Governance 44 Chairman’s introduction 46 Board of Directors 48 Executive Committee 49 Corporate governance report 61 Committee reports 74 Directors’ remuneration report 100 Directors’ report
Other information 172 Additional information 174 Glossary and appendices 180 Forward-looking statements disclaimer 181 Contact information
“At half year we refreshed our medium-term targets and our results show we’ve been delivering on our management priorities to maintain revenue growth, reduce expense and commission ratios and deliver underwriting and pricing excellence.
“Looking to the future, this success enables us to continue investing in our technology and customer experience, supporting our plans to grow the business whilst improving efficiency. Together with our track record of delivery, these give us the confidence to continue to target a combined operating ratio of 93% to 95% over the medium term.”
Notes: 1. See glossary on pages 174 to 176 for definitions and Appendix A Alternative performance measures (“APM”) from page 177 for reconciliation to financial statement line items. 2. A reduction in the ratio represents an improvement as a proportion of net earned premium, while an increase in the ratio represents a deterioration.
Our strong performance reflects our success in satisfying customers and a focus on profitability and returns
• Strong growth in direct own brands1 premiums and in-force policies up 9.3% and 5.3% respectively, driven again by continued Direct Line momentum in Motor
• Reported expense ratio in line with 2016. Excluding non-cash intangible assets impairment of £56.9 million (2016: £39.3 million), underlying expense ratio improved 0.5 percentage points to 23.5%
• Final regular dividend up by 40.2% to 13.6 pence bringing the total ordinary dividends to 20.4 pence (2016: 14.6 pence) and a special dividend of 15.0 pence (2016: 10.0 pence). Total dividends for 2017 of 35.4 pence per share (2016: 24.6 pence)
Maintain solvency capital around the middle of the 140% to 180% Solvency II target range
Our three strategic pillars have already helped us deliver sustainable growth and at least 15% RoTE1.
We have the scale and data to provide our customers with an excellent service at a competitive price however they choose to access our insurance – via partners, price comparison websites (“PCWs”) or direct. As an example, a strategic decision was taken with the aim of becoming the largest insurance owner of accident repair centres in the UK. This helped us continue the brand experience throughout the customer journey, targeting excellent workmanship and service at highly competitive prices. We are well placed to work with our partners to deliver more than just insurance. We want to build sustainable relationships, combining our strengths to meet our customers’ needs, such as working on digital innovations with our partner RBS2, helping their customers receive fast, pre-populated insurance quotes.
Our performance in the five years since our initial public offering demonstrates the strength of our strategy and processes.
Direct Line has maintained its brand heritage of speed, simplicity and a common-sense human touch. We continue to sell products direct to customers by phone and online. Our customers want a premium product with exceptional customer care that is tailored to their needs at a competitive price.
Direct Line for Business is an extension of our Direct Line brand. We market a range of business insurance products over the phone and online. Our customers are looking for the right level of cover at the right price.
Privilege targets customers who mainly buy through PCWs. Our customers want a quick and efficient service at the best price.
DLG Partnerships is the Group’s partnerships arm. We specialise in providing personal lines insurance, and roadside rescue and recovery products to some wellknown brands.
We have multiple brands, products and distribution channels. These enable our customers to choose the right cover to protect their cars, homes, holidays, businesses and pets.
Rescue and other personal lines £421.1m Gross written premium 7.7m In-force policies
We are Britain’s leading personal motor insurer measured by in-force policies1, mainly represented through our well-known 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 4.0 million in-force policies.
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 PCWs.
Creating value for our stakeholders Our multi-brand, multi-product and multi-distribution channel business offers different propositions to distinct customers. We believe this approach should enable us to provide good value for customers and sustainable returns for our shareholders.
See page 2 for our investment case See page 30 for operating review
Employees We invest in initiatives to develop our people, creating a high-performance culture based on diversity, continuous training and customer focus.
Shareholders We aim to give our shareholders value by generating sustainable business profits, part of which we distribute as dividends.
Returns to our shareholders remain a key focus in this challenging market environment. Cumulative dividends represent approximately 80% of the share price at the initial public offering.
Linking remuneration to performance We remain committed to ensuring that executive pay is aligned with the Company’s strategy of delivering long-term shareholder and customer value.
The Group achieved a return on tangible equity (“RoTE”) of 21.7% for 2017. An increase of 3.3% (2016: a decrease of 9.4%) in the share price over the year to 381.7 pence (2016: 369.4 pence) at 31 December 2017, together with dividend payments, provided a total shareholder return (“TSR”) of 8.1% for the year (2016: minus 1%). Over the past five years, shareholders have received a TSR of 152% compared to the FTSE 350 (excluding investment trusts) of 62%. The Group has continued to deliver very good results each year, which has enabled the Board to declare cumulative dividends, including special dividends, equivalent to approximately 80% of the IPO share price.
Solvency II The Group uses its partial internal model (“PIM”) to calculate its solvency capital requirement (“SCR”). Taking into account the final dividend and special interim dividend proposed to be paid in May 2018, the Group’s 2017 year-end capital surplus amounts to approximately £0.86 billion above its SCR (2016: £0.91 billion above its SCR). This is equivalent to a solvency capital ratio of 162% (2016: 165%). The Board considers the appropriate Group risk appetite range to be 140% to 180% of
Board and Committee membership changes Succession planning remains a key area of focus for the Board. In February 2017, Danuta Gray was appointed as a NonExecutive Director (“NED”) and Mike Holliday-Williams was appointed as an Executive Director to the Board. Danuta was also appointed as a member of the Remuneration Committee in March 2017 and the Nomination Committee in August 2017.
Employees The Group’s employees are fundamental to the Group’s strategy and to ensuring a high level of service to our customers. I would like to thank each of them for their hard work, initiative and commitment to our mission. Their positive energy, embodiment of the Group’s values and unwavering dedication to our customers helped our businesses progress over these five successful years, and has put us in a strong position for the future.
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 22 and 56.
Q: How is Direct Line Group making insurance much easier and better value for customers? A: I’m really proud that we’re growing our brands and our customer base whilst continuing to deliver a strong financial performance. A lot of our growth is coming through the Direct Line brand, where we have put a huge amount of work into reinvigorating what we do for our customers. We know that insurance is not just about competitive prices; customers value great products and services as well as great prices. This year we’ve added even more propositions which are unique to Direct Line, including providing alternative accommodation should customers be unable to live in their home after an insured event, as well as an emergency plumber service. Our Green Flag brand has also grown fast, showing its effectiveness as a disruptor brand in the Rescue market. And we’ve continued to develop the digital journey through mobile devices, allowing personal customers to use their smartphones in a broader range of claims situations.
Q: What role does IT investment play in your plans? A: Technology is the backbone of our organisation and we’ve seen major changes in infrastructure and software over the last few years. Our profitability has enabled us to pay good dividends and also to continue to invest in technology. In 2017 we launched our new digital platform for small business customers using the Direct Line for Business brand. This addresses the fact that today’s small businesses, particularly start-ups, find insurance complex and expensive and need policies and services that are tailored to the needs of their businesses. Meanwhile we are working on our core personal lines policy and related systems, bringing in best-inclass software aimed at delivering faster, better, digital customer experience at lower cost.
We have invested significantly in IT and data knowledge and capability. We have brought in new talent over the past two years across IT, IT security, digital and data to help achieve this. During the year, we decided that some of the investment undertaken as part of the improvement in IT capability would not deliver the targeted performance levels to meet its customers’ expectations. Therefore, we decided to rework some elements of data storage and data flows. As a result we incurred an intangible asset impairment charge of £56.9 million in the year, reflecting capitalised costs of intangible assets that will no longer be utilised.
In the longer term, our core markets of motor and home and the products we are insuring are changing rapidly and while this brings challenges, it also presents many opportunities. That is why we are investing to stay ahead, for example through a number of strategic partnerships in the FinTech sector which position the Group for some of the disruption which we expect to occur. The most significant challenge in the long term is the potential for driverless cars to enter the mainstream market. We have a positive attitude to new car technology and believe it will make cars much safer, which would be a good thing for society while reducing the pool of risk which customers need to cover via insurance. We believe the insurance industry has a critical role to play in the analysis and adoption of the technology and we are therefore developing insight into the impact of automated driving systems on liability and claims. This is happening, for example, through MOVE_UK and StreetWise, a driverless car consortia which the Group has joined. We also have the benefit of our state-of-the-art repair network, which is investing to stay abreast of new car technology. If the risk pool declines as a result of the new technologies, we would expect the size of the Motor market to contract. In these circumstances we will need to continue to win more of it. With the insights we are gaining, and the relationships we are building, I believe we will be wellpositioned to do that.
All this leads to a high level of employee engagement, which rose again in 2017. Our full engagement score has gone up to 78% (five points higher than last year and 33 points higher than when we first ran the survey in 2014) and over 9,200 people (87%) took part in our DiaLoGue colleague survey this year. We are grateful that so many people participated, and we’re delighted that our efforts in engaging and motivating our colleagues – who, importantly, our internal survey indicates feel that they are listened to and respected – continue to pay off. We want them to know that what they think and what they do really matters to the company.
Q: What is your outlook for the Group in 2018? A: Looking beyond the external uncertainties like the weather, whiplash reforms and the changes to the personal injury discount rate, we have a good plan in place for our customers, shareholders and colleagues. Achieving a balance between all three has been central to our success since IPO and that continues to be our aim.
Turning to our performance beyond 2017, the Group targets a combined operating ratio of between 93% and 95% over the medium term, assuming a normal level of claims from major weather events and no further change to the Ogden discount rate, supported by reductions in our expense and commission ratios and reiterates our ongoing target of achieving at least a 15% RoTE. For 2018, we expect net investment income yield to be around 2.1%, with overall investment return in the region of £150 million.
We operate in a dynamic environment and as such invest in evolving our business to meet the demands of changing customer needs, regulatory requirements and technological disruption. This enables us to serve our customers and manage claims to high standards.
Digitalisation & technology Technology provides opportunities for insurers • Digital technology is changing how customer needs can be met • Data available to insurers is increasing as homes, vehicles and devices become connected
• Increased data and digital access brings a risk to information security
• We continued to pursue our ambitious IT transformation programme and enhanced our digital offering
• We focussed on expenses reduction by using robotics and offshoring as well as investing in our fraud analytics capability
Our response • Launched Direct Line for Business new digital platform, targeting small and micro businesses >£218m invested in UK InsureTechs in the first half of 20171
On average £44m is paid out each day in personal motor and property claims in the UK2
• These changes will give rise to opportunities and challenges for motor insurers. Access to data from connected cars may present a significant opportunity for insurers to evolve their products
Our response • Maintaining our industry-leading position in in-car technology with participation in the StreetWise project aiming to use artificial intelligence to put autonomous vehicles on Britain’s roads by 2019
• Brand strength has a material impact in driving purchase and retention5
Our response • We believe investing in our brands and differentiating propositions is an effective strategy for success, with Direct Line brand policies passing 4 million in 2017
• The strength of our brands and propositions enabled us to operate successfully through the direct distribution channel, deliver a superior service to our customers, great returns to our shareholders and gave us the scale and expertise to operate effectively in the partnership and aggregator channels
• We launched two headline propositions for Direct Line and the “Drive on” proposition for Churchill
• New management appointed for Green Flag and a new advertising campaign highlighting its challenger status
– announcement of the Civil Liability Bill aimed at reducing the cost of soft tissue injury claims
• The vote to leave the EU has continued to bring a level of uncertainty over regulation, in particular on Solvency II
Over of all new cars are already classed as connected in the first half of 20174 of customers believe that claims efficiency and trustworthiness are important5
It is estimated that soft tissue injury reform could cut £1.2bn per year from insurance costs6
Notes: 1. Accenture 2. Association of British Insurers 3. Business statistics, December 2017 – UK Government 4. PwC 5. Morgan Stanley 6. Ministry of Justice
Growth ambition over the longer term We have shown ourselves to be a business that can deliver great things for our customers through our brands and at the same time deliver excellent returns for our shareholders. As we embrace the future we will do so with our consistent strategy which targets sustainable growth. As a forward-looking and proactive insurer we are well-positioned to keep pace with technological change and the opportunities it creates for us to grow the business and continue our history of disrupting the insurance market.
Great retailer Compelling brands, propositions and customer experience to meet diverse and long-term customer needs
Customer satisfaction is critical to the success of our business and our brand. As such we link our customer satisfaction scores to our executive remuneration through the Annual Incentive Plan (“AIP”).
• We are planning to continue to “supercharge” Churchill with new propositions, such as “Drive On” launched this year, assisting customers to replace cars if theirs is written off
• Frontline colleagues continue to have a high focus on delivering great customer experience with 85% of customers surveyed (1 million + responses) in 2017 rating our people’s performance as 9 or 10 out of 10
• Our customer satisfaction scores for the Direct Line brand have seen an 8% improvement from last year, with Churchill seeing a 5% improvement over the same period
Find out how this responds to market drivers on pages 12 and 13
Customer satisfaction with and the quality of our claims process are a crucial part of our brand and help differentiate us from our competitors. As such we link our senior executives’ remuneration to customer satisfaction through the AIP.
Our response • This year we centralised procurement and supply chain management into a single strategic function to enable us to be more proactive in driving performance and value from our supply chain. This helped us lower the total cost of hire car provision, escape of water repairs and our IT infrastructure costs
• We have implemented robotics process automation as one of our initiatives aimed at reducing our expense ratio. We now have 80 robots managing over 30 processes of varying complexity, with over 600,000 transactions completed this year. Next year we plan to expand our robotics programme which currently has the infrastructure to support an additional 170 robots
• We have also invested in our fraud analytics capabilities, moving some of our data and analytics to an agile, cloudbased infrastructure, enabling real time fraud identification and management, as well as the use of wider datasets
• We continued to expand our accident repair network, with the addition of a new garage, bringing the total to 19 across the country. These have enabled us to control indemnity expenditure better while delivering an improved customer experience. To demonstrate our confidence in the service our repair network delivers, we’ve rebranded our repair network as DLG Auto Services
• This year also saw the launch of our car maintenance service proposition for Green Flag, giving our customers access to a network of garages at discounted rates through our partner Roadserve
Our response • We continued to invest in our data science capability with the appointment of a new Chief Data Officer and are focussing on improving our data architecture and driving further value from the data we hold
• We’ve developed a custom-built digital platform to securely interface with our partners, including RBS, NatWest and other third parties, allowing us to provide a seamless customer journey
• We are planning to expand our digital platform to connect with more datasets, enabling us to improve our customer experience and improve the quote and buy journey
Direct Line for Business In 2017 we launched a technology platform that enables small business customers to tailor policies to their requirements. First launched through Hair and Beauty insurance, this “pick and mix” approach delivers more personalised insurance, and we are rolling it out across other commercial lines.
We believe investing in strong development and employee engagement leads to better business performance and a better customer experience. We continue to invest to ensure our people are highly engaged, through targeted interventions at all levels of the organisation. As such we have diversity, engagement and succession targets in the AIP, an important component of our senior executives’ remuneration.
Our response • Our employee engagement has remained high, improving on last year’s already strong result in our engagement survey. We look to retain the strong levels of employee engagement through a combination of local team action planning and top-down activity
• In support of this, over 600 of our people managers have attended our Engage programme, a three-day residential course, helping them develop deeper and more authentic relationships with their teams and colleagues
• Our focus on open and honest conversations led to us speaking to over 650 of our people managers about mental health at our November 2017 leadership conference, initiating a dialogue on this important subject and progressing our value of “bring all of yourself to work”
Capital & risk management Strong foundation of capital and risk management
Our response • We rebased our dividends upwards to reflect the Group’s confidence in our future earnings potential and the progress made since our IPO five years ago. We aim to grow the dividend in line with business growth
• We restructured our debt through the issue of Tier 1 notes and the buy-back of older, more costly debt. As a result we have been able to reduce our interest payments, increase our flexibility and spread the maturity dates of the debt we hold
• We continued to work on embedding risk management across our organisation and this year we launched two internal campaigns to support this
• We purchase reinsurance to reduce volatility of earnings, facilitate effective capital management and transfer risk that is not within the Group’s risk appetite. This includes purchasing reinsurance to protect against large claims for catastrophe, property risk and motor claims. This year, we placed a major proportion of our catastrophe programme on a fixed price for three years.
“The highenergy, interactive delivery encouraged me to take some valuable time to look at my world differently.” Elizabeth Fairburn, Claims Response, Leeds
Engaging our people We are committed to investing in our people. Our newly launched “Engage” programme is designed to energise our managers and build a working environment to be proud of. The aim is to equip managers with the tools and techniques to build high-performing teams, and together deliver outstanding performance.
This is calculated by dividing the earnings attributable to shareholders by the weighted average number of Ordinary Shares in issue.
We have a progressive dividend policy and aim to grow regular dividend in line with business growth. Additionally, we look to return surplus capital to shareholders when appropriate.
See Finance review page 38 See Finance review page 39 See Finance review page 38 See Finance review page 36
We base the Long-Term Incentive Plan (“LTIP”) awards partly on RoTE over a three-year performance period.
Note: 1. See glossary on pages 174 to 176 and APM in appendix A from page 177.
Net Promoter Score (“NPS”) is an index that measures the willingness of customers to recommend products or services to others. It is used to gauge customers’ overall experience with a product or service, and customers’ loyalty to a brand.
While the proportion of complaints received improved on 2016 we recognise we have more to do to reduce these.
As part of this, the Group’s appetite is for general insurance risk, focusing on personal lines retail and SME insurance in the UK. The Group has appetite for non-insurance risks, as appropriate, to enable and assist it to undertake its primary activity of insurance.
3. Maintain stakeholder confidence The Group has no appetite for material risks resulting in reputational damage, regulatory or legal censure, poor customer outcomes, fines or prosecutions, and other types of non-budgeted operational risk losses associated with Group conduct and activities. The Group will maintain a robust and proportionate internal control environment.
The Strategic report, on pages 1 to 43, sets out the Group’s financial performance, business environment, outlook and financial management strategies. It covers how the Group measures its regulatory and economic capital needs, and deploys capital. You can find discussion about the Group’s principal risks and risk management in this section. Note 3 to the consolidated financial statements starts on page 127 and sets out financial disclosures relating to the Group’s principal risks. This covers insurance, market and credit risk; and the Group’s approach to monitoring, managing and mitigating exposures to these risks.
The ERMF enables us to manage the business with the necessary understanding of our risks and controls, as well as having appropriate oversight to manage risks proactively. The ERMF is aligned to the Three Lines of Defence model, and provides a comprehensive approach for managing our risks. Our Policy Framework is a central part of the ERMF, and includes policies and minimum standards which provide the context and risk appetite boundaries within which the business conducts its activities.
• Third party experts review the majority of 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 set our reserves using the latest data and trends.
In particular, the decision to reduce the Ogden discount rate has been reflected in the estimate of reserves
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 131 to 135.
• We only purchase reinsurance from reinsurers with at least an A– rating. For liabilities with a relatively long period of time to settlement, this rating will be at least A+
Operational risk • Information security risk • IT and business continuity risk • Outsourcing risk • Financial reporting risk • Model risk • Partnership contractual obligations risk • Strategic change delivery risk
The risk of loss due to inadequate or failed internal processes, people, systems, or from external events. See page 136.
• Our risk management framework is designed to enable us to capture risk information in a robust and consistent way
Chief Executive Officer • We agree, monitor and manage performance against the Board-approved plan and targets
• We identify and manage emerging risks using established governance processes and forums
Emerging risks Our definition of emerging risks is new or developing risks which are often difficult to quantify; they are also highly uncertain and are external to the Group. Emerging risks are identified by management and are recorded within an Emerging Risk Register. We report these to the BRC for review and challenge. Our emerging risks processes aim to: • identify emerging risks on a timely basis; • manage emerging risks proactively; • mitigate the impact of emerging risks which could affect the delivery of the strategic plan; and • reduce the uncertainty and volatility of our business’ results.
Changes to traditional insurance business models New market entrants and changes in consumer expectations could result in significant changes to the structure of the general insurance market, and require us to update our business model. Our strategy, aligned to our mission to make insurance much easier and better value for our customers, is positioned to take advantage of changes in technology and customer behaviours, and building our partnership capabilities.
Climate change Climate change could increase the frequency of severe weather events in the UK, and in particular, flooding claims costs. We continue to monitor changes in claims experience and consider weather trends as part of our pricing and underwriting approach.
Safer young drivers We have set an ambitious long-term aim of helping to cut deaths of young drivers in their first 1,000 miles of driving to zero. We will, of course, need to work with many other stakeholders to achieve this goal.
Our own claims experience confirms this, as we see that around one in five young drivers crash in the first year.
To help improve young people’s driving behaviour, we identified three key insights that needed to be true if we wanted to help. The first was that we needed to be in the car with them, the next that we needed to provide feedback for improvement and finally that we needed to make the learning experience rewarding, fun and competitive.
We designed a free app, which tracks a person’s driving. Once drivers have downloaded Shotgun to their phones, we monitor their driving for 1,000 miles, with each individual journey receiving tailored feedback. For example: “That was a bumpy ride! Accelerate gradually and be less heavy on the pedals. Let’s turn this around.”
There are six levels of reward. Drivers begin on level one, which enables them to get rewards like a free Amazon voucher. As their driving improves, taking on board their feedback they can progress through all levels and choose rewards from other leading brands. Level six rewards are higher value and experience-based, such as a free helicopter ride. The rewards are meaningful and help drive engagement with the app.
Approach Our approach to Corporate Social Responsibility (“CSR”) helps us put society’s interests at the heart of our business.
We manage our approach through a CSR Advisory Group that comprises senior managers from across the business supported by our CSR team and backed by executive ownership. The CSR Committee oversees our approach.
To find out more about our CSR Committee, see page 68
Marketing this product was not easy: we needed to grab the attention of young drivers who typically aren’t that engaged with the subject of road safety. To do this, we concentrated our efforts on social media, generating awareness with some edgy viral content. This has worked well, helping us to raise awareness of our app with over a million 17 to 25-year olds and we have so far achieved over 20,000 downloads. We also made sure that a wider audience could find out about how Direct Line is taking a broader role in society and tackling meaningful issues. There was a wealth of PR-generated media coverage that spread the word to parents of young drivers and other opinion formers.
PACTS In December, we launched our fourth Road Safety Dashboard with the Parliamentary Advisory Council for Transport Safety (“PACTS”). This pioneering tool uses Department for Transport statistics to produce an index that ranks the road safety record of individual parliamentary constituencies. MPs tell us they find the tool valuable. We also sponsored the PACTS Annual Westminster Transport Safety Lecture in the House of Commons where policymakers and campaigners come together to share ideas and best practice.
Department for Transport We continue to engage with the Department for Transport on various topics, including telematics technology, driverless cars and road safety policy, providing written evidence to assist legislative proposals such as on the Department’s Automated and Electric Vehicles Bill.
Brake We maintained our partnership with road safety charity, Brake, and agreed a new three year programme to produce a series of topical survey reports on driver behaviour and attitudes. The reports include speed, in-vehicle distractions, advanced driver assistance systems and tiredness. Brake uses this research for its wider campaigning, education, community and professional engagement activities to raise awareness of road safety issues. We also share the results with the media and policymakers. At the beginning of the year we sponsored Brake’s Parliamentarian of the Year Awards, which recognise Members of Parliament who have campaigned on road safety issues.
Our people strategy supports our business strategy, ensuring we have capable, skilled and engaged people who can help make buying insurance much easier and better value for our customers.
We continue to focus on building pride in the Direct Line Group, encouraging and celebrating the quality and diversity of our workforce. Various volunteer groups, such as our Employee Representative Bodies and Local Co-ordination Teams, increase our employees’ voice within the organisation.
You can find the ratio of female to male employees and the age profile of our employees at 31 December 2017 in the charts below.
Gender pay gap Information relating to gender pay gap can be found on the Group’s website www.directlinegroup.com.
Anti-bribery and corruption Our Code of Business Conduct sets out our most important legal obligations and helps colleagues follow key policies. We have an anti-bribery and corruption standard in place to ensure that the Group undertakes a consistent approach to bribery and corruption risks in line with risk appetite. We encourage a ‘speak up’ culture across our supplier base, and amongst our colleagues and have a whistleblowing policy in place. For more information see page 67 of the Board Risk Committee report.
Furthermore, following the terrible fire at Grenfell Tower, the Group is working with the Housing Plus Academy to develop a programme which begins to build resilience against such tragedies amongst residents of other tower blocks in the UK. Aside from giving tenants a voice, the programme is being shaped by research, analysis and expert opinion. The key output will be self-help training and materials for residents, though it is anticipated that a number of policy proposals will also follow. These outputs will be shared with Government and relevant agencies.
Volunteering and fundraising We know that participating in fundraising and volunteering is linked to higher engagement levels amongst our people. In order to encourage our people to participate, we run a network of Community and Social Committees which are made up of local volunteers. These receive central funding and support from the Group to support Group-wide national appeals and create a programme of events and activities based on the interests of employees at their sites.
We encourage all employees to volunteer individually or as a team through our ‘One Day’ initiative.
Our Employee Opinion Survey revealed that 33% of staff volunteered or fundraised in company time last year. Our target for 2018 is to at least maintain this level of engagement.
Emissions You can find information on Group-wide greenhouse gas (“GHG”) emissions in the chart below – and more details of our emissions in the Directors’ report on page 102. We are targeting a 57% reduction in absolute GHG emissions (scope 1 and 2) by 2020 against a 2013 baseline.
Note: 1. This excludes discontinued operations, the Group’s former International division.
Personal Lines Motor Highlights • A leading British personal Motor insurer by in-force policies • In-force policies increased by 3.8% with growth in own brands maintained in each quarter • Gross written premium increased by 8.5% with own brands increasing by 11.4% • COR improved by 14.4 percentage points due to the non-repeat of the substantial charge incurred in 2016 as a result of the reduction in the Ogden discount rate
Gross written premium £1,670.4m £1,539.1m Loss ratio 60.9% 74.9% Commission ratio 2.5% 3.2% Expense ratio 28.5% 28.2% Combined operating ratio 91.9% 106.3% Operating profit £364.5m £149.1m
Motor risk adjusted prices increased by 9.5% in 2017 while risk mix reduced by 3.2% reflecting the way the Group deployed Ogden pricing changes which were in line with claims experience. As a result, Motor average premium1 grew by 5.9% in 2017. The Group traded well throughout 2017 and benefitted from its reinsurance programme which was fixed prior to the Ogden discount rate change. Motor also benefitted from better claims experience in 2017 compared with the Group’s long term view of claims inflation. These two factors enabled the Group to grow policy count and premiums at attractive margins.
The market continued to experience a high level of shopping behaviour following the change to the Ogden discount rate, IPT increases and the introduction of last year’s premium disclosures. Market premiums increased during 2017, albeit slowing in the second half, due to better claims experience.
The current-year attritional loss ratio improved by 4.4 percentage points to 79.7% (2016: 84.1%). This reflects strong trading in 2017, the benefit of the Group’s reinsurance arrangements renewed prior to the Ogden discount rate change announcement in February 2017 and better than expected claims experience.
Operating profit was £364.5 million, higher than the prior year, due to the non-repeat of the £150.3 million Ogden charge, the £49 million reserve release and a reduction in commission costs. These positive effects were offset by lower other prior-year reserve releases.
The excess of loss reinsurance programme renewed on 1 January 2018 at a somewhat increased cost reflecting the reduction in the Ogden discount rate and at a level within the Group’s plans and risk appetite. The Group renewed all layers, but retained 10% of the first risk layer (£2 million excess £1 million). This was a successful renewal in an uncertain climate reflecting the Group’s historically strong performance and financial position.
Note: 1. Average incepted written premium excluding IPT for total Motor for year ended 31 December 2017.
Home Highlights • A leading British personal Home insurer by in-force policies • Own brands in-force policies increased by 2.0%; overall reduction in in-force policies of 3.8%, primarily due to partnerships
In-force policies (thousands) 3,248 3,378 Of which own brands 1,794 1,759
The market continued to experience a high level of shopping behaviour following IPT increases and the introduction of last year’s premium disclosures. Market new business premiums increased in 2017 albeit not reflective of claims inflation.
Rescue and other personal lines Highlights • In-force policies for Rescue reduced by 1.5% primarily due to lower partner volumes • Gross written premium for Rescue and other personal lines increased by 5.1% to £421.1 million primarily due to Travel partnerships pricing
In-force policies (thousands) Rescue 3,591 3,646 Other personal lines 4,148 4,234
Operating profit of £43.6 million reduced by £2.3 million. Within Rescue and other personal lines, Rescue operating profit was similar to the prior-year at £43.5 million (2016: £42.8 million).
During Q4 2017 the Group agreed to renew its rescue services partnership with RBS/NatWest for a further five years. The Group is currently in discussion with RBS/NatWest regarding its travel partnership, which is subject to a tender.
The Rescue category has positioned itself as the market disruptor and is seeking to challenge the rescue market. Green Flag launched a new advertising campaign in the second half of 2017, highlighting the value of Green Flag policies compared to its main competitors.
Direct Line for Business gross written premium grew by 11.9% to £122.6 million
Total in-force policies 708 675 Gross written premium £501.5m £499.8m Loss ratio 49.9% 55.3% Commission ratio 19.1% 19.5% Expense ratio 24.4% 23.9%
Performance Commercial in-force policies increased 4.9% to 708k compared with 2016 with a particularly strong performance in Direct Line for Business which increased 8.1%. Commercial gross written premium increased by 0.3% to £501.5 million compared to 2016, reflecting strong growth of 11.9% in Direct Line for Business; particularly in landlord and van products. Gross written premium for NIG decreased by 2.9% compared to 2016, as the Group continued to price for risk and improved profitability.
In addition to the direct channel, NIG continued to support commercial insurance brokers by focusing on enabling easier trading. This included using technology to improve trading efficiency through more on-line products, moving to a paperless offering and investing in new systems for more complex business.
• Operating profit from Ongoing operations of £610.9 million (2016: £403.5 million), primarily due to the non-repeat of the Ogden discount rate change which was reflected in 2016's results. Profit before tax of £539.0 million (2016: 353.0 million)
• Final dividend up by 40.2% to 13.6 pence bringing the total ordinary dividends to 20.4 pence (2016: 14.6 pence) and a special dividend of 15.0 pence (2016: 10.0 pence). Total dividends for 2017 of 35.4 pence per share (2016: 24.6 pence)
Operating profit – Ongoing 610.9 403.5 Run-off 43.8 26.6 Restructuring costs (11.9) (39.9)
Profit after tax 434.0 278.8 Of which Ongoing operations2 462.9 293.0
Notes: 1. See glossary on pages 174 to 176 for definitions and APM in appendix A from page 177 for reconciliation to financial statement line items. 2. Profit after tax for Ongoing operations has been adjusted to exclude the one-off subordinated debt buy back charge of £53.4 million net of tax. 3. A reduction in the ratio represents an improvement as a proportion of net earned premium, while an increase in the ratio represents a deterioration. 4. Estimates based on the Group’s Solvency II partial internal model reported after proposed dividends.
Operating profit from Ongoing operations increased to £610.9 million (2016: £403.5 million). The underwriting result (for both current and prior year), instalment and other operating income and investment income were all higher than for 2016, which was impacted by the change to the Ogden discount rate announced in February 2017. Operating profit from Ongoing operations in 2017 included strong growth at improved margins in the Motor business and strong Commercial results, offset by Home, where 2016 benefitted from significant releases from reserves established following the storms of late 2015. Investment return was higher, with investment income stable while strong realised and unrealised gains more than offset the increased cost of hedging.
Home total 3,248 3,378 Of which Nationwide and Sainsbury’s 631 719
Of which Green Flag direct 802 729 Direct Line for Business 468 433
Home total 799.1 834.4 Of which Nationwide and Sainsbury’s 193.8 215.5
Underwriting profit (£m) 256.9 70.1 Loss ratio 57.4% 60.9% Commission ratio 9.1% 11.5% Expense ratio 25.3% 25.3%
The COR for Ongoing operations of 91.8% (2016: 97.7%) improved 5.9 percentage points, primarily as a result of the improvement in the loss and commission ratios. At the start of the year, the Group set its 2017 COR target for Ongoing operations in the range of 93% to 95%. This assumed a normal level of claims from major weather events. On this basis, the Group achieved a normalised COR towards the lower end of the Group’s target range. This also includes an intangible asset impairment charge of £56.9 million (2016: £39.3 million).
The loss ratio was 3.5 percentage points lower at 57.4% (2016: 60.9%) and reflects a broadly flat current-year loss ratio and higher prior-year reserve releases. The current year loss ratio was broadly stable, as improvements in Motor were offset by EoW claims in Home. Prior-year reserves releases included a charge in 2016 of £175.1 million due to the impact of the change to the Ogden discount rate announced in February 2017, while 2017 includes a reserve release of £49 million, arising after a detailed case review of the Group’s 2016 Ogden provision. Other prior-year releases were lower year on year, albeit large bodily injury claims developed favourably. Home was impacted by higher EoW claims in 2017, whilst 2016 included favourable development from the storms of late 2015.
The decrease in the commission ratio by 2.4 percentage points to 9.1% primarily reflected lower profit share payments to Home partners, as a result of lower prior-year reserve releases, a higher current-year attritional loss ratio and changes to the business mix and partnership arrangements.
The Group’s expense ratio remained stable at 25.3%, as efficiency improvements in the cost base offset higher intangible asset impairments and industry levies. Excluding the impairment charge of £56.9 million (2016: £39.3 million), the underlying expense ratio improved by 0.5 percentage points to 23.5% (2016: 24.0%).
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 is broadly flat at 69.4% in 2017 (2016: 69.2%) with a significant improvement in Motor partially offset by deterioration in other segments.
By division, the COR improved in 2017 in Motor and Commercial, mainly due to higher prior-year reserve releases, as 2016 included a £175.1 million charge for the Ogden discount rate change while 2017 included a £49 million reserve release. The COR deteriorated in Home, primarily due to lower prior-year reserve releases, as 2016 included releases from the 2015 storms; and the impact of higher EoW claims inflation.
Loss ratio – current-year attritional 79.7% 52.0% 67.1% 68.8% 69.4% Loss ratio – prior-year reserve releases (18.8%) (3.0%) (1.7%) (18.9%) (12.4%) Loss ratio – major weather events – Home2 n/a 1.6% n/a n/a 0.4%
Net earned premium (£m) 4 1,337.1 816.3 394.4 452.8 3,000.6 Net insurance claims (£m) 4 1,001.7 332.0 243.0 250.5 1,827.2 Prior-year reserve releases (£m) 33 123.5 75.9 17.5 49.8 266.7 Major weather events (£m) n/a (18.0) n/a n/a (18.0)
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%
Notes: 1. Commercial attritional loss ratio includes weather costs. 2. Home claims for major weather events, including inland and coastal flooding and storms.
Amortisation and impairment of other intangible assets 10 111.0 96.7 Depreciation 10 27.9 30.1
Total costs for Ongoing operations increased to £969.4 million (2016: £923.7 million) reflecting additional costs in line with business growth, along with increases in levies of £13 million during the year and higher intangible asset impairments of £56.9 million (2016: £39.3 million). The impairments are in respect of intangible assets capitalised on the balance sheet and primarily relate to IT projects which aim to improve customer experience, support growth and increase the efficiency of the business. Staff and marketing costs remain broadly flat while absorbing business growth. The increase in claims handling expenses is primarily due to the claims handing provision release of £14 million in 2016. Operating expenses includes £12.5 million (2016: £14.2 million) of investment expenses.
The Group’s expense ratio remained stable at 25.3% (2016: 25.3%). Excluding the impairment charge the underlying expense ratio improved 0.5 percentage points to 23.5% (2016: 24.0%).
Vehicle recovery and repair services include post-accident and pay-on-use-recovery and repairs performed on behalf of third party customers. This income decreased due to a change in the basis of allocation. Other income, which includes salvage income and fee income, increased by £10.1 million in the year to £23.7 million (2016: £13.6 million), primarily due to a change in contractual terms for salvage income.
Note: 1. See glossary on pages 174 to 176 for definitions.
For 2018 the Group expects the net investment yield, after cost of hedging, to be around 2.1%, reflecting the UK’s current low interest rate environment. The performance of the Group’s property portfolio has been very strong since its commencement in 2012. However, given the current levels of the UK property market, the Group does not expect significant gains on property in 2018. Overall, the Group currently anticipates a total investment return in the region of £150 million in 2018.
Ongoing operations All divisions were profitable in 2017, with Motor and Commercial reporting significant improvements in operating profit compared to 2016 due mainly to the non-repeat of the Ogden discount rate change. This was partially offset by a decrease in Home, primarily due to lower prior-year reserve releases and the impact of higher EoW claims. Rescue operating profit of £43.5 million (2016: £42.8 million) is included in the Rescue and other personal lines result.
Previously the Group has reported that Run-off profits and restructuring costs which are not reported in Ongoing operations will broadly offset each other between 2015 and 2018 inclusively. Up to the end of 2017, the accumulated net result from Run-off and restructuring was a profit of £43 million.
For simplicity of reporting going forward, the Group's reporting will focus on operating profit rather than operating profit from Ongoing operations. Material restructuring activities or other one-off items will be disclosed if they occur.
Finance costs Finance costs increased significantly to £103.8 million (2016: £37.2 million) due to the one-off cost associated with the buy-back of £250 million nominal value of the Group’s subordinated guaranteed dated notes. The price paid included a premium to nominal value of £76.8 million, reflecting the market price of the notes. Taking into account associated costs and the interest rate swaps, the net impact of this buy-back was £66.1 million.
Taxation The effective tax rate was 19.5% (2016: 21.0%), which was broadly in line with the standard UK corporation tax rate of 19.25% (2016: 20.0%).
Profit for the year and return on tangible equity Profit after tax for the year was £434.0 million (2016: £278.8 million) primarily resulting from higher underwriting profit following the change to the Ogden discount rate in 2016 and reduced restructuring costs partially offset by higher finance charges which include a one-off charge of £66.1 million.
Earnings per share Basic earnings per share were 31.8 pence (2016: 20.4 pence) reflecting the increase in profit after tax.
In normal circumstances, the Group expects to operate around the middle of its solvency capital ratio risk appetite range of 140% to 180%. As a result of the Group’s lower capital requirements in 2017 and the strong financial performance in the year, the Group has declared a special dividend of 15.0 pence per share as an interim dividend, taking the estimated Group solvency capital ratio post-dividends to 162%. The final dividend will be put to shareholders for approval at the AGM on 10 May, and the final dividend and the special dividend are to be paid on 17 May 2018 to shareholders on the register on 6 April 2018. The ex-dividend date will be 5 April 2018.
Cash flow Net cash generated from operating activities before investment of insurance assets totalled £204.0 million (2016: £35.0 million). This reflected an increase in cash generated from operations to £277.9 million (2016: £117.1 million) and lower taxes paid.
Net cash used in investing activities of £95.3 million (2016: £125.6 million) reduced mainly due to lower purchases of property, plant and equipment assets.
Overall, cash and cash equivalents increased by £193.7 million (2016: £208.4 million increase) across the year to £1,304.5 million (31 December 2016: £1,110.8 million).
The net asset value at 31 December 2017 was £2,715.1 million (31 December 2016: £2,521.5 million) with a tangible net asset value of £2,244.0 million (31 December 2016: £2,012.6 million). The increase since the beginning of the year reflected the 2017 profit offset by dividends paid and a decrease in the available-for-sale (“AFS”) investments reserve from £92.1 million at 31 December 2016 to £80.2 million at 31 December 2017.
Reserving The Group makes provision for the full cost of outstanding claims from its general insurance business at the balance sheet date, including for claims estimated to have been incurred but not yet reported at that date and claims handling provision.
The Group seeks to adopt a conservative approach to assessing liabilities, as evidenced by the favourable development of historical claims reserves. Reserves are based on management’s best estimate (“MBE”), which includes a prudence margin that exceeds the internal actuarial best estimate (“ABE”). This margin is made in reference to various actuarial scenario assessments and reserve distribution percentiles. It also considers other short and long-term risks not reflected in the actuarial inputs, as well as management’s view on the uncertainties in relation to the ABE.
The Group will continue to exercise judgement around the Ogden discount rate used in its reserves allowing for the possibility for it to change in the future. It considers the uncertainties around the legal framework and its implementation risks to the future rate as being significant but broadly balanced and therefore provisions at the current proposed rate of minus 0.75%. An allowance for further movements in the Ogden discount rate is made within the Group’s Solvency ll balance sheet and capital requirement. However, it should be noted that the Government is considering not only the appropriate level for the rate but also the methodology of how it is applied, so any sensitivity has considerable limitations and uncertainty.
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 13.99% of gross earned premium (c.£150 million) and cover is placed annually on 1 July, up to a modelled one in 200 years loss event of 118.94% of gross earned premium (c.£1,275 million). At the last renewal, 1 July 2017, approximately 60% of the reinsurance programme was placed on a fixed price basis (reinsurers’ rate on line) for three years.
Taxation The Board recognises that the Group has an important responsibility to its stakeholders to manage its tax position effectively. The Board has delegated day-to-day management of taxes to the Chief Financial Officer. The Audit Committee provides oversight.
The tax policy of the Group is published on the Direct Line Group corporate website in accordance with the requirements of paragraph 16(2) of Sch 19 of the Finance Act 2016. The policy sets out the approach of the Group to managing its tax affairs, to ensure it complies with applicable tax laws and regulations, meets its corporate social responsibilities as a contributor of corporate taxes and as a collector of taxes on behalf of HMRC, manages its tax affairs efficiently, and claims tax reliefs and incentives where appropriate.
• to match PPO and non-PPO liabilities in an optimal manner • to deliver a suitable risk-adjusted investment return commensurate with the Group’s risk appetite
Notes: 1. Asset allocation at 31 December 2017 includes investment portfolio derivatives, which have been included and have a mark-to-market asset value of £55.1 million included in investment grade credit (31 December 2016: mark-to-market liability value of £5.8 million). This excludes non-investment derivatives that have been used to hedge interest on subordinated debt and operational cash flows.
Motor bodily injury deterioration equivalent to accident years 2008 and 2009 (7pts) One-off catastrophe loss equivalent to the 1990 storm (9pts) One-off catastrophe loss based on extensive flooding of the River Thames (9pts) Change in reserving basis for PPOs to use a real discount rate of minus 1%1 (13pts) 100bps increase in credit spreads1,2 (11pts) 100bps decrease in interest rates2 (9pts)
Capital surplus The Group’s SCR and solvency capital ratio are as follows: Solvency capital requirement (£bn) 1.39 1.40 Capital surplus above solvency capital requirement (£bn) 0.86 0.91 Solvency capital ratio post-dividend 162% 165%
Tier 1 capital – unrestricted 1.59 1.74 Tier 1 capital – restricted 0.35 –
On 7 December 2017, the Group issued £0.35 billion of Tier 1 notes with a coupon of 4.75%. The notes have an optional redemption date of 7 December 2027 and if the notes are not repaid on that date, the rate of interest will be reset. Proceeds of the issuance were primarily used to fund the repurchase of half of the Group’s £0.50 billion 9.25% Tier 2 capital. This repurchase of Tier 2 capital was achieved at a value of approximately £0.33 billion including accrued interest. The remaining Tier 2 capital of £0.25 billion nominal value has a redemption date of 27 April 2022.
Notes: 1. The methodology for calculating the impact on the ratio of an increase in credit spreads and a change in the reserving basis for PPOs to use a real discount rate of minus 1% have been updated in 2017.
2. The sensitivities only include the assessed impact of the above scenarios in relation to AFS investments.
Notes: 1. Foreseeable dividends included above are adjusted to exclude the expected dividends waivers in relation to shares held by the employee share trusts, which are held to meet obligations arising on the various share option awards. 2. Total IFRS financial debt as a percentage of total IFRS capital employed.
Total shareholders’ equity 2.72 2.52 Goodwill and intangible assets (0.47) (0.51) Change in valuation of technical provisions (0.19) (0.05) Other asset and liability adjustments (0.08) (0.09) Foreseeable dividends1 (0.39) (0.13)
Leverage The Group’s financial leverage continued to be conservative at 18.4% (2016: 17.6%). While the Tier 1 notes issued during 2017 are presented as equity in the balance sheet, the Group considers this to be part of its total leverage and the £346.5 million (net of arrangement costs) is included in the ratio.
Tier 1 notes 346.5 --- Financial debt − sub debt 264.7 539.6
Outlook For 2018 and over the medium term, the Group targets achieving a 93% to 95% COR assuming a normal annual level of claims from major weather events and no further change to the Ogden discount rate, supported by reductions in its expense and commission ratios; and reiterates its ongoing target of achieving at least a 15% RoTE.
Following a review of the Board’s expertise and experience, the Nomination Committee engaged external consultants in the search for new candidates. The Nomination Committee led the selection and appointment of Danuta Gray as a Non-Executive Director, with effect from 1 February 2017, and Mike Holliday-Williams was appointed as an Executive Director also on 1 February 2017. On 1 November 2017, Penny James joined the Board as an Executive Director and Chief Financial Officer-designate. The appointment coincided with the announcement that John Reizenstein would be retiring from the Board following the AGM on 10 May 2018. Penny will take over as CFO on 1 March 2018. She joined us from Prudential plc, where she served as Chief Risk Officer and a Group Board member. You can find further information on our diversity policy, our approach to succession planning and Board appointments on pages 70 and 71.
Our commitment to good corporate governance The Corporate Governance report sets out the Direct Line Group framework, which we believe enables effective decisionmaking and management of the risks in the markets in which we operate. Matters Reserved to 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 2017.
Succession planning and Board changes Succession planning has been an area of focus for the Board in 2017. The Board recognises the importance of succession planning and understands the need to have leaders who live the Group’s culture and values. Board diversity from various perspectives is also considered an important matter by the Board and its Nomination Committee. The Board has female representation of 36% and the Board remains committed to seeking to improve further its position on diversity when appropriate opportunities arise.
Executive remuneration The debate in the UK over executive remuneration remains a valid topic for discussion and continuous evaluation. The Group’s remuneration policy was approved by shareholders at the AGM in 2017 and is expected to remain in place for three years. Further details on the work of the Remuneration Committee can be found on page 72 and the remuneration policy summary is detailed on pages 94 to 99.
UK Corporate Governance Code The Board is committed to the principles of the UK Corporate Governance Code 2016 issued by the Financial Reporting Council (the “Code”). I am pleased to report that we have complied with all of the principles of the Code. You can find further explanation and details on pages 49 to 58.
Culture and values The Board is responsible for securing the long-term success of the Group. The Board aims to deliver this success by creating an open and collaborative culture that encourages the Group to make decisions that are best for our shareholders, whilst having regard for our other stakeholders. I believe that the values and the Code of Business Conduct set by the Board are central to the Group’s culture. Our Code of Business Conduct governs the way we treat our stakeholders and our values determine our behaviours. Together, these elements reflect the way we do business with the objectives of delivering long-term sustainable shareholder value and of ensuring our Group’s long-term success. You can find further information on how the values and the Code of Business Conduct aim to deliver long-term success whilst having regard to the interests of our stakeholders on page 59.
Biography Mike is Managing Director, Personal Lines. He joined Direct Line in 2014 and has over 10 years’ insurance industry experience. Under his leadership, the Personal Lines division has delivered strong growth, improved profitability and strengthened its competitive position. This has been achieved through a strong focus on our customers, by enhancing our proposition across our brands and channels, and improving our capability in trading, pricing and digital. Mike was previously CEO 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.
Current external appointments Mike is a member of the ABI General Insurance Council.
Biography Penny joined the Board as Chief Financial Officer-designate on 1 November 2017 and will succeed John Reizenstein as Chief Financial Officer (“CFO”) on 1 March 2018. Penny has extensive financial services experience, having been Group Chief Risk Officer and Executive Director at Prudential plc, where she was responsible for leading risk oversight globally. Before this she was Director of Group Finance at Prudential. She had previously been Group Chief Financial Officer at Omega Insurance Holdings Limited and CFO, UK General Insurance, at Zurich Financial Services. Penny was a Non-Executive Director of Admiral Group plc from January 2015 to September 2017. Penny is an Associate of the Institute of Chartered Accountants in England and Wales.
Current external appointments Jane is Chair of Reclaim Fund Ltd and an Independent Member of the Fairness Committee at ReAssure Ltd. She has her own financial sector consulting business and is also a magistrate.
Biography Mike is Chair of the Nomination Committee. He has over 40 years’ experience of the UK and international financial services sector. He is a respected figure in the insurance industry and well regarded by City investors. Mike was previously Chairman of Resolution, then a FTSE 100 UK life assurance business, and has acted as Chief Executive Officer and Group Finance Director of Resolution plc. He was previously Group Finance Director of Aviva plc. He is an Associate of the Institute of Chartered Accountants in England and Wales.
Current external appointments Mike is Chairman of Close Brothers Group plc.
Biography Paul is Chief Executive Officer (“CEO”). He has been CEO since 2009 and led the Group through its financial turnaround, separation from RBS Group, initial public offering (“IPO”) and its entry into the FTSE 100. Under his leadership, the Group has delivered value for its customers and returns for shareholders by maintaining strong financial performance and underwriting discipline. This has been achieved with a clear strategy, by investing in the engagement of Direct Line people, embedding a values-driven culture and a focus on making insurance much easier and better value for customers. After joining RBS Group in 2004 as Managing Director responsible for products and marketing, he became the CEO of RBS Group’s mainland UK retail banking business. Before joining RBS Group, Paul held various senior multi-channel retailing roles in the GUS and Kingfisher groups. Paul started his career in marketing, with UK and European roles at Procter & Gamble.
Current external appointments Paul is the Deputy Chairman of the Association of British Insurers (“ABI”) Board and a Non-Executive Director of Channel Four Television Corporation.
Biography Danuta was Chairman of Telefónica O2 in Ireland until December 2012, having previously been its Chief Executive from 2001 to 2010. During her nine year tenure as Chief Executive, she increased the customer base from just under 1 million to over 1.7 million. Prior to Telefónica O2, Danuta held various senior positions within BT Group from 1984 to 2001.
Biography Dr Richard Ward is Senior Independent Director (“SID”). Richard was Chief Executive of Lloyd’s of London, from 2006 to 2013. He was a NonExecutive Director of Partnership Assurance Group plc, now part of Just Group plc, between 2013 and 2016 and was Chairman of the Remuneration Committee from 2014 to 2016. Richard previously worked for over 10 years at the London-based International Petroleum Exchange, the second largest energy trading exchange, re-branded ICE Futures, as both CEO and Vice-Chairman. 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.
Biography Clare is Chair of the Remuneration Committee. She has extensive experience and knowledge of people and remuneration gained from her roles at PwC. These included People Partner for Assurance which focused on talent management and career development planning, as well as involvement in the design and operation of remuneration structures across PwC UK. She also has significant financial and audit experience. Clare was a partner at PwC from 1988 to 2011. During her 23 years as a partner, she held several senior and high-profile roles, particularly in the insurance sector. She is a Fellow of the Institute of Chartered Accountants in England and Wales.
Experience and qualifications Humphrey is General Counsel. He joined the Group in 2011 and has over 25 years’ experience as a solicitor. Humphrey is responsible for the Group Legal function and oversees a range of areas of legal advice and services. During Humphrey’s leadership of the Group Legal function and its team of lawyers, he has overseen the legal aspects of the Group’s £500 million debt issue, the IPO and the related separation of the Group from RBS Group, the sale of the Group’s International division, and the 2017 £350 million Restricted Tier 1 debt issue. He is also a Director of DLG Legal Services Limited. Humphrey’s experience includes advising on corporate and commercial matters, steering corporate transactions in the UK and internationally, managing legal risk and dealing with corporate governance issues. Before joining the Group, Humphrey was Group Legal Director at RSA and prior to that he was a corporate lawyer with the City law firm, Ashurst Morris Crisp. He is a graduate of the University of Oxford.
Paul Geddes chairs the Executive Committee. In addition to Paul Geddes, Mike Holliday-Williams, Penny James and John Reizenstein, the Committee comprises the following: José Vazquez, Chief Risk Officer
The UK Corporate Governance Code Direct Line Insurance Group plc (the “Company”) has complied with all of the principles and, except as explained below, all provisions of the Code throughout the financial year up to the date of this report.
The only exception is the recommendation contained in Provision E.1.1 of the Code that the SID should attend sufficient meetings with major shareholders to listen to their views. Throughout 2017, the Board received regular updates from the Company’s corporate brokers on the views of its institutional shareholders and, in addition, the Investor Relations team provided regular updates to the Board. The Chairman, CEO and CFO met with key shareholders following announcements of results and reported shareholders’ views back to the Board. On this basis the Board is satisfied that it understands the views of shareholders, and major shareholders have been invited to meet with the SID should they wish to do so.
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 49 • Effectiveness – page 52 • Accountability – page 56 • Remuneration – page 57 • Relations with shareholders – page 57 For more information about the Code, visit the Financial Reporting Council’s website at www.frc.org.uk.
Board, which contains items reserved for the Board to consider and approve, relating to strategy and management, contracts, financial reporting and controls, internal controls and risk management, Board membership and succession planning, corporate governance, structure and capital, delegation of authority and remuneration.
In addition to the schedule of Matters Reserved, each Board Committee has written terms of reference defining its role and responsibilities. Further details regarding the role and activities of the Board and Board Committees can be found on pages 50 and 61 to 73.
Biographical details of current Directors of the Company as at the date of this report are set out on pages 46 and 47.
Chairman Mike Biggs 9 of 9 – – – – 3 of 3 3 of 3 Senior Independent Director Richard Ward 9 of 9 – 5 of 5 – – 3 of 3 – Non-Executive Directors Danuta Gray2 7 of 8 – – – – 1 of 1 2 of 2 Jane Hanson 9 of 9 5 of 5 5 of 5 3 of 3 4 of 4 – – Sebastian James 9 of 9 – – 3 of 3 – – 3 of 3 Andrew Palmer 9 of 9 5 of 5 5 of 5 – 4 of 4 3 of 3 3 of 3 Clare Thompson 9 of 9 5 of 5 – – – – 3 of 3 Executive Directors Paul Geddes 9 of 9 – – 3 of 3 – – – Penny James 2 of 2 – – – – – – Mike Holliday-Williams 8 of 8 – – – – – – John Reizenstein 9 of 9 – – – 1 of 1 – – Executive Committee member Simon Linares – – – 3 of 3 – – – Notes: 1. Attendance is expressed as the number of scheduled meetings attended out of the number of such meetings possible or applicable for the Director to attend. 2. Due to external business commitments arranged prior to Danuta Gray’s appointment, she was unable to attend the June 2017 Board meeting.
The Remuneration Committee: • Sets and oversees how the Group implements its remuneration policy • Oversees the level and structure of remuneration arrangements for senior executives, approves share incentive plans, and recommends them to the Board and shareholders
The CSR Committee: • Provides oversight and advice on how the Group conducts its business responsibly, including matters relating to environmental, employee engagement and wellbeing, community involvement, ethics and diversity
The Nomination Committee: • Reviews the Board’s structure, size, composition, and balance of skills, experience, independence, expertise and knowledge of the Company • Leads the process for Board appointments and makes recommendations to the Board • Provides guidance to management on executive succession planning
Information & Support The Board accesses assistance and advice from the Company Secretary. The Board may seek external independent professional advice at the Company’s expense, if required, to discharge its duties.
The Chairman: • Maintains, develops and leads the Board • Plans and manages the
Board’s business • Ensures the Directors receive accurate, timely and clear information
• Presides at Board meetings • The Board has agreed individual role profiles for the Chairman and the CEO. These clearly define their roles and responsibilities and ensure that no one person has unlimited powers of decision-making.
The NEDs: • Challenge management in an objective and constructive manner
• Use their wider business experience to help develop the Group’s strategy
The CEO As authorised by the Board, the CEO manages the Group’s day-to-day operations and delivers its strategy and financial results. The CEO delegates certain elements of his authority to Executive Committee members to help ensure that senior executives are accountable and responsible for managing their businesses and functions.
Board meetings The activities undertaken by the Board in 2017 intended to promote the success of the Company, are focused on its role as the leadership and decision-making 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; resetting the Group’s dividend policy; approval of catastrophe reinsurance arrangements; motor reinsurance renewal; authorising the Group’s planned capital management exercise of issuing of £350 million Fixed Rate Reset Perpetual Restricted Tier 1 notes with a coupon of 4.75% (“Tier 1 notes”) to investors, which were primarily used to fund the repurchase of half the Group’s £500 million (nominal) 9.25% Tier 2 debt; and reviewing broker reports on the Group alongside feedback from investor meetings.
Board & Board Committee governance, including: receiving reports from the Board’s Committees; updating terms of reference for the Committees; and implementing an annual review of the Board and Board Committees’ effectiveness.
In addition to routine business, the Board considers and discusses key issues that impact on the business as they arise. 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. The NEDs meet with key management outside the Board and Committee fora to get a wider view of the Group’s activities.
Strategy day The Board sets aside time each year outside the annual Board calendar to hold a strategy day giving the Directors the opportunity to focus solely on strategic matters. In June 2017, the Board held a session offsite to set and monitor progress against the Group’s strategy and to discuss the strategic challenges and opportunities the Group faces in the future, including advances in car technology.
Board training The Board is committed to the training and development of Directors and employees. The Company Secretary is responsible for helping the Chairman regularly review and organise training for the Directors. The Company Secretary also maintains an annual training agenda for the Board and its Committees. In order for our Directors, particularly the NEDs, to discharge their responsibilities, it is essential that they understand our business.
The main Board training activities in 2017 included training on topics such as: • competition law; • Solvency II matters; • the Group’s Internal Economic Capital Model (“IECM”); • the Group’s investment risk appetite; • cyber risk and security; • the upcoming new insurance contracts standard (IFRS 17); • the outlook for internal audit in 2020; • EU General Data Protection Regulation (“EUGDPR”); • alternative pricing; • conduct pricing; and • motor reinsurance.
Jan Feb March April May June July August September October November December
Business unit visits The Board visits different business units during the year. During 2017, NED visits to operational business units were arranged to meet the management teams and better understand how the business operates. These included visits to Sales, Customer Operations, Auto Services, Digital, Personal Lines, Data Science, Operational Risk and Commercial teams in Ipswich, Glasgow, Warwick, Doncaster and Bromley.
Board inductions All new Directors appointed to the Board undertake an induction programme aimed at ensuring they develop an understanding and awareness of our businesses, people and processes, and of their roles and responsibilities as Directors of the Company. The programmes are tailored to suit each Director and include: • provision of relevant current and historical information about the Company and the Group; • visits to operations around the Group; • induction briefings from Group functions; and • one-to-one meetings with Board members, senior management and the Company’s advisers.
Danuta Gray’s programme focused on the Group’s businesses, strategic and transformational priorities, regulatory and governance frameworks, capital and financial management, and risk framework. Given Mike Holliday-Williams’ extensive experience of the business, his induction programme focused on his duties and responsibilities as an Executive Director of the Company and corporate governance matters.
Penny James commenced her induction programme in September 2017 which prepared her for her role as an Executive Director and CFO of the Company. The programme was tailored to familiarise Penny with the business, its culture, the market in which it operates and its people.
Board and Committee 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. In 2017, the Board chose to conduct its effectiveness review in-house.
The Company Secretary designed and co-ordinated the process. This involved agreeing a structured questionnaire with the Chairman, SID and the Chairs of the Board’s Committees, distributing it to and interviewing the directors and stakeholders and preparing reports. The Board and each of its Committees reviewed and discussed the relevant reports.
Whilst the findings of the 2017 effectiveness review were positive, the Board and each of its Committees will focus during 2018 on opportunities for fine-tuning with the objective of further improving effectiveness.
Governance framework and structure The Board is responsible for ensuring an appropriate system of governance is in operation throughout the Group. This includes a robust system of internal controls and a sound risk management framework. The Board has established a risk management model that separates the Group’s risk management responsibilities into three lines of defence. An explanation of these responsibilities can be found on page 22.
(“ERMF”), which is described on page 23; • Executive Governance Framework, which outlines how each business function is governed and details the authority delegated to Executive Committee members; • Group policies, which address specific risk areas and inform the business how it needs to conduct its activities to remain within Risk Appetite; and
• Minimum Standards, which interpret the Group policies into a set of operational requirements that can be implemented throughout the Group.
Policy owners approve Minimum Standards subject to non-objection from the Risk Management Committee.
Conflicts of interest The Company’s Articles of Association allow the Board to authorise matters where there is, or may be, a conflict between the Group’s interests and the direct or indirect interests of a Director, or between a Director’s duties to the Group and another person. This is in accordance with the Companies Act 2006.
Further information regarding the Group’s approach to diversity including the process for Board appointments and reappointments can be found on pages 70 and 71 of the Nomination Committee report.
Senior management gender diversity The Board remains committed to ensuring that high-performing women from within the business and from a variety of backgrounds, who have the requisite skills, are given the opportunity to progress their career internally.
Additional 2017 diversity initiatives Other initiatives to broaden the diversity of the Board and senior management were also undertaken during 2017 and included: the revitalisation of the Diversity Network Alliance disability strand and the addition of the neuro-diversity strand; the creation of an inclusive work environment programme; the introduction of unconscious bias training for people managers; and the Group’s sponsorship of multiple diversity events.
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. The Board is also satisfied that the Chairman’s external appointment as Chairman of Close Brothers Group plc set out on page 46 does not restrict him from carrying out his duties effectively.
• the Audit Committee reviewed the substantially final draft of the Annual Report & Accounts, before consideration by the Board.
The Group operates a Three Lines of Defence model. You can find out more about this in the Risk management section on page 22.
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 programme of activity to upgrade and better integrate the major IT systems within the Group’s technology infrastructure, including focusing on developing future capability for both customers and colleagues and monitoring risks relating to IT systems’ stability, cyber security and the internal control environment.
Accountability An explanation of how the Board complies with the Code in relation to accountability is set out below, except for the following matters, which are covered elsewhere in the Annual Report & Accounts: • how the Company seeks to generate value over the long term is explained in the business model on pages 6 and 7, and the strategy for delivering Company objectives is on pages 14 to 19; and
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 61 to 64.
You can find an explanation from the Directors about their responsibility for preparing the financial statements in the Statement of Directors’ responsibilities on page 103. The Company’s External Auditor explains its responsibilities on page 111.
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 appropriate 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 process included reporting on the nature and effectiveness of the controls, and other management processes that manage these risks.
The BRC regularly reviews significant risks and how they might affect the Group’s financial position; comparisons to agreed risk appetites; and what the Group does to manage risks outside its appetite.
Assessing principal risks The Board determines the nature and extent of the risks that it is willing to take to achieve its strategic objectives. The Directors 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 24 and 25.
The Chairman, SID and NEDs are available to attend meetings with major shareholders at their request. During 2017, the Company’s major shareholders were offered the opportunity to meet with the Chairman and/or the SID. In 2017, the Chairman met some of the Company’s major shareholders and discussed corporate governance topics including the Board’s philosophy on shareholder returns with respect to regular and special dividends.
It is open to all shareholders to raise any issues they wish with the Chair of the Remuneration Committee. As part of the development of the revised remuneration policy for Executive Directors which was approved by shareholders at the Group’s 2017 AGM, the Chair of the Remuneration Committee led a wide-ranging consultation through engagement with proxy advisers, regulators and shareholders on matters relating to executive remuneration.
The Investor Relations team helps the Directors to communicate with investors. As demonstrated in the calendar on the next page, the Directors, in conjunction with senior management and the Investor Relations team, participated in varied forms of engagement, including investor meetings, seminars and conferences throughout 2017.
During 2017, the brokers undertook a comprehensive collection of investor views of the Group. The feedback received from the brokers helped the Group in its aim to provide investors with a simpler and more succinct summary of progress to date and the medium term direction of the business, from a financial, operational and strategic perspective.
Taking feedback received from the brokers into account, the Board also reviewed the Company’s dividend policy. The revised policy which was disclosed in the 2017 Half Year Report, aims to maintain flexibility and guide investors in their understanding of how the Group approaches the consideration of special dividend payments in the future. Further details on the revised dividend policy can be found on pages 42 and 100.
Q2 2017 • Q1 Trading Update • AGM • Keefe, Bruyette & Woods
In December 2017, the Group announced the successful completion of its planned capital management exercises of the issue of Tier 1 notes to investors, which were primarily used to fund the repurchase of half the Group’s £500 million 9.25% Tier 2 debt. The principal purposes of the transaction were to increase Tier 2 debt capacity and to spread the maturity profile of the Company’s debt. Debt investor feedback received was positive, with strong support for the transaction rationale, investment case, strength of the balance sheet and overall business performance of the Company.
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 2017.
The Directors have regard to the interests of the Company’s stakeholders with a view to promoting the success of the Group for the benefit of its shareholders as a whole, and pursuing initiatives for the benefit of wider stakeholders. This resonates with the Group’s open and collaborative culture and corporate values.
Accordingly the Board has regard to matters including: the consequences of its decisions for the long term; the interests of the Company’s employees; the need to foster the Company’s business relationships with suppliers, customers and others; the impact of the Company’s operations on the community and the environment; and the requirement to act fairly as between members of the Company.
• The Board has regularly reviewed the strategy, plans and progress of the multi-year transformation programmes to upgrade the Group’s operating systems for Personal Lines and Commercial customers aimed at improving customer experience and covering pricing and other related data and digital systems across all products.
• The Board listened to telephone calls between customers and employees and reviewed customer feedback to gain a deeper insight into matters including customer retention, complaints handling, overcoming price related problems and the use of telematics.
• The Remuneration Committee has incorporated customer metrics into its decision making process for the award of bonuses to management as part of the Group’s AIP.
• The Non-Executive Directors visited various office locations and participated in CONNECT activities. CONNECT is a development programme aimed primarily at supporting employees in having better customer conversations.
• A Leadership conference for circa 650 people managers was held in November 2017, which was attended by members of the Board and all members of the Executive Committee.
• The Group is a signatory to the Women in Finance Charter and the Board is committed to seeking to increase female representation in senior management to 30% by the end of 2019. As at 31 December 2017, female representation in the Group’s senior management was 25%.
• The Directors have encouraged and supported management with Shotgun, which is the CSR campaign with the ambitious long term aim to reduce deaths of young people in their first 1,000 miles of driving to zero.
• As part of a Board visit to Doncaster, management presented to the Board on how the Doncaster office had delivered against the Group’s CSR strategy, with a particular focus on the work undertaken in the local community and raising money for charities.
• In December 2017, the CSR Committee approved a new CSR strategy which has two overarching goals: ‘Protecting Britain’s road users’ and ‘Reflecting an everchanging Britain’. The priority for each goal is Shotgun and diversity and inclusion respectively.
• For the five years after the IPO the Group has consistently achieved profitable growth and returned £2.4 billion to shareholders, including the £393 million after payment of the proposed final and special dividends. The diagram below sets out the returns relating to RoTE and TSR for the financial years from 2013 to 2017.
Dealing with shareholders and other stakeholders We shall seek to maximise shareholder value over time, recognising that wealth generated also benefits customers, employees and the communities where we operate.
Dealing with communities and the environment We shall contribute to the social and economic well-being of those communities where we are an employer, and encourage employees to participate in projects and initiatives to strengthen those communities.
Dealing with regulators We shall maintain a constructive and open relationship with our regulators to foster mutual trust, respect and understanding, and will not offer anything to officials in return for favourable treatment.
Our Code of Business Conduct The Board has approved a Code of Business Conduct which summarises the Group’s business practices in relation to customers, shareholders and other stakeholders, employees, suppliers, the community and environment, competitors and regulators.
• On 27 February 2017 the MoJ announced a change in the personal injury discount rate used in the assessment of damages for large bodily injury claims. The rate changed from 2.50% to minus 0.75%. The Committee reviewed and challenged management’s assessment of the impact of the proposed new discount rate on both the cost of settling reported claims and claims incurred but not reported. The associated second order impacts on claims cost, such as the additional cost for claims settling as PPOs and associated reinsurance recoveries were also reviewed. The Committee agreed that the Group should recognise the best estimate net impact of the rate change immediately and therefore the impact was reflected in the 2016 IFRS financial statements and Solvency II surplus capital reported position. Further information can be found in the Annual Report & Accounts for 2016.
• The Committee provides oversight of the accounting estimates and judgements used in the preparation of the financial statements. For further details please see the table of significant judgements and issues on page 62.
• In relation to Group Audit, the Committee received a report on compliance with the updated Chartered Institute of Internal Auditors guidance on effective internal audit in the financial services sector (“IA Code”). This provided an opportunity to challenge how the function sought to comply fully with the IA Code.
Committee skills and experience In line with 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 across a number of different insurance businesses, enabling them to contribute diverse expertise to the Committee’s proceedings. To keep their skills current and relevant, and in addition to Board training, members of the Committee have received training during the period on matters including a deep dive of Group Audit, IFRS 17 and the Solvency II technical provisions.
Main activities during the year At each scheduled Committee meeting, the Committee receives reports on financial reporting, reserves, internal controls and Group Audit, except at the December 2017 meeting where the focus was on pre year-end financial matters. You can find out more about this in the following sections.
During the year, the Committee reviewed the preliminary announcement of the Group’s 2016 financial results, the 2016 Annual Report & Accounts, the 2017 Half Year Report, the Regular Supervisory Report and the Solvency and Financial Condition Report. The Committee then recommended them to the Board for approval. The Committee also reviewed the trading updates for the first and third quarters of 2017.
The Committee followed a review process before recommending the reports to the Board which focused on significant accounting policies and practices, emphasising those requiring a major element of judgement. The review also considered the going concern assumptions and viability statement in the case of the Annual Report & Accounts, valuation of assets and impairment reviews, reserving provisions, unusual transactions, clarity of disclosures and significant audit adjustments. This included the Solvency II balance sheet and the annual Quantitative Reporting Templates.
When the Lord Chancellor announced the change to the personal injury discount rate (the “Ogden discount rate” or “ODR”) in February 2017, reducing it from 2.50% to minus 0.75%, the Committee considered the impact on the 2016 accounts and discussed and challenged the analysis. Furthermore, at the time of the Half Year results in 2017, the Committee also considered the proposed release of reserves of £49 million in connection with reduced sensitivity to the Ogden discount rate from reserve releases in the first half of the year.
The Committee reviewed the ABE of the level of reserves. This included a report from independent external actuarial consultants on their assessment of the appropriate level of reserves for certain risks. Following the review of the ABE, the Committee also considered the MBE of reserves which can take into account certain trends, risks and higher confidence levels than those which are allowed for in the ABE due to its reliance on past experience. Further information on reserves is provided in this report.
The Committee considered the accounting estimates and judgements that had a material impact on the IFRS financial statements.
The Committee continues to consider major accounting estimates and judgements made in preparing the financial statements.
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. An external actuarial review focusing on some of the reserves requiring most judgement was carried out by PricewaterhouseCoopers LLP for the Directors of the Company.
The Committee considered reports prepared by management on the significant estimates and judgements that were material to the financial statements and challenged the judgements being made, in particular in relation to the non-cash intangible asset impairment of £56.9 million. This relates to capitalised software development costs for ongoing IT projects primarily relating to the development of new systems. The Committee also discussed these matters with the External Auditor.
IFRS 17, which relates to recognition, measurement, presentation and disclosure of insurance contracts, applies to annual reporting periods beginning on or after 1 January 2021. It is expected to have a significant impact on accounting for insurance contracts and the Committee received a training session dedicated to the key aspects of IFRS 17 and the likely areas of impact on the Group.
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 the most significant actions are completed. The Committee also approves the Group Audit Charter.
External audit Deloitte LLP (“Deloitte”) has served as the Company’s Auditor since 2000. Before listing, the Group was audited as a division of RBS Group. 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.
Effectiveness of the external audit process and re-appointing Deloitte as External Auditor In 2017, the Committee assessed the External Auditor’s effectiveness. This was in addition to regularly questioning the External Auditor during its meetings. The Committee assessed the External Auditor through: (i) a detailed questionnaire completed by key stakeholders; (ii) discussing matters with the CFO; (iii) formally reviewing Deloitte’s independence; and (iv) assessing whether it fulfilled the agreed audit plan.
The Committee subsequently recommended to the Board that the Group re-appoint Deloitte as External Auditor. The Group will put a resolution regarding this to shareholders at the 2018 AGM.
Note: 1. You can find further information in note 10 to the consolidated financial statements.
The Committee monitored the Group’s exposure against these risk appetite statements and the lower level risk appetite statements, reviewed key risk indicators and assessed the drivers that affect status against risk appetite. The Committee reviewed and questioned the justification of the assessment of certain risks and the robustness of management action plans to address areas close to or outside tolerance. The extent of change being executed continued to be an area of focus for management and the Committee reviewed and challenged the actions taken by management in relation to change risk.
• The Group is focused on making insurance much easier and better value for its customers. The Committee reviewed and challenged the design and embedding of action plans developed to improve the management of customer complaints, including the plans to re-energise the training and coaching of staff to support improvements in complaint handling. The Committee probed management on the top five complaint categories for each of Personal Lines, Claims and Commercial and the activities planned to improve customer journeys.
• The Group is progressing multi-year transformation programmes to upgrade its operating systems for Personal Lines and Commercial customers aimed at improving customer experience, covering pricing and other related data and digital systems across the business. The Committee regularly scrutinised and challenged the plans, progress, governance and key risks relating to these programmes including in relation to build, testing and deployment. In addition, the Committee monitored these programmes in the context of seeking to achieve the planned benefits to customers. The Committee also considered the outputs of reviews undertaken by the Risk function regarding these programmes.
• The European Union General Data Protection Regulation (“EUGDPR”) is an important area of focus for companies. The Committee monitored and challenged the plans, progress and governance regarding preparedness for EUGDPR which comes into force on 25 May 2018. The regulations include more stringent requirements on how personal data can be collected and processed and for enhanced privacy rights for individuals. The Committee questioned management on activities and action plans including, in relation to: (i) e-Privacy; (ii) notices of consent; (iii) the scope of the legislation; (iv) data retention; and (v) data portability. Training on EUGDPR was delivered to the Board in 2017.
Membership, attendance and responsibilities of the Committee can be found on pages 49 and 50.
The Committee assessed the principal risks facing the Group, which you can find listed on pages 24 and 25. The Committee achieved this by reviewing and challenging the Group’s Material Risk Register in the context of the Group’s risk appetite and through consideration of the risk assessment contained in the CRO’s report that was discussed at each scheduled meeting.
Customer and Conduct The Group aims to make insurance much easier and better value for its customers by endeavouring to deliver on its commitments and seeking to 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 gain assurance that customer expectations and outcomes were reasonable and appropriate and to determine that the Group was operating within its defined conduct risk appetite, as set by the Board.
At the Committee’s meeting in February 2017, and following the transfer of responsibility for ownership of the Group’s Conduct Policy from the Risk function to management, the Committee reviewed and challenged reports from management on conduct culture and customer complaints.
The Committee reviewed and challenged the outputs from conduct and compliance assurance reviews, including in relation to Solvency II compliance.
The Committee reviewed the Group’s Regulatory Governance Map and received updates on regulatory interactions, particularly with the FCA and PRA. The Committee also received updates on relevant regulatory developments, including an update on the changes to the Senior Manager and Certification Regime. The regime now covers employees who are considered to be performing functions which are of specific importance to the sound and prudent management of the firm.
The Committee received regular reports on the Group’s actions to prevent financial crime, including reviewing the annual Financial Crime Report.
Risk governance Every year, the Committee reviews and approves the ERMF, which includes details of the Group’s Policies and Minimum Standards. The Committee reviewed and challenged each Group Policy and the Regulatory Governance Map as part of the Group’s Solvency II requirements and recommended them for approval by the Board. The Committee also considered the results of the annual Group assessment of the effectiveness of the internal control environment undertaken by each business directorate, as well as monitoring controls on an ongoing basis.
Whistleblowing The Committee reviewed the arrangements by which employees may, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters (“whistleblowing”). The Committee also reviewed 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. The Committee probed management and was satisfied that the whistleblowing process met the necessary standards and that it was adequately designed, operated effectively and adhered to regulatory requirements.
The Chair reports on matters dealt with at each Committee meeting to the subsequent Board meeting.
In December 2017, the Committee approved a new CSR strategy which has two overarching goals: ‘Protecting Britain’s road users’ and ‘Reflecting an ever-changing Britain’. The priority for each goal is Shotgun and Diversity and Inclusion respectively.
“Shotgun”, the CSR initiative designed with the ambitious goal of seeking to reduce young driver deaths in their first 1,000 miles of driving to zero. The Committee received reports at each meeting on the development of the app and the key milestones.
• The Committee reviewed the progress achieved in the year in relation to the community. This included responding to the fire at the Grenfell Tower, London, in June 2017 and to the terror attacks which took place in the UK in 2017. The Committee supported management in its decisions to fund a project to help tower block tenants build resilience and in providing support for the British Red Cross, respectively.
• During the year, the Committee reviewed the key statistics in relation to the gender pay gap, and the work being undertaken to increase the number of women in senior roles. The Committee was delighted to note the continued strong performance in raising employee engagement scores across the Group, as measured by the annual employee survey, and continues to push for initiatives to further increase engagement.
Helping to make our society safer (Shotgun): During the year, the Committee received progress updates at each meeting on Shotgun. You can find further details on Shotgun and about the Group’s priorities in the CSR report on pages 26 to 29.
Being recognised as part of our communities The Committee reviewed progress on strengthening the level of support provided by the Group to the network of Community and Social Committees operating across the Group. The Committee challenged the main targets which related to volunteering, fund raising, matched payroll giving; and the Community Cashback scheme, a scheme which supports the causes and community groups which employees felt most passionately about when they fundraise or volunteer in their own time.
The ‘One Day’ volunteering initiative, which gives employees paid leave to volunteer in their local community, and Community Cashback scheme continued to be considered the two areas with the greatest potential for impact. These arrangements encourage colleagues to take part and raise funds for local causes.
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 (“GHG”) 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 reviewed the CSR-related feedback received from proxy voting advisers and encouraged management to consider addressing the relevant feedback.
• At the meeting in January 2017, the Committee approved the proposal by the Investment & Treasury department to bring in-house the management of certain Sterling investment grade fixed income assets as part of the drive to deliver a more cost-effective investment operating model. Approval followed a long period of scrutiny by the Committee starting early in 2016, during which time an independent assessment was received on the adequacy of credit selection and monitoring processes to be employed and the results from a model portfolio examined on several occasions. Later in 2017, the Committee received a positive internal audit report which had been requested at the time of authorising the initiative to provide further assurance over the ongoing management of the internally managed portfolios. The report confirmed that the key controls for the internally managed portfolios were operating effectively.
• The Committee considered research undertaken to identify the most appropriate metrics to employ with regard to sizing the investment risk budget within the context of the Group’s other risks (primarily insurance risk), and capital. A number of metrics, with proposed risk appetite limits, were agreed and recommended to the Board.
• The Committee wanted to understand the actions undertaken to comply with the requirements of the Prudent Person Principle (“PPP”) under the Solvency II Directive. 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 actions and risks taken against the PPP guidelines.
Main activities during the year Market developments At each scheduled meeting the Committee received a market update from the Director of Investment Management and Treasury. The update covered economic conditions in the UK, the United States of America and the Eurozone; market levels for key asset classes (notably credit); the outlook for interest rates and inflation; and developing issues viewed as appropriate to be brought to the attention of the Committee. High asset prices, divergent monetary policies pursued by central banks, the expected slowdown in UK annual growth and growing consumer indebtedness shaped the Committee’s investment concerns across the course of 2017.
Suitability of investment strategy An annual asset and liability management study is presented to the Committee each year which informs strategic benchmark allocations and provides part of the context for the addition of new asset classes or exiting a present holding. The Committee was particularly interested this year to understand how the change in the Ogden discount rate, which was announced in February 2017, impacted asset benchmark holdings given changes to the relevant underlying reserves.
Monitoring investment activity and performance The Committee received a comprehensive report at each scheduled meeting covering: the financial results from investment activity; aggregate portfolio positioning versus strategic benchmarks; performance of each individual portfolio against benchmark; adherence with operational controls; performance of suppliers; and compliance with an agreed framework of risk limits. During 2017, the Committee was particularly interested to understand that (i) the new operating model (following the change of custodian and middle office supplier in 2016), and (ii) Solvency II reporting of assets and derivatives to the PRA, had been implemented and were operating effectively.
• During 2017, 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 (“NEDs”) 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 with a view to ensuring that the Group’s future leadership will have the qualities needed for the strategic and cultural development of the business.
Succession planning The Committee places great importance on Board and Executive succession planning and monitors its progress as a standing agenda item at each of its scheduled meetings. The Committee guides management in Executive succession planning.
The Company also announced that John Reizenstein and Andrew Palmer would not seek re-election at the Company’s AGM on 10 May 2018. The Committee also recommended the appointment of Danuta Gray as a member of the Remuneration Committee and Nomination Committee, and John Reizenstein as a member of the Investment Committee, all of which the Board subsequently approved. The Committee continues to monitor the membership of the Board’s Committees to ensure that each Committee has a suitable balance of skills as well as taking into consideration the length of service of the members.
Board appointment and reappointment process The Committee oversaw the process to appoint Danuta Gray as a Non-Executive Director and Penny James as an Executive Director and CFO-designate. The process to appoint Danuta was disclosed in the 2016 Annual Report & Accounts. For the appointment of Penny James, the Committee produced a detailed brief and engaged external search consultants, Heidrick & Struggles, to find suitable candidates.
Heidrick & Struggles prepared a long list of candidates of appropriate merit from diverse backgrounds for the position. The Committee agreed a shortlist for the role and interviewed candidates. It then approached the PRA and FCA for approval, and recommended appointing Penny James as an Executive Director and CFO-designate to the Board.
Electing and re-electing Directors Before recommending the proposed election or re-election of Directors at the 2017 AGM, the Committee reviewed the independence of NEDs. It concluded that Danuta Gray, Jane Hanson, Sebastian James, Andrew Palmer, Clare Thompson and Richard Ward were all independent within the Code’s meaning. Jane Hanson, Clare Thompson and Mike Biggs have served on the Board since December 2011, September 2012 and April 2012 respectively. In accordance with the Code, the extension of their terms of appointment beyond six years has been the subject of a particularly rigorous review by the Committee. Mike Biggs, as Chairman of the Board and Chair of the Committee, was not involved in his own review.
• The Committee completed the review of the Remuneration policy which it had begun in 2016 and which had previously been amended in 2014. The revised Remuneration policy was approved by shareholders at the AGM in May 2017, with over 98% of the votes cast in favour of the policy. The policy is expected to remain in place for the next three years.
• In anticipation of appointing Penny James as an Executive Director and CFO-designate, the Committee reviewed the remuneration package being offered. Having regard to the long-term success of the Company, as well as the new remuneration policy and the calibre of candidate being sought, the Committee agreed on the remuneration package to be offered to Ms James. This included agreeing those elements of Ms James’ remuneration to be bought out from her previous employer and the terms of the buy-out.
• Towards the end of the year the Committee reviewed the impact of the tender offer to purchase half the Group’s subordinated notes and the issue of new Tier 1 notes (the “capital management exercises”). Whilst these transactions had a neutral effect overall on the capital position of the Group, the IFRS profit for 2017 was reduced by a one-off charge which related to the premium paid to redeem the notes in issue. The Committee exercised its discretion to adjust the financial outcome so that the impact on the IFRS profit was excluded from the 2017 AIP outturn.
Main activities during the year Annual incentive plan During the year, the Committee monitored the operation of the AIP. For the 2016 financial year, this involved reviewing the Group’s financial performance, in particular the effect of the change in the ODR, 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 and Board Risk Committees about whether the Group had achieved the required performance within risk appetite. The Committee also concluded that no malus or clawback of previous awards was required in 2017.
For the 2017 financial year, the Committee approved the performance metrics which included new customer measures and people measures. The Committee also monitored performance against the 2017 targets and subsequently reviewed the full year performance. The Committee also discussed the performance metrics for the 2018 AIP and approved them, being satisfied that they were sufficiently challenging.
Long-term incentives During 2017, the Committee reviewed and approved the level of vesting of the 2014 awards made under the Company’s LTIP against the performance criteria. These awards had two performance metrics based on RoTE and total shareholder return (“TSR”). After assessing performance against these metrics, the awards vested in March at a level of 85.6% and in August at a level of 79.2%. When considering the RoTE performance for 2016, the Committee discussed the impact of the ODR change which did not become effective until February 2017, but impacted the results of the 2016 financial year. This was important to the Committee because the timing of the announcement (two months after the year end) meant that executive management did not have the ability to make adjustments to prices or costs to allow for the amended ODR and the related fall in profit. Following consideration, the Committee decided not to make any adjustment to the RoTE outturn even though the ODR change reduced RoTE by approximately 30% and consequently materially impacted the LTIP outturn. Before vesting, the Committee considered the LTIPs’ financial and risk underpins. The Committee also determined the quantum of awards made in 2017 under the LTIP in view of business and individual performance.
The Committee considered the RoTE and TSR targets to ensure they remain challenging in the context of the Group’s planned performance, in particular noting the impact of the capital management exercises on RoTE and ensured this was taken into account for awards to be granted in 2018.
During the year, the Committee reviewed and approved the level and structure of the pay and incentives of the Executive Directors and other senior executives. Additionally, it reviewed remuneration for the strategic leadership team. As part of this review, the Committee considered the Share Ownership Guidelines for the Executive Directors and Executive Committee members.
Regulatory landscape Throughout the year the Committee received regular briefings on external developments in relation to remuneration in order to consider and plan for potential changes.
In addition to attending Committee meetings, the Chair of the Board Risk Committee, with input from the Chair of the Audit Committee, provides a certificate to the Committee on her assessment of whether the AIP outcome has been achieved within risk appetite and on the quality of earnings. Also, before any long-term incentives can vest, the Board Risk Committee Chair is consulted and the Committee takes a formal decision on whether the incentives are allowed to vest and/or whether to operate the malus and/or clawback clauses in the incentive schemes rules.
The Board reviewed and approved this report on 26 February 2018.
As the Chair of the Remuneration Committee (the “Committee”), I am pleased to introduce our report on Directors’ remuneration for the 2017 financial year.
We have set out this report in the following sections: Section Pages
Consistent with the regulations, our Directors’ remuneration policy was resubmitted to the Company’s AGM on 11 May 2017 and approved by a significant majority of shareholders (98% voted in favour). We are pleased with the support shown by our shareholders to the work of this Committee and hope that you will equally agree with how we have applied that policy during 2017 and plan to do so in 2018.
We therefore awarded bonuses of 88% of the maximum to the Executive Directors. In line with the remuneration policy, 40% of any AIP award is automatically deferred into a Deferred Annual Incentive Plan (“DAIP”) award.
Shareholders may recall that, at the time of the approval of the 2016 AIP outturn, the Government had just announced a change in the Ogden discount rate (February 2017) which materially impacted the financial results for 2016. To align the 2016 AIP outturn with the shareholder experience, the Committee significantly reduced the AIP outturn, but agreed, in these exceptional circumstances, to keep its assessment of the 2016 AIP outcome under review until the end of 2017. This would enable the Committee to recalculate the outturn for the 2016 financial year if the Ogden discount rate was raised or the mechanism for setting it was changed during 2017. The Government indeed made announcements in this regard but is proceeding at a slower pace than anticipated and, while it has stated that the mechanism needs reform, no legislation has been forthcoming. A new rate therefore is still to be announced. The Committee noted that, in reducing the AIP outturn in 2016, it operated more conservatively than many of its competitors and, as it remains unclear whether the reduction taken in 2016 was appropriate, it has agreed to extend the review period for the 2016 AIP until the end of 2018.
The Long-Term Incentive Plan (“LTIP”) has two performance measures: Return on Tangible Equity (“RoTE”) (60% of the total award) and Total Shareholder Return (“TSR”) (40% of the total award).
Awards under the LTIP granted in March and August 2014 vested during 2017. The Group achieved an average RoTE of 16.2% over 2014, 2015 and 2016 resulting in 76% of the maximum potential vesting of the RoTE element (45.6% of the total award).
The Company’s TSR performance over the three-year vesting period was positioned above upper quintile against its comparator group for the March 2014 awards and slightly below the upper quintile for the August 2014 awards. This resulted in 100% and 83.9% respectively of the maximum potential vesting under the TSR element (40% and 33.6% of the total award).
In calculating the RoTE achievement, the reported RoTE for 2017 was adjusted downwards in order to exclude the favourable impact of the capital management exercises on the outcome for these awards. The ongoing enhancement to earnings expected in future years has been explicitly recognised by the Committee in setting higher targets than would otherwise be the case.
Consistent with the regulations, the TSR element of the 2015 awards due to vest during 2018 will be reported separately next year. We have included the RoTE vesting outcomes plus the TSR vestings from the 2014 awards in the single figure remuneration table for the Executive Directors.
• The Committee considers a range of factors when determining salaries, including pay increases throughout the Group, individual performance and market data
• Maximum opportunity remains at 175% of salary for the CEO and for the CFO-designate, and 150% for the other Executive Directors; 40% of the award is deferred into shares, typically vesting after three years
• At least 50% of bonus is based on financial measures. The Committee considers various non-financial and strategic performance measures. It bases its judgement on the payment outcome at the end of the performance period on its assessment of the level of stretch inherent in targets
• No change to the weighting or measures used for 2018
• No change to the maximum annual award levels • Nil-cost options will continue to be used for the grants • The current 60% RoTE and 40% TSR mix will continue to apply • Increase to the level of RoTE required for the 2018 awards to vest from the current range of 15.0% to 18.0% to a range of 17.5% to 20.5%
AIP achievement This chart illustrates the actual amounts earned from the AIP and reflecting performance in 2017. 60% of the amount will be payable in March 2018 and 40% will be deferred into shares for three years.
Shareholding at year end This chart illustrates the number of shares held at the end of 2017 by the Executive Directors against the share ownership guidelines of 200% of salary.
Actual (% of salary) Actual (£ ‘000)Maximum (% of salary)Target (% of salary)
Release of value This chart illustrates the total value of the March and August 2014 LTIP awards that vested in 2017.
Annual remuneration report Remuneration Committee members and governance The following list details members of the Remuneration Committee during 2017. You can find information about each member’s attendance at meetings on page 49. You can find their biographies on pages 46 and 47.
Note: 1. Appointed to the Committee with effect from 6 March 2017.
Advisers to the Committee The Committee consults with the Chief Executive Officer, the Human Resources Director, and senior representatives of the HR, Risk and Finance functions on matters relating to the appropriateness of all remuneration elements for Executive Directors and Executive Committee members. The Chairman, Chief Executive Officer and the Human Resources Director are not present when their remuneration is discussed. The Committee works closely with the Chairs of the Board Risk Committee and the Audit Committee, including receiving input from those Chairs regarding target-setting and payouts under incentive plans, and whether it is appropriate to operate malus and clawback. The Chair of the Audit Committee is currently a member of the Remuneration Committee, and the Chair of the Board Risk Committee attended Remuneration Committee meetings on three occasions. The Remuneration and Board Risk Committees can also hold joint meetings to consider matters of common interest.
During the year, FIT advised on market practice, corporate governance and regulations, incentive plan design and target-setting, recruitment and other matters that the Committee was considering. FIT does not provide the Company with other services. The Committee is satisfied that the advice FIT provides is objective and independent.
FIT’s total fees for remuneration-related advice in 2017 were £125,633 exclusive of VAT. FIT charged its fees based on its standard terms of business for providing advice.
Implementing policy and pay outcomes relating to 2017 performance Single figure table (Audited)
These deferred awards are not subject to any conditions, except continuous employment. However, awards remain subject to malus and clawback. 4. 2014 LTIP awards RoTE – the expected vesting outcome figures for the RoTE portion of the awards granted under the LTIP in 2014 and reported in 2016 have been updated. These updates are based on the actual vesting of the RoTE portion of the awards and a share price of £3.376 and £3.819 on 26 March 2017 and 29 August 2017 respectively, compared to the three-month average share price of £3.55686 used in reporting this figure in the 2016 remuneration report. The revised figures include the actual number of dividends accrued on this portion of the award at vesting. This results in an adjusted reportable increase of approximately £4,855 for Paul Geddes and £2,938 for John Reizenstein, with a corresponding increase of the single figure for 2016 reflected in the table above.
Strategic A basket of measures – key customer and people metrics 25% See narrative Above target
Including objective shared among all Executive Committee members 20% See narrative On target
The only adjustment from the reported accounting position, as explained in the letter from the Committee Chair, was to exclude the impact of the one-off cost associated with the buying back of the Group’s subordinated guaranteed notes which was an unbudgeted initiative to the benefit of the Company and its shareholders. While this, in fact, had no impact on the outturn, given the level of outperformance of the target, it was the correct principle and consistent with best practice and past practice to exclude the impact.
In the table below, we have disclosed the target set for PBT performance. The actual PBT performance includes the adjustment to reported PBT as described above. We have included details of the performance achieved against the non-financial measures to improve transparency for shareholders although some metrics remain commercially sensitive.
The Committee also considered performance against the “gateway” criteria outlined on page 91 and determined that it was appropriate to pay a bonus and that it was not necessary to reduce the payment in light of performance against these criteria.
Taking performance against each Executive Director’s individual performance objectives and the above challenges into account, the Committee determined that the Executive Directors should each receive awards of 60% of the maximum available under this element.
Consequently, the annual incentive awards for Executive Directors for the financial year ended 31 December 2017 were as follows: (Audited) Maximum
Note: 1. The annual incentive award made to Penny James represents a pro-rated amount for the period 1 November to 31 December 2017 since joining the Company.
Awards under the LTIP granted in March and August 2015 are due to vest during 2018. 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 RoTE performance period for these awards ended on 31 December 2017. The three-year average RoTE performance for 2015, 2016 and 2017 was 18.1% against a maximum target of 17.5%. Awards under the RoTE element are due to vest at 100% of the maximum potential (60% of the total award). We have included these RoTE vesting outcomes plus the TSR vestings from the 2014 awards in the single remuneration figure for the CEO, the CFO and the MD Personal Lines. You can find details of this on page 79. Performance under the relative TSR measure will be assessed at the end of the vesting period in March and August as appropriate.
Relative TSR test – To be tested based on performance to 24 March 2018
Non-Executive Directors (Audited) Fees were the only remuneration paid to Non-Executive Directors in 2016 and 2017. Non-Executive Directors may also claim for reasonable travel and subsistence expenses, in accordance with the Group’s travel and expenses policy, and, where these are classified as taxable by HMRC, they are shown under ‘Benefits’ below. The Non-Executive Directors receive no other benefits.
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. The 2016 single figure has been revised to reflect the actual vesting of the 2014 awards under the LTIP, an increase of £4,855.
For Against Number of votes withheld (abstentions) Percentage of votes withheld (abstentions) Number Percentage Number Percentage
Approval of Directors’ remuneration report (2017 AGM) 916,037,366 99.32% 6,285,817 0.68% 6,738,340 0.73%
August 2015 that are subject to the RoTE performance condition, measured to 31 December 2017, are due to vest at 100% of the maximum potential. These shares will be delivered to Executive Directors in March and August 2018. For Penny James this also relates to one-off awards pursuant to Listing Rule 9.4.2 as disclosed on page 90.
6. Includes holdings of connected persons, as defined in section 96B(2) of the Financial Services and Markets Act 2000, and free and partnership shares held under the SIP which are not subject to forfeiture and considered beneficially owned.
7. Beneficial share interests include partnership shares John Reizenstein purchased under the SIP and free shares held by the CEO and the CFO under the SIP. At 26 February 2018, the number of shares beneficially held by John Reizenstein has increased to 455,949. There was no change to the number of shares held by Paul Geddes.
Notes: 1. Awards are granted as nil-cost options. 2. Paul Geddes exercised on 27 March 2017 at £3.3434 resulting in an aggregate gain of £569,613. 3. John Reizenstein exercised on 27 March 2017 at £3.3412 resulting in an aggregate gain of £282,916.
Direct Line Group Long-Term Incentive Plan (“LTIP”) awards (Audited) This table details the Directors’ interests in the Company’s LTIP. For all LTIP awards, 20% of the awards granted would vest if the minimum performance was achieved.
2. The RoTE targets for awards granted in 2017, applying to 60% of the award, were 15% for 20% vesting, 16% for 40% vesting and 18% for full vesting. A straight-line interpolation occurs from threshold to target, and then from target to maximum performance. The remaining 40% of each award is based on TSR performance conditions, which are the same as noted on page 92.
7. John Reizenstein exercised on 27 March 2017 at £3.3412 resulting in an aggregate gain of £671,100, and on 29 August 2017 at £3.8019 resulting in an aggregate gain of £573,216.
8. Mike Holliday-Williams exercised on 29 August 2017 at £3.8019 resulting in an aggregate gain of £981,327. 9. A full year’s award to a total face value of 200% of base salary was made to the CFO-designate on 28 November 2017 as agreed as part of the remuneration package offered on recruitment. The award is subject to the same performance conditions as awards made to the other Executive Directors earlier in the year (except that TSR will be measured over the three years commencing on the date of grant).
No. of dividend shares acquired at vesting No. of share options exercised
This table details buy-out awards made to Penny James. These awards were made to the CFO-designate in November 2017 as compensation for the forfeiture of legacy awards granted by her previous employer. The awards were made in the form of restricted stock options and are subject to performance conditions that, as far as possible, mirror those of the original awards. Performance will be assessed as soon as possible after the normal vesting date and following publication of the performance outturn over the relevant performance period. The awards will accrue dividend equivalent shares until vesting, as per the terms of the legacy awards.
Direct Line Group 2012 Share Incentive Plan (“SIP”) (Audited) During 2017, all employees, including Executive Directors, were eligible to invest from £10 to £150 a month from their pre-tax pay into the scheme, and receive one matching share for every two shares they purchased. This table details the number of shares held by John Reizenstein under the SIP. Paul Geddes, Mike Holliday-Williams and Penny James do not participate in the 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.
Statement of policy implementation in 2018 Executive Directors’ salaries in 2018 The salary increase awarded to the Executive Directors, effective 1 April 2018, reflects the average increase awarded to staff generally.
Score and complaints; and • people measures, including measures of gender diversity and engagement
Personal Objectives for each Executive Director, including shared objectives across the Executive Committee
Gateway criteria for the AIP for 2018 – outcomes for Executive Directors • Year-on-year changes in profit before tax • Quality and sustainability of earnings, referring to reserving, gross written premium, costs and loss ratio, and relevant lead indicators • Additional customer context, for example, conduct, experience, brand and franchise health • Capital strength and affordability • Risk management within risk appetite • The Group’s relative performance to that of its peers • The wider economic environment • Exceptional events, such as abnormal weather • Any regulatory breaches and/or reputational damage to the Group • Committee satisfaction that paying the bonus does not cause major reputational concerns
Pension and benefits A pension contribution of 25% of base salary will be paid to the CEO, CFO and CFO-designate in 2018. Before his promotion to the Board in 2017, 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. No Directors participate in any defined benefit pension arrangements operated by the Company.
In addition, and as disclosed on page 90, she received one-off awards pursuant to Listing Rule 9.4.2 to compensate for the loss of LTIP awards made by her former employer. Performance conditions and comparator groups for these awards will be identical to those of the original LTIPs, save for the award which vests in 2019 where DLG’s TSR performance will replace that of the former employer for the period from 1 November 2017 to 31 December 2018 (post-joining).
Policy report The following is a copy of the main table from the policy approved by shareholders at the 2017 AGM. The full policy is available in last year’s report.
• When determining salary increases, the Committee will consider the factors outlined in this table under ‘Operation’. In any event, no increase will be made if it would take an Executive Director’s salary above £850,000 (the current median level of salaries for CEOs in the FTSE 100), as further increased by UK RPI from the date of approving this policy
• The maximum pension contribution is set at 25% of base salary per annum
• 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
Policy table Element Purpose and link to strategy Operation Maximum opportunity Performance measures
• Base salaries are typically reviewed annually and set in April of each year, although the Committee may undertake an out-of-cycle review if it determines this to be appropriate
• The Committee will keep the percentage deferred and terms of deferral under review. This will ensure levels are in line with regulatory requirements and best practice and may be changed in future years but will not, in the Committee’s view, be changed to be less onerous overall
• Malus and clawback provisions apply to the cash and deferred elements. These are explained in the notes to the policy table
• Awards will typically be made in the form of nil-cost options or conditional share awards, which vest to the extent performance conditions are satisfied over a period of at least three years. Under the Plan rules, awards may also be settled in cash at the discretion of the Committee. This may be appropriate, for example, if legal difficulties arise with settling in shares
• For awards made after adopting the new policy at the 2017 AGM, Executive Directors will be subject to an additional two-year holding period following the three-year vesting period, during which time awards may not normally be exercised or released. During the additional holding period the awards will continue to accrue dividends. Following the holding period awards will cease to accrue dividends if not exercised
• 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
• To align the interests of Executive Directors with those of shareholders
• These may be financial, non-financial (Group, divisional or business line) and individual. Each year, at least 50% of the bonus is based on financial measures. The remainder of the bonus may be based on a combination of strategic, shared and individual performance measures
LTIP • Aligning executives’ interests with those of shareholders to motivate and incentivise delivering sustained business performance over the long term
• Awards of up to 300% of base salary are permitted in exceptional circumstances, relating to recruiting or retaining an employee, as determined by the Committee
• Awards vest based on performance against financial and/or such other (including share return) measures, as set by the Committee, to be aligned with the Group’s long-term strategic objectives
• Additionally, there is a financial underpin relating to the Committee’s view of the Group’s underlying financial performance for the TSR and RoTE (and any other) elements 20% of the award vests for threshold performance, with 100% vesting for maximum performance. The Committee reserves the right in respect of future awards to lengthen (but not reduce) any performance period and/or amend the terms of any holding period; however, there is no intention to reduce the length of the holding period
• 200% of salary for all Executive Directors • The Committee reserves the discretion to amend these levels in future years
Note: A chart for John Reizenstein has not been prepared on the basis that he will retire during the course of the year, will cease to be eligible for any AIP from the date of the AGM and will not receive a 2018 LTIP award.
To reflect the preference of some shareholders, this replicates the maximum assumptions above and also shows combined share price appreciation and dividend roll-up of 10% per annum over the three-year vesting period
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 44 to 99. This information is incorporated in the Directors’ report by reference.
Directors’ waivers of emoluments None Directors’ waivers of future emoluments Not applicable Non pro-rata allotments for cash (issuer) Not applicable Non pro-rata allotments for cash (major subsidiaries)
Where the Board believes that the Group has capital which is expected to be surplus to the Group’s requirements for a prolonged period, it would intend to return any surplus to shareholders. In normal circumstances, the Board expects that a capital coverage ratio around the middle of its risk appetite range of 140% to 180% of the Group’s solvency capital requirement (“SCR”) would be appropriate and it will therefore take this into account when considering the potential for special distributions.
The Group expects that one-third of the annual dividend will generally be paid in the third quarter as an interim dividend, and two-thirds will be paid as a final dividend in the second quarter of the following year. The Board may revise the dividend policy from time to time. The Company may consider a special dividend and/or a repurchase of its own shares to distribute surplus capital to shareholders.
Directors You can find the current Directors’ biographies on pages 46 to 47. All Directors will retire and, excepting Messrs Palmer and Reizenstein, be submitted for election or re-election at the 2018 AGM. This is in accordance with the UK Corporate Governance Code and the Articles of Association of the Company, which govern appointing and replacing Directors. The Directors listed on pages 46 and 47 were the Directors of the Company throughout the year apart from Danuta Gray and Mike Holliday-Williams, who were each appointed as a Director on 1 February 2017, and Penny James, who was appointed as a Director on 1 November 2017.
Share capital The Company has a premium listing on the London Stock Exchange. As at 31 December 2017, the Company’s share capital comprised 1,375,000,000 fully paid Ordinary Shares of 10 10/11 pence each.
To date, the Directors have not used these authorities. At the 2018 AGM, shareholders will be asked to renew these authorities and vote on some additional resolutions in relation to the disapplication of pre-emption rights 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 2017 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 a participant’s instructions.
The Trustee of this Trust has waived its right to dividends on all shares within the Trust. You can find out more about the number of shares held by the employee share plan trusts in note 29 on page 154. The Company is only aware of the dividend waivers and voting restrictions mentioned above.
Shareholder voting rights and restrictions on transfer of shares All the Company’s issued Ordinary Shares rank equally in all respects. The Company’s Articles of Association set out the rights and obligations attaching to the Company’s Ordinary Shares.
There is no arrangement or understanding with any shareholder, customer or supplier, or any other external party, which provides the right to appoint a Director or a member of the Executive Committee, or any other special rights regarding control of the Company.
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.
Our Diversity Network Alliance focuses on a number of strands including employees with disabilities. It identifies areas where we can improve and help people to continue working for us. We reasonably adjust employees’ working environments and equipment, and roles and role requirements. We also ensure that everyone can access the same opportunities.
Scope 3 – includes all other indirect emissions such as waste disposal, business travel and staff commuting.
Total GHG emissions (Scope 1 and Scope 2) for continuing operations for 2017 were 17,399 tonnes (2016: 19,315 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 2017, this was 5.5 tonnes CO2e per £ million of net earned premium for continuing operations (2016: 6.4 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. You can find verification statements on the Group’s website at www.directlinegroup.com. You can find further information on the Group’s approach to energy and the environment in the CSR section on page 29.
Combustion of fuel & operation of facilities (Scope 1) 8,027 8027
Intensity metric: tonnes CO2e/Million GBP net earned premium (£m) 5.5 5.9
Transmission and Distribution (“T&D”) losses from electricity (Scope 3) 876 876
Intensity metric: tonnes CO2e/Million GBP net earned premium (£m) 5.8 6.2
Intensity metric: tonnes CO2e/Million GBP net earned premium (£m) 9.0 6.8 5.8 36%
Going concern The Group has sufficient financial resources to meet its financial needs, including managing a mature portfolio of insurance risk. The Directors believe the Group is wellpositioned to manage its business risks successfully in the current economic environment.
The Group’s financial position is also covered in that section, including a commentary on cash and investment levels, reserves, currency management, insurance liability management, liquidity, and borrowings. Additionally, note 3 to the consolidated financial statements describes capital management needs and policies. The note also covers insurance, market, liquidity and credit risks which may affect the Group’s financial position.
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 26 February 2018 – the date of approval of the financial statements. Accordingly, the Directors have adopted the going concern basis in preparing the financial statements.
Each of the Directors, whose names and functions are listed on pages 46 to 47, confirm that, to the best of their knowledge: • the financial statements, prepared in accordance with IFRS, give a true and fair view of the assets, liabilities, financial position, and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; • the Strategic report (on pages 1 to 43) and Directors’ report (on pages 100 to 103) include a fair review of: (i) the business’s development and performance; and (ii) the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties they face; and
Notes to the consolidated financial statements 1. Accounting policies 117 2. Critical accounting estimates and judgements 125 3. Risk management 127 4. Segmental analysis 138 5. Net earned premium 141 6. Investment return 141 7. Other operating income 142 8. Net insurance claims 142 9. Commission expenses 142 10. Operating expenses 142 11. Finance costs 144 12. Tax charge 144 13. Current and deferred tax 145 15. Earnings per share 146 16. Net assets per share and return on equity 147 17. Goodwill and other intangible assets 147 18. Property, plant and equipment 149 19. Investment property 149 21. Reinsurance assets 150 22. Deferred acquisition costs 150 23. Insurance and other receivables 150 24. Derivative financial instruments 151 25. Retirement benefit obligations 151 26. Financial investments 153 27. Cash and cash equivalents and borrowings 154 28. Assets held for sale 154 29. Share capital 154 30. Other reserves 154 32. Subordinated liabilities 155 33. Insurance liabilities 156 34. Unearned premium reserve 157 35. Share-based payments 158 36. Trade and other payables including insurance payables 37. Notes to the consolidated cash flow statement 160 38. Contingent liabilities 161 40. Fair value 162 41. Related parties 163
• The financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation
• the Consolidated and Parent Company Statements of Changes in Equity; and
The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union and, with regards to the Parent Company’s financial statements, as applied in accordance with the provisions of the Companies Act 2006.
We are independent of the Group and the Parent Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, including the FRC’s Ethical Standard as applied to listed public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We confirm that no non-audit services prohibited by the FRC’s Ethical Standard were provided to the Group or the Parent Company.
Materiality The materiality that we used for the Group financial statements was £28.0 million which approximates 5.2% of three year average profit before tax from Ongoing operations.
Scoping Our Group audit scoping included two entities being subject to a full scope audit and a further two entities being subject to an audit of specified account balances. These four entities represent the principal business units and account for 99% of the Group’s net assets, 100% of the Group’s gross earned premium and 98% of the Group’s profit before tax.
The Group’s insurance reserves total £4.2 billion (2016: £4.7 billion). The determination of the value of the insurance reserves requires significant judgement in the selection of key actuarial 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 given their significance to the Group’s result and the level of judgement involved. We have also identified these as potential fraud risk areas.
1) The frequency and severity of excess bodily injury claims; Key audit matter description The insurance reserve valuation for bodily injury excess claims has a significant impact on the Group’s results, with the ultimate number of large bodily injury claims being inherently uncertain and driven by a number of factors. These include the completeness and accuracy of source data, the transparency of any changes in the reporting of excess claims, and actuarial assumptions being consistent with emerging data, internal processes and market factors.
• perform analytical procedures and diagnostic testing in challenging the reserving impact pre and post the change in Ogden discount rate; and
• inspect the Group’s actuarial models and perform sensitivity testing and peer benchmarking on key assumptions
2) The inflation and discount rate assumptions for valuing PPOs Key audit matter description 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 £898.7 million (2016: £983.0 million) on a discounted gross basis as detailed in note 2. PPO liabilities are sensitive to the choice of inflation and discount rate used. These assumptions require significant management judgement which increases the susceptibility of the balance to material misstatement due to error and fraud.
• review the Group’s sensitivity testing on the PPO inflation assumption, requesting additional sensitivity testing from management where required
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. Given the current low yield environment we determined that these assumptions continue to require close monitoring going forward.
Key audit matter description The Group continues to invest in initiatives and systems with the aim of improving the customer experience, supporting growth and increasing efficiency. This investment spans policy, pricing, payment and other related data and digital systems across the business. Following the appointment of a system integrator during the year, the Group has decided to rework certain elements of the original capital expenditure already incurred on the assets, aimed at ensuring the initiatives achieve the targeted performance levels. Management identified this rework as an impairment indicator and performed a detailed review which resulted in an impairment charge of £56.9 million (2016: £39.3 million), bringing the valuation of intangible assets to £258.8 million (2016: £297.6 million).
In addition we performed the following audit procedures: • we held inquiries with system consultants, inspected internal reports, system architecture maps and meeting minutes in order to challenge management on which components of the capital expenditure incurred to date will ultimately be used in the end-state system. We also engaged our IT consultants to assess the feasibility of the IT architecture in delivering the expected benefits across the Group
• we assessed whether the initiatives and systems under development are expected to generate cash flows independently from other groups of assets and the wider business. We performed an independent assessment of whether the future cash flows will be generated independently to evaluate the appropriateness of testing the asset as part of the asset’s CGU; and
Key observations We have determined that the £56.9 million impairment charge is reasonable.
Key audit matter description We have identified a key audit matter for investments relating to the valuation of credit asset portfolios that are not held at fair value totalling £589.0 million (2016: £501.8 million) as detailed in note 26. Our work primarily focused on the Group’s commercial real estate loan, infrastructure debt and private placement bond portfolios. These debt instruments are carried at amortised cost and represent a higher credit risk relative to the majority of DLG’s investment portfolio.
During the year, the Group recognised an impairment provision totalling £9.5 million (2016: £nil) which arose from the cessation of interest on non-performing credit assets. Management judgement is required in determining if an incurred loss event has occurred and there is significant uncertainty in determining the fair value of the credit assets in the instance an event has occurred. As a result we identified the valuation of investments not held at fair value as a key audit matter.
How the scope of our audit responded to the key audit matter We have assessed the design and implementation and tested the operating effectiveness of the key controls that mitigate the risk over the valuation of investments not held at fair value. Our work included attendance at the year-end impairment review meeting in order to observe the operation of a key management review control.
In addition we performed the following audit procedures: • traced a sample of interest payments recognised to bank statements to test for default or delinquency in interest payments
• independently calculated the fair value for a sample of assets to identify any significant decreases in fair value below book cost; and
Key observations We have determined that the £9.5 million impairment charge arising on non-performing credit assets is reasonable. In performing our procedures we did not note any other indicators of material impairment.
Materiality £28.0 million (2016: £28.0 million). £25.2 million (2016: £25.2 million).
Materiality was determined as approximately 5.2% (2016: 5.6%) of average profit before tax from Ongoing operations, excluding the impact of the Ogden discount rate change on 2016 year end results.
We 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 which we deemed appropriate due to the inherent volatility of profits in the insurance industry. We also elected to exclude the impact of the Ogden discount rate change on the 2016 results due to the non-recurring nature of this event.
We determined that the critical benchmark for the Parent Company was shareholder’s equity. This is because the Parent Company is not a trading entity but rather receives dividend income from its subsidiaries.
Group materiality is used for setting audit scope and the assessment of uncorrected misstatements. Materiality is set for each significant component in line with the components proportion of the chosen benchmark. This is capped at the lower of 90% of Group materiality and the component materiality determined for a standalone audit. The main UK insurance trading entity, U K Insurance Limited, which makes up 100% of Group gross earned premium and 94% of Group statutory profit before tax, is scoped to a component materiality of £25.2 million (2016: £25.2 million).
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 £19.6 million (2016: £19.6 million) and the audit testing for UK Insurance Limited is carried out to a performance materiality of £17.6 million (2016: £17.6 million).
We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £1.4 million (2016: £1.4 million) for the Group financial statements and £1.3 million (2016: £1.3 million) for the Parent Company financial statements, 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.
This resulted in two entities being subject to a full scope audit, while a further two were subject to an audit of specified account balances where the extent of our testing was based on our assessment of the risks of material misstatement and of the materiality of the Group’s operations. All entities within scope of the Group audit are based in the UK.
These four entities represent the principal trading and service operations of the Group and account for 99% (2016: 99%) of the Group’s net assets, 100% (2016: 100%) of the Group’s gross earned premium and 98% (2016: 98%) of the Group’s profit before tax. They were also selected to provide an appropriate basis for undertaking audit work to address the risks of material misstatement identified above.
At the parent entity level we also tested the consolidation process and carried out analytical procedures to confirm our conclusion that there were no significant risks of material misstatement of the aggregated financial information of the remaining components not subject to audit or audit of specified account balances. The Group audit team also performs the audit of the in scope UK entities.
In this context, matters that we are specifically required to report to you as uncorrected material misstatements of the other information include where we conclude that: • Fair, balanced and understandable – the statement given by the Directors that they consider the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy, is materially inconsistent with our knowledge obtained in the audit; or
• 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
• Directors’ statement of compliance with the UK Corporate Governance Code – the parts of the Directors’ statement required under the Listing Rules relating to the company’s compliance with the UK Corporate Governance Code containing provisions specified for review by the auditor in accordance with Listing Rule 9.8.10R(2) do not properly disclose a departure from a relevant provision of the UK Corporate Governance Code
• the strategic report and the Directors’ report have been prepared in accordance with applicable legal requirements
Matters on which we are required to report by exception Adequacy of explanations 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
Under the Companies Act 2006 we are also required to report if in our opinion certain disclosures of Directors’ remuneration have not been made or the part of the Directors’ remuneration report to be audited is not in agreement with the accounting records and returns.
Consolidated statement of comprehensive income For the year ended 31 December 2017 £m 2016 £m
Items that may be reclassified subsequently to the income statement: Exchange differences on translation of foreign operations – 0.1 Cash flow hedges (1.1) 1.4 Fair value gain on AFS investments 30 8.8 119.6 Less: realised net gains on AFS investments included in income statement 30 (23.2) (15.3) Tax relating to items that may be reclassified 30 2.5 (17.6)
Current tax assets 13 0.1 0.1 Deferred acquisition costs 22 185.4 203.1 Insurance and other receivables 23 981.2 988.3 Prepayments, accrued income and other assets 146.2 131.0 Derivative financial instruments 24 84.4 79.7 Retirement benefit asset 25 14.4 12.0
Consolidated cash flow statement For the year ended 31 December 2017 £m 2016 £m
Net cash generated from operating activities before investment of insurance assets 37 204.0 35.0 Cash generated from investment of insurance assets 37 341.9 827.4 Net cash generated from operating activities 545.9 862.4 Cash flows from investing activities Purchases of property, plant and equipment 18 (22.4) (49.9) Purchases of goodwill and other intangible assets 17 (73.2) (80.8) Proceeds on disposals of assets held for sale – 5.1 Proceeds on disposal of property, plant and equipment 0.3 – Net cash used in investing activities (95.3) (125.6) Cash flows from financing activities Net proceeds from issue of Tier 1 notes 31 346.5 – Repayment of subordinated liabilities (326.8) –
Finance costs (31.7) (38.3) Purchase of employee trust shares (19.6) (39.5) Net cash used in financing activities (256.9) (528.4) Net increase in cash and cash equivalents 193.7 208.4 Cash and cash equivalents at the beginning of the year 27 1,110.8 902.4 Cash and cash equivalents at the end of the year 27 1,304.5 1,110.8
IFRS 12 ‘Disclosure of Interests in Other Entities’ – the amendment clarifies that the disclosure requirements of IFRS 12 are applicable to entities classified as held for sale or distribution.
1.1 Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and the entities that are controlled by the Group at 31 December 2017 and 31 December 2016. Control exists when the Group is exposed, or has rights, to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. In assessing if the Group controls another entity, the existence and effect of the potential voting rights that are currently exercisable or convertible are considered.
Notes to the consolidated financial statements continued 1. Accounting policies continued 1.3 Contract classification Insurance contracts are those contracts where the Group (the insurer) has accepted significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.
Other income Commission fee income in respect of services is recognised when a policy has been placed and incepted. Income is stated excluding applicable sales taxes.
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 ABE 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 ABE. This amount is recorded within claims provisions.
Notes to the consolidated financial statements continued 1. Accounting policies continued 1.10 Impairment of intangible assets, goodwill and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets, goodwill or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss, if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent of those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit (“CGU”) to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. Value in use is the present value of future cash flows from the asset or CGU, discounted at a rate that reflects market interest rates, adjusted for risks specific to the asset or CGU that have not been reflected in the estimation of future cash flows.
HTM 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.
1.13 Cash and cash equivalents and borrowings Cash and cash equivalents comprise cash in hand and demand deposits with banks together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.
Deferred tax assets and liabilities are calculated at the tax rates expected to apply when the assets are realised or liabilities are settled based on laws and rates that have been enacted or substantively enacted at the balance sheet date. Deferred tax is charged or credited in the income statement, except when it relates to items charged or credited to other comprehensive income or equity, in which case the deferred tax is also dealt with in other comprehensive income or directly in equity.
The cost of employee services received in exchange for an award of shares or share options granted is measured by reference to the fair value of the shares or share options on the date the award is granted and takes into account non-vesting conditions and market performance conditions (conditions related to the market price of the Company’s Ordinary Shares).
In 2017 the Group conducted a high-level assessment of the three aspects of IFRS 9 and based on current information, the impact of applying the expected loss model for the first time is currently immaterial. The Group does not expect any other significant impact on its financial statements. The Group satisfies the exemption criteria within IFRS 4 ‘Insurance Contracts’ and has decided 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.
In January 2016 the IASB issued IFRS 16 ‘Leases’ to replace the existing leasing standard IAS 17; it was endorsed by the EU in October 2017 and will be effective from 1 January 2019. IFRS 16 sets out the principles for recognition, measurement, presentation and disclosure of leases and requires lessees to account for all leases under a single on-balance sheet model similar to the accounting for finance leases under IAS 17. There are two exemptions: for leases of a low value and for leases of a short-term nature of 12 months or less. At the start of a lease a lessee will recognise a liability for the lease payments and an asset, representing the right to use the asset during the lease term. Lessees will be required to separately recognise the interest expense on the lease liability and the depreciation expense on the right-of-use asset. Lessor accounting under IFRS 16 is substantially unchanged from the current approach under IAS 17.
The following new standard and amendments to IFRSs and IASs have been issued and are expected to be endorsed by the EU during 2018. With the exception of the new standard IFRS 17 ‘Insurance Contracts’, the Group does not expect the following amendments to have a material impact on the financial statements of the Group in future periods.
Notes to the consolidated financial statements continued 1. Accounting policies continued IFRS 17 ‘Insurance Contracts’ was issued by the IASB in May 2017 to replace IFRS 4 ‘Insurance Contracts’, and will be effective for reporting periods beginning on or after 1 January 2021, with comparative figures required. IFRS 17 is a comprehensive new accounting standard for all insurance contracts covering recognition and measurement, presentation and disclosure. The overall objective of IFRS 17 is to provide an accounting model for insurance contracts that is more useful and consistent for insurers and to replace the requirements of IFRS 4 that allowed insurers to apply grandfathering of previous local accounting policies. IFRS 17 provides a comprehensive model for insurance contracts, covering all relevant accounting aspects.
The IASB issued amendments to IAS 40 ‘Investment Property’ – Transfers of Investment Property in December 2016 to clarify when an entity should transfer property, including property under construction or development into, or out of investment property. The amendments state that a change in use occurs when the property meets, or ceases to meet, the definition of an investment property and there is evidence of the change in use. The amendments are effective from 1 January 2018.
IFRIC 23 ‘Uncertainty over Income Tax Treatments’ was issued in June 2017 and provides interpretation when there is uncertainty over income tax treatments under IAS 12 ‘Income Taxes’ and has an effective date of 1 January 2019.
WWW.DIRECTL INEGROUP.COM 125 2. Critical accounting judgements and key sources of estimation uncertainty 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 117 to 124. 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.
In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB’s Framework for the Preparation and Presentation of Financial Statements. The judgements and assumptions involved in the Group’s accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.
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; or
• 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.
Had all the declines in AFS asset values met the criteria above at 31 December 2017, the Group would suffer a loss of £6.5 million (2016: £12.6 million), being the transfer of the total AFS reserve for unrealised losses to the income statement. These movements represent mark-to-market movements and where there is no objective evidence of any loss events that could affect future cash flows, no impairments are recorded for these movements.
The Group has also made the judgement that investment properties, most of the HTM debt securities, commercial real estate loans and infrastructure debt fall within level 3 of the Group’s fair value hierarchy (note 40) as the valuation models used are driven predominantly by unobservable inputs: investment property valuations are derived from recent market transactions which are adjusted for specific characteristics of each property including the size, location and condition by reference to the benchmark property transactions.
Notes to the consolidated financial statements continued 2. Critical accounting judgements and key sources of estimation uncertainty continued 2.4 General insurance: outstanding claims provisions and related reinsurance recoveries continued Claims reserves are assessed separately for large and attritional claims, typically using standard actuarial methods of projection. Key sources of estimation uncertainty include those arising from the selection of specific methods as well as assumptions for claims frequency and severity through the review of historical claims and emerging trends.
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 calculations have reference to a standardised Ogden annuity factor at a discount rate of minus 0.75% in 2017 (2016: minus 0.75%). 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.
The table below analyses the outstanding PPO claims provisions on a discounted and an undiscounted basis at 31 December 2017 and 31 December 2016. These represent the total cost of PPOs rather than any costs in excess of purely Ogden-based settlement.
Net of reinsurance Approved PPO claims provisions 248.4 653.5 240.4 633.6
In the majority of cases, the inflation agreed in the settlement is the Annual Survey of Hours and Earnings SOC 6115 inflation published by the Office for National Statistics, for which the long-term rate is assumed to be 4.0% (2016: 4.0%). The rate of interest used for the calculation of present values is 4.0% (2016: 4.0%), which results in a real discount rate of 0.0% (2016: 0.0%).
WWW.DIRECTL INEGROUP.COM 127 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 23.
3.3 Principal risks from insurance activities and use of financial instruments The risk management section of the strategic report sets out all the risks assessed by the Group as principal risks. Detailed below is the Group’s risk exposure arising from its insurance activities and use of financial instruments specifically in respect of insurance risk, market risk, operational risk and credit risk.
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.
Reserve risk is controlled through a range of processes: • regular reviews of the claims and premiums, along with an assessment of the requirement for a liability adequacy provision for the main classes of business by the internal actuarial team; • the use of external actuaries to review periodically the ABE reserves produced internally, either through peer review or through provision of independent reserve estimates; • accompanying all reserve reviews with actuarial assessment of the uncertainties through a variety of techniques including bootstrapping and scenario analysis; • oversight of the reserving process by relevant senior management and the Board; • regular reconciliation of the data used in the actuarial reviews against general ledger data and reconciliation of the claims data history against the equivalent data from prior reviews; and
• regular assessment of the uncertainty in the reserves to help the Board set management best estimate reserves.
Uncertainty in claims reserves estimation is larger for claims such as PPOs for which annually indexed payments are made, typically over the lifetime of the injured party. Claims reserves for PPOs are held on a discounted basis and are sensitive to a change in the assumed real discount rate.
PPOs1 Impact of an increase in the discount rate used in the calculation of present values of 100 basis points 54.6 68.2 Impact of a decrease in the discount rate used in the calculation of present values of 100 basis points (75.1) (97.9)
• a process is in place to deal with major weather and other catastrophic events, known as the ‘Surge Demand Plan’. A surge is the collective name given to an incident which significantly increases the volume of claims reported to the Group’s claims functions. The plan covers surge demand triggers, stages of incident, operational impact, communication and management information monitoring of the plan.
Underwriting risk This is the risk that future claims experience on business written is materially different from the results expected, resulting in current-year losses. The Group predominantly underwrites personal lines insurance including motor, residential property, roadside assistance, creditor, travel and pet business. The Group also underwrites commercial risks primarily for low-to-medium risk trades within the SME market. Contracts are typically issued on an annual basis which means that the Group’s liability usually extends for a 12 month period, after which the Group is entitled to decline to renew or can impose renewal terms by amending the premium or other policy terms and conditions such as the excess as appropriate.
• sector concentration risk – the concentration of the Group to any given industry sector is monitored and analysed in respect of commercial customers
Reinsurance risk This is the risk of inappropriate selection and / or placement of reinsurance arrangements, with either individual or multiple reinsurers which renders the transfer of insurance risk to the reinsurer(s) inappropriate and / or ineffective. 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 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 is mainly exposed to the following market risk factors: • spread risk; • interest rate risk; • property risk; and
Notes to the consolidated financial statements continued 3. Risk management continued 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 by the Investment Committee.
The investment management objectives are to: • maintain the safety of the portfolio’s principal both in economic terms and from a capital, accounting and reporting perspective; • maintain sufficient liquidity to provide cash requirements for operations, including in the event of a catastrophe; and
• maximise the portfolio’s total return within the constraints of the other objectives and the limits defined by the investment guidelines and capital allocation.
Spread risk This is the risk of loss from the sensitivity of the value of assets and investments to changes in the level or in the volatility of credit spreads over the risk-free interest rate term structure. The level of spread is the difference between the risk-free rate and actual rate paid on the asset, with larger spreads being associated with higher risk assets. The Group is exposed to spread risk through its investments in bonds.
The subordinated guaranteed dated notes with a nominal value of £500 million were issued on 27 April 2012 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 for a floating rate of three-month LIBOR plus a spread of 706 basis points which was credit value adjusted to 707 basis points with effect from 29 July 2013.
The Group also invests in floating rate debt securities, whose investment income is influenced by the movement of the short-term interest rate. A movement of the short-term interest rate will affect the expected return on these investments.
The market value of the Group’s financial investments with fixed coupons is affected by the movement of interest rates. For the majority of investments in US Dollar corporate bonds, excluding £403.9 million of short duration high yield bonds (2016: £432.0 million) the Group hedges the exposure of this portfolio to the US Dollar interest rate risk using swaps.
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 £2,084.5 million (2016: £2,107.1 million) of investments in US Dollar corporate bonds and Euro securities through £110.4 million (2016: £91.8 million) 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 risk on the hedging contracts.
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 points increase in spreads would have been £23.7 million (2016: £34.4 million) and a 100 basis points increase in interest rate would have been £6.2 million (2016:£4.8 million).
• reinsurance recoveries – counterparty exposure to reinsurance counterparties 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; and
Concentration risk This is the risk of loss associated with inadequately diversified portfolios of assets and / or obligations, in particular: • large exposures to individual credits (either bond issuers or deposit-taking institutions); and
Notes to the consolidated financial statements continued 3. Risk management continued The table below analyses the distribution of debt securities by geographical area (commercial real estate loans and infrastructure debt are all within the UK).
Notes to the consolidated financial statements continued 3. Risk management continued 3.3.4 Operational risk This is the risk of loss due to inadequate or failed internal processes, people, systems, or from external events. 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.
Notes to the consolidated financial statements continued 3. Risk management continued
Using the Group’s partial internal model, there is a capital surplus of approximately £0.86 billion above an estimated SCR of £1.39 billion as at 31 December 2017 (31 December 2016: £0.91 billion and £1.40 billion respectively). The Group’s capital requirements and solvency position are produced and presented to the Board on a regular basis.
Home This segment consists of home insurance together with associated legal protection cover. The Group sells home insurance direct through its own brands, Direct Line, Churchill and Privilege, and also through partnership brands and through PCWs.
Commercial This segment consists of commercial insurance for SME entities sold through NIG who distribute through proxies, Direct Line for Business which sells direct to SMEs, Churchill for Business and through partnership brands.
Restructuring costs Restructuring costs are costs incurred in respect of the business activities where the Group has a constructive obligation to restructure its activities.
No inter-segment transactions occurred in the year ended 31 December 2017 (2016: £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 (payable to) / recoverable from reinsurers (96.8) 2.8 0.5 (50.6) (144.1) (39.0) (183.1)
Restructuring costs (11.9) Operating profit 642.8 Finance costs (103.8) Profit before tax 539.0
Notes to the consolidated financial statements continued 4. Segmental analysis continued The table below analyses the Group’s revenue and results by reportable segment for the year ended 31 December 2016.
Restructuring costs (39.9) Operating profit 390.2 Finance costs (37.2) Profit before tax 353.0 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%
The segmental analysis of assets and liabilities is prepared using a combination of asset and liability balances directly attributable to each operating segment and an apportionment of assets and liabilities managed at a Group wide level. This does not represent the Group’s view of the capital requirements for its operating segments.
Reinsurance premium: Premium payable (208.4) (206.2) Movement in reinsurance unearned premium reserve 3.7 4.0 6. Investment return £m 2016 £m
Investment income: Interest income from debt securities 137.5 136.5 Cash and cash equivalent interest income 3.0 4.2 Interest income from infrastructure debt 6.8 7.8 Interest income from commercial real estate loans 3.6 1.0 Interest income 150.9 149.5 Rental income from investment property 16.2 18.4
Notes to the consolidated financial statements continued 7. Other operating income £m 2016 £m
Current accident year claims paid 1,165.0 (0.2) 1,164.8 1,131.7 – 1,131.7 Prior accident year claims paid 847.0 (13.8) 833.2 905.2 (18.8) 886.4 (Decrease) / increase in insurance liabilities (440.9) 197.1 (243.8) 142.1 (356.4) (214.3)
Commission expenses 225.4 246.8 Expenses incurred under profit participations 61.0 97.2 10. Operating expenses
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.
The aggregate remuneration of those employed by the Group’s operations comprised: £m 2016 £m
Notes to the consolidated financial statements continued 10. Operating expenses continued Aggregate Directors’ emoluments The table below analyses the total amount of Directors’ remuneration in accordance with Schedule 5 to the Accounting Regulations.
Salaries, fees, bonuses and benefits in kind 5.6 3.1 Gains on exercise of share options 5.3 3.5
At 31 December 2017, no Directors (2016: one Director) had retirement benefits accruing under the defined contribution pension scheme in respect of qualifying service. During the year ended 31 December 2017, three Directors exercised share options (2016: one Director).
Interest expense on subordinated liabilities 44.8 46.3 Net interest received on designated hedging instrument1 (8.0) (8.0) Unrealised loss / (gain) on designated hedging instrument1 10.4 (19.6) Unrealised (gain) / loss on associated interest rate risk on hedged item1 (11.7) 17.8 Realised gain on associated interest rate risk on hedged item1 (11.3) – Premium paid to repurchase subordinated liabilities and associated transaction costs 77.4 – Amortisation of arrangement costs and discount on issue of subordinated liabilities 2.2 0.7
Note: 1. As described in note 32, 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. On 8 December 2017, the Group redeemed £250 million nominal value of the notes.
Current taxation: Charge for the year 114.4 84.4 Under / (over) provision in respect of prior year1 5.3 (7.7)
Deferred taxation (note 13): Credit for the year (5.8) (5.1) (Over) / under provision in respect of prior year (8.9) 2.6
Current taxation 119.7 76.7 Deferred taxation (note 13) (14.7) (2.5) Tax charge for the year 105.0 74.2
The following table analyses the difference between the actual income tax charge and the expected income tax charge computed by applying the standard rate of corporation tax of 19.25%1 (2016: 20.0%).
Per balance sheet: Current tax assets 0.1 0.1 Current tax liabilities (40.7) (0.5) Deferred tax liabilities (31.1) (46.0)
(Charge) / credit to the income statement (0.7) (0.4) (1.8) 5.5 0.2 (0.3) – 2.5 Credit / (charge) to other comprehensive income – 0.7 – – – – (18.0) (17.3) Charge direct to equity – – – – – (1.3) – (1.3)
In addition, the Group has an unrecognised deferred tax asset at 31 December 2017 of £7.4 million (2016: £7.5 million) in relation to capital losses of which £4.1 million (2016: £4.1 million) relates to realised losses and £3.3 million (2016: £3.4 million) relates to unrealised losses.
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 2017 by £1.6 million (2016: £1.8 million).
Earnings attributable to owners of the Company 434.0 278.8 Weighted average number of Ordinary Shares (millions) 1,366.1 1,368.7 Effect of dilutive potential of share options and contingently issuable shares (millions) 12.9 13.1 Weighted average number of Ordinary Shares for the purpose of diluted earnings per share (millions) 1,379.0 1,381.8 Diluted earnings per share (pence) 31.5 20.2
Net assets 2,715.1 2,521.5 Goodwill and other intangible assets1 (471.1) (508.9) Tangible net assets 2,244.0 2,012.6 Number of Ordinary Shares (millions) 1,375.0 1,375.0 Shares held by employee share trusts (millions) (9.9) (9.9) Closing number of Ordinary Shares (millions) 1,365.1 1,365.1 Net asset value per share (pence) 198.9 184.7 Tangible net asset value per share (pence) 164.4 147.4
Note: 1. Goodwill has arisen on acquisition by the Group of subsidiary companies. Intangible assets are primarily comprised of software development costs.
Accumulated amortisation and impairment At 1 January 2016 – 181.4 181.4 Charge for the year – 57.4 57.4 Disposals and write-off1 – (5.8) (5.8) Impairment losses2 – 39.3 39.3
Notes: 1. Disposals and write-off include fully amortised intangible assets no longer utilised by the Group in its operating activities. 2. The impairment losses relate to capitalised software development costs for ongoing IT projects primarily relating to development of new systems. The impairment losses result from capitalised costs that will no longer be utilised and the charge which reduced the carrying value of impaired assets to £nil, is reflected in the Motor segment.