How the scope of our audit responded to the key audit matter We have gained a detailed understanding over management’s process for setting these assumptions and obtained an understanding of relevant controls surrounding the setting of the PPO inflation rate and discount rate. In addition, we tested the relevant direct and precise business control, performed weekly, over the completeness of the PPO listing; this is a key data input which has a material impact on the PPO assumptions and hence the valuation.
We have worked with our actuarial specialists to challenge: – The PPO inflation assumption through inquiries with the Actuarial Director, reviewing relevant supporting documentation and benchmarking against market economic data and peers; – The Group’s sensitivity testing on the PPO inflation assumption; – The selected discount rate with reference to current and future performance of the assets backing the PPO
Key observations We have determined that the inflation and discount rate assumptions used in the calculation of the PPO claims reserve are in the middle of a reasonable range.
How the scope of our audit responded to the key audit matter We obtained an understanding and tested the key controls over the impairment of intangible assets. This included senior management review and approval of the impairment review.
– worked with our in-house IT specialists to challenge the benefits attributed to the platform and evaluate the feasibility of management’s plans for future deployment phases in 2020.
5.3 Valuation of investments not held at fair value Refer to page 94 (Audit Committee Report), page 162 (Accounting policies) and page 198 (Financial statements).
148 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2019 5.3 Valuation of investments not held at fair value continued
Materiality £28.0 million (2018: £28.0 million) £25.2 million (2018: £25.2 million)
Materiality equates to less than 1% (2018: 1%) of shareholders’ equity and is capped at 90% (2018: 90%) of Group materiality.
6.3 Error reporting threshold We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £1.4 million (2018: £1.4 million), as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. We also report to the Audit Committee on disclosure matters that we identified when assessing the overall presentation of the financial statements.
Business process and financial reporting controls In planning our 2019 audit we identified 18 business cycles that were material to the Group’s financial reporting processes. These cycles spanned the Group’s material transactions and account balances including the premiums, claims, reinsurance, expenses, payroll, investments and intangibles cycles and part of the reserving cycle relating to reconciliation of data, and we intended to rely on the business controls associated with all of these cycles. Having completed our testing over the operating effectiveness of business controls associated with these cycles, through a combination of current period testing and reliance on prior period testing, we concluded that we were able to rely upon the business controls associated with all 18 cycles.
150 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2019 8. Other information continued If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact.
– Audit Committee reporting – the section describing the work of the Audit Committee does not appropriately address matters communicated by us to the audit committee; or
10. Auditor’s responsibilities for the audit of the financial statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.
11. Extent to which the audit was considered capable of detecting irregularities, including fraud We identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, and then design and perform audit procedures responsive to those risks, including obtaining audit evidence that is sufficient and appropriate to provide a basis for our opinion.
We also obtained an understanding of the legal and regulatory framework that the Group operates in, focusing on provisions of those laws and regulations that had a direct effect on the determination of material amounts and disclosures in the financial statements. The key laws and regulations we considered in this context included the UK Companies Act, Listing Rules and tax legislation. In addition, we considered provisions of other laws and regulations that do not have a direct effect on the financial statements but compliance with which may be fundamental to the Group’s ability to operate or to avoid a material penalty. These included the Group’s operating licence and regulatory solvency requirements, such as those under the relevant Solvency II requirements and those required by the PRA and FCA.
Report on other legal and regulatory requirements 12. Opinions on other matters prescribed by the Companies Act 2006 In our opinion the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.
13. Matters on which we are required to report by exception 13.1. Adequacy of explanations received and accounting records Under the Companies Act 2006 we are required to report to you if, in our opinion: – we have not received all the information and explanations we require for our audit; or – 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 – the Parent Company financial statements are not in agreement with the accounting records and returns.
14. Other matters 14.1 Auditor tenure Following the recommendation of the Audit Committee of Royal Bank of Scotland Group plc (“RBSG”), which at the time owned Direct Line, we were appointed by the Board of Directors of RBSG on 21 March 2000 to audit the financial statements for the year ending 31 December 2000 and subsequent financial periods. When the Group became independent of RBSG the Group’s Board reappointed us to audit the newly demerged Group. Taking into account our service to predecessor organisations, the period of total uninterrupted engagement including previous renewals and reappointments of the firm is 20 years, covering the years ending 31 December 2000 to 31 December 2019. Under the Companies Act 2006, the last financial year of our maximum engagement period is the year ending 31 December 2023.
14.2 Consistency of the audit report with the additional report to the audit committee Our audit opinion is consistent with the additional report to the Audit Committee we are required to provide in accordance with ISAs (UK).
15. Use of our report This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
FOR AND ON BEHALF OF DELOITTE LLP SENIOR STATUTORY AUDITOR LONDON, UNITED KINGDOM
Operating expenses (including restructuring and one-off costs) 10 (704.9) (718.2) Total expenses (916.4) (918.6)
Profit for the year attributable to owners of the Company 419.9 472.0
Profit for the year 419.9 472.0 Other comprehensive income Items that will not be reclassified subsequently to the income statement: Actuarial (loss) / gain on defined benefit pension scheme 27 (7.3) 2.7 Tax relating to item that will not be reclassified 13 1.3 (0.4)
Other comprehensive income / (loss) for the year net of tax 77.6 (114.2) Total comprehensive income for the year attributable to owners of the Company 497.5 357.8
Assets Goodwill and other intangible assets 17 702.5 566.8 471.1 Property, plant and equipment 18 143.4 156.2 174.4 Right-of-use assets 19 149.2 153.4 157.9
Insurance and other receivables 24 846.5 875.9 981.2 Prepayments, accrued income and other assets 25 120.2 124.5 143.0
Notes: 1. The balance sheet as at 1 January 2018 and 31 December 2018 have been restated to reflect the fully retrospective adoption of IFRS 16
‘Leases’, see note 44. 2. Presentational amendments included ‘Provisions’ previously presented within ‘Trade and other payables, including insurance payables’ are now presented separately on the consolidated balance sheet. This amendment has been made to provide additional analysis of these balances and is in accordance with international accounting standards.
The financial statements were approved by the Board of Directors and authorised for issue on 2 March 2020. They were signed on its behalf by: TIM HARRIS CHIEF FINANCIAL OFFICER
First application of IFRS 161 – – – – – (13.2) (13.2) – (13.2)
Dividends and appropriations paid (note 14) – – – – – (503.8) (503.8) – (503.8) Shares acquired by employee trusts – (19.5) – – – – (19.5) – (19.5) Credit to equity for equity-settled share-based payments (note 36) – – – – – 21.0 21.0 – 21.0 Shares distributed by employee trusts – 18.4 – – – (18.4) – – – Tax on share-based payments – – – – – 0.8 0.8 – 0.8
Net cash generated from operating activities before investment of insurance assets 39 88.2 23.5 Cash generated from investment of insurance assets 39 373.9 468.1 Net cash generated from operating activities 462.1 491.6 Cash flows used in investing activities Purchases of goodwill and other intangible assets 17 (175.7) (142.4) Purchases of property, plant and equipment 18 (11.9) (13.3) Proceeds on disposals of assets held for sale – 13.8 Proceeds on disposal of property, plant and equipment – 0.1 Net cash used in investing activities (187.6) (141.8) Cash flows used in financing activities Dividends and appropriations paid 14 (420.7) (503.8) Finance costs (including lease interest) (26.4) (26.1) Principal element of lease payments 39 (13.1) (12.5) Purchase of employee trust shares (10.4) (19.5) Net cash used in financing activities (470.6) (561.9) Net decrease in cash and cash equivalents (196.1) (212.1) Cash and cash equivalents at the beginning of the year 29 1,092.4 1,304.5 Cash and cash equivalents at the end of the year 29 896.3 1,092.4
158 DIRECT LINE GROUP aNNUAL REPORT AND ACCOUNTS 2019 Financials v6.1
Where necessary, adjustments have been made to the financial statements of subsidiaries to bring the accounting policies used into line with those used by the Group. The policies set out below have been applied consistently throughout the years ended 31 December 2019 and 31 December 2018 to items considered material to the consolidated financial statements.
Adoption of new and revised standards The Group has adopted the following new amendments to IFRSs and International Accounting Standards (“IASs”) that became mandatorily effective for the Group for the first time during 2019.
The Group has adopted IFRS 16 ‘Leases’ for the first time in 2019. IFRS 16 replaces IAS 17 ‘Leases’ and sets out the principles for recognition, measurement and disclosure of lease arrangements entered into by the Group. For all contractual arrangements where the Group is a lessee, it is required to account for these leases under a single on-balance sheet model with exemptions available for low value and short-term leases. The Group recognises a lease liability measured at the present value of future lease payments from the commencement of all lease arrangements which were previously classified as ‘operating leases’ under IAS 17. A further assessment was performed to ensure all leases had been recognised. These lease payments are discounted using the lessees’ incremental borrowing rate at the commencement of the lease unless the interest rate implicit in the lease is readily determinable. A corresponding right-of-use asset is recognised on the balance sheet. Lease payments are allocated between the liability and finance cost, and the right-of-use asset is depreciated on a straight-line basis over the lease term.
IFRS 16 ‘Leases’ has been adopted on a fully retrospective basis and therefore, in accordance with IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, prior periods have been restated. The opening equity and prior period impact of IFRS 16 on the primary financial statements are presented in note 44 to the consolidated financial statements. An assessment has been undertaken to determine whether adoption of IFRS 16 included any material new accounting judgements or identifying any sources of estimation uncertainty. The Group concluded that there were none.
In September 2019, the IASB issued ‘Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39 and IFRS 7’ which although not mandatory for the Group until 2020, has been adopted in 2019. The amendments modify some specific hedge accounting requirements to provide relief from the potential effects of the uncertainty caused by the IBOR reform. In addition, it requires companies to disclose additional information about their hedging relationships which are directly affected by these uncertainties. By adopting these amendments early, the Group is able to continue applying hedge accounting to some of its benchmark interest rate exposure as the amendments permit the continuation of hedge accounting where in future the hedged benchmark interest rate may no longer be separately available. The amendment does not alter the requirement for the designated interest rate risk component to be measurable. If the risk component is no longer reliably measurable, the hedging relationship is discontinued.
The Group will not discontinue hedge accounting should the retrospective assessment of hedge effectiveness fall outside the 80‑125% range where the hedging relationship is subject to interest rate benchmark reforms. For those hedging relationships that are not subject to the interest rate benchmark reforms the entity continues to cease hedge accounting if retrospective effectiveness is outside the 80‑125% range.
Assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition, are translated into sterling at the foreign exchange rates ruling at the balance sheet date. Income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on the translation of a foreign operation are recognised in the consolidated statement of comprehensive income. The amount accumulated in equity is reclassified from equity to the consolidated income statement on disposal or partial disposal of a foreign operation.
Rental income from investment property is recognised in the income statement on a straight-line basis over the period of the contract.
The Group’s income also comprises vehicle repair services provided to other third-party customers. Income in respect of repairs to vehicles is recognised upon completion of the repair obligations. The price is determined using market rates for the services and materials used after discounts have been deducted where applicable.
1.5 Insurance claims Insurance claims are recognised in the accounting period in which the loss occurs. Provision is made for the full cost of settling outstanding claims at the balance sheet date, including claims incurred but not yet reported at that date, net of salvage and subrogation recoveries.
Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the incidence, timing and amount of claims and any specific factors such as adverse weather conditions. When calculating the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable probability parameters, the value of outstanding claims (gross and net) at the balance sheet date. Also included in the estimation of outstanding claims are factors such as the potential for judicial or legislative inflation.
Provisions for more recent claims make use of techniques that incorporate expected loss ratios and average claims cost (adjusted for inflation) and frequency methods. As claims mature, the provisions are increasingly driven by methods based on actual claims experience. The approach adopted takes into account the nature, type and significance of the business and the type of data available, with large claims generally being assessed separately. The data used for statistical modelling purposes is generated internally and reconciled to the accounting data.
1.6 Reinsurance The Group has reinsurance treaties and other reinsurance contracts that transfer significant insurance risk.
The principal acquisition costs deferred are direct advertising expenditure, directly attributable administration costs, commission paid and costs associated with telesales and underwriting staff.
Expenditure on internally generated goodwill and indirect advertising costs is written off as incurred. Direct costs relating to the development of internal-use computer software and associated business processes are capitalised once technical feasibility and economic viability have been established. These costs include payroll costs, the costs of materials and services and directly attributable overheads. Capitalisation of costs ceases when the software is capable of operating as intended. During and after development, accumulated costs are reviewed for impairment against the projected benefits that the software is expected to generate. Costs incurred prior to the establishment of technical feasibility and economic viability are expensed as incurred, as are all training costs and general overheads.
The gain or loss arising from the derecognition of an item of property, plant and equipment is determined as the difference between the disposal proceeds, if any, and the carrying amount of the item.
In calculating the present value of lease payments, the Group uses the incremental borrowing rate at the lease commencement date unless the interest rate implicit in the lease is readily determinable. The incremental borrowing rate is determined based on available risk-free market yield to maturity pricing linked to the lease amount and term, and includes a credit spread. The lease liability is subsequently measured at amortised cost using the effective interest rate method and remeasured, with a corresponding adjustment to the right-of-use asset when there is a change in future lease payments, terms or reassessment of options.
Held-to-maturity Non-derivative financial assets not designated as AFS or loans and receivables with fixed or determinable payments and fixed maturity where the intention and ability to hold them to maturity exists are classified as HTM.
1.15 Financial liabilities Financial liabilities are initially recognised at fair value net of transaction costs incurred. Other than derivatives which are recognised and measured at fair value, all other financial liabilities are subsequently measured at amortised cost using the effective interest rate method.
1.17 Provisions The Group recognises a provision for a present legal or constructive obligation from a past event when it is more likely than not that it will be required to transfer economic benefits to settle the obligation and the amount can be reliably estimated.
Restructuring provisions are made, including redundancy costs, when the Group has a constructive obligation to restructure. An obligation exists when the Group has a detailed formal plan and has communicated the plan to those affected.
The Group’s defined benefit pension scheme, as described in note 27, was closed in 2003. Scheme liabilities are measured on an actuarial basis, using the projected unit credit method, and discounted at a rate that reflects the current rate of return on a high-quality corporate bond of equivalent term and currency to the scheme liabilities.
Deferred tax assets are reviewed at each balance sheet date and reduced to the extent that it is probable that they will not be recovered.
Vesting conditions include service conditions (requiring the employee to complete a specified period of service) and performance conditions (requiring the Group to meet specified performance targets).
1.22 Dividends Interim dividends on Ordinary Shares are recognised in equity in the period in which they are paid. Final dividends on Ordinary Shares are recognised when they have been approved at the AGM.
1.23 Accounting developments New IFRS standards and amendments that are issued, but not yet effective for the 31 December 2019 reporting period and have not been early adopted by the Group are disclosed below. The Group intends to adopt these standards, if applicable, when they become effective, except for amendments to IFRS 9 ‘Financial Instruments’, as explained below.
In July 2014, the IASB issued the final version of IFRS 9 ‘Financial Instruments’ which replaces IAS 39 ‘Financial Instruments: Recognition and Measurement’ and all previous versions of IFRS 9; it 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; it was effective for annual periods beginning on or after 1 January 2018, however adoption by the Group has been deferred as described below.
The fair value at the end of the reporting period for financial assets with contractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount are disclosed in note 42. The amount of change in the fair value during the period for these financial assets was: – AFS debt securities £118.6 million increase (2018: £103.7 million decrease); – HTM debt securities £3.8 million increase (2018: £3.2 million decrease); – infrastructure debt £10.6 million increase (2018: £18.2 million decrease); and
‘Amendments to IFRS 9: Prepayment Features with Negative Compensation’ was issued in October 2017 and is endorsed by the EU to allow instruments with symmetric prepayment options to qualify for amortised cost or fair value through other comprehensive income measurement because they would otherwise fail the ‘solely payments of principal and interest on the principal amount’ condition. The amendments are effective from the same period as IFRS 9.
IFRS 17 ‘Insurance Contracts’ was issued by the IASB in May 2017 to replace IFRS 4 ‘Insurance Contracts’. IFRS 17 is currently effective for reporting periods beginning on or after 1 January 2021, however it is expected to be delayed until 1 January 2022 following the IASB’s ‘Amendments to IFRS 17’ exposure draft published in June 2019. Comparative figures are required.
The core of IFRS 17 is the general model, supplemented by an optional simplified premium allocation approach which is permitted for the liability for the remaining coverage for short duration contracts. The general model measures insurance contracts using the building blocks of: discounted probability weighted cash flows; an explicit risk adjustment; and a contractual service margin representing the unearned profit of the contract which is recognised as revenue over the coverage period.
An assessment on the impact of IFRS 17 on the Group’s financial statements remains in progress. The Group expects to be able to apply the simplified premium allocation approach to most of its insurance and reinsurance contracts. IFRS 17 is yet to be endorsed by the EU.
In March 2018 the IASB issued ‘Amendments to References to the Conceptual Framework in IFRS standards’ amending some references to previous versions of the ‘Conceptual Framework in IFRS Standards’ and their accompanying documents and IFRS Practice Statements. These amendments are effective from 1 January 2020 and are endorsed by the EU.
Accounting judgement The Group makes a judgement that financial assets are impaired when there is objective evidence that an event or events since initial recognition of the assets have adversely affected the amount or timing of future cash flows from the asset. The determination of which events could have adversely affected the amount or timing of future cash flows from the asset requires judgement. In making this judgement, the Group evaluates, among other factors, the normal price volatility of the financial asset, the financial health of the investee, industry and sector performance, changes in technology and operational and financing cash flow or whether there has been a significant or prolonged decline in the fair value of the asset below its cost. Impairment may be appropriate when there is evidence of deterioration in these factors. There was no evidence of impairment of any assets within the loan and receivables portfolio in the year ended 31 December 2019 (2018: £6 million).
On a quarterly basis, the Group reviews whether there is any objective evidence that a financial asset is impaired based on the following criteria: – actual, or imminent, default on coupon interest or nominal; – adverse movements in the credit rating for the investee/borrower; – price performance of a particular AFS debt security, or group of AFS debt securities, demonstrating an adverse trend compared to the market as a whole; and – an event has occurred that could be reliably estimated and which had an impact on the financial asset or its future cash flows.
Had all the declines in AFS asset values met the criteria above at 31 December 2019, the Group would suffer a loss of £4 million (2018: £21 million), being the transfer of the total AFS reserve for unrealised losses to the income statement. These movements represent mark-to-market movements and there was no objective evidence of any loss events that could affect future cash flows, no impairments have therefore been recorded.
Source of estimation uncertainty The Group makes provision for the full cost of outstanding claims from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling costs. Outstanding claims provisions net of related reinsurance recoveries at 31 December 2019 amounted to £2,670.0 million (2018: £2,900.7 million).
The corresponding reinsurance recoveries are calculated on an equivalent basis, with similar estimation uncertainty, as discussed in note 1.6. The reinsurance bad debt provision is mainly held against expected recoveries on future PPO payments.
The Group reserves its large bodily injury claims at the relevant discount rate for each jurisdiction, with the overwhelming majority now reserved at minus 0.25% as most will be settled under the law in England and Wales. The Ogden discount rate will be reviewed again at the latest in 2024 but, following the change in 2017, only small movements are expected in future. These will have a low impact on the Group’s reserves. This is also a function of the ongoing reduction in large bodily injury exposures as a result of continued positive prior-year development of claims reserves, and a higher proportion of reserves being covered by reinsurance as a result of the decision to opt for a lower reinsurance attachment point from 2014 onwards.
The table in note 34 to the financial statements provides an analysis of outstanding PPO claims provisions on a discounted and an undiscounted basis at 31 December 2019 and 31 December 2018 and further details on sources of estimation uncertainty. Details of sensitivity analysis to the discount rate applied to PPO claims are shown in note 3.3.1.
WWW.DIRECTLINEGROUP.CO.UK 169 3. Risk management 3.1 Enterprise Risk Management Strategy and Framework The Enterprise Risk Management Strategy and Framework sets out, at a high level, the Group’s approach and processes for managing risks. Further information can be found in the Risk management section of the Strategic report on page 52.
Understatement of reserves may result in not being able to pay claims when they fall due. Alternatively, overstatement of reserves can lead to a surplus of funds being retained resulting in opportunity cost; for example, lost investment return or insufficient resource to pursue strategic projects and develop the business.
170 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 3. Risk management continued 3.3.1 Insurance risk continued The table below provides a sensitivity analysis of the potential net impact of a change in a single factor (the internal discount rate used for PPOs and separately the Ogden discount rate) with all other assumptions left unchanged. Other potential risks beyond the ones described could have additional financial impacts on the Group.
PPOs3 Impact of an increase in the discount rate used in the calculation of present values of 100 basis points 48.5 50.7 Impact of a decrease in the discount rate used in the calculation of present values of 100 basis points (66.5) (70.1) Ogden discount rate4 Impact of the Group reserving at a discount rate of 0.75% compared to minus 0.25% (2018: 1% compared to 0%) 53.3 56.2 Impact of the Group reserving at a discount rate of minus 1.25% compared to minus 0.25% (2018: minus 1% compared to 0%) (75.0) (76.3)
4. Ogden discount rate sensitivity has been calculated on the direct impact of a permanent change in the discount rate in England and Wales with all other factors remaining unchanged. The Group will consider the statutory discount rate when setting its reserves but not necessarily provide on this basis, as was the case at the year ended 31 December 2018. This is intended to ensure that reserves are appropriate for current and potential future developments.
The sensitivity above is calculated on the basis of a change in the internal discount rate used for the actuarial best estimate reserves as at 31 December 2019. It does not take into account any second order impacts such as changes in PPO propensity or reinsurance bad debt assumptions.
Other risks include: – reinsurance concentration risk – the concentration of credit exposure to any given counterparty; – reinsurance capacity being reduced and/or withdrawn; – underwriting risk appetite and reinsurance contract terms not being aligned; – reinsurance contract terms being inappropriate or ineffective resulting in classes or types of business not being appropriately reinsured; – non-adherence to the reinsurance policy terms and conditions, in terms of both policy management and claims not being handled within the reinsurance contract terms and conditions or paid on an ex-gratia basis resulting in reinsurance recoveries not being made in full; – inappropriate or inaccurate management information and/or modelling being used to determine the value for money and purchasing of reinsurance (including aggregate modelling); and
– changes in the external legal, regulatory, social or economic environment (including changes resulting from climate change) altering the definition and application of reinsurance policy wordings or the effectiveness or value for money of reinsurance.
3.3.2 Market risk Market risk is the risk of loss resulting from fluctuations in the level and in the volatility of market prices of assets, liabilities and financial instruments.
South Africa 2.4 – – – 2.4 South Korea 3.0 – – – 3.0 172 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2019
174 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 3. Risk management continued 3.3.2 Market risk continued The table below analyses the distribution of infrastructure debt by industry sector classifications.
The hedging relationship was redesignated to reflect this transaction and ensure continuing hedge effectiveness.
The Group also has perpetual Tier 1 notes with fixed coupon rates with a nominal value of £350 million that were issued on 7 December 2017.
The Group is closely monitoring the market and the output from the various industry working groups managing the transition to new benchmark interest rates. This includes announcements made by LIBOR regulators (including the FCA and the US Commodity Futures Trading Commission) regarding the transition away from LIBOR (including GBP LIBOR, USD LIBOR) to Sterling Overnight Index Average Rate and the Secured Overnight Financing Rate respectively and announcements on the transition from EURIBOR to Euro Short Term Rate. The FCA has made clear that, at the end of 2021, it will no longer seek to persuade, or compel, banks to submit to LIBOR.
In response to the announcements, the Group has prepared an IBOR transition plan which has been reviewed by the Board’s Investment Committee and shared with the PRA. The plan identifies where the Group has IBOR exposures and the departments responsible for ensuring suitable actions/monitoring is in place to enable a smooth transition to alternative benchmark rates. Delivering the plan is under the governance of the Chief Financial Officer.
For the Group’s derivatives, the International Swaps and Derivatives Association’s fall-back clauses were made available at the end of 2019 and the Group will begin discussion with its banks with the aim to implement this language into its International Swaps and Derivatives Association’s agreements in early 2020.
Below are details of the hedging instruments and hedged items in scope of the IFRS 9 / IAS 39 amendments due to benchmark interest rate reform, by hedge type.
Pay USD fixed, receive 1-month USD LIBOR interest rate swaps 2020 - 2028 US$901 million Portfolio fair value hedge of the 1-month USD LIBOR component of US dollar denominated fixed rate debt securities
Property risk This is the risk of loss arising from sensitivity of assets and financial investments to the level or volatility of market prices, rental yields, or occupancy rates of properties. At 31 December 2019, the value of these property investments was £291.7 million (2018: £322.1 million). The property investments are located in the UK.
Currency risk This is the risk of loss from changes in the level or volatility of currency exchange rates.
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 652.6 10.1 – – 10.1 Designated as hedging instruments: Foreign exchange contracts (forwards) 10.4 0.2 – – 0.2
Notes: 1. These sensitivities exclude the impact of taxation. 2. 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. The income statement is not impacted in relation to fixed rate instruments, in particular AFS debt securities, where the coupon return is not impacted by a change in prevailing market rates, as the accounting treatment for AFS debt securities means that only the coupon received is processed through the income statement with fair value movements being recognised through total equity.
3. 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 points increase in spreads would have been £16.7 million (2018: £22.2 million) and a 100 basis points increase in interest rate would have been £4.9 million (2018: £5.8 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 2019, the Group has pledged £37.8 million in cash (2018: £31.8 million and £2.9 million in UK Gilts) to cover initial margins and out-of-the-money derivative positions. At 31 December 2019, counterparties have pledged £0.3 million in cash and £9.2 million in UK Gilts (2018: £24.0 million in cash and £7.6 million in UK Gilts) to the Group to cover in-the-money derivative positions.
The main sources of counterparty default risk for the Group are: – investments – this arises from the investment of funds in a range of investment vehicles permitted by the investment policy; – reinsurance recoveries – this arises in respect of reinsurance claims against which a reinsurance bad debt provision is assessed. PPOs have the potential to increase the ultimate value of a claim and, by their very nature, to increase significantly the length of time to reach final payment. This can increase reinsurance counterparty default risk in terms of both amount and longevity; – commercial credit – this arises as brokers collect premiums on behalf of the Group; and – consumer credit – exposure from offering monthly instalments on annual insurance contracts.
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.
Insurance and other receivables 805.9 40.5 0.1 – 846.5 Derivative assets 121.5 – – – 121.5 Debt securities 4,189.6 – – – 4,189.6 Infrastructure debt 278.1 – – – 278.1 Commercial real estate loans 205.7 – – – 205.7 Cash and cash equivalents1 948.6 – – – 948.6
Note: 1. This represents money market funds with no notice period for withdrawal and cash at bank and in hand.
Total £m 178 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2019
The tables below analyse the credit quality of financial and insurance assets that are neither past due nor impaired (excluding debt securities analysed above). The tables include reinsurance exposure, after provision. The Group’s approach to reinsurance counterparty default risk is detailed on page 177.
3.3.4 Operational risk This is the risk of loss due to inadequate or failed internal processes, people, systems, or from external events. Material sources of operational risk for the Group include: Change risk This is the risk of failing to manage the Group’s change portfolio resulting in conflicting priorities and failure to deliver strategic outcomes to time, cost or quality.
Information security risk This is the risk of loss, corruption to Group or customer data, intellectual property or failure of business-critical systems resulting in reputational damage, regulatory censure, supervision, fines and/or loss of competitive advantage.
The Group has in place agreed policies and standards to establish and monitor key controls relating to operational risk.
Trade and other payables, including insurance payables 473.7 4.2 0.2 – – 478.1 478.1
Carrying value £m 3.4 Capital management At 31 December 2019, the Group's capital position was comprised of shareholders' equity of £2,643.6 million (31 December 2018: £2,558.2 million) and Tier 1 notes of £346.5 million (31 December 2018: £346.5 million). In addition, the Group's balance sheet also included £259.0 million of subordinated loan capital (31 December 2018: £259.5 million) which is classified as Tier 2 for Solvency II purposes.
The Group’s regulatory capital position is assessed against the Solvency II framework. From 1 July 2016, the Group gained approval 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 considers business written to date and one year of future written business over a one-year time horizon, in line with Solvency II requirements.
3.5 Capital adequacy (unaudited) Using the Group’s partial internal model, there is a capital surplus of approximately £0.85 billion above an estimated SCR of £1.32 billion as at 31 December 2019 (31 December 2018: £0.89 billion and £1.26 billion respectively). The Group’s capital requirements and solvency position are produced and presented to the Board on a regular basis.
Rescue and other personal lines This segment consists of rescue products which are sold direct through the Group’s own brand, Green Flag, and other personal lines insurance, including travel, pet and creditor sold through its own brands Direct Line, Churchill and Privilege, and through partnership brands and through PCWs.
The table below analyses the Group’s assets and liabilities by reportable segment at 31 December 2019.
Operating expenses before restructuring and one-off costs (356.9) (148.5) (98.0) (114.8) (718.2)
The table below analyses the Group’s assets and liabilities by reportable segment at 31 December 20181 (restated).
Gross earned premium: Gross written premium 3,203.1 3,211.9 Movement in unearned premium reserve (0.5) 94.8
Note: 1. Foreign exchange forward contracts are measured at fair value through profit and loss and interest rate swaps are designated as hedging instruments.
Revenue from vehicle recovery and repair services1 28.3 25.1 Vehicle replacement referral income 19.1 17.2 Legal services income 11.3 11.2 Other income2,3 7.5 18.6
Notes: 1. Revenue from vehicle recovery and repair services includes salvage income previously reported in other income. Comparative data for the year ended 31 December 2018 has been re-presented accordingly. 2. Other income includes mainly fee income from insurance intermediary services. 3. In 2018 other income included a £9.6 million gain on the sale of a property in Bristol.
8. Net insurance claims Gross Reinsurance Net Gross Reinsurance Net £m £m £m restated £m restated
Of which restructuring and one-off costs 11.2 – Total excluding restructuring and one-off costs 693.7 718.2
At 31 December Average for the year 2019 2018 2019 2018
Wages and salaries1 387.2 380.9 Social security costs 41.9 41.2 Pension costs1 25.5 22.7 Share-based payments 18.4 21.0
The table below analyses Auditor’s remuneration in respect of the Group’s operations.
Fees payable for the audit of: The Company’s annual accounts 0.2 0.2 The Company’s subsidiaries 1.8 1.7
Audit-related assurance services 0.1 0.1 Other assurance services 0.1 0.1 Non-audit services 0.1 0.6
At 31 December 2019, one Director (2018: no Directors) had retirement benefits accruing under the defined contribution pension scheme in respect of qualifying service. During the year ended 31 December 2019, three Directors exercised share options (2018: four Directors).
Interest expense on subordinated liabilities 23.1 23.1 Net interest received on designated hedging instrument2 (3.4) (3.8) Unrealised losses on designated hedging instrument2 0.1 5.0 Unrealised gains on associated interest rate risk on hedged item2 (0.8) (5.6) Amortisation of arrangement costs and discount on issue of subordinated liabilities 0.3 0.4 Interest expense on lease liabilities 6.7 6.8
Notes: 1. In the Finance Act 2016 the UK Government enacted a reduction in the UK corporation tax rate from 19% to 17% effective from 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.
2. Results for the year ended 31 December 2018 have been restated to reflect the fully retrospective adoption of IFRS 16 ‘Leases’, see note 44.
188 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 13. Current and deferred tax £m restated
Credit / (charge) to the income statement 0.7 (0.1) (3.9) 4.9 (0.5) – 1.1 Credit / (charge) to other comprehensive income – (0.4) – – – 23.8 23.4 Charge direct to equity – – – – (0.6) – (0.6)
The Board has also approved a share buyback of up to £150 million which it expects to complete by the end of July 2020.
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 dividends paid for the year ended 31 December 2019 by £1.5 million (2018: £2.4 million).
Earnings attributable to owners of the Company 419.9 472.0 Coupon payments in respect of Tier 1 notes (16.6) (16.6) Profit for the calculation of earnings per share 403.3 455.4 Weighted average number of Ordinary Shares (millions) 1,367.2 1,366.5
Acquisitions and additions 0.4 142.0 142.4 Disposals and write-off1 – (4.7) (4.7)
Accumulated amortisation and impairment At 1 January 2018 – 383.3 383.3 Charge for the year – 45.2 45.2 Disposals and write-off1 – (4.7) (4.7) Impairment losses2 – 1.5 1.5
The Group’s testing for impairment of goodwill and intangible assets includes the comparison of the recoverable amount of each CGU to which goodwill and other intangible assets have been allocated with its carrying value and updated at each reporting date and whenever there are indications of impairment.
The recoverable amounts of all CGUs were based on the value-in-use test, using the Group’s strategic plan. The longterm growth rates have been based on gross domestic product rates adjusted for inflation. The risk discount rates incorporate observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
Accumulated depreciation and impairment At 1 January 2018 4.2 104.8 109.0 Depreciation charge for the year 1.1 30.0 31.1
Accumulated depreciation and impairment At 1 January 2018 50.2 5.5 0.1 55.8 Depreciation charge for the year 9.9 4.0 0.2 14.1
DL Insurance Services Limited 03001989 United Kingdom Management services U K Insurance Limited 01179980 United Kingdom General insurance
The Group did not acquire or dispose of any subsidiaries in the years ended 31 December 2019 and 31 December 2018.
194 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 22. Reinsurance assets £m
Receivables arising from insurance contracts: Due from policyholders 684.8 740.4 Impairment provision of policyholder receivables (1.0) (0.9) Due from agents, brokers and intermediaries 111.5 82.9 Impairment provision of agent, broker and intermediary receivables (0.2) (0.5) Amounts due from reinsurers1 10.1 13.5
Note: 1. Amounts due from reinsurers have previously been reported in other debtors. Comparative data for the year ended 31 December 2018 has been re-presented accordingly.
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 10.1 20.6 Designated as hedging instruments: Foreign exchange contracts (forwards)1 0.2 – Interest rate swaps 20.2 5.3
Defined benefit scheme The Group’s defined benefit pension scheme was closed in 2003 although the Group remains the sponsoring employer for obligations to current and deferred pensioners based on qualifying years’ service and final salaries. The defined benefit scheme is legally separated from the Group with Trustees who are required by law to act in the interests of the scheme and of all the relevant stakeholders. The Trustees of the pension scheme are responsible for the investment policy with regard to the assets of the scheme.
196 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 27. Retirement benefit obligations continued The table below sets out the principal assumptions used in determining the defined benefit scheme obligations.
Rate of increase in pension payment 2.1 2.2 Rate of increase of deferred pensions 2.1 2.2 Discount rate 2.0 2.9 Inflation rate 3.0 3.3
Notes: 1. The liquidity fund is an investment in an open-ended fund incorporated in the Republic of Ireland which targets capital stability and income in the UK. It is invested in short-term fixed income and variable rate securities (such as Treasury Bills) listed or traded on one or more recognised exchange.
2. The absolute return bond fund is an investment in an open-ended fund incorporated in Luxembourg which targets positive returns in all market conditions. It is invested in short-term fixed income asset classes and seeks additional returns via a range of additional investments including certificate of deposits, rates and global currencies.
All UK debt instruments have quoted prices in active markets. The absolute return bond fund holds bonds that, rather than being traded on exchange, are traded through agents, brokers or investment banks matching buyers and sellers.
Return on plan assets excluding amounts included in the net interest on the defined benefit asset (3.5) – (3.5) Actuarial gains of defined benefit scheme
Income statement: Net interest income / (cost)1 2.7 (2.2) 0.5 Administration costs (0.5) – (0.5)
Experience gains – 0.4 0.4 Gains from change in demographic assumptions – 0.8 0.8 Gains from change in financial assumptions – (12.9) (12.9)
Experience adjustment gains on scheme liabilities 0.4 – 1.5 1.2 1.2 Return on plan assets excluding amounts included in the net interest on the defined benefit asset 4.4 (3.5) 1.0 13.7 (1.9)
198 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 27. Retirement benefit obligations continued Sensitivity analysis The sensitivity analysis has been calculated by valuing the pension scheme liabilities using the amended assumptions shown in the table below and keeping the remaining assumptions the same as disclosed in the table above, except in the case of the inflation sensitivity where other assumptions that depend on assumed inflation have also been amended correspondingly. The pension cost has been determined allowing for the estimated impact on the scheme’s assets. The sensitivity to discount rates is based on a movements in credit spreads, rather than gilt yields, which are hedged in the scheme’s assets. The selection of these movements to illustrate the sensitivity of the defined benefit obligation to key assumptions should be viewed as illustrative, rather than providing a view on the likely size of any change.
Impact on present value of defined benefit scheme obligations £m £m
Discount rate 0.25% increase in discount rate (0.1) (0.2) (4.5) (3.9)
The most recent funding valuation of the Group’s defined benefit scheme was carried out as at 1 October 2017. This showed an excess of assets over liabilities. The Group agreed with the Trustees to make contributions of up to £1.5 million per annum in 2019, 2020 and 2021 in the event that a deficit subsequently emerges on the anniversary of the funding valuation date.
At the date of signing these financial statements, no contributions are expected to be payable in 2020 (2019: £nil).
Loans and receivables Infrastructure debt 278.1 289.6 Commercial real estate loans 205.7 201.6
Note: 1. The Group swaps a fixed interest rate for a floating rate of interest on its US dollar and Euro and a small amount of its sterling corporate debt securities by entering into interest rate derivatives. The hedged amount at 31 December 2019 was £955.8 million (2018: £1,206.1 million).
Notes: 1. This represents money market funds. 2. Bank overdrafts represent short-term timing differences between transactions posted in the records of the Group and transactions flowing through the accounts at the bank. 3. Cash and bank overdrafts disclosure note is included for the purposes of the consolidated cash flow statement.
Issued and fully paid: equity shares Ordinary Shares of 1010/11 pence each1 1,375 1,375 150.0 150.0
Note: 1. The shares have full voting dividend and capital distribution rights (including wind up) attached to them; these do not confer any rights of redemption.
Employee trust shares The Group satisfies share-based payments under the Group’s share plans primarily through shares purchased in the market and held by employee share trusts.
At 31 December 2019, 8,445,670 Ordinary Shares (2018: 10,432,376 Ordinary Shares) were owned by the employee share trusts with a cost of £30.2 million (2018: £35.2 million). These Ordinary Shares are carried at cost and at 31 December 2019 had a market value of £26.4 million (2018: £33.2 million).
31. Other reserves Movements in the AFS investments revaluation reserve £m
Revaluation during the year – gross 118.1 (121.4) Revaluation during the year – tax (20.1) 20.6 Realised gains – gross (16.5) (19.5) Realised gains – tax 2.8 3.3
Current estimate of cumulative claims 3,400.7 2,219.5 1,892.1 1,712.1 1,830.1 1,859.3 1,934.9 1,998.0 2,237.8 2,110.4
Estimate of ultimate net claims costs: At end of accident year 3,902.0 2,644.4 2,271.8 2,093.9 1,971.0 1,926.7 1,922.2 2,016.9 2,125.9 1,941.2 One year later (125.2) (131.5) (146.7) (123.6) (29.7) (67.0) (18.9) (79.7) (41.4) Two years later (120.4) (82.1) (107.8) (134.4) (42.0) (77.8) (38.2) (65.3) Three years later (44.0) (76.5) (35.6) (27.8) (100.7) (30.4) (43.7) Four years later (93.6) (48.7) (11.6) (64.3) (41.3) (24.1) Five years later (52.3) (37.3) (54.2) (38.9) (52.5) Six years later (43.9) (37.0) (30.4) (17.7) Seven years later (24.8) (20.4) (14.6) Eight years later (17.4) (23.0) Nine years later (17.1)
Incurred but not reported2 924.9 (295.4) 629.5 Claims handling provision 80.0 – 80.0
Cash paid for claims settled in the year (2,103.6) 25.3 (2,078.3) Increase / (decrease) in liabilities: Arising from current-year claims 2,311.3 (169.2) 2,142.1 Arising from prior-year claims (394.0) 99.5 (294.5)
Analysis of outstanding PPO claims provisions on a discounted and an undiscounted basis The Group settles some large bodily injury claims as PPOs rather than lump sum payments.
The provisions for PPOs have been categorised as either claims which have already been determined by the courts as PPOs (approved PPO claims provisions) or those expected to settle as PPOs in the future (anticipated PPOs). The Group has estimated the likelihood of large bodily injury claims settling as PPOs. The anticipated PPOs in the table above are based on historically-observed propensities adjusted for the assumed Ogden discount rate.
204 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 36. Share-based payments The Group operates equity-settled, share-based compensation plans in the form of an LTIP, a Restricted Shares Plan, a DAIP and Direct Line Group Share Incentive Plans, including both the Free Share awards and a Buy-As-You-Earn Plan, details of which are set out below. All awards are to be satisfied using market purchased shares.
Weighted average assumptions during the year: Share price (pence) 318 355 Exercise price (pence) 0 0 Volatility of share price 19% 21% Average comparator volatility 29% 30% Expected life 3 years 3 years Risk-free rate 0.5% 0.9%
The awards outstanding at 31 December 2019 have no performance criteria attached; there is a requirement that the employee remains in employment with the Group for three years from the date of grant.
Direct Line Group Share Incentive Plans: Free Share awards In early 2018, the Group offered all eligible employees a Free Share award granting 133 Ordinary Shares free of charge to celebrate the Group’s fifth anniversary in October 2017 of its launch on the London Stock Exchange. These awards have no performance criteria attached and vest on the third anniversary of the award grant date, subject to completion of three years, continuing employment. The Group initially granted 1.4 million Ordinary Shares with an estimated fair value of £5.4 million using the market value at the date of grant.
Movement in total share awards Number of share awards millions 2018 millions
In respect of the outstanding options at 31 December 2019, the weighted average remaining contractual life is 1.57 years (2018: 1.58 years). No share awards expired during the year (2018: nil).
The weighted average share price for awards exercised during the year ended 31 December 2019 was £3.29 (2018: £3.58).
The Group recognised total expenses in the year ended 31 December 2019 of £18.4 million (2018: £21.0 million) relating to equity-settled share-based compensation plans.
Profit for the year 419.9 472.0 Adjustments for: Investment return (134.6) (154.6) Instalment income (114.0) (119.9) Finance costs 26.0 25.9 Defined benefit pension scheme – net interest charge – 0.1 Equity-settled share-based payment charge 18.4 21.0 Tax charge 89.8 108.5 Depreciation and amortisation charge 77.5 90.4 Impairment of property, plant and equipment, goodwill and intangible assets 1.3 1.5 Impairment provision movements on reinsurance contracts (14.1) (5.2) Gain on sale on assets held for sale – (9.6) Loss on sale of property, plant and equipment and ROU assets 0.3 0.3
Cash generated from operations 182.4 125.2 Taxes paid (95.8) (102.5) Cash flow hedges 1.6 0.8 Net cash generated from operating activities before investment of insurance assets 88.2 23.5 Interest received 280.7 303.6 Rental income received from investment property 16.2 15.9 Purchase of investment property – (0.1) Proceeds on disposal of investment property 24.2 – Proceeds on disposal / maturity of AFS debt securities 1,886.4 2,159.2 Proceeds from maturity of HTM debt securities – 2.5 Advances made for commercial real estate loans (32.3) (59.3) Repayments of infrastructure debt and commercial real estate loans 40.6 49.2 Purchase of AFS debt securities (1,838.8) (2,002.9) Purchase of HTM debt securities (3.1) – Cash generated from investment of insurance assets 373.9 468.1
Notes: 1. Results for the year ended 31 December 2018 have been restated to reflect the fully retrospective adoption of IFRS 16 ‘Leases’, see note 44. 2. Presentational amendments includes ‘Prepayments’ previously presented in ‘Net decrease / (increase) in prepayments and accrued income and other assets’ are now presented separately in the ‘Operating cash flows before movements in working capital’. The comparative data for year ended 31 December 2018 has been re-presented accordingly.
Net lease additions 10.2 9.7 – – – – Amortisation of arrangement costs and discount on issue of subordinated liabilities
40. Commitments and contingent liabilities The Group did not have any material commitments and contingent liabilities at 31 December 2019 (2018: none).
Within one year 13.8 14.5 In the second to fifth years inclusive 39.2 42.9 After five years 69.1 70.4
208 DIRECT LINE GROUP aNNUAL REPORT & ACCOUNTS 2019 42. Fair value Fair value hierarchy Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, regardless of whether that price is directly observable or estimated using another valuation technique.
– level 2 financial assets and liabilities are measured using a valuation technique based on assumptions that are supported by prices from observable current market transactions. These include AFS debt security assets for which pricing is obtained via pricing services, but where prices have not been determined in an active market, or financial assets with fair values based on broker quotes or assets that are valued using the Group’s own models whereby the majority of assumptions are market-observable. Derivatives are valued using broker quotes or appropriate valuation models. Model inputs include a range of factors which are deemed to be observable, including current market and contractual prices for underlying instruments, period to maturity, correlations, yield curves and volatility of underlying instruments.
Commercial real estate loans (note 28) 205.7 – – 203.0 203.0
Commercial real estate loans (note 28) 201.6 – – 201.6 201.6
Differences arise between carrying value and fair value where the measurement basis of the asset or liability is not fair value (e.g. assets and liabilities carried at amortised cost). Fair values of the following assets and liabilities approximate their carrying values: – insurance and other receivables; – cash and cash equivalents; – borrowings; and – trade and other payables, including insurance payables.
The table below shows the unobservable inputs used by the Group in the fair value measurement of its investment property.
31 December 2019 Fair value £m Valuation technique Unobservable input Range
The table below analyses the movement in assets classified as level 3 in the fair value hierarchy.
Decrease in fair value in the period through profit or loss (notes 6 & 20) (6.2)
There were no sales and purchases of products and services to or from related parties in the year ended 31 December 2019 (2018: £nil).
Profit for the period attributable to owners of the Company 473.7 (1.7) 472.0
Notes: 1. In prior periods, the internal cost reallocation model reflected a portion of rental expenses relating to claims handling expense in insurance claims. Under IFRS 16 rental expenses were replaced with a lower depreciation charge in operating expenses, reducing the costs recharged to claims handling after reallocations. The prior period has been restated in respect of this to improve comparability with the current period. This adjustment is also reflected in note 8 and note 34.
Impact on the consolidated balance sheet as at 1 January 2018
Assets Right-of-use assets – 157.9 157.9 Deferred acquisition costs 185.4 (0.4) 185.0 Prepayments, accrued income and other assets 146.2 (3.2) 143.0 Equity Shareholders’ equity 2,715.1 (13.2) 2,701.9 Liabilities Deferred tax 31.1 (2.7) 28.4 Lease liabilities – 170.1 170.1
Current tax assets 4 3.5 – Derivative financial instruments 5 0.6 1.4
Cash and cash equivalents 7 124.2 236.1 Total assets 3,649.8 3,909.9
Profit for the year 143.3 449.6 Other comprehensive loss Items that may be reclassified subsequently to income statement: Loss on fair value through other comprehensive income investments – (0.1) Other comprehensive loss for the year net of tax – (0.1) Total comprehensive income for the year attributable to owners of the Company 143.3 449.5
Total comprehensive income for the year – – – (0.1) 449.6 449.5 – 449.5
Credit to equity for equity-settled share-based payments – – 21.0 – – 21.0 – 21.0 Shares distributed by employee trusts – – (18.4) – – (18.4) – (18.4)
Financials v6.1 1. Accounting policies 1.1 Basis of preparation Direct Line Insurance Group plc, registered in England and Wales (company number 02280426), is the ultimate parent company of the Group. The principal activity of the Company is managing its investments in subsidiaries, providing loans to those subsidiaries, raising funds for the Group and the receipt and payment of dividends.
The address of the Company’s registered office is Churchill Court, Westmoreland Road, Bromley, BR1 1DP, England.
Fair value through other comprehensive income Assets which are held both to collect contractual cash flows and to sell the financial asset, where the contractual terms of the asset give rise to cash flows which are solely payments of principal and interest on the principal amount outstanding, are measured at fair value through other comprehensive income, unless designated as fair value through profit or loss. The Company’s financial assets at fair value through the other comprehensive income relate to UK sovereign debt securities. Movements in the carrying amount are taken through other comprehensive income, except for gains or losses recognised in the income statement when the asset is derecognised, modified or impaired.
Hedge accounting The Company has utilised the transition for hedge accounting option in IFRS 9 to continue applying the hedge accounting requirements of IAS 39.
Additional investment in subsidiary undertakings 18.4 20.9 Impairment of investment in subsidiary undertakings – (1.0)
The subsidiary undertakings of the Company are set out in the table below. Their capital consists of Ordinary Shares which are unlisted. In all cases, the Company owns 100% of the Ordinary Shares, either directly or through its ownership of other subsidiaries, and exercises full control over their decision making.
U K Insurance Business Solutions Limited1 05196274 United Kingdom Insurance intermediary services U K Insurance Limited2,3 01179980 United Kingdom General insurance Indirectly held by the Company: 10-15 Livery Street, Birmingham UK Limited4 JE109119 Jersey Dormant8
Farmweb Limited1 03207393 United Kingdom Dormant7 Green Flag Group Limited2 02622895 United Kingdom Intermediate holding company Green Flag Holdings Limited1 03577191 United Kingdom Intermediate holding company Green Flag Limited2 01003081 United Kingdom Breakdown recovery services Intergroup Assistance Services Limited1 03315786 United Kingdom Dormant7 National Breakdown Recovery Club Limited1 02479300 United Kingdom Dormant7
The deferred tax liability of £0.6 million as at 1 January 2019 and 31 December 2019 is in respect of provisions and other temporary differences. There were no movements to the balance in the year.
Note: 1. At 31 December 2019 the fair value through other comprehensive income debt securities are corporate debt securities of £79.9 million
(2018: £nil) classified as level 2 and fixed interest UK sovereign debt of £5.1 million (2018: £5.1 million) classified as level 1 within the Group’s fair value hierarchy which is set out in note 42 of the consolidated financial statements.
8. Share capital and capital reserves Full details of the share capital and capital reserves of the Company are set out in notes 30 and 31 to the consolidated financial statements.
The aggregate fair value of subordinated guaranteed dated notes at 31 December 2019 was £297.8 million (2018: £297.8 million).
14. Share-based payments Full details of share-based compensation plans are provided in note 36 to the consolidated financial statements.
16. Directors and key management remuneration The Directors and key management of the Group and the Company are the same. The aggregate emoluments of the Directors are set out in note 10 to the consolidated financial statements, the compensation for key management is set out in note 43 to the consolidated financial statements and the remuneration and pension benefits payable in respect of the highest paid Director are included in the Directors’ remuneration report in the Governance section of the Annual Report & Accounts.
Corporate website The Group’s corporate website is www.directlinegroup.co.uk. It contains useful information for the Company’s investors and shareholders. For example, it includes press releases, details of forthcoming events, essential shareholder information, a dividend history, a financial calendar, and details of the Company’s AGM. You can also subscribe to email news alerts.
Market The Company has a premium listing on the UK Listing Authority’s Official List. The Company’s Ordinary Shares (EPIC: DLG) are admitted to trading on the London Stock Exchange.
To access information, the website requires shareholders to quote their shareholder reference number. Shareholders can find this number on their share certificates.
– If the firm does not have contact details on the Register or they tell you the details are out of date, call the FCA on 0800 111 6768.
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Report a scam If fraudsters approach you, tell the FCA using the share fraud reporting form at www.fca.org.uk/consumers/reportscam -unauthorised-firm. You can also find out more about investment scams on the same web page.
Dealing facilities Shareholders who wish to buy, sell or transfer their shares may do so through a stockbroker or a high street bank; or through the Registrar’s share-dealing facility.
Dividend tax allowance The dividend tax-free allowance is £2,000 across an individual’s entire share portfolio. Above this amount, individuals will pay tax on their dividend income. The rate of this tax depends on their income tax bracket and personal circumstances. The Company will continue providing registered shareholders with a confirmation of the dividends paid. Shareholders should include this with any other dividend income they receive when calculating and reporting total dividend income received to HMRC. The shareholder is responsible for including all dividend income when calculating tax requirements. If you have any tax queries, please contact your financial adviser.
Dividend Reinvestment plan 06 May1 Trading update for the first quarter of 2020 14 May Annual General Meeting 21 May Payment date for 2019 final dividend 04 August1 Half Year Report 2020 13 August1 ‘Ex-dividend’ date for 2020 interim dividend 14 August1 Record date for 2020 interim dividend 20 August1 Final date for election under the
Dividend Reinvestment plan 11 September1 Payment date for 2020 interim dividend 10 November1 Trading update for the third quarter
The Articles of Association of the Company (marked up to show the amendments proposed at the AGM) and the letters of appointment of the Executive Directors, the Chairman and the NEDs are available for inspection at the Company’s registered office and at the offices of Allen & Overy LLP.
Available-for-sale investments are non-derivative financial assets that are designated as such, or are not classified as loans and receivables, held to maturity, or financial assets at fair value through profit or loss.
Bootstrapping A statistical sampling technique used to estimate reserve variability around the Actuarial Best Estimate (“ABE”). Results produced from bootstrapping historical data are used to set and inform the level of margin incorporated in the Management Best Estimate (“MBE”).
Claims frequency The number of claims divided by the number of policies per year. Claims handling provision (provision for losses and lossadjustment expense)
Clawback The ability of the Company to claim repayment of paid amounts for equity-settled sharebased payments.
Commission expenses Payments to brokers, partners and price comparison websites for generating business. Commission ratio The ratio of commission expense divided by net earned premium. (See page 225 alternative performance measures.) Company Direct Line Insurance Group plc (the “Company”). Current-year attritional loss ratio
The loss ratio for the current accident year, excluding the movement of claims reserves relating to previous accident years and claims relating to major weather events. (See page 225 alternative performance measures.)
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These reserves are based on management’s best estimate, which includes a prudence margin that exceeds the internal ABE.
This is calculated in the same way as investment income yield but includes the cost of hedging. (See page 225 alternative performance measures.)
Operating expenses These are the expenses relating to business activities excluding restructuring and one-off costs. (See page 225 alternative performance measures.)
Operating profit The pre-tax profit that the Group’s activities generate, including insurance and investment activity, but excluding finance costs, restructuring and one-off costs. Normalised operating profit is operating profit adjusted for weather and changes to the Ogden discount rate. (See page 226 alternative performance measures.)
This is adjusted profit after tax divided by the Group’s average shareholders’ equity less goodwill and other intangible assets. Profit after tax is adjusted to exclude restructuring and one-off costs and to include the Tier 1 coupon payments. It is stated after charging tax using the UK standard rate of 19% and for 2018 it is stated after charging tax using the effective income tax rate of 18.7%. (See page 226 alternative performance measures.)
Further information is presented below, defined in the glossary on pages 222 to 224 and reconciled to the most directly reconcilable line items in the financial statements and notes. Note 4 on page 182 of the consolidated financial statements presents a reconciliation of the Group’s business activities on a segmental basis to the consolidated income statement. All note references in the table below are to the notes to the consolidated financial statements on pages 158 to 211.
Commission ratio is defined in the glossary on page 222 and is reconciled in note 4 on page 182.
Current-year attritional loss ratio is defined in the glossary on page 222 and is reconciled to the loss ratio (discussed below) on page 32.
Expresses underwriting and policy expenses in relation to net earned premium.
Investment income yield is defined in the glossary on page 223 and is reconciled on page 226.
Loss ratio is defined in the glossary on page 223 and is reconciled in note 4 on page 182.
This is a measure of underwriting profitability excluding the effects of weather, Ogden discount rate changes and restructuring and one-off costs and excluding non-insurance income, whereby a ratio of less than 100% represents an underwriting profit and a ratio of more than 100% represents an underwriting loss.
Return on tangible equity is defined in the glossary on page 224 and is reconciled on page 228.
This shows the equity excluding Tier 1 notes and intangible assets for comparability with companies who have not acquired businesses or capitalised intangible assets.
This shows the equity excluding Tier 1 notes and intangible assets per share for comparability with companies who have not acquired businesses or capitalised intangible assets.
This shows underwriting performance calculated as net earned premium less net claims and operating expenses, excluding restructuring and one-off costs.
Opening investment property 322.1 309.3 Opening financial investments 4,737.8 5,040.4 Opening cash and cash equivalents 1,154.4 1,358.6 Opening borrowings (62.0) (54.1) Opening derivatives asset4 11.8 55.1 Opening investment holdings 6,164.1 6,709.3 Closing investment property 20 291.7 322.1 Closing financial investments 28 4,673.4 4,737.8 Closing cash and cash equivalents 29 948.6 1,154.4
Closing derivatives asset4 81.8 11.8 Closing investment holdings 5,943.2 6,164.1 Average investment holdings 6,053.7 6,436.7 Investment income yield 2.4% 2.5% Net investment income yield1 2.1% 2.0% Investment return yield 2.2% 2.4%
Notes: 1. See glossary on page 223 for definitions. 2. See notes to the consolidated financial statements. 3. Includes net realised and unrealised gains / (losses) of derivatives in relation to AUM. 4. See footnote 1 on page 41 (Investment holdings).
Combined operating ratio normalised for weather 86.9% 91.6% 99.4% 97.7% 94.1% 91.5% Effect of Ogden discount rate
Notes: 1. See glossary on page 222 for definition. 2. Results for the year ended 31 December 2018 have been restated to reflect the fully retrospective adoption of IFRS 16 ‘Leases’, see note
Notes: 1. See glossary on page 223 for definition. 2. See notes to the consolidated financial statements. 3. Results for the year ended 31 December 2018 have been restated to reflect the fully retrospective adoption of IFRS 16 ‘Leases’, see note
Certain information contained in this document, including any information as to the Group’s strategy, plans or future financial or operating performance, constitutes “forwardlooking statements”. These forward-looking statements may be identified by the use of forward-looking terminology, including the terms “aims”, “ambition”, “anticipates”, “aspire”, “believes”, “continue”, “could”, “estimates”, “expects”, “guidance”, “intends”, “may”, “mission”, “outlook”, “over the medium term”, “plans”, “predicts”, “projects”, “propositions”, “seeks”, “should”, “strategy”, “targets” or “will” or, in each case, their negative or other variations or comparable terminology, or by discussions of strategy, plans, objectives, goals, future events or intentions. These forward-looking statements include all matters that are not historical facts. They appear in several places throughout this document and include statements regarding the intentions, beliefs or current expectations of the Directors concerning, among other things: the Group’s results of operations, financial condition, prospects, growth, strategies and the industry in which the Group operates. Examples of forward-looking statements include financial targets and guidance which are contained in this document specifically with respect to the return on tangible equity, solvency capital ratio, the Group’s combined operating ratio, percentage targets for current-year contribution to operating profit, prior-year reserve releases, cost reduction, reductions in expense and commission ratios, investment income yield, net realised and unrealised gains, capital expenditure and risk appetite range. By their nature, all forward-looking statements involve risk and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future and/or are beyond the Group’s control.
The forward-looking statements contained in this document reflect knowledge and information available as of the date of preparation of this document. The Group and the Directors expressly disclaim any obligations or undertaking to update or revise publicly any forwardlooking statements, whether because of new information, future events or otherwise, unless required to do so by applicable law or regulation. Nothing in this document constitutes or should be construed as a profit forecast.
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Telephone: +44 (0)20 7489 1188 Website: www.rbccm.com 230 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2019