and other service providers; and compliance with risk limits and internal delegated authorities. The Committee also received presentations from external asset managers on their performance against benchmark.
 developing various asset and derivative reports to submit to the PRA and European Insurance and Occupational Pensions Authority.
The Investment Committee’s effectiveness A formal and rigorous annual evaluation of the Committee’s performance and effectiveness was undertaken during the year. Professor Rob Goffee of London Business School facilitated this effectiveness review, and prepared a report based on responses from Committee members and other stakeholders to a questionnaire and interview. After reviewing and discussing the report, the Committee concluded that it was operating effectively and has access to sufficient resources to perform its duties.
 As part of its focus on executive succession planning, and to improve gender and other diversity in the Group’s senior management, the Committee encouraged management to develop its talent pipeline. This is being achieved by the systematic assessment of potential, bespoke personal coaching and development plans for high-potential employees. The Committee also encouraged the targeted recruitment of new senior executives to strengthen leadership and capability in disciplines including strategic development, change management, IT, claims management, data, finance and procurement.
 During the reporting period, the Committee oversaw the appointments to the Board of: Richard Ward as Senior Independent Director; Danuta Gray as an independent Non-Executive Director; and Mike Holliday-Williams, MD Personal Lines, as an Executive Director. The Committee recommended changes to the membership of the Board’s Committees to make the best use of Directors’ experience and expertise.
 The Committee agreed the choice of Egon Zehnder as search agent and the profile and criteria to be used in the search which culminated in the appointment of Danuta Gray. In view of the lead time for identifying candidates and obtaining regulatory approval in advance of their appointment, and with the aim of ensuring continuity and stability in the Board’s succession planning, the Committee has engaged Egon Zehnder in a search for further Non-Executive Director candidates.
 considering and recommending to the Board the Directors’ annual re-election and reappointment at the end of their term in office.
 An active Nomination Committee is vital for promoting effective Board and executive succession. During 2016, the majority of the Committee’s time was devoted to considering the composition of the Board. It ensured that the recruitment process for Non-Executive Directors identified the skills and experience that the Board needs to be able to challenge and support senior management in developing and executing the Group’s strategy. It also reviewed executive succession planning, to ensure that the Group’s future leadership will have the qualities needed for the strategic and cultural development of the business. The case study on page 77 details the activities undertaken by the Committee during 2016 on succession planning for the Board and management.
The Committee held three scheduled meetings in 2016. It also held eight additional meetings to consider succession planning and to deal with: the appointment of Richard Ward as Senior Independent Director; membership of the Board’s Committees; searching and appointing Danuta Gray as a Non-Executive Director; appointing Mike Holliday-Williams as an Executive Director; and appointing an external board effectiveness facilitator.
Mike Biggs (Chair) 3 of 3 100% Andrew Palmer 3 of 3 100% Priscilla Vacassin1 1 of 1 100% Richard Ward1 2 of 2 100% Note: 1. Attendance is expressed as the number of scheduled meetings attended out of the number of such meetings possible or applicable to attend
Board composition During the year, the Committee: considered the Board’s skills and experience; reviewed the structure, size and composition of the Board; reviewed the membership and chairmanship of the Board’s Committees; and reviewed Non-Executive Directors’ letters of appointment, terms of appointment and time commitment.
Board appointment and reappointment process The Committee oversaw the process to appoint Danuta Gray as a Non-Executive Director. The Committee reviewed the Board members’ expertise and experience. It then produced a detailed brief and engaged external search consultants, Egon Zehnder, to find suitable candidates. Egon Zehnder is a signatory to the Voluntary Code of Conduct for executive search firms. It is not connected in any way to the Company.
 Prior to any awards vesting under the LTIP and deferred AIP schemes the Committee considered whether the financial and risk underpins had been met. It received confirmation from the Chair of the BRC that there had been no material risk failings, regulatory or reputational concerns. The Chair of the Audit Committee confirmed that there had been no circumstances regarding the adequacy and effectiveness of the Group’s internal financial controls and internal control systems that would affect the vesting. The Committee approved the vesting of awards.
 The Committee considered whether the performance targets of RoTE and TSR remain appropriate and in line with the Group’s strategic objectives. When considering awards under the LTIP scheme the Committee considered the appropriate targets to ensure that they remain challenging in the context of the Group’s planned performance.
The Committee’s main responsibilities are:  setting the remuneration policy for the Executive Directors and Board Chairman and monitoring its operation.
 approving the Group’s remuneration governance framework. This includes approving the design and targets of any performance-related pay arrangements, and liaising with the Board Risk and Audit Committees where appropriate.
The Remuneration Committee’s main role and responsibilities are set out in written terms of reference and are available at www.directlinegroup.co.uk/termsofreference
Committee composition, skills and experience and meetings in the year The Committee comprised three independent NEDs in 2016: Clare Thompson, Sebastian James and Andrew Palmer, and the Chairman of the Board, Mike Biggs. Danuta Gray was appointed a member of the Committee on 6 March 2017. You can find their biographical information on pages 50 and 51.
Annual incentive plan During the year, the Committee monitored the operation of the AIP. For the 2015 financial year, this involved reviewing the Group’s financial performance and assessing the Group’s performance against the targets that the Committee set at the start of the year. It also received reports from the Chairs of the Audit Committee and BRC about whether the Group had achieved the required performance within risk appetite. The Committee concluded that no clawback of awards was required in 2016.
Review: Initially the Committee undertook a fundamental review of remuneration arrangements for the strategic leadership team (including Executive Directors and Executive Committee members). The Committee was supported in the review by management and FIT. The structure of the review team was designed to minimise any conflicts of interest when analysing current remuneration arrangements.
Solvency II identified staff The Committee reviewed and approved the staff who, for the purposes of Solvency II, were identified as Solvency II staff. The Committee’s remit was extended to include oversight of the remuneration of Solvency II identified staff. The Committee also reviewed and approved a remuneration policy statement for submission to the PRA. The Committee considered and examined the current remuneration structure for control functions, which are Corporate Actuarial, Compliance, Group Audit and Risk. The Committee is satisfied that the remuneration arrangements for control functions are appropriate but will continue to review developments in this area.
Regulatory developments in Remuneration During the year, a joint meeting was held with the BRC to review regulatory developments in relation to remuneration and to ensure remuneration arrangements remain appropriate. The Committees also examined the assurance processes in connection with incentive arrangements. You can find out more about this in the Board Risk Committee report on pages 68 to 71.
Additional information The Committee also interacts with the Audit Committee and BRC when considering setting targets and pay-outs. As part of this, the Committee receives reports from the Chairs of those Committees at least twice a year. The Chair of the Audit Committee is a member of the Committee. The Chair of the Board Risk Committee attended Committee meetings on three occasions.
As the Chair of the Remuneration Committee (the “Committee”), I am pleased to introduce our report on Directors’ remuneration for the 2016 financial year, including our proposed Directors’ remuneration policy.
Executive remuneration snapshot – summarising the remuneration arrangements for Executive Directors 84 to 86 Annual report on remuneration – detailing pay outcomes for 2016 and covering how the Group will implement its remuneration policy in 2017 87 to 99 Policy report for shareholder approval 100 to 109
The Directors’ remuneration policy for shareholder approval at the 2017 AGM Our Directors’ remuneration policy was approved at the Company’s AGM on 13 May 2014 by a significant majority of shareholders (97.5% voted in favour). In accordance with the legislation, we must submit a new policy for shareholder approval at the 2017 AGM. As stated in the 2015 Directors’ remuneration report, the Committee reviewed the current policy during 2016. The Committee concluded that the policy had supported the business effectively and operated well over the last three years.
Shareholders may be aware that the design of executive pay arrangements for UK-listed companies continues to face considerable external commentary. As part of the review the Committee considered alternative approaches to remuneration arrangements, particularly those outlined in the Executive Remuneration Working Group’s final report. The Committee considers that the existing arrangements work well, and that the mix of Annual Incentive Plan (“AIP” or annual bonus) and Long-Term Incentive Plan (“LTIP”) provides a balanced way of incentivising executives to deliver for shareholders in the short and longer terms. We consider the LTIP measures of RoTE and relative TSR to be relatively simple to set, aligned with wider strategy and reward consistent delivery for shareholders. The Committee will closely monitor regulatory, market and best practice developments over the coming years, including any guidance from the PRA regarding the design of pay arrangements.
The Committee therefore intends to continue with the current policy which will remain largely unchanged. Reflecting developments in best practice, the Committee has introduced a ‘holding period’ for Executive Directors. LTIP awards granted from August 2017 onwards will be subject to an additional two-year holding period following the end of the three-year performance period.
Shareholder consultation The Committee consulted with our key shareholders and the major institutional voting agencies between October 2016 and January 2017. This engagement was well received and we have had good feedback on our proposal.
New Executive Director Following the year end, Mike Holliday-Williams, MD Personal Lines, joined the Board. He did not receive an increase in his salary as a result of being promoted to the Board (beyond the average salary increase for employees across the rest of the organisation explained below) and his AIP and LTIP opportunity from 2017 onwards were set at the same level as those of the CFO.
 No change will be made to either the weighting or the approach to assessment of the financial metric under the AIP. Consistent with regulatory best practice, we measure performance across a balanced scorecard of measures to ensure that management maintain an appropriate focus on continuing to deliver an excellent customer experience. However, given the good progress that has been made on the customer experience and the importance of the people agenda, the strategic element will now encompass both people and customer targets under the overall 25% weighting assigned to this element.
Executive remuneration snapshot The information for 2017 in this section relates to the Chief Executive Officer (“CEO”), the Chief Financial Officer (“CFO”) and the Managing Director of Personal Lines (“MD Personal Lines”). Information relating to pay decisions for 2016 relates to the CEO and the CFO only.
Key elements Key operation features (For more information, see the policy report on pages 100 to 109) Implementation in 2017
Base salary  Reviewed annually with any increases taking effect on 1 April
Pensions  CEO and CFO contribution rate of 25% of salary
AIP  Maximum opportunity level remains at 175% of salary for the CEO and 150% for the CFO (with the MD Personal Lines aligned at this level)
 At least 50% of bonus is based on financial measures. The Committee considers various non-financial and strategic performance measures. It bases its judgement over the payment outcome at the end of the performance period on its assessment of the level of stretch inherent in targets
 Any payment is subject to an additional gateway assessment, including assessing risk factors
 No change to the weighting of measures used for 2016. 55% of the bonus is based on financial performance with 25% based on strategic measures and 20% based on shared strategic objectives
 For 2017 the strategic measures will encompass a broader range of measures covering both customer and people targets
 Awards typically granted every six months at half the annual level
 The Plan allows for awards with a maximum value of 200% of base salary per financial year
 Performance is measured over three years and determined by RoTE and relative TSR measures
 The current 60% RoTE and 40% TSR mix will continue to apply
 Awards granted from August 2017 onwards will be subject to an additional two-year holding period following the end of the threeyear performance period
Release of value under the Long-Term Incentive Plan The March and August 2013 awards under the LTIP vested in March and August 2016. The total value of the awards vesting at the end of the three-year performance period in March and August 2016, including shares vesting under the RoTE and TSR elements, was £3,294,930 to the CEO and £1,994,284 to the CFO. This compares with an increase of approximately £2 billion in the Company’s value plus £1.6 billion returned to shareholders as dividends over the period of March 2013 to August 2016.
Notes: 1. The headline vesting level was 96.4% and the above chart shows the impact of both dividend roll-up and share price appreciation 2. The difference in shares held at grant reflects the impact of the share consolidation on 30 June 2015 in which 12 existing Ordinary Shares were replaced by 11 new Ordinary Shares, meaning the aggregate number of Ordinary Shares in issue was reduced www.directlinegroup.com 85
Note: 1. For the purposes of this chart, holdings include all vested but unexercised awards which are valued on a basis that is net of applicable personal taxes
 Annual bonus: The annual bonus amounts for 2016 were 43% of the maximum potential of 175% and 150% of salary for the CEO and CFO respectively.
You can find more information on these outcomes in the implementation report.
Annual remuneration report Remuneration Committee members and governance The following list details members of the Remuneration Committee during 2016. You can find information about each member’s attendance at meetings in the Remuneration Committee report on pages 79 to 81. You can find their biographies on pages 50 and 51.
Committee Chair Clare Thompson1 Non-Executive Directors Mike Biggs Sebastian James Andrew Palmer Priscilla Vacassin2
Salary1 Benefits2 Annual bonus3 Long-term incentives4,5,6 All employee share plans7 Pension Total
Notes: 1. Salary – The Company operates a flexible benefits policy, and salary is reported before any personal elections are made 2. Benefits – Benefits include a company car or allowance; private medical and income protection insurance 3. Annual bonus – Includes amounts earned for performance during the year, but deferred for three years under the DAIP. For more information, see page 95. These deferred awards are not subject to any conditions, except continuous employment. However, awards remain available for malus and clawback 4. 2013 LTIP awards RoTE – The expected vesting outcome figures for the RoTE portion of the awards granted under the LTIP in 2013 and reported in 2015 have been updated. These updates are based on the actual vesting of the RoTE portion of the awards and a share price of £3.716 and £3.634 on 29 March 2016 and 30 August 2016 respectively, compared to the three-month average share price of £3.9728 used in reporting this figure in the 2015 remuneration report. The revised figures reflect the actual number of dividends accrued on this portion of the award at vesting. This results in an adjusted reportable decrease of approximately £19,277 for Paul Geddes and £11,670 for John Reizenstein, with a corresponding decrease of the single figure for 2015 reflected in the table above 5. 2014 LTIP awards RoTE – the expected levels of vesting are set out on page 90. The corresponding values under long-term incentives, including the estimated value of dividends accrued to 31 December 2016, are £1,098,472 for Paul Geddes and £664,864 for John Reizenstein, based on a three-month average Company share price to 31 December 2016 of £3.55686. Any shares vesting under the LTIP granted in 2014 will not be delivered until the end of the applicable vesting periods in March and August 2017 6. 2013 LTIP awards TSR – the level of vesting is set out on page 90. The corresponding values under long-term incentives, including the value of dividends on vesting, are £1,367,191 for Paul Geddes and £827,504 for John Reizenstein, using the share prices on 29 March 2016 and 30 August 2016 of £3.716 and £3.634 respectively 7. SIP – Includes the value of matching shares under the SIP
AIP outcomes for 2016 The Committee established target performance levels at the start of the year. The Committee’s approach to setting and assessing PBT targets under the AIP is to set a target level of profit performance and then, at the year end, to assess over or underperformance by judging overall corporate performance both on an absolute and relative basis. While the Committee does not set a formal threshold to maximum profit range against which performance is formulaically assessed the original intent was, following the year end, to reset an indicative range against which performance could be assessed, as occurred in 2015. However, as the potential results were then impacted by the Lord Chancellor announcing a plan to review the Ogden discount rate, the Committee felt that the position was too uncertain to set a meaningful range for modelling and therefore awaited the outcome of the Ogden review. In determining pay-out levels, the Committee carefully considered performance relative to the targets in its assessment of over or underperformance of the target. It applied overall judgement in light of the year-end corporate performance and decided an out-turn of 10% (out of the 55% available for PBT) was appropriate and should be payable under this element.
Throughout 2016 our PBT performance was positive, driven by our continued investment in brand differentiation, propositions and trading capabilities, and we ended the year significantly ahead of target. Motor and Home Own Brands, Green Flag and Direct Line for Business have all continued to grow within a competitive market. They are all significantly favourable to target and grew year-on-year. Overall, before the reduction in the discount rate, profit before tax would have increased £62.8m to £570.3m (2015: £507.5m) reflecting improved operating profits. This would most likely have achieved a maximum pay-out for this element. Reported PBT for 2016, including impact of the reduction in the Ogden discount rate, is £353.0m. Given the strong profit progress absent the Ogden rate change and the Group’s resilience as the Group already reserved at a more conservative discount rate of 1.5% (compared to the actual 2.5% rate), shareholders have been protected to some extent from the effects of the reduction to the Ogden discount rate. The Committee, having considered that the Group made strong profits before the reduction and had a good capital position, determined that it was fair and reasonable that 10% (out of the 55% for PBT) should be payable.
Strategic A basket of measures of ten key customer metrics 25% See narrative Above target
Strategic element (25% weighting) The Group’s strategy is to make insurance much easier and better value for our customers. It aims to deliver on its commitments in this area and ensure that fairness is a natural outcome of what the Group does. Overall, performance on the customer agenda against our ten key customer metrics remains very strong and, in 2016, we introduced new metrics to monitor and assess conduct performance and complaints.
Through the year there was a strong focus on removing the reasons for customer problems with multiple initiatives delivering tangible improvement. One such initiative was the roll-out of focused investment in customer training to our front-line staff across Home and Motor Claims which has had a positive impact on NPS and NetEase scores. Our new approach to problem handling and recording has driven an improved customer experience and reductions in reportable complaint volumes.
Persistency and retention remained strong with some of our brands consistently outperforming the market, and we have achieved a good commercial and customer experience balance. The Committee considered that the Company has made good progress over the past couple of years in improving the customer experience in the context that it is now becoming more challenging to improve on or maintain an already strong performance. Having considered performance against targets and an assessment of the quality of performance achieved, the Committee agreed that the level of out-turn of 92% under this element was appropriate in order to reflect the continued strong performance in trading and customer satisfaction despite competitive market conditions.
Consequently, the annual incentive awards for Executive Directors for the financial year ended 31 December 2016 were as follows: (Audited) Maximum
LTIP outcomes for 2016 (Audited) The following summarises the outcome against performance targets set for the 2013 and 2014 LTIP awards: Awards under the LTIP granted in March and August 2013 vested during 2016. They were subject to TSR performance over the three-year vesting period, and RoTE performance in 2013, 2014 and 2015. The Group achieved an average RoTE of 17.6% over the three-year performance period. This resulted in 94% of the maximum potential vesting of the RoTE element (56.4% of the total award). The TSR element comprises the other 40% of the total award. For the March 2013 and August 2013 awards, the Company’s TSR was positioned above upper quintile against its comparator group. This resulted in 100% of the maximum potential vesting under the TSR element. Overall, 96.4% of the total awards vested in March 2016 and August 2016 as the Committee was satisfied that the financial and risk underpins were met at the end of the vesting period.
Awards under the LTIP granted in March and August 2014 are due to vest during 2017. The RoTE performance period for these awards ended on 31 December 2016. This is subject to the Committee’s satisfaction that the financial and risk underpins have been met at the end of the vesting period. The three-year average RoTE performance for 2014, 2015 and 2016 was 16.2% against a maximum target of 17.0%. Awards under the RoTE element are due to vest at 76.0% of the maximum potential, again reflecting the returns delivered to shareholders. We have included these RoTE vesting outcomes plus the TSR vestings from the 2013 awards in the single remuneration figure for the CEO and the CFO. You can find details of this on page 87. Performance under the relative TSR measure will be assessed at the end of the vesting period in March and August as appropriate.
Directors’ remuneration report continued 90 Direct Line Group Annual Report & Accounts 2016
Year included in single figure 2015 – updated 2016 – final 2016 – final
Dec 2012 Dec 2013 Dec 2014 Dec 2015 Dec 2016 Dec 2017
Relative TSR test – upper quintile – 100% vesting 2015 – updated 2016 – estimated 2016 – estimated
Relative TSR test – To be tested based on performance to 26 March 2017
Director 2016 Fees1 £’000 2016 Benefits2 £‘000 Total 2016 £’000 2015 Fees £‘000 £‘000 Total 2015 £’000
Notes: 1. Non-Executive Directors are not eligible to participate in any of the Group’s bonus or share incentive schemes or to join any Group pension scheme 2. The values shown under ‘Benefits’ above comprise the value of taxable travel and subsistence expenses reimbursed by the Company (including any potential gross-up for tax and National Insurance Contributions due)
3. Sebastian James was appointed as Chair of the CSR Committee from 1 March 2016 4. Andrew Palmer was appointed as Chair of the Investment Committee from 1 March 2016 and was the Senior Independent Director during 2015 and until 18 January 2016 5. Clare Thompson was appointed as Chair of the Remuneration Committee with effect from 1 March 2016, and stepped down as Chair of the CSR Committee and Investment Committee and as a member of the Board Risk Committee. She remained a member of the Audit Committee 6. Priscilla Vacassin stepped down from the Board on 1 March 2016 7. Richard Ward was appointed to the Board as the Senior Independent Director from 18 January 2016. He was appointed as a member of the Nomination Committee with effect from 25 February 2016 and was appointed to the Board Risk Committee with effect from 9 May 2016
Chief Executive Officer 2.5% 3% (47)% All employees (average) 4.5% 3% (3)%
Distribution statement This chart shows the overall pay expenditure across all Group employees compared with the total dividend value paid to shareholders for 2015 and 2016. A special dividend payment was made in 2015 in relation to the sale of the International division. The total dividend value paid to shareholders in 2015 has been calculated including and excluding this special dividend for comparison.
Historical performance of TSR This graph shows the Company’s TSR since its shares began trading on the London Stock Exchange in October 2012, against the FTSE 350 Index (excluding investment trusts) over the same period. This peer group is the same used for measuring relative TSR under the LTIP.
The table below shows historical levels of the Chief Executive Officer’s pay between 2012 and 2016. It also shows vesting of annual and long-term incentive pay awards as a percentage of the maximum available opportunity.
Approval of Directors’ remuneration report (2016 AGM) 990,481,636 97.75% 22,775,906 2.25% 6,090,605 0.6% Approval of Directors’ remuneration policy (2014 AGM) 1,064,002,114 97.5% 26,743,783 2.5% 1,945,618 0.2%
The Committee is grateful for the strong vote in favour of the Directors’ annual remuneration report in 2016. The Committee continues to communicate with investors on developments in the remuneration aspects of corporate governance generally, and, in particular, changes to the Company’s executive pay arrangements.
Notes: 1. Executive Directors are expected to retain all the Ordinary Shares they obtain from any of the Company’s share incentive plans until they achieve a shareholding level that is equal to 200% of base salary. This is calculated after any disposals necessary to pay personal taxes on acquiring such Ordinary Shares 2. For these purposes, holdings of Ordinary Shares will be treated as including all vested but unexercised awards, valued on a basis that is net of applicable personal taxes www.directlinegroup.com 93
Notes: 1. There were no changes to the number of shares held by Directors between the year end and the date of this report 2. Includes holdings of connected persons, as defined in section 96B(2) of the Financial Services and Markets Act 2000 3. Priscilla Vacassin stepped down from the Board on 1 March 2016 and this represents her holding at that date 4. Richard Ward was appointed to the Board as the Senior Independent Director from 18 January 2016
Notes: 1. Awards are granted as nil-cost options 2. The terms on which Paul Geddes’ 2012 bonus outcome was deferred meant that 60% of the outcome was deferred, with deferral split broadly evenly between deferral into deferred cash and deferred shares, with phased vestings of the deferred amounts over the three-year deferral period 3. Exercised on 30 August 2016 at £3.63, resulting in an aggregate gain of £175,957 4. Although not required in order to comply with statutory requirements, we have provided the detail for Mike Holliday-Williams for completeness www.directlinegroup.com 95
The Company’s policy is to grant awards twice a year, after the Group announces its full and half-year results. The value of each grant of awards is set at 50% of the normal annual policy level. This means the total combined face value of awards to the CEO and CFO during the year equates to 200% of their base salary paid in the year.
Direct Line Group Restricted Shares Plan (“RSP”) Awards (Audited) This table details the last tranche of the award made to Mike Holliday-Williams under the Direct Line Group RSP that is due to vest this year. This award was made to the MD Personal Lines on recruitment in May 2014 as compensation for the forfeiture of legacy awards granted by his previous employer. Executive Directors do not participate in the RSP and Mike Holliday-Williams will not receive any subsequent grants under this plan.
Note: 1. The accumulated market value of matching shares at the time of each award. Purchase of the matching shares takes place within 30 days of the contributions being deducted from salary
Executive Directors were eligible to participate in the award of £265 worth of free Company shares in March 2016. However, all Executive Directors waived their eligibility to this award.
Director Position 2017 base salary £’000 2016 base salary £’000 Annual change in base salary
Paul Geddes Chief Executive Officer 175% 40% John Reizenstein Chief Financial Officer 150% 40% Mike Holliday-Williams MD Personal Lines 150% 40%
During 2016, the Committee reviewed the AIP performance measures’ weightings and composition. It also reviewed the overall framework’s operation to make sure it is still fit for purpose. The review concluded that the framework successfully linked Executive Directors’ variable pay with the Group’s performance and a scorecard ensured that management are incentivised both to deliver superior financial returns and excellent customer service. Therefore, the AIP continues to provide the most appropriate incentive. However, to further align the Executive Directors’ interests with those of shareholders and the objectives of the business in 2017, the Committee decided to broaden the measures under the strategic element to encompass both customer and people targets given the good progress that has been made on customer experience, the importance of the people agenda and the fact that the Company has signed up to HM Treasury’s Women in Finance Charter. The overall weighting of 25% assigned to this element has not changed. Please see pages 24 and 25 for a complete list of our key performance indicators and how these relate to Executive Directors’ remuneration.
 Additional customer context, for example, conduct, experience, brand and franchise health
 Committee satisfaction that paying the bonus does not cause major reputational concerns
For these purposes, we use the Group’s standard definition for RoTE, subject to such other adjustments as the Committee may consider appropriate. To find out more about how we calculate RoTE, see page 190.
The Committee reviewed the performance targets and, in line with its commitment to ensure that awards to Executive Directors would only be payable if significant value has been created for shareholders, decided to increase the RoTE target range as follows: Performance measure
For the TSR element, there is a straight-line interpolation between threshold and maximum performance on a ranked basis. For the RoTE element, 20% of the award will vest for threshold RoTE and 40% for a ROTE of 16.0% for awards to be made in March 2017. Otherwise, vesting is similar to TSR: a straight-line interpolation occurs from threshold to target, then from target to maximum performance.
Pension and benefits A pension contribution of 25% of base salary will continue to be paid to the CEO and CFO in 2017. Before his promotion to the Board the MD Personal Lines received a pension contribution of 15% of base salary and the level of contribution has not been changed following his appointment to the Board.
Benefits comprise providing a company car or car allowance, private medical insurance, life assurance, income protection and health screening. Like all employees, the Executive Directors are also eligible for certain discounted Group products.
Paul Geddes was appointed as a non-Executive Director for Channel 4 on 5 December 2016 for which he receives an annual fee of £22,177. Total fees received from Channel 4 in 2016 were £1,848. John Reizenstein is a trustee and Director of Farm Africa, for which he receives no fees. Otherwise, the Executive Directors do not currently hold any further external directorships.
Policy report The following sets out our proposed Directors’ remuneration policy. This policy will be put forward for shareholder approval at the 2017 AGM on 11 May 2017 and, if approved, will apply to payments made from that date. Until this time, the policy approved on 13 May 2014 will continue to apply. The main changes in this policy from the 2014 policy have been summarised in the Remuneration Committee Chair’s letter above and in the notes to the policy tables.
 This is the core element of pay that reflects the individual’s role and position within the Group. It is payable for doing the expected day-to-day job
 Staying competitive in the market allows us to attract, retain and motivate high-calibre executives with the skills to achieve our key aims while managing costs
 general base salary movements across the Group  The Committee does not follow market data strictly. However, it uses it as a reference point in considering, in its judgement, the appropriate salary level, while regarding other relevant factors, including corporate and individual performance, and any changes in an individual’s role and responsibilities
 For Executive Directors, at least 40% of the award is deferred into shares under the Deferred Annual Incentive Plan (the “DAIP”). This typically vests three years after grant (with deferred awards also capable of being settled in cash at the discretion of the Committee, for example, when it gives rise to legal difficulties to settle in shares). The remainder of the award is paid in cash following the year end
 Vested options will remain exercisable for up to the tenth anniversary of grant  Malus and clawback provisions apply to the LTIP. These are explained in the notes to the policy table  Awards under the LTIP may be made at various times during the financial year. While the Committee reserves the right to do otherwise, the Committee’s practice has been to make awards twice in each financial year, following the announcement of the Group’s annual and half-year results
 Maximum and target bonus levels for Executive Directors are set by taking into account annual bonus practice throughout the organisation and referring to practice at other insurance and general market comparators
 The Committee sets targets at the beginning of each financial year  No more than 10% of the bonus is paid for threshold performance (30% of the bonus for the individual performance element). No more than 60% of the maximum opportunity pays out for target performance. However, the Committee retains flexibility to amend the pay-out level at different levels of performance for future bonus cycles. This is based on its assessment of the level of stretch inherent in the set targets, and the Committee will disclose any such determinations appropriately
 The maximum LTIP award in normal circumstances is 200% of salary
 Awards will be subject to a payment gateway, such that the Committee must be satisfied that there are no material risk failings, reputational concerns or regulatory issues
 Pension contributions are paid only in respect of base salary  Executive Directors are eligible to participate in the defined contribution pension arrangement or alternatively they may choose to receive a cash allowance in lieu of pension
 Executive Directors are eligible to participate in any of the employee share plans operated by the Company, in line with HMRC guidelines (where relevant) and on the same basis as other eligible employees. Currently, this includes the Share Incentive Plan (“SIP”), which has been used to provide an award of free shares to all employees (including Executive Directors), and permit employees to purchase shares with a corresponding matching award
 Where an Executive Director is required to relocate to perform their role, they may be offered appropriate relocation benefits. The level of such benefits would be determined based on the circumstances of the individual and typical market practice
 To align the interests of Executive Directors with those of shareholders
Notes to the policy table Malus and clawback Malus (reducing or forfeiting unvested awards) and clawback (the Company’s ability to claim repayment of paid amounts) provisions apply to the AIP (cash and deferred element) and LTIP if, in the Committee’s opinion, any of the following has occurred:  There has been a material misstatement of the Company’s financial results, which has led to an overpayment
 The assessment of performance targets is based on an error, or inaccurate or misleading information or assumptions
 An event during the relevant period which has, in the view of the Committee, sufficiently and significantly impacted the Company’s reputation as to justify such action
Amounts in respect of awards under both plans (LTIP and DAIP) may be subject to clawback for up to three years post payment or vesting (with such period lengthened if there is an investigation as to whether relevant circumstances exist) as appropriate. Consistent with developments in the market generally, the provisions clarify that any recoupment is out of the post-tax amount, except to the extent that the participant recovers tax from the relevant tax authority.
 The Executive Directors may be entitled to retain fees received for any directorships held outside the Group
 Consistent with GC100 guidance, the cap to base salary has been re-expressed as a fixed monetary amount. Please note that this is simply to align with reporting guidance and the cap does not represent any form of aspiration
Exercise of discretion In line with market practice, the Committee retains discretion relating to operating and administering the AIP, DAIP and LTIP. This discretion includes, but is not limited to:  the timing of awards and payments;  the size of awards, within the overall limits disclosed in the policy table;  the determination of vesting;  the treatment of awards in the case of change of control or restructuring;  the treatment of leavers within the rules of the plan, and the termination policy shown on page 107; and
Selecting performance measures Annual Incentive Plan The Committee has selected the AIP performance measures to incentivise Executive Directors to achieve financial targets for the year, and specific strategic, shared and personal objectives. These measures are aligned with the key performance indicators we use as a business to monitor performance against our strategic priorities, as shown on pages 24 and 25.
The relevant targets are set at or following the start of each year to ensure the Executive Directors focus appropriately on the key objectives for the next twelve months.
As set out in the policy table, different performance measures may apply for awards granted in future years.
Differences in remuneration policy from broader employee population To ensure that the arrangements in place remain appropriate, when determining Executive Directors’ remuneration, the Committee accounts for pay throughout the Group.
 Pension and benefits – depending on employee grade, the Company contributes between 9-25% to the defined contribution pension scheme without any requirement for an employee contribution. Employees may also opt for a proportion or all of this to be paid as cash rather than into the pension scheme
Remuneration policy for Non-Executive Directors Element Purpose and link to strategy Approach to setting fees and cap Other items
 Non-Executive Directors are paid a basic annual fee. Additional fees may be paid to Non-Executive Directors who chair a Board Committee, sit on a Board Committee, and for the Senior Independent Director to reflect additional responsibilities, as appropriate. The level of fees for 2017 is shown in the annual remuneration section
 Non-Executive Directors may receive certain expenses, including the reimbursement of travel expenses and accommodation or similar which, consistent with general market practice, will be grossed-up for any tax arising on such expenses. It is the Committee’s view that expenses (which are deemed to be benefits) are covered under the aggregate cap set by the Articles of Association and that this cap is not restricted to fees only
 Fee levels for Non-Executive Directors are reviewed and may be increased at appropriate intervals by the Board, with affected individual Directors absenting themselves from deliberations
 In setting the level of fees, the Company accounts for the role’s expected time commitment, and fees at other companies of a similar size, sector and/or complexity to the Group
The Non-Executive Directors are not entitled to receive any compensation for loss of office, other than fees for their notice period. They do not participate in the Group’s bonus, employee share plans or pension arrangements, and do not receive any employee benefits
Recruitment remuneration policy To strengthen the management team and secure the skills to deliver the Group’s strategic aims, the recruitment remuneration policy aims to give the Committee sufficient flexibility to secure the appointment and promotion of high-calibre executives.
Paul Geddes 1 September 2012 12 months Base salary only for unexpired portion of notice period to be paid in a lump sum or monthly instalments, in which case, instalments are subject to mitigation if an alternative role is found.
John Reizenstein 1 September 2012 12 months Base salary only for unexpired portion of notice period to be paid in a lump sum or monthly instalments, in which case, instalments are subject to mitigation if an alternative role is found.
30 January 2014 12 months Base salary only for unexpired portion of notice period to be paid in a lump sum or monthly instalments, in which case, instalments are subject to mitigation if an alternative role is found.
Termination policy It is appropriate for the Committee to retain discretion to consider the termination terms of any Executive Director, having regard to all the relevant facts and circumstances available to them at the time. A Director is deemed a ‘good leaver’ if the following circumstances are met:  AIP and LTIP – death, injury, ill-health, redundancy, retirement, the sale of the individual’s employing company or business out of the Group, or in such other circumstances as the Committee determines
During the holding period, awards cease to be contingent on employment and, therefore, will not lapse (except on dismissal for cause) but may be subject to malus
Awards will vest subject to applying the performance conditions and, unless the Committee determines otherwise, time pro-rating. The Committee may determine that such awards shall not vest early and, instead, be rolled over into replacement awards granted on a similar basis, but over shares in the acquirer or another company or settled in cash or other securities.
Depending on the circumstances of departure, an Executive Director may have additional claims under relevant employment protection laws, and the Company may contribute to any legal fees involved in agreeing a termination. It may also agree to incur certain other expenses such as providing outplacement services. Any such fees would be disclosed as part of the detail of any termination arrangements. The Committee reserves the right to make any other payments connected with a Director’s cessation of office or employment, where the payments are made in good faith in discharge of an existing legal obligation (or by way of damages for breach of such an obligation) or by way of a compromise or settlement of any claim arising connected with the cessation of a Director’s office or employment.
Considering employment conditions elsewhere in the Group As explained elsewhere in the Directors’ remuneration report, the Committee reviews the overall pay and bonus decisions in aggregate for the wider Group, and, therefore, takes into account pay and conditions in the wider Group in determining the Directors’ remuneration policy and the remuneration payable to Directors. Through the Chief Executive Officer, Paul Geddes, and other senior management, the Committee may receive input from employee groups in the Group, such as the Employee Representative Body, as required.
When setting the remuneration policy, the Committee, consistent with its approach of operating within the highest standards of corporate governance, takes significant account of guidelines issued by the leading shareholder and proxy agencies.
The Committee has considered the level of remuneration that may be paid under different performance scenarios to ensure it would be appropriate in each situation, in the context of the performance delivered and the value created for shareholders.
 Pension measured as the defined contribution or cash allowance in lieu of Company contributions, as a percentage of salary (25% of base salary for the CEO and CFO, and 15% of salary for the MD Personal Lines)
Maximum Based on the maximum remuneration receivable (excluding share price appreciation and dividends):  Fixed remuneration as above
 LTIP – consists of the face value of awards (200% of base salary for all Executive Directors)
The Board reviewed and approved this report on 6 March 2017.
Corporate governance statement The FCA’s Disclosure Guidance and Transparency Rules require a corporate governance statement in the Directors’ report to include certain information. You can find information that fulfils the corporate governance statement’s requirements in this Directors’ report; the Corporate Governance report; the Committee reports; and the Directors’ remuneration report, on pages 48 to 109. This information is incorporated in the Directors’ report by reference.
The Articles of Association of the Company permit it to indemnify the Company’s officers, and officers of any associated company, against liabilities arising from conducting Company business, to the extent permitted by law. As such,
The Directors present their report for the financial year ended 31 December 2016.
Disclosure of information under Listing Rule 9.8.4R In accordance with Listing Rule 9.8.4C, the table below sets out the location of the information required to be disclosed, where applicable.
Directors’ waivers of emoluments 97 Directors’ waivers of future emoluments Not applicable Non pro-rata allotments for cash (issuer) Not applicable Non pro-rata allotments for cash (major subsidiaries)
Details of shareholder dividend waivers 111 Controlling shareholder agreements Not applicable
Post-balance sheet events The Group has made an adjustment to its consolidated financial statements following the announcement on 27 February 2017 by the Lord Chancellor of a reduction in the Ogden discount rate to minus 0.75%.
Additionally, if the Board believes the Group has capital surplus to its view of its solvency capital requirements, it is intended that such excess capital will be returned to shareholders alongside the full-year results. The Company may consider a special dividend and/or a repurchase of its own shares to distribute surplus capital to shareholders.
The Board recommends a final dividend of 9.7 pence per share to shareholders. Subject to shareholder approval at the Company’s 2017 AGM, this will become payable on 18 May 2017 to all holders of Ordinary Shares on the Register of members at close of business on 17 March 2017.
You can find further details regarding dividends paid during 2015 and 2016 in the Finance review on page 38 and in note 15 to the financial statements on page 159. You can also find information on dividends and capital management in the Finance review on page 45.
Secretary Roger Clifton is the Company Secretary of Direct Line Insurance Group plc. He can be contacted at the Company’s Registered Office, details of which are on page 196.
Share capital The Company has a premium listing on the London Stock Exchange. As at 31 December 2016, the Company’s share capital comprised 1,375,000,000 fully paid Ordinary Shares of 10 10/11 pence each.
At the Company’s 2016 AGM, the Directors were authorised to:  allot shares in the Company or grant rights to subscribe for, or convert, any security into shares up to an aggregate nominal amount of £50,000,000;  allot shares up to an aggregate nominal amount of £100,000,000, for the purpose of a rights issue;  allot shares having a normal amount not exceeding in aggregate £15,000,000 for cash without offering the shares first to existing shareholders in proportion to their holdings; and
To date, the Directors have not used these authorities. At the 2017 AGM, shareholders will be asked to renew these authorities and vote on some additional resolutions in relation to the disapplication of pre-emption rights and the issue of Solvency II Tier 1 Instruments in line with the most recent institutional investors’ guidelines. The Company has not held any shares in treasury during the period under review. You can find out more about the Company’s share capital and shares under option at 31 December 2016 in notes 29 and 35 to the consolidated financial statements.
Under the Company’s Share Incentive Plan, Trustees hold shares on behalf of employee participants. The Trustees will only vote on those shares and receive dividends that a participant beneficially owns, in accordance with the participant’s wishes. An Employee Benefit Trust also operates. The Trustee of this has discretion to vote on any shares it holds as it sees fit, except any shares participants own beneficially; in which case, the Trustee will only vote on such shares as per the participant’s instructions.
Significant agreements affected by a change of control A number of agreements may take effect, alter or terminate upon a change of control of the Company. None of these agreements are considered significant in terms of their impact on the Group’s business as a whole.
All the Company’s employee share incentive plans contain provisions relating to a change of control. Outstanding awards would typically vest and become exercisable. This is subject to satisfying any performance conditions, and normally with an additional time-based pro-rata reduction where performance conditions apply, and approval from the Remuneration Committee.
Having made due enquiries, the Directors reasonably expect that the Company and the Group have adequate resources to continue in operational existence for at least 12 months from the date of approval of the financial statements. Accordingly, the Directors have adopted the going concern basis in preparing the financial statements.
Political donations The Group made no political donations during the year (2015: nil).
Total GHG emissions for continuing operations for 2016 were 19,315 tonnes (2015: 22,611 tonnes), as set out in the table below. This primarily comprised emissions from purchased electricity and natural gas, diesel fuel, and refrigerant gas used. In addition to total emissions, the Group also monitors emissions per £ million of net earned premium. In 2016, this was 6.4 tonnes CO2e per £ million of net earned premium for continuing operations (2015: 8.0 tonnes). This is a measure of how efficiently insurance products are provided. It allows us to compare our year-on-year performance and performance against other insurance companies. Ecometrica has externally verified the GHG emissions data. You can find verification statements on the Group’s website at www.directlinegroup.com.
When reviewing the strategic plan, the Board considered the Group’s prospects over the five-year period that the plan covered. This review included reviews of solvency, liquidity, assessment of principal risks, and risk management. The oneyear planning period has greater certainty, so it was used to set detailed budgets across the Group. Outcomes for the four-year period are less certain. However, the plan provides a robust planning tool for strategic decisions. The Board recognises that, in a strategic plan, uncertainty increases over time and, therefore, future outcomes cannot be guaranteed or accurately predicted.
Considering the Group’s current capital and trading position, its principal risks, and the remaining four years of the strategic plan, the Board has a reasonable expectation that the Company and the Group can continue in operation, and provide the appropriate degree of protection to those who are, or may become, policyholders or claimants in the period to 31 December 2020.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose, with reasonable accuracy, the Company’s financial position at any time; and enable them to ensure the financial statements comply with the Companies Act 2006. Additionally, the Directors are responsible for safeguarding the Company’s assets and, hence, taking reasonable steps to prevent and detect fraud and other irregularities. The Directors are responsible for maintaining and ensuring the integrity of the corporate and financial information included on the Company’s website at www.directlinegroup.com. Legislation in the UK governing preparing and disseminating financial statements may differ from legislation in other jurisdictions.
Notes to the Parent Company financial statements 1. Accounting policies 182 2. Investment in subsidiary undertakings 182 3. Other receivables 183 4. Current and deferred tax 184 5. Derivative financial instruments 184 6. Financial investments 184 7. Cash and cash equivalents 184 8. Share capital and capital reserves 184 9. Subordinated liabilities 185 10. Trade and other payables 185 12. Cash generated from operations 185 13. Related parties 186 14. Share-based payments 186 15. Risk management 186 16. Directors and key management remuneration 186
Opinion on the financial statements of Direct Line Insurance Group plc In our opinion:  the financial statements give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2016 and of the Group’s and Parent Company’s profit for the year then ended;  the financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; and
The financial reporting framework has been applied in their preparation is applicable law and IFRSs as adopted by the European Union.
Separate opinion in relation to IFRSs as issued by the IASB As explained in note 1 to the consolidated financial statements, in addition to complying with its legal obligation to apply IFRSs as adopted by the EU, the Group has also applied IFRSs as issued by the IASB.
We agreed with the Directors’ adoption of the going concern basis of accounting and we did not identify any such material uncertainties. However, because not all future events or conditions can be predicted, this statement is not a guarantee as to the Group’s ability to continue as a going concern.
The Group’s insurance reserves total £4.7bn (2015: £4.5bn). The determination of the value of the insurance reserves requires significant judgment in the selection of key methodologies and assumptions. Small changes in these methodologies or assumptions can materially impact the valuation of these liabilities. We have identified the following two key areas of focus for our audit: 1) The frequency and severity of excess bodily injury claims; and 2) The propensity, severity and discount rate assumptions for valuing PPOs.
Having done this, we worked with those specialists to:  challenge the suitability of the methodology and assumptions used in estimating the ultimate number of large bodily injury claims by comparing it to industry benchmarks;  challenge the approach to and the assumptions used in adjusting reserves for the change in the Ogden discount rate;  assess whether the reserving methodology has been applied consistently across periods;  evaluate prior year reserve releases and emerging trends for consistency with management’s calculations.
Risk How the scope of our audit responded to the risk 2) The Group is required to settle a proportion of large bodily injury claims as PPOs rather than lump sum payments. The valuation of PPOs has a material impact on the financial statements, with these liabilities totalling £983m (2015: £991m) on a discounted gross basis as detailed in note 2. PPO liabilities are sensitive to the choice of the propensity, severity and discount rate assumptions used. These assumptions require significant management judgement which increases the susceptibility of the balance to material misstatement.
In addition, the Lord Chancellor’s announcement of a reduction in the Ogden discount rate is likely to impact the propensity of a claim becoming a PPO going forward which increases the level of uncertainty in the setting of this assumption at year end.
 test the model of a sample of individual PPO’s through re-performance using a Deloitte developed model.
Change and IT Refer to page 65 (Audit Committee Report), page 129 (accounting policies) and page 161 (financial disclosures).
A number of projects are ongoing across DLG aimed at improving the customer experience and enhancing operational efficiency. Certain costs relating to these projects are capitalised on the balance sheet, with the carrying amount of intangible assets at year-end totalling £298m (2015: £314m). We have identified a key risk that costs relating to these projects are incorrectly capitalised or that the impairment charge recognised in the year of £39m (2015: £4m) has not been accurately determined in line with IAS 36. Significant judgements and estimates have been made in calculating the future economic benefit of these assets, including the expected future cash flows and the discount rate used.
In addition, we have identified a risk that the transformation programme, which includes the outsourcing and offshoring of finance and operations, could impact the financial reporting control environment, in particular where processes and controls have changed operation and location. There is a risk that these changes will cause management stretch which could impact on the effectiveness of existing financial reporting internal controls, particularly in relation to adequate segregation of duties.
We have assessed the design and implementation and tested the operating effectiveness of key controls over the capitalisation of costs and the impairment of intangible assets. These included senior management approval for costs to be capitalised against projects having analysed the detailed business plan and assessed feasibility. We have tested the capitalisation criteria of key projects by assessing the inputs and noting whether these are applicable expenses in accordance with IAS 38. We have tested the impairment charge by performing the following:  testing the completeness and accuracy of the data used in the model;  testing the accuracy and mechanics of the model and assessing whether this was compliant with IAS 38;  challenging management’s expected future cash flows by performing benchmarking analysis and engaging our IT consultants to assess the IT architecture; and
 engaging our valuation specialists to assess the appropriateness of the discount rate applied to the asset.
Risk How the scope of our audit responded to the risk
Investments not held at fair value Refer to page 65 (Audit Committee Report), page 130 (accounting policies) and page 165 (financial disclosures).
 challenged management on loans of interest where indicators could point to issuer financial difficulty, obtaining evidence to assess whether the position taken by management is reasonable.
Key observations: We completed our procedures and did not note any indicators of material impairment within the loan portfolios.
Last year our report included risks relating to the reinsurance asset valuation and the Group’s IT control environment. From performing our detailed risk assessment for the 2016 audit, we concluded that these no longer represented key risks of material misstatement. The reinsurance bad debt methodology has remained consistent with prior year and is deemed appropriate. Similarly, the IT infrastructure fully transitioned in 2015 to an independently hosted data centre. In addition, this year we have not reported on our presumed risk over revenue recognition. We concluded that this risk does not exhibit the same level of complexity or management judgement as the risks we have disclosed above.
We have determined that the critical benchmark for the Group was average profit before tax from Ongoing operations. This measure uses a three-year average of profit before tax, excluding the impact of discontinued activities, transformation costs and the impact of the Ogden discount rate change to exclude the effect of year on year volatility. With the exception of Ogden, this is consistent with the approach we adopted last year. We determined materiality for the Group to be £28m (2015: £28m), which is below 5.6% (2015: 5.9%) of average profit before tax from Ongoing operations.
Our assessment of materiality was made prior to the announcement of the change in the Ogden discount rate, the impact of which has been disclosed in note 3 on page 137. We have considered whether materiality should be revised for both the Group audit and the audit of the insurance subsidiaries and have concluded that the levels of materiality remain appropriate as the scale and nature of the underlying businesses have not changed. We have performed focused procedures on the impact of the Ogden rate change as reported in the significant risk section of this report.
We also considered this measure to be suitable having compared to other benchmarks: our materiality equates to 7.9% (pre-Ogden change: 4.9%, 2015: 5.5%) of statutory profit before tax, 0.9% (pre Ogden change: 0.9%, 2015: 0.9%) of gross earned premium and 1.1% (pre-Ogden change: 1.0%, 2015: 1.1%) of equity.
We determine performance materiality at a level lower than materiality to reduce the probability that, in aggregate, uncorrected and undetected misstatements exceed materiality for the financial statements as a whole. We have set Group performance materiality at £19.6m (2015: £19.6m) and the audit testing for U K Insurance Limited is carried out to a performance materiality of £17.6m (2015: £17.4m).
 adequate accounting records have not been kept by the Parent Company, or returns adequate for our audit have not been received from branches not visited by us; or
Corporate governance statement Under the Listing Rules we are also required to review the part of the corporate governance statement relating to the Company’s compliance with certain provisions of the UK Corporate Governance Code. We have nothing to report arising from our review.
Colin Rawlings FCA (Senior Statutory Auditor) for and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 6 March 2017
Insurance claims recoverable from reinsurers 9 375.2 162.4 Net insurance claims 9 (1,803.8) (1,666.9)
Profit from continuing operations, net of tax 278.8 399.2 Profit from discontinued operations, net of tax 5A – 181.2 Profit for the year attributable to owners of the Company 278.8 580.4
Consolidated statement of comprehensive income For the year ended 31 December 2016 www.directlinegroup.com 123 £m 2015 £m
Items that may be reclassified subsequently to the income statement: Exchange differences on translation of foreign operations 0.1 14.4 Cash flow hedges 1.4 (1.4) Fair value gain / (loss) on AFS investments 30 119.6 (100.5) Less: realised net gains on AFS investments included in income statement 30 (15.3) (44.3) Tax relating to items that may be reclassified 30 (17.6) 34.6
Direct Line Group Annual Report & Accounts 2016 124 £m 2015 £m
Current tax assets 14 0.1 0.1 Deferred acquisition costs 23 203.1 203.8 Insurance and other receivables 24 988.3 955.8 Prepayments, accrued income and other assets 131.0 110.9 Derivative financial instruments 25 79.7 19.6 Retirement benefit asset 34 12.0 13.1
Cash and cash equivalents 27 1,166.1 963.7 Assets held for sale 28 3.8 5.1 Total assets 10,121.7 9,956.6
Derivative financial instruments 25 45.1 46.4 Trade and other payables including insurance payables 36 699.2 656.5 Deferred tax liabilities 14 46.0 29.9 Current tax liabilities 14 0.5 10.3 Total liabilities 7,600.2 7,326.6 Total equity and liabilities 10,121.7 9,956.6
Consolidated statement of changes in equity For the year ended 31 December 2016 www.directlinegroup.com 125
Transfer to non-distributable reserve 30 – – – – 28.0 – (28.0) – Shares acquired by employee trusts – (17.8) – – – – – (17.8) Credit to equity for equity-settled share-based payments 35 – – – – – – 12.1 12.1 Shares distributed by employee trusts – 11.0 – – – – (11.0) – Tax on share-based payments – – – – – – 2.9 2.9
Profit for the year – – – – – – 278.8 278.8
The Company’s financial statements and the consolidated financial statements are presented in Sterling, which is the functional currency of the Company.
Adoption of new and revised standards The Group has adopted the following new amendments to IFRSs and the IASs that became effective for the Group for the first time during 2016, however these have had no impact on the consolidated financial statements, performance and / or disclosure.
Amendments to IFRS 10 ‘Consolidated Financial Statements’, IFRS 12 ‘Disclosure of Interests in Other Entities’ and IAS 28 ‘Investments in Associates and Joint Ventures’ – Investment Entities: Applying the Consolidation Exception – the amendments address issues that have arisen in applying the investment entities exception under IFRS 10.
IFRS 11 (amended) ‘Joint Arrangements’ Accounting for Acquisitions of Interests in Joint Operations – the amendments require an entity to apply the principles of IFRS 3 ‘Business Combinations’ when it acquires an interest in a joint operation which constitutes a ‘business’ as defined by IFRS 3.
IAS 16 (amended) ‘Property, Plant and Equipment’ and IAS 38 (amended) ‘Intangible Assets’ – Classification of Acceptable Methods of Depreciation and Amortisation – the amendments state that revenue-based amortisation models are explicitly prohibited for property, plant and equipment and may only be used in very limited circumstances to amortise intangible assets.
Annual Improvements 2012-2014 Cycle – these improvements include: IFRS 5 (amended) ‘Non-Current Assets Held for Sale and Discontinued Operations’ – assets are generally disposed of either through sale or through a distribution to owners. The amendment clarifies that changing from one disposal method to another is a continuation of the original plan of disposal.
IFRS 7 (amended) ‘Financial Instruments: Disclosures’ – provides additional guidance to clarify whether a servicing contract that includes a fee can constitute continuing involvement in a financial asset for the purpose of the disclosures required in relation to transferred assets.
Direct Line Group Annual Report & Accounts 2016 128 1. Accounting policies continued Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date. Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in the income statement.
1.4 Revenue recognition Premiums earned Insurance and reinsurance premiums comprise the total premiums receivable for the whole period of cover provided by contracts incepted during the financial year, adjusted by an unearned premium provision, which represents the proportion of the premiums incepted in the year or prior periods that relate to periods of insurance cover after the balance sheet date. Unearned premiums are calculated over the period of exposure under the policy, on a daily basis, 24ths basis or allowing for the estimated incidence of exposure under policies.
The calculation is particularly sensitive to the estimation of the ultimate cost of claims for the particular classes of business at gross and net levels and the estimation of future claims handling costs. Actual claims experience may differ from the historical pattern on which the actuarial best estimate is based and the cost of settling individual claims may exceed that assumed. As a result, the Group sets provisions at a margin above the actuarial best estimate. This amount is recorded within claims provisions.
Direct Line Group Annual Report & Accounts 2016 130 1. Accounting policies continued property, plant and equipment comprises major components having different useful lives, they are accounted for separately.
A reversal of an impairment loss on intangible assets or property, plant and equipment is recognised as it arises provided the increased carrying value does not exceed the carrying amount that would have been determined had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
Impairment of financial assets Insurance receivables At each balance sheet date the Group assesses whether there is any objective evidence that a financial asset or group of financial assets classified as AFS, HTM or loans and receivables is impaired. A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.
AFS When a decline in the fair value of a financial asset classified as AFS has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in the income statement. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on AFS equity instruments are not reversed through profit or loss, but those on AFS debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event.
The fair value of options granted is estimated using valuation techniques which incorporate exercise price, term, risk-free interest rates, the current share price and its expected volatility.
In July 2014, the IASB issued the final version of IFRS 9 ‘Financial Instruments’ that replaces IAS 39 ‘Financial Instruments: Recognition and Measurement’ and all previous versions of IFRS 9 which was endorsed by the EU in 2016. IFRS 9 addresses the classification, measurement and derecognition of financial assets and financial liabilities, introduces new rules for hedge accounting and a new impairment model for financial assets and is effective for annual periods beginning on or after 1 January 2018.
In 2016 the Group conducted a high-level assessment of the three aspects of IFRS 9 and based on current available information expects no significant impact on its balance sheet and equity, except for the impact of applying the expected loss model for the first time and this impact is currently immaterial. The Group plans to defer the application of IFRS 9 until the effective date of the new insurance contracts standard IFRS 17 of 1 January 2021, applying the temporary exemption from applying IFRS 9 as introduced by the amendments to IFRS 4 ‘Insurance Contracts’, detailed below.
The amendments introduce two alternative options, the overlay approach and the temporary exemption from IFRS 9. The overlay approach allows an entity applying IFRS 9 to reclassify between the income statement and other comprehensive income an amount that results in the income statement at the end of the reporting period for the designated financial assets being the same as if an entity had applied IAS 39 ‘Financial Instruments – Recognition and Measurement’ to these designated financial assets. The temporary exemption from IFRS 9 allows entities to defer the implementation date of IFRS 9 for annual periods beginning before 1 January 2021, if it has not applied any version of IFRS 9 previously and its activities are predominantly connected with insurance on its annual reporting date that immediately precedes 1 April 2016.
In May 2014 the IASB issued IFRS 15 ‘Revenue from Contracts with Customers’ to establish a single comprehensive model to use in accounting for revenue recognition and measurement. The standard provides guidance on when and how combined contracts should be unbundled and when a contract price includes a variable consideration element. IFRS 15 was endorsed by the EU in 2016 and either a full retrospective application or a modified retrospective application is required for annual periods beginning on or after 1 January 2018. The Group expects to apply IFRS 15 fully retrospectively. Insurance contracts are out of the scope of IFRS 15 and therefore the Group does not expect the impact on other operating income to be material.
Direct Line Group Annual Report & Accounts 2016 134 1. Accounting policies continued The following amendments to IFRSs and IASs have been issued during 2016 that are expected to be endorsed by the EU during 2017. The Group does not expect the amendments to have a material impact on the financial statements of the Group in future periods.
2. Critical accounting estimates and judgements The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial information. The Group’s principal accounting policies are set out on pages 127 to 134. Company law and IFRSs require the Directors, in preparing the Group’s financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent.
The most common method of settling bodily injury claims is by a lump sum paid to the claimant and, in the cases where this includes an element of indemnity for recurring costs such as loss of earnings or ongoing medical care, settlement normally occurs using a standardised Ogden annuity factor at a discount rate of 2.5% in 2016 (2015: 2.5%). This is normally referred to as the Ogden discount rate. Other estimates are also required for case management expenses, loss of pension, court protection fees, alterations to accommodation and transportation fees.
Net of reinsurance Approved PPO claims provisions 240.4 633.6 221.2 594.2
There was no impairment of the Group’s financial assets in the year ended 31 December 2016 (2015: £nil).
3. Risk management 3.1 Enterprise Risk Management Strategy and Framework The ERMF sets out, at a high level, our approach and processes for managing risks. Further information can be found in the Risk management section of the Strategic report on page 27.
 regular assessment of the uncertainty in the reserves to help the Board set management best estimate reserves.
In addition, there is the risk that claims are reserved or paid inappropriately, including the timing of such activity. However, there are claims management controls in place to mitigate this risk, as outlined below:  Claims are managed utilising a range of IT system-driven controls coupled with manual processes outlined in detailed policies and procedures to ensure claims are handled in an appropriate, timely and accurate manner.
 Each member of staff has a specified handling authority, with controls preventing them handling or paying claims outside their authority, as well as controls to mitigate the risk of paying invalid claims. In addition, there are various outsourced claims handling arrangements, all of which are monitored closely by management, with similar principles applying in terms of the controls and procedures.
 Loss adjustors are used in certain circumstances to handle claims to conclusion. This involves liaison with the policyholder, third parties, suppliers and the claims function.
 Specialist bodily injury claims teams are responsible for handling these types of losses with the nature of handling dependent on the level and type of claim. Claims exceeding a certain threshold are referred to the technical and large loss teams who also deal with all other claim types above defined limits or within specific criteria.
Distribution risk This is the risk that material change in the volume of policies written, may result in losses or reduced profitability.
 Changes in the external legal, regulatory, social or economic environment altering the definition and application of reinsurance policy wordings or the effectiveness or value for money of reinsurance.
 transfer risk that is not within the Group’s current risk appetite.
The Group monitors its market risk exposure on a monthly basis and has established an aggregate exposure limit consistent with its risk objective to maintain capital adequacy. Interdependencies across risk types have also been considered within the aggregate exposure limit. The allocation of the Group’s investments across asset classes has been approved at the Investment Committee.
The Group has a property portfolio and an infrastructure debt portfolio in order to improve matching to the longer duration PPOs.
Property risk This is the risk of loss as a result of sensitivity of assets and financial investment to the level or volatility of market prices of property. At 31 December 2016, the value of these property investments was £329.0 million (2015: £347.4 million). The property investments are located in the UK.
Foreign currency risk The exposure to currency risk is generated by the Group’s investments in US Dollar and Euro denominated corporate bonds.
The Group maintains exposure to US Dollar securities through £2,107.1 million (2015: £1,876.3 million) of investments in US Dollar corporate bonds and Euro securities through £91.8 million (2015: £nil) of Euro corporate bonds. The foreign currency exposure of these investments is hedged by foreign currency forward contracts, maintaining a minimal unhedged currency exposure on these portfolios, as well as a low basis currency risk on the hedging.
Increase / (decrease) in total equity5 at 31 December £m £m
Notes: 1. The income statement impact on financial investments is limited to floating rate instruments and interest rate derivatives used to hedge a portion of the portfolio.
2. The increase or decrease in total equity does not reflect any fair value movement in infrastructure debt, HTM debt securities and commercial real estate loans that would not be recorded in the financial statements under IFRSs as they are classified as loans and receivables and HTM respectively, which are carried at amortised cost. It is estimated that a fair value reduction in these asset categories resulting from a 100 basis point increase in spreads would have been £34.4 million (2015: £29.5 million) and a 100 basis point increase in interest rate would have been £4.8 million (2015:£0.1 million).
The Group has a number of open interest rate and foreign exchange derivative positions. Collateral management arrangements are in place for significant counterparty exposures. At 31 December 2016, the Group has pledged £23.7 million in cash (2015: £12.3 million) and £3.4 million in UK Treasury Bills (2015; £nil) to cover initial margins and out-of-the-money derivative positions. At 31 December 2016, counterparties have pledged £19.1 million in cash and £39.4 million in UK Gilts (2015: £19.7 million in UK Gilts) to the Group to cover in-the-money derivative positions.
3.3.3 Credit risk This is the risk of loss resulting from default on cash inflows and / or changes in market value of issuers of securities, counterparties and any debtors to which the Group is exposed. The Group is mainly exposed to the following credit risk factors:  Counterparty default risk; and
Direct Line Group Annual Report & Accounts 2016 142 3. Risk management continued The following tables analyse the carrying value of financial and insurance assets that bear counterparty default risk between those assets that have not been impaired by age in relation to due date, and those that have been impaired.
Reinsurance assets 1,011.4 – – – 1,011.4 Insurance and other receivables 917.3 32.4 6.1 – 955.8 Derivative assets 19.6 – – – 19.6 Debt securities 5,240.1 – – – 5,240.1 Deposits with credit institutions with maturities > three months 44.9 – – – 44.9 Infrastructure debt 329.6 – – – 329.6 Cash and cash equivalents1 963.7 – – – 963.7
Within the analysis of debt securities above are bank debt securities at 31 December 2016 of £1,199.5 million (2015: £1,305.1 million), that can be further analysed as: secured £62.2 million (2015: £86.4 million); unsecured £973.8 million (2015: £1,059.6 million); and subordinated £163.5 million (2015: £159.1 million).
Concentration risk This is the risk of exposure to increased losses associated with inadequately diversified portfolios of assets and / or obligations, in particular:  large exposures to individual credits (either bond issuers or deposit-taking institutions);  large exposures to different credits where movements in values and ratings are closely correlated.
Mortgage and other asset backed securities – – 356.1 7% Sovereign, supranational and local government 461.5 10% 688.1 13%
Note: 1. Securitised credit consisted of prime mortgage backed securities, collateralised loan obligations, securitised student loans and commercial mortgage backed securities. Following a strategic decision, the Group decided to exit this asset class during August and September 2016.
Cash and cash equivalents2 831.9 – 60.8 71.0 – – 963.7
Outsourcing risk This is the risk of failing to implement a robust framework for the sourcing, appointment and ongoing contract management of external suppliers, outsourced service providers and intragroup relationships. This includes both domestic and offshore outsourcing activities.
The measurement and management of liquidity risk within the Group is undertaken within the limits and other policy parameters of the Group’s liquidity risk appetite and is detailed within the liquidity risk minimum standard. As part of this process the Investment and Treasury team are required to put in place a liquidity plan which must consider expected and stressed scenarios for cash in-flows and out-flows that is reviewed at least annually by the Investment risk forum. Compliance is monitored in respect of both the minimum standard and the regulatory requirements of the PRA.
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 2,589.6 43.5 – – 43.5 Designated as hedging instruments: Interest rate swaps 634.8 1.1 – 0.5 1.6
Direct Line Group Annual Report & Accounts 2016 148 3. Risk management continued The tables below analyse financial investments, cash and cash equivalents, insurance and financial liabilities by remaining duration, in proportion to the cash flows expected to arise during that period, for each category.
Commercial real estate loans 79.7 1.3 32.6 45.8 – – Cash and cash equivalents1 1,166.1 1,166.1 – – – –
Trade and other payables including insurance payables 656.5 652.9 3.0 0.2 0.3 0.1
From 1 January 2016, the Group’s regulatory capital position has been assessed against the Solvency II framework. From 1 July 2016, the Group was approved to assess its SCR using a partial internal model, including a full internal economic capital model for the UKI underwriting entity. The model is calibrated to a 99.5% confidence interval and consider business written to date and one year of future business, in line with Solvency II requirements.
Using the Group’s partial internal model, there is a capital surplus of approximately £0.9 billion above a solvency capital requirement of £1.4 billion at 31 December 2016. On 1 January 2016, this surplus was £0.6 billion above a solvency capital requirement of £1.8 billion calculated using the standard formula approach. The Group’s capital requirements and solvency position are produced and presented to the Board on a regular basis.
Commercial This segment consists of commercial insurance for small and medium-size entities sold through NIG, Direct Line for Business, Churchill for Business and through partnership brands.
No inter-segment transactions occurred in the year ended 31 December 2016 (2015: £nil). If any transaction were to occur, transfer prices between operating segments would be set on an arm’s length basis in a manner similar to transactions with third parties. Segment income, expenses and results will include those transfers between business segments which will then be eliminated on consolidation.
Insurance claims recoverable from reinsurers 295.6 0.1 – 47.2 342.9 32.3 375.2
Underwriting (loss) / profit (84.8) 122.5 26.6 5.8 70.1 Loss ratio 74.9% 40.7% 61.6% 55.3% 60.9% Commission ratio 3.2% 22.6% 7.2% 19.5% 11.5% Expense ratio 28.2% 21.7% 24.5% 23.9% 25.3% COR 106.3% 85.0% 93.3% 98.7% 97.7%
Direct Line Group Annual Report & Accounts 2016 152 5. Discontinued operations and disposal group The Group completed the disposal of its Italian and German subsidiaries (represented by Direct Line Insurance S.p.A and Direct Line Versicherung AG respectively) on 29 May 2015, which was treated as discontinued operations, generating a gain on disposal of £167.1 million.
A) Discontinued operations The following table analyses performance relating to the discontinued operations for the period from 1 January to disposal on 29 May 2015.
Gross written premium 261.1 Gross earned premium 207.2 Reinsurance premium (78.8) Net earned premium 128.4 Investment return1 37.1 Instalment income 1.4 Other operating income 0.1 Total income 167.0 Insurance claims (156.2) Insurance claims recoverable from reinsurers 60.9 Net insurance claims (95.3) Commission expenses (28.0) Operating expenses (10.2) Total expenses (38.2) Operating profit from discontinued operations 33.5 Gain on disposal of discontinued operations 167.1 Profit before tax from discontinued operations 200.6 Tax charge (19.4) Profit after tax from discontinued operations 181.2 Underwriting loss (5.1) Loss ratio 74.2% Commission ratio 21.8% Expense ratio 8.0% COR 104.0%
Note: 1. Realised net gains on AFS investments in 2015 included £29.9 million of gains reclassified through the income statement, on disposal of International.
The following table analyses the other comprehensive loss relating to discontinued operations, included in the consolidated statement of comprehensive income for the period from 1 January to disposal on 29 May 2015.
Assets Intangible assets 5.4 Property, plant and equipment 5.2 Reinsurance assets 171.0 Deferred tax assets 41.9 Current tax assets – Deferred acquisition costs 105.5 Insurance and other receivables 152.3 Prepayments and accrued income 3.1 Financial investments 665.5 Cash and cash equivalents 95.4 Total assets 1,245.3 Liabilities Insurance liabilities 504.5 Unearned premium reserve 355.0 Trade and other payables including insurance payables 125.3 Deferred tax liabilities 32.0 Current tax liabilities 4.0 Total liabilities 1,020.8 Net assets 224.5 Cash consideration received1 438.1 Transaction costs (15.6) Net cash consideration 422.5 Net assets disposed (224.5) Currency translation reserve reclassified to the income statement (30.9) Gain on disposal of discontinued operations 167.1
Direct Line Group Annual Report & Accounts 2016 154 6. Net earned premium £m 20151 £m
Associated interest rate risk on hedged items 9.3 (27.6) 9.7 4.9 Net (losses) / gains on interest rate derivatives (7.6) (6.9) (19.0) 6.1
9. Net insurance claims Gross Reinsurance Net Gross Reinsurance Net £m £m £m £m 20151 £m
Notes: 1. Staff costs and other operating expenses attributable to claims handling activities are allocated to the cost of insurance claims. 2. Other operating expenses include IT costs, insurance levies, professional fees and property costs. 3. A property site in Bristol comprising of freehold property and fixtures and fittings was transferred from freehold property to assets held for sale in 2016. The property with a carrying value of £23.5 million was remeasured on transfer to its fair value of £3.8 million resulting in a charge to other operating expenses in Restructuring of £19.7 million.
Direct Line Group Annual Report & Accounts 2016 156 11. Operating expenses continued
Restructuring and other one-off costs Run-off Total Group £m 20151 £m
Staff costs2 254.2 18.7 0.4 273.3 Other operating expenses2,3,4 219.0 30.0 0.2 249.2 Marketing 117.8 – 0.1 117.9 Amortisation and impairment of other intangible assets 67.4 – – 67.4 Depreciation 30.7 – – 30.7 Total 689.1 48.7 0.7 738.5
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations. 2. Staff costs and other operating expenses attributable to claims handling activities are allocated to the cost of insurance claims. 3. Other operating expenses include IT costs, insurance levies, professional fees and property costs. 4. The Pudsey sites were transferred from property, plant and equipment to assets held for sales in 2015. The sites with a carrying value of £22.1 million were remeasured on transfer to their fair value of £5.1 million resulting in a charge to other operating expenses in Restructuring of £17.0 million.
Fees payable for the audit of: The Company’s annual accounts 0.3 0.3 The Company’s subsidiaries 1.5 1.6
Total audit fees 1.8 1.9 Fees payable for non-audit services: Audit-related assurance services 0.2 0.3 Other services 0.2 0.6
At 31 December 2016, one Director (2015: one) had retirement benefits accruing under the defined contribution pension scheme in respect of qualifying service. During the year ended 31 December 2016, one Director exercised share options (2015: two).
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations. 2. As described in note 31, on 27 April 2012 the Group issued subordinated guaranteed dated notes with a nominal value of £500 million at a fixed rate of 9.25%. On the same date, the Group also entered into a 10-year designated hedging instrument to exchange the fixed rate of interest on the notes for a floating rate of three-month LIBOR plus a spread of 706 basis points, which increased to 707 basis points with effect from 29 July 2013.
76.7 98.9 Deferred taxation (note 14): (Credit) / charge for the year (5.1) 6.4 Under provision in respect of prior year 2.6 3.0
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations. 2. The prior year current tax credit for the year ended 31 December 2016 includes £5.6 million relating to retrospective claims for research and development tax relief.
Direct Line Group Annual Report & Accounts 2016 158 13. Tax charge continued
Tax charge for the year 74.2 108.3 Effective income tax rate 21.0% 21.3%
Notes: 1. In the Finance Act 2013 the UK Government enacted a reduction in the UK corporation tax rate from 21% to 20% effective from 1 April 2015. The Finance
(No 2) Act 2015 enacted further reductions to 19% effective from 1 April 2017 and 18% effective from 1 April 2020. The Finance Act 2016 then enacted a further reduction to 17% effective from the 1 April 2020. 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.
(Charge) / credit to the income statement on continuing operations (2.1) (0.1) – (3.9) (3.6) 0.3 – (9.4) Charge to other comprehensive income – (1.6) – – – – – (1.6) Credit direct to equity – – – – – 1.7 – 1.7
Note: 1. The Board paid an interim dividend in lieu of a final dividend.
The trustees of the employee share trusts waived their entitlement to dividends on shares held to meet obligations arising on the Long Term Incentive Plan, Deferred Annual Incentive Plan and Restrictive Share Plan awards, which reduced the total dividend paid for the year ended 31 December 2016 by £1.8 million (2015: £1.7 million).
16. Earnings per share Earnings per share is calculated by dividing earnings attributable to the owners of the Company by the weighted average number of Ordinary Shares during the year.
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 Basic earnings per share (pence): Continuing operations 20.4 27.9 Discontinued operations – 12.7 Total Group 20.4 40.6
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 Opening shareholders’ equity 2,630.0 2,810.5 Closing shareholders’ equity 2,521.5 2,630.0 Average shareholders’ equity 2,575.8 2,720.2 Return on equity 10.8% 21.3%
Acquisitions and additions – 74.7 74.7 Disposals and write-off1 – (8.0) (8.0)