Contents 1 Corporate highlights 2 Business structure 3 Chairman’s statement 5 Chief Executive’s report 12 Insurance carriers 16 Group financial performance 22 Risk management 28 Corporate responsibility 30 Board of Directors 32 Corporate governance 35 Directors’ remuneration report 43 Directors’ report 44 Directors’ responsibilities statement 45 Report of the independent registered public accounting firm 46 Consolidated income statement 46 Consolidated statement of comprehensive income 47 Consolidated balance sheet 48 Consolidated statement of changes in equity 49 Consolidated cash flow statement 50 Notes to the financial statements 96 Five year summary
Net assets per share increased by 23.2% to 258.1p (2007: 209.5p)
Return on equity of 9.2% (2007: 28.8%) or 16.4% (2007: 28.8%) excluding certain foreign currency items*
Strong balance sheet after share repurchases of £63m at average price 221.7p
Expansion in the USA: five new offices opened and 43 additional staff recruited since September
Good opportunities to continue to grow a balanced business internationally *excludes foreign currency items on economic hedges and intragroup borrowings.
Profit before tax and certain foreign currency items* (£m) 156.2 237.2
Return on equity excluding certain foreign currency items* (%) 16.4 28.8
Robert Childs Chief Underwriting Officer, Chairman of Hiscox USA, Chief Executive Officer, Hiscox Bermuda
Art and private client; PI and specialty commercial; regional technology and media; direct.
Michael Gould Chairman of Hiscox European Steering Group, Chief Operating Officer
Art and private client; PI and specialty commercial; regional technology and media.
Dividend and capital management The Board proposes a final dividend of 8.5p (2007: 8p) making a total dividend for the year of 12.75p (2007: 12p), an increase of 6.25%. This will be paid on 16 June 2009 to shareholders on the register at the close of business on 15 May 2009. We have always advocated a progressive dividend policy and being able to cover an increased dividend after such a difficult year is extremely satisfying.
During 2008 we bought in 28,300,742 shares for a total of £62,866,000 (an average price of 221.7p per share). Our balance sheet is strong and sufficient for our current plans. We like to use our capital as fully as is prudent to keep the returns to shareholders as high as possible. Interestingly, we last raised capital through a rights issue in 2005 raising £170 million net, since when we have returned £207 million to shareholders through dividends and share buy-backs.
The Global Markets division has recently expanded in the US with the acquisition of some highly talented people and new offices have been opened. We have long abandoned the Lloyd’s business model of sitting in the Room waiting for business to come from around the world which is no longer sustainable. Bermuda has a bigger share of the world reinsurance
Chairman’s statement 2008 was a year that will be written about for decades to come, and it was a good year for Hiscox to show the robustness of its business. Global Markets’ underwriting was tested by the third most expensive hurricane on record but the reinsurance account still made a decent profit; the regional business continued to grow in size and profitability, and the worldwide financial collapse stress tested our investment portfolio beyond any expert forecast and a very small investment loss was a fair result, with currency movements adding substantially to our profits and assets.
In the 2008 interim report I wrote that it seemed surreal to be announcing record profits when the share price was so low. Our sector was subsequently re-rated, and the appraisal was valid. We had not followed the banks into speculating heavily on borrowed money, and we had continued to price risk and to monitor our liabilities to the best of our ability, using the best models available but aware of their frailty. We had in our corporate memory the agonies Lloyd’s suffered in the early 1990s from the spiral of reinsurance liabilities and the seemingly unquantifiable liabilities from asbestosis and pollution, and we had learnt.
Change is the price of survival, and the change at Hiscox over the last decade from a Lloyd’s agency to a group of international insurance companies has been dramatic. We have a balanced business both geographically and in our products; we have a dominant position in many of our specialisms; we are building a strong brand, and most important, we have first class people devoted to doing first class business in a first class way. We will continue to build on our strong foundations during the forthcoming very difficult economic conditions, and then should flourish enormously when the world comes out of recession.
Chairman’s statement continued market than London, and our operation here in Bermuda showed us the viability and efficiency of underwriting electronically, even on a small island 600 miles from anywhere. Bermuda benefits from advantageous tax and regulatory regimes, and also from being closer to the USA. Human relationships and proximity remain a key factor in doing business, so we have opened, or are opening, offices selectively across the USA, in addition to our Global Markets presence in London and Paris.
Gl ob al err ors an d o mi ss ion s, dir ec tor s a nd offi ce rs
Lo ca l e rro rs an d om iss ion s a nd co m m er cia l 1
The rewards of this approach are shown in its ability to generate a profit despite losses from Hurricanes Ike and Gustav. At a trading level Global Markets benefited from the strength in the US Dollar. This was an advantage this year but could present a future challenge if Sterling strengthens.
Our reinsurance area had a great year despite the run of large risk losses which affected the market in the first half and the impact of Hurricanes Ike and Gustav into the second half. The team’s performance benefited from the commutation of the Panther Re sidecar, which saw Hiscox assuming the risk of all losses occurring after 31 January 2009. We replaced Panther with a Lloyd’s sidecar Cougar Syndicate 6104 and other reinsurances. January renewals saw an increase in the rates in the US. We have expanded our writings slightly but expect to expand further as the year develops, as we expect rates to rise generally as the year progresses. The property team underwrites our catastrophe exposed primary property business, together with some international homeowner and small business insurance. The team suffered in the hurricanes but delivered a positive result overall, helped by releases on older years, including some arising out of the positive settlement of claims relating to the events of September 11, 2001. We are pursuing our subrogation actions relating to these and other claims with vigour.
The specialty division, which brings together political risks, aviation war, terrorism, contingency, kidnap and ransom and bloodstock, had a good year. Hiscox’s deep expertise attracts business. The key challenge for this team is to continue to draw business into London as businesses – including Hiscox – build their capability in domestic markets.
Marine and energy, unsurprisingly, had an unprofitable year. They were in the front line for both Hurricanes Ike and Gustav. The losses sustained were within our expectations. Rates in the Gulf will have to rise significantly if the class is to be underwritten profitably there.
In addition to disciplined underwriting, the Global Markets team has recognised that business no longer flows to London as a right, and in 2007 invested in creating teams who were located mainly in Paris and New York. Since September, Global Markets has taken advantage of the disruption caused by the financial crises by recruiting people and working with our USA business to open new offices in Boston, Kansas City, Lexington and Miami. We expect to open a further office in Los Angeles this year. This expanded footprint will enable us to underwrite our specialist lines locally in the US domestic market.
Hiscox UK and Hiscox Europe Our commitment to growing our domestic businesses in the UK and mainland Europe paid off in 2008. We saw strong growth in both divisions and much stronger underwriting performance. Looking at each in turn: Hiscox UK saw growth of 14.3% to £261.9 million (2007: £229.2 million). Growth was strong in all areas, but we are particularly
Hiscox UK and Hiscox Europe rating index Index level (%). 12 month rolling period
Netherlands made substantial improvements to their performance year on year. The progress of the business reflects our decision to focus our efforts in those countries where we already have offices in order to drive economies of scale. To drive this point home we have set a target of a gap of 10% between the rate of growth of expenses and revenues. We achieved this in 2007 and came close in 2008. Of particular note in Europe is the turnaround in Germany. Some tough decisions were made to end relations with brokers who had produced poor quality business, allowing the team to focus on more productive relationships. The Netherlands has seen a real growth in scale with very little increase in expense, with consequent positive impact on the bottom line. Spain has new leadership in place.
Operations and IT With the relentless advance of technology, operations and IT are now central to the business. Ten years ago if our IT collapsed we could continue to trade, but this is no longer the case. Our core infrastructure is based in the UK and France, removing the Group’s dependence for communications on our London office. The resilience of these new arrangements was tested during 2008 and our systems worked well.
We have also significantly improved our online response times and service in the UK which is critical to the direct customer experience.
We appointed Michael Gould as Chief Operating Officer during the year and he has already improved operating disciplines. This includes more rigour in prioritising and managing projects, as well as developing consistent operational measures to track the Group’s performance.
In addition to the upheaval and volatility in the financial market, 2008 saw equivalent volatility in the currency exchange market and in the course of the year the US Dollar fluctuated from 1.99 opening to 1.44 closing.
Balance sheet and ratings Total shareholders’ funds grew to £951.0 million (2007: £824.3 million). On a per share basis this is equal to net assets per share of 258.1p (2007: 209.5p) and net tangible assets per share of 244.9p (2007: 199.3p). We continue to see building per share asset value as a key performance metric as we think that over time it is the most important factor driving our share price.
We see these opportunities continuing for some time as the global capital shortage means that there is unlikely to be a flood of new capital into the industry. In addition many capital raisings will be focused on repairing damage to balance sheets with little net additional capital entering the industry.
key ingredient to success is the people within the business. Our staff have had a great year. There is inevitable nervousness when so much turmoil abounds, but they stuck to their knitting and delivered great business development, underwriting, investment and operations performance.
It is these attitudes, sacrifices and day to day performance which gives Hiscox the strength and agility to respond to challenging markets. I am deeply grateful to all of our staff for this.
Europe Amsterdam Bordeaux Brussels Cologne Dublin Guernsey Hamburg Lisbon Lyon Madrid Munich Paris Stockholm
Rest of w orld 12 ­Insurance carriers Hiscox Ltd Report and Accounts 2008
The geographical and currency splits are shown to the right. One of the main advantages of trading through Lloyd’s is the considerably lower capital ratios that are available due to the diversification of business written in Syndicate 33 and in Lloyd’s as a whole. Syndicate 33 has a capital requirement ratio of approximately 45.6% of Syndicate capacity. The size of the Syndicate is increased or reduced according to the strength of the insurance environment in its main classes. At present, Hiscox owns approximately 72.5% of the Syndicate, with 27.5% being owned by third party Lloyd’s Names. Hiscox receives a fee and a profit commission of approximately 17.5% of profit on the element it does not own.
The chart to the right shows the performance of Syndicate 33 for the last eight years.
Syndicate 3624 Syndicate 3624 is a new wholly owned syndicate with an initial underwriting capacity of £80 million. The Syndicate was approved by Lloyd’s during the last quarter of 2008 and began underwriting for the 2009 year of account. No business was written in the Syndicate in 2008.
Cougar Syndicate Cougar Syndicate was set up for the 2008 year of account with a capacity of £34 million and is wholly backed by external Names. The Syndicate takes a pure year account quota share of Syndicate 33’s international property catastrophe reinsurance account under a limited tenancy agreement. This was initially for a one-year period only. Cougar Syndicate 6104 is managed by Hiscox Syndicates Limited. The arrangement was extended for the 2009 year of account and Cougar Syndicate 6104’s capacity was increased to £43 million. In addition Hiscox has put in place reinsurance with a number of conventional reinsurers on a similar basis to the Cougar and Panther arrangements.
Hiscox Insurance Company Limited Gross premiums written (£m) and combined ratio (%)
In September A.M. Best upgraded the rating of Hiscox Insurance Company Limited to A (Excellent). In December Standard & Poor’s upgraded its rating to A (Strong). At the end of 2008, net assets exceeded £151 million (2007: £126 million).
Hiscox Insurance Company (Guernsey) Formed by Hiscox in 1998, Hiscox Insurance Company (Guernsey) Limited writes mainly kidnap and ransom and fine art insurance. Its gross premiums written since inception are shown in the chart opposite. During the year, A.M. Best upgraded the rating of Hiscox Guernsey to A (Excellent). At the end of 2008, net assets exceeded $23.1 million (2007: $20.6 million).
Hiscox Insurance Company Inc. Hiscox Insurance Company Inc. was acquired by the Group in July 2007 through the purchase of the then parent holding company ALTOHA, Inc. It is rated A (Excellent) by A.M. Best.
Hiscox Insurance Company Inc. is based in Geneva, Illinois and is an admitted insurance company with licences in all 50 US states. Its insurance is also available internationally in Australia and South Africa. Its main business is animal mortality insurance for cattle and horses.
Earnings per share fell to 18.8p (2007: 48.4p). The revival of the US Dollar during the second half of the year generated material exchange gains, which combined with good underwriting profits, assisted in growing overall net asset value per share by 23% to 258.1p (2007: 209.5p). Gross premiums written reduced by 4.3% as the Global Markets and Bermuda businesses contracted on rates. This was offset by growth in all other business units. The Group achieved a profit before tax of £105.2 million in 2008 (2007: £237.2 million). The post-tax return on shareholders’ equity was 9.2% (2007: 28.8%). Total dividend for the year increased by 6.25% to 12.75p (2007: 12.0p).
Post-tax return on equity 16 Group financial performance Hiscox Ltd Report and Accounts 2008
Group financial performance Global UK and Corporate Global UK and Corporate
Foreign currency items on economic hedges and intragroup borrowings (£m) 6.0 – – (57.0) (51.0) – – – – –
income securities. Consequently, the underlying investment performance before the impact of derivative items was £27.6 million negative (2007: £100.8 million positive). Although disappointing, this remains a creditable result in an exceptional year and a significant portion represents unrealised fair value adjustments which may be expected to reverse over the medium term as the affected assets mature.
Hiscox Global Markets performance Hiscox Global Markets comprises the results of Syndicate 33, excluding Syndicate 33’s fine art, UK regional events coverage, non-US household business and the underwriting result of Hiscox Inc.
Profit before tax was consequently lower at £140.5 million (2007: £155.6 million). The combined ratio was 68.5% (2007: 81.7%), having been impacted by positive foreign exchange movements.
Hiscox UK performance Hiscox UK comprises business written by Hiscox Insurance Company Limited in the UK and Ireland. It also includes the results of Syndicate 33’s fine art, UK regional events coverage and non-US household business, together with income and expenses arising from the Group’s retail agency activities in the UK. It excludes the results of the larger retail TMT business written by Hiscox Insurance Company Limited and the Irish surety business.
Hiscox Europe performance Hiscox Europe comprises business written in mainland Europe by Hiscox Insurance Company Limited and the Irish surety business. It also includes the results of Syndicate 33’s European fine art, European regional events coverage and European household business, together with the income and expenses arising from the Group’s retail agency activities in Continental Europe.
Europe’s gross premiums written grew by 27% to £93.0 million (2007: £73.1 million) as a result of strong underlying growth in all countries except for Ireland, where demand for surety bond insurance was constrained by the slowdown in the construction market. The strengthening Euro offered support to the reported top line.
The reduction in gross premiums written of £14 million is wholly attributable to the strategic contraction of the Bermudian external reinsurance business in response to softer market conditions. A reduction of 23% of the Bermuda premium was offset by organic growth of 21% achieved in Guernsey where we experienced increased demand for our specialised products, and 43% growth in the USA which benefited from organic growth and the inclusion of one full year of business from the ALTOHA Inc. Group which was acquired in August 2007. Exchange rate movements also had a beneficial impact. The reinsurance outwards spend was slightly lower in 2008 reflecting the lower underwriting activity in Bermuda which more than offset the impact of the reinstatement premiums incurred after Hurricanes Ike and Gustav.
Investment result – derivatives (£m) – (10.5) (10.5) – – –
Underlying investment income decreased to £1.8 million negative (2007: £11.9 million positive).
Cash and liquidity The Group’s primary source of liquidity is generated from premium income and interest income received on investments. Funds received are used predominantly to pay claims, increase investments and pay dividends and taxes.
The Group maintains relationships with a limited selection of banks who are monitored for their credit status and ability to meet the day-to-day banking requirements of the Group. There were no impairments recorded against cash or cash equivalents and no recoverability issues have been identified on such assets.
The increased outflow was driven primarily by cashflows on the purchase of own shares as part of the share buy-back programme of £62.9 million (2007: £11.3 million) and £2.2 million for purchases held in trust.
The complete lack of liquidity in most areas of the bond markets has led to many discounted mark to market valuations. This has been most pronounced in the US Dollar bond portfolio where the valuations of some of the mortgage backed securities have suffered. The underlying securities, however, continue to pay down interest and principal in line with expectations and remain highly rated. Indeed cashflow from our bond portfolios is being generated at the rate of approximately £100 million a quarter which, together with undrawn bank facilities, provides us with ample liquidity. By the end of the year, 18.5% of the total portfolio was represented by cash. Government and Government supported assets accounted for 52% of the debt securities, with 94.6% of the debt securities being rated A or higher.
Away from cash and treasuries, which will be maintained at an appropriate level to provide liquidity, we see good opportunities in investment grade corporate bonds and would expect to increase our allocation there.
We have investments with four hedge fund managers totalling £40 million (2007: £30 million) all of whom are essentially stock pickers and none of whom employ any leverage. In light of recent scandals and events, the maxim of keeping it simple has found new relevance and still lies at the heart of our philosophy.
High quality and well diversified portfolio Investment portfolio: £2,522m 2.3% CAD
Risk management framework The risk management framework extends to all aspects of risk including insurance, market, credit, operational, liquidity, environmental, ethical and strategic risks. The core business of Hiscox is dealing with risk. The understanding of risk is intrinsic to every level of decision-making in the Group.
The risks associated with the core business represent some of the greater exposures, however the Group is exposed to a number of other risks and has systems and procedures to identify and manage them. These procedures are regularly reviewed and improved in the light of the changing risk environment and best practices. Risk appetite is set by the main Board and cascaded down into the Group’s global operations as part of the business planning cycle and through various risk and operational committees. These committees have terms of reference that assign specific areas of focus, such as underwriting, loss modelling, reinsurance purchase and security, liquidity, broker credit risk, investments, claims reserving and business continuity. Senior management responsibilities are clearly defined together with their reporting lines and the execution of delegated responsibility is closely monitored by reporting to the Board and its committees. This monitoring, supported by financial and non-financial management information, covers performance against agreed targets and objectives, as well as the risks to achieving these objectives and the effectiveness of the measures in place to manage these risks. In parallel with these direct risk management processes, there is a dedicated risk management function which, in conjunction with Internal Audit and Group risk committees, monitors and reviews the effectiveness of risk management activities throughout the organisation and reports to the Board. These functions are organised centrally to assist in the integration of best practice throughout the Group. A range of risk management tools are used to assess and manage risk both at business unit level and on a Group-wide basis.
Of critical importance is the quality of our underwriting models and risk aggregation capability. Incentives ensure that underwriting staff make sound and objective judgements that are aligned with the Group’s overall strategic objectives. Clear authority limits are also in place that are regularly reviewed and monitored. Policy wordings are reviewed regularly by specialists and legal experts in the light of legal developments to ensure that the Group’s exposure is restricted, as far as possible, to those risks identified at the time of policy issuance. The modelling and monitoring tools are used both in the underwriting process and by independent risk specialists. They are used to design the insurance and reinsurance programmes and control the business underwritten to ensure that the risk profiles of contracts match the exposures for which the programmes were devised.
to deliver a well-diversified book of uncorrelated business. This enables us to maximise expected risk/return on the portfolio as a whole and offset potential losses on the more volatile accounts.
Mutualisation is a related risk arising from the phenomenon of pricing cycles in the industry. The Group is required to contribute towards the obligations of other financial institutions who fail. Syndicates 33 and 3624 contribute to the New Central Fund operated by the Council of Lloyd’s, and in the UK certain Hiscox entities contribute to the Financial Services Compensation Scheme (FSCS). Insurance companies have not yet been asked to fund the recent claims on the FSCS from the banking industry, currently funded by the Treasury. Any such requests will depend on the final level of claims from deposit-holders (net of asset recoveries), the period of repayment demanded by the Treasury and the ability of the banks to make such repayments. The Treasury has indicated that it will not demand any principal repayments in the next three years. The Group participates in many industry bodies, associations and task-force initiatives in order to monitor developments and influence their strategic direction. In particular, the continued involvement of the Group’s executives in the reshaping of the Lloyd’s market underscores that commitment.
Credit Reinsurance counterparties The Group purchases reinsurance protection to limit its exposure to single claims and the aggregation of claims from catastrophic events. The Group places reinsurance with companies that it believes are strong financially and operationally. Credit exposures to these companies are closely managed by the Reinsurance Security Committee (RSC), which is chaired by the Group Finance Director. All reinsurers used must be approved by the RSC following an internal assessment of the companies’ financial strength, trading record, payment history, outlook and organisational structure, in addition to credit ratings granted by external agents. Approved reinsurers are monitored continuously to identify potential deteriorations as early as possible. Monitoring procedures include consideration of public information produced by reinsurers; the Group’s experience of the reinsurers and their behaviour in the marketplace; analysis from external consultants and from rating agencies. Credit limits are set for approved reinsurers both at a Hiscox Group level and for each underwriting subsidiary based on a defined risk appetite. The Group’s experience of bad debts arising from its reinsurance arrangements has been minimal.
Operational and other key risks Business continuity The Group has taken significant steps to minimise the impact of business interruption that could result from a major external event. A formal disaster recovery plan is in place for both workspace recovery and retrieval of communications, IT systems and data. In the event of a major event, these procedures will enable the Group to move the affected operations to alternative facilities within very short periods of time. The disaster recovery plan is tested regularly and includes disaster simulation tests. Staff are widely distributed throughout the UK, Europe, USA, Bermuda and Guernsey. This geographical dispersion reduces the Group’s exposure to natural or terrorist events that could prevent access to premises or loss of staff. In the event of a loss of staff, for example as a result of a pandemic, a plan is in place to re-assign key responsibilities and transfer resources to ensure key business functions can continue to operate.
Emerging risk identification and control is a core part of risk management activities in relation to all aspects of our business, including underwriting, operational and strategic.
Investments and foreign exchange Investment policy The investment policy is designed to maximise returns within the overall risk appetite of the Group which stipulates a one in 100 year loss tolerance. The overriding philosophy with the Group’s assets is not to lose money or to put at risk the Group’s capacity to underwrite. In this regard 2008 by most measures, will be viewed as a one in 100 year event. These turbulent times have not diminished the Group’s capacity to underwrite due to our conservative investment policy.
Technical funds, the investments held for the payment of future claims, are primarily invested in high quality bonds and cash. The high quality and short duration of these funds allows the Group to meet its aim of paying valid claims quickly. These funds are maintained in the currency of the insurance policy to reduce foreign exchange risk.
Due to the short tail nature of the Group’s insurance liabilities, the aim is not to match the duration of the assets and liabilities precisely. Benchmarks are instead set for the fixed income fund managers which approximate the payment profile of the claims as well as providing the managers with some flexibility to enhance returns.
A proportion of the Group’s assets are allocated to riskier assets, principally equities. Here, it is the Group’s philosophy to take a long-term view in search of acceptable risk adjusted returns. The proportion of the Group’s funds invested in risk assets will depend on the outlook for investment and underwriting markets. An allocation within the risk assets is made to less volatile, absolute return strategies. This balances the desire to enhance returns against the need to ensure capital is available to support underwriting throughout any downturn in financial markets.
Liquidity Liquidity risk is the risk of being unable to meet liabilities to customers or other creditors as they fall due, or the risk of incurring excessive costs in selling assets or having to raise finance in a very short period.
Second, taking into account the stress and scenario analyses, we maintain extensive borrowing facilities. These are held with a diverse range of major international banks in order to minimise the risk of one or more being unable to honour their commitments.
Using these measures we believe the likelihood of being unable to meet our liabilities, or of incurring excessive costs in doing so, to be extremely remote.
b m ar ke t lo ss ye ar re tu rn p er io d 27Risk management Hiscox Ltd Report and Accounts 2008
Fundamental to corporate and social responsibility is honest and fair dealing in all activities of the Group. Hiscox has always been extremely conscious of its reputation. Management has always believed that a reputation for integrity and decent behaviour in all dealings, be they within the Group or with those from outside who come in contact with the Group, will be good for morale and for the results of the business.
Hiscox’s commitment to responsible business practices is reflected: In the marketplace Dealing with customers Hiscox is dedicated to advising customers on risk management to prevent burglary and fire in the home and other distressing losses. Should a loss occur, the Hiscox UK philosophy is that insurance is a promise to pay, and the claims service aims to support customers and make them whole as soon as possible.
Dealing with business partners Insurance brokers are an important Hiscox stakeholder, and Hiscox endeavours to have good relationships with them to create a competitive advantage in the marketplace. Clear communication is key to good relations and a quarterly Hiscox broker magazine keeps brokers informed of developments at Hiscox and in the insurance industry.
Rewards and benefits Hiscox encourages employees to identify with the success of the Group through performance-related pay and bonus schemes, savings related share option schemes and executive share option schemes. Competitive benefits packages contain health, fitness, flexible working and career break opportunities. Salary packages are benchmarked by Watson Wyatt against the financial services industry as a whole and against the Lloyd’s market specifically, where applicable. Packages are also considered on a country-by-country basis.
Communication and participation Employees are kept informed of business developments through formal briefings, team meetings, intranet bulletins, video conferences and informal routes. Management takes these opportunities to listen to staff and involve them in taking the business forward. A monthly staff e-zine provides updates on issues and social events.
Hiscox strives for the highest standards of corporate governance while being in essence a non-bureaucratic organisation.
In the community Hiscox donated £717,000 to charities in 2008. As the Group expands internationally, it aims to recruit local staff wherever possible to help develop a rapport with the local community and make a direct contribution to the local economy. The Group has maintained its involvement in its local communities with the strong support of its employees. In Bermuda, Hiscox supports the Bermuda Sunshine League which is a transitional living facility for children removed from unstable living environments and gives employees the opportunity to contribute their time and effort to children who require adult role models and a semblance of stability. Hiscox is a member of the Lloyd’s Community programme, which supports local initiatives concerning education, training, enterprise and regeneration. In London, the Reading Partners scheme has continued, through which staff assist pupils at the Elizabeth Selby Infants School in Tower Hamlets. Employees also mentor students at Morpeth School in Tower Hamlets.
Hiscox Art Projects, a contemporary exhibition space situated in the London office with free entry to the public, continues to provide artists with an opportunity to exhibit their talents.
The Hiscox Foundation The Hiscox Foundation, a charity funded by an annual donation from Hiscox, has been set up to give donations to deserving causes. It gives priority to any charity in which a member of staff is involved with the aim of encouraging and developing such activity. Hiscox staff continued their seven year long support of the Richard House Hospice, raising over £25,000 during 2008. The foundation has committed to support HART (Humanitarian Aid Relief Trust) over a three year period. The charity helps some of the poorest and most abused people in the world. As part of the purchase of American Live Stock, Hiscox has taken over a small charitable foundation based in Illinois, USA. Four Hiscox employees have been appointed to the Board of the Foundation. The Foundation, which formerly supported animal charities, will now broaden its scope to support relevant causes in the US.
The Group’s direct environmental impact is mainly from the energy it uses and the emissions and waste it generates from its premises. In accordance with the Group’s environmental policy, consumables are recycled and reused wherever possible. The Group continues to take steps to reduce the amount of raw materials used in business processes and by staff, particularly through the extensive use of computerisation and communications technology. Programmes for recycling batteries, mobile phones, lamps and CDs continued during the year.
During 2008 Hiscox UK conducted an audit of its impact on the environment and with Corporate Citizenship, calculated the carbon footprint of the UK business. Hiscox UK aims to be Carbon Neutral by the end of 2009 by reducing greenhouse gas emissions, engaging employees to modify their behaviours and seeking to offset unavoidable carbon emissions.
More detailed information relating to the actions Hiscox is taking to meet each of the Climatewise Principles will be published on Hiscox.com in June 2009.
Daniel Maurice Healy Non Executive Director and Chairman of the Audit Committee (Aged 66) Daniel Healy joined Hiscox in 2006. He was appointed Executive Vice President and Chief Financial Officer of North Fork Bancorporation in 1992 and a member of its Board of Directors in 2000. He was a partner with KPMG LLP before joining North Fork. He was the Managing Partner of the San José, California and Long Island, New York offices and held other positions in that firm during his tenure. He is Chairman of Herald National Bank and he holds Board positions with KBW, Inc. and Harlem RBI, a not for profit organisation. He is also a senior adviser to Permira Advisers LLC an international private equity firm.
Robert Ralph Scrymgeour Hiscox Chairman (Aged 66) Robert Hiscox joined Hiscox in 1965 and has been Chairman of the main holding company of Hiscox since its incorporation in 1973. He was Deputy Chairman of Lloyd’s between 1993 and 1995. He is a Non Executive Director of Grainger Trust plc and AGICM Ltd.
Dr James Austin Charles King Non Executive Director and Chairman of the Conflict Committee (Aged 70) Dr James King joined Hiscox in 2006. He chairs Keytech Limited, The Bermuda Telephone Company Ltd, the Argus Group of Companies, Grotto Bay Properties Ltd and the Establishment Investment Trust, a UK listed company. He was chairman of the Bank of N.T. Butterfield & Son Limited until 19 April 2007. He is a Trustee of the Bermuda Institute of Ocean Sciences and a Director of Castle Harbour Limited. Dr King is a fellow of the Royal College of Surgeons, Canada and the American College of Surgeons.
Andrea Sarah Rosen Acting Senior Independent Director and Acting Chairman of the Remuneration and Nomination Committee (Aged 54) Andrea Rosen joined Hiscox in 2006. She was appointed as a Director of Alberta Investment Management Corporation in October 2007 and is a Director of Emera Inc. She was previously Vice Chair of TD Financial Group and President of TD Canada Trust from 2002 to 2005. Prior to this she held various positions within the TD Financial Group from 1994 to 2002, including Executive Vice President of TD Commercial Banking and Vice Chair of TD Securities. She was Vice President of Varity Corporation from 1991 to 1994 and held various positions with Wood Gundy Inc. from 1981 to 1990.
Gunnar Stokholm Non Executive Director (Aged 59) Gunnar Stokholm joined Hiscox on 20 November 2008. He worked for Zurich Financial Services between 1995 and 2004, in a number of roles including CEO for Australia and Asian markets. He spent the majority of his career at Topdanmark Insurance and held the position of Managing Director of Topdanmark Holding from 1986 to 1995.
Dirk Arie Stuurop Non Executive Director (Aged 60) Dirk Stuurop joined Hiscox in 2006. He is managing partner of Lighthouse Holdings LLC. From 2004 to 2009 he was Vice Chairman of the Board of RAM Holdings Limited, a Bermudian domiciled financial guaranty reinsurance operation. From 1999 to 2006, Dirk was President of Stuurop & Company, a privately owned firm providing strategic advice to executive managements and boards of directors. In 1999 he retired as Chairman of Global Financial Institutions at Merrill Lynch where he worked from 1982. He served as Chairman of Worldinsure Ltd, from 2000 to 2002 and as Senior Executive Director to Banc of America Securities in 2003.
Overview and basis of reporting Hiscox Ltd (‘the Company’) is a Bermudian domiciled holding company for the Group. The Company is listed on the London Stock Exchange’s main market for listed securities. The corporate governance framework for companies registered in Bermuda is established by the Company’s constitution together with Companies Act legislation.
During 2008, and up to the date of this report and accounts, the Group has complied with the provisions of the Combined Code in all material respects.
The Board of Directors The Board comprises four Executive Directors and seven independent Non Executive Directors, including a Senior Independent Director. Biographical details for each member of the Board are provided on pages 30 to 31.
In accordance with the Company’s Bye-Laws all Directors are required to submit themselves for re-election at least every three years. The appointment and removal of the Company Secretary is a matter for the Board as a whole. All Directors are entitled to seek independent professional advice at the Company’s expense. A copy of the advice is provided to the Company Secretary who will circulate it to all Directors. No such advice was sought during the year.
The Board’s committees The Board has appointed and authorised a number of committees to manage aspects of the Group’s affairs. Each committee operates within established written terms of reference and each committee Chairman reports directly to the Board.
The Group Executive Committee The Group Executive Committee, comprised of the Executive Directors, meets monthly to raise and discuss topics such as Group strategy (subject always to Board approval), approval of senior appointments and remuneration (other than Board appointments), management of the Group’s trading performance, mergers and acquisitions (which are not significant to the Group), significant issues raised by the London and international executive committees and approval of exceptional spend within the limits established by the Board. The London Executive Committee considers day-to-day issues arising from the Group’s UK and mainland Europe businesses. The International Executive Committee considers issues arising from the Group’s Bermuda, Guernsey and US businesses.
A succession planning review identified the requirement for additional Non Executive Directors. An evaluation of the skills, knowledge and experience of the Board was undertaken in order to achieve the desired level of diversity across the Board. Spencer Stuart were appointed to conduct an executive search. Following consultation with the members of the Remuneration and Nomination Committee, the Chairman and Chief Executive interviewed prospective candidates. The Remuneration and Nomination Committee recommended to the Board the appointment of Ernst Jansen and Gunnar Stokholm.
Risk Committees There are a number of committees within the Group which have been established to oversee specific risk areas, including underwriting, reserving, reinsurance credit, liquidity, broker credit, business continuity and investments. A Group risk committee ensures risk management activities are effective and integrated. These committees are comprised of Directors of the Company and its subsidaries and relevant senior employees.
The risk management systems are set out in detail in the risk management report on pages 22 to 27.
This report sets out the remuneration policy for the Group’s senior executives. This policy is consistent with the overall reward approach across the Group.
As a business Hiscox is focused on generating strong pre-tax return on equity and long-term shareholder returns, therefore our reward structure is aligned with this.
Remuneration elements The elements of remuneration at Hiscox are; fixed reward (base salary, benefits and retirement benefits) and variable reward (annual cash incentives (bonuses) and share incentive schemes).
When approving Executive Directors salaries, the Remuneration and Nomination Committee takes into account rates of inflation, performance and competitive positioning of salaries as informed by Watson Wyatt data and other publicly available reports.
Retirement benefits These also vary by local country practice. With the exception of Holland, all Hiscox retirement schemes are based on defined contributions. In Holland, we closed the defined benefit scheme to new members from July 2008. We will introduce a defined contribution scheme in 2009 and transition all current employees into this scheme from 2010.
Variable reward Annual cash incentives (bonuses) Hiscox’s remuneration policy is underpinned by the belief that a significant portion of total remuneration should be attained through incentive awards, thereby linking rewards directly with performance. The expectation is that successful performance (company and individual) should enable employees to achieve upper quartile total remuneration.
All employees, including Executive Directors, are eligible for the Profit Related Bonus. The PRB scheme is triggered when the business profits of the Group, based on the year’s pretax operating result, exceed a return on equity (ROE) linked to the longer term rate of return (‘Hurdle Rate’). The minimum Hurdle Rate is currently set at a 10% pre-tax return on allocated equity with the bonus pool comprising 15% of profits in excess of that. Bonus pools are then calculated for each major business division based on the performance of that division against the Hurdle Rate of return for the division’s allocated equity.
It has historically been Hiscox’s practice to base bonuses on operating profits, increasing the Group’s focus on generating underwriting profit. Operating profit is determined using a normalised investment return which has been set at 4% on bonds and 6% equities for the last few years. In 2007 actual investment return exceeded the normalised return. In view of the unprecedented market volatility the Remuneration Committee has decided that in future bonuses should be based on pre-tax profit which is determined using actual investment return. In 2008 the actual investment return was substantially below the normalised investment return. In order to provide a fair transition to this retrospective change in bonus approach in favour of the interests of shareholders it was decided that 2008 bonuses for junior employees
Bonus of £50,000, Entire bonus taken €75,000, $100,000 in cash in year one and below and below £100,000 $100,000 taken in Bonus above €75,000 year one and below €150,000 Balance of bonus Bonus above $100,000 split 50% in year two, and below $200,000 and 50% in year three
Share ownership is encouraged amongst senior personnel by allowing the deferred element of the annual bonus to be used, without deferral for: payment of the exercise price on the exercise of share options; payment of tax on the exercise of share options; purchase of shares; and payment of debt due on share purchases.
Share Incentive Schemes The Remuneration and Nomination Committee believes that employees should be encouraged to own Hiscox shares so that they are aligned to the long-term success of the company. Hiscox operates a Performance Share Plan for senior managers, a UK Save as You Earn scheme and an International Save as You Earn Scheme.
Performance Share Plan Restricted share awards or nil cost option awards (depending on the appropriate practice by country) are made to Executive Directors and other senior managers at the discretion of the Remuneration and Nomination Committee. Awards under this plan were made in 2008 and the Remuneration and Nomination Committee has also agreed to make awards under this plan in 2009. The maximum annual award to an individual under the Performance Share Plan is a value of 200% of basic salary. The highest actual grant awarded in 2008 was 115% of basic salary.
Executive Directors’ cash incentives and ROE Pre-tax return Average bonus as a on equity percentage of salary
Executive Director Reward Executive Directors’ reward packages are consistent with the rest of the business. The actual compensation paid to the four Executive Directors in 2008 is outlined in the table below. Details of their contractual notice periods, is contained in the table opposite.
As from 1 January 2007, certain benefits were rolled into basic salary. At the request of the Group, RS Childs will be returning from assignment in Bermuda in April, 2009. In that circumstance, the Committee has agreed that bonus payments from financial years 2007 and 2008, which have been disclosed as bonuses in the relevant years and parts of which remain outstanding, will be paid early in 2009. The amounts involved are £437,500 in respect of 2007 and £100,000 in respect of 2008. As a condition of early payment RS Childs has signed an agreement requiring him to repay these amounts in full, should he leave/resign from the Group before the dates in 2010 and 2011 when these payments would normally have been made.
External Non Executive Directorships No external appointments may be accepted by an Executive Director where such appointment may give rise to a conflict of interest. The consent of the Chairman is required in any event. During the year RRS Hiscox has been a Non Executive Director of Grainger Trust plc and was paid £35,000 for his services and AGICM Ltd and was paid £10,000. SJ Bridges, BE Masojada and RS Childs did not hold any Non Executive Director positions during the year.
The fees in relation to Hiscox Ltd for the year were: Hiscox Ltd Total Total
The Pound Sterling equivalent of the total was £391,000 (2007: £321,000). *Sir Mervyn Pedelty receives £10,000 for serving on a UK subsidiary board.
Share options The conditions of exercise of the approved and unapproved share options are described on pages 37 and 38.
Number of Number of Market price options at Number of Number of Number of options at at date of Date from 1 January options options options 31 December Exercise price exercise which 2008 granted lapsed exercised 2008 £ £ exercisable Expiry date 41Directors’ remuneration report Hiscox Ltd Report and Accounts 2008
Number of Number of Market price awards at Number of Number of Number of awards at at date of 1 January awards awards awards 31 December exercise Date from 2008 granted lapsed exercised 2008 £ which released
for the purposes of such Dividend Access Plan prior to the payment date of such dividend. If Hiscox Ltd has declared a dividend, those shareholders who have elected to participate in the Dividend Access Plan will receive payment of that dividend on 16 June 2009.
The Directors have pleasure in submitting their Annual Report and financial statements for the year ended 31 December 2008.
Directors’ interests 31-Dec-2008 31-Dec-2008 31-Dec-2007 31-Dec-2007 5p Ordinary Shares 5p Ordinary Shares 5p Ordinary Shares 5p Ordinary Shares number of shares number of shares number of shares number of shares beneficial non-beneficial beneficial non-beneficial
Annual General Meeting The notice of Annual General Meeting, to be held at the Elbow Beach Hotel, 60 South Shore Road, Paget PG04, Bermuda on 3 June 2009 at 10am (2pm BST), is contained in a separate circular to shareholders enclosed with this report.
The Board is responsible for ensuring the maintenance of proper accounting records which disclose with reasonable accuracy the financial position of the company. It is required to ensure that the financial statements present a fair view for each financial period.
The Directors responsible for authorising the responsibility statement on behalf of the Board are the Chairman, RRS Hiscox and the Group Finance Director, SJ Bridges. The statements were approved for issue on 9 March 2009.
Report of the independent registered public accounting firm to the Board of Directors and the shareholders of Hiscox Ltd
We have audited the accompanying consolidated financial statements of Hiscox Ltd (‘the Company’) on pages 46 to 95 which comprise the consolidated balance sheet as at 31 December 2008, and the consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory notes.
Management’s responsibility for the financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the EU. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatements, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with relevant ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements and the part of the Directors’ remuneration report to be audited are free of material misstatement.
Opinion In our opinion: the consolidated financial statements give a true and fair view of the consolidated financial position of the Company as at 31 December 2008, and of its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the EU; and the part of the Directors’ remuneration report which we were engaged to audit has been properly prepared in accordance with Schedule 7A to the UK Companies Act 1985, as if those requirements were to apply to the Company.
Results excluding Foreign currency foreign currency items on economic items on economic hedges and hedges and intragroup intragroup borrowings 2008 2007 borrowings (note 14) Total Total
Gross premiums earned 1,171,511 – 1,171,511 1,179,444 Premiums ceded to reinsurers (218,491) – (218,491) (214,254)
Expenses Claims and claim adjustment expenses, net of reinsurance 26.2 (479,380) – (479,380) (423,365) Expenses for the acquisition of insurance contracts 18 (252,868) – (252,868) (264,570)
Profit for the year (all attributable to owners of the Company) 125,928 (55,120) 70,808 191,248
Consolidated statement of comprehensive income For the year ended 31 December 2008, after tax
In order to permit a fuller understanding of the current year’s results and specifically the impact of certain foreign currency items, the Group has elected to present additional columns on the consolidated income statement and the consolidated statement of comprehensive income. No material items of this nature arose in the prior year and the comparative 2007 results are therefore unaffected (note 14).
Property, plant and equipment 16 19,668 19,378 Investments in associates 17 7,200 1,502 Deferred acquisition costs 18 131,130 123,081 Financial assets carried at fair value 20 2,081,772 1,747,827
The consolidated Group financial statements were approved by the Board of Directors on 9 March 2009 and signed on its behalf by: RRS Hiscox Chairman
Purchase of own shares held in treasury – – – – (11,343) (11,343) Deferred tax – – – – (2,074) (2,074) Dividends paid to owners of the Company 32 – – (43,591) – – (43,591)
Charges in respect of share based payments 10 5,269 5,689 Other non-cash movements (766) (3,571) Effect of exchange rate fluctuations on cash presented separately (62,086) 2,930
Changes in operational assets and liabilities: Insurance and reinsurance contracts 281,633 133,951 Financial assets (284,069) (489,745) Other assets and liabilities (10,474) 31,112
Proceeds from the issue of ordinary shares 24 4,632 5,159 Cash flows from the purchase of own shares including those arising on share buy-back programme 25 (65,066) (11,343) Dividends paid to owners of the Company 32 (46,756) (43,591) Net repayments of borrowings and financial liabilities 20 (1,292) (272)
The purchase, maturity and disposal of financial assets is part of the Group’s insurance activities and is therefore classified as an operating cash flow. The purchase, maturity and disposal of derivative contracts is also classified as an operating cash flow.
Included within cash and cash equivalents held by the Group are balances totalling £47,094,000 (2007: £53,336,000) not available for immediate use by the Group outside of the Lloyd’s Syndicate within which they are held.
The Group elected to apply the transitional arrangements contained in IFRS 4 that permitted the disclosure of only five years of data in claims development tables, in the year ended 31 December 2005 which was the year of adoption. The number of years of data presented was increased from seven in the prior year, to eight in the current financial year, and will be increased in each succeeding additional year up to a maximum of ten years if material outstanding claims exist for such periods.
The consolidated financial statements reflect the early adoption of IFRS 8 Operating Segments, which was first adopted in the prior year. IFRS 8 is a disclosure standard concerning the designation and presentation of operating segment information and therefore had no impact on the reported primary financial statements or financial position of the Group.
The Group has financial assets of over £2.5 billion. The portfolio is predominantly invested in liquid short dated bonds and cash to ensure significant liquidity to the Group and to reduce risk from the financial markets. In addition the Group has significant borrowing facilities.
The Group writes a balanced book of insurance and reinsurance business spread by product and geography. The Directors believe that the current reinsurance and insurance markets are favourable and that the Group is well placed to trade in these markets whilst successfully managing its business risks.
Standards and interpretations relevant to the Group published and effective or early adopted at 1 January 2008 IAS 1 Presentation of financial statements The IASB published the revised IAS 1 Presentation of financial statements on September 6, 2007 with an effective date of 1 January 2009. The Group early adopted on 1 January 2008. The revised standard is as a result of Phase A of the IASB’s financial statement presentation
The Company is registered and domiciled in Bermuda and on 12 December 2006 its ordinary shares were listed on the London Stock Exchange. As such it is required to prepare its annual audited financial information in accordance with Section 4.1 of the Disclosure and Transparency Rules and the Listing Rules, both issued by the Financial Services Authority (FSA), in addition to the Bermuda Companies Act 1981. The first two pronouncements issued by the FSA require the Group to prepare financial statements which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes 1 to 38 in accordance with International Financial Reporting Standards (‘IFRS’) as adopted by the European Union.
The consolidated financial statements for the year ended 31 December 2008 include all of the Group’s subsidiary companies and the Group’s interest in associates. All amounts relate to continuing operations.
Since 2002, the standards adopted by the International Accounting Standards Board have been referred to as IFRS. The standards from prior years continue to bear the title ‘International Accounting Standards’ (IAS). Insofar as a particular standard is not explicitly referred to, the two terms are used in these financial statements synonymously. Compliance with IFRS includes the adoption of interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC).
2 Significant accounting policies continued 2.2 Basis of preparation continued project, the objective of which is to enhance the usefulness of information presented in a complete set of financial statements.
Amendments to IFRS 2 Share-based Payment Amendments to IFRS 2 Share-based Payment were published on 17 January 2008 with an effective date of 1 January 2009 with early application permitted. The amended standard clarifies the definition of vesting conditions and introduces the term of ‘non-vesting’ conditions which are conditions which are other than service or performance conditions. Non-vesting conditions are reflected in the measurement of the grant date fair value of the awards. There is no requirement to reflect a true up for any differences arising between expected and actual outcome due to failure to meet non-vesting conditions. The amendment has no material impact on the Group’s financial results.
Standards and interpretations published but not yet effective Amendments to IAS 23 Borrowing Costs Amendments to IAS 23 Borrowing Costs, was published on 29 March 2007 and are applicable from 1 January 2009. The amendment makes it compulsory to capitalise borrowing costs relating to qualifying assets and removes the option to expense such costs. The amendment excludes eligible assets measured at fair value from the revised standard’s scope of application. The amendment has no material impact on the Group’s financial results.
Amendments to IAS 32 Financial Instruments: Presentation and IAS 1 Presentation of Financial Statements – Puttable Financial Instruments and Obligations Arising on liquidation Amendments to IAS 32 and IAS 1 were published on 14 February 2008 and are effective for annual periods beginning on 1 January 2009. The amendment to IAS 32 will exempt some financial instruments, which would usually be considered equity, from the financial liability classification. The exemption is available to financial instruments that have particular features and meet specific conditions. The application of the amended standard will have limited impact on the Group.
(b) Associates Associates are those entities in which the Group has significant influence but not control over the financial and operating policies. Significant influence is generally identified with a shareholding of between 20% and 50% of an entity’s voting rights. The consolidated financial statements include the Group’s share of the total recognised gains and losses of associates on an equity accounted basis from the date that significant influence commences until the date that significant influence ceases. The Group’s share of its associates’ postacquisition profits or losses after tax is recognised in the income statement each period, and its share of the movement in the associates’ net assets is reflected in the investments’ carrying values in the balance sheet. When the Group’s share of losses equals or exceeds the carrying amount of the associate, the carrying
Notes to the financial statements continued 2 Significant accounting policies continued 2.3 Basis of consolidation continued (b) Associates continued amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the associate.
2.4 Foreign currency translation (a) Functional and presentational currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The functional currency of all individual entities in the Group is deemed to be Sterling with the exception of the entities operating in France, Germany, the Netherlands and Belgium whose functional currency is Euros, those subsidiary entities operating from the USA and Bermuda whose functional currency is US Dollars, and Hiscox Insurance Company (Guernsey) Limited whose functional currency is also US Dollars.
(b) Transactions and balances Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the retranslation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when deferred in equity as IAS 39 effective net investment hedges or when the underlying balance is deemed to form part of the Group’s net investment in a subsidiary operation and is unlikely to be settled in the forseeable future. Nonmonetary items carried at historical cost are translated in the balance sheet at the exchange rate prevailing on the original transaction date. Non-monetary items measured at fair value are translated using the exchange rate ruling when the fair value was determined.
(c) Group companies The results and financial position of all the Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: (i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet (ii) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the date of the transactions) (iii) all resulting exchange differences are recognised as a separate component of equity.
2.6 Intangible assets (a) Goodwill Goodwill represents amounts arising on acquisition of subsidiaries and associates. In respect of acquisitions that have occurred since 1 January 2004, goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the acquisition date.
Financial assets are initially recognised at fair value. Subsequent to initial recognition financial assets are measured as described below.
Fair value for securities quoted in active markets is the bid price exclusive of transaction costs. For instruments where no active market exists, fair value is determined by referring to recent transactions and other valuation factors including the discounted value of expected future cash flows. Fair value changes are recognised immediately within the investment result line in the income statement.
Notes to the financial statements continued 2 Significant accounting policies continued 2.9 Impairment of assets continued
2.10 Derivative financial instruments Derivatives are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently valued at their fair value at each balance sheet date. Fair values are obtained from quoted market values and, if these are not available, valuation techniques including option pricing models as appropriate. The method of recognising the resulting gain or loss depends on whether the derivative is designated as a hedging instrument and, if so, the nature of the item being hedged. For derivatives not formally designated as a hedging instrument, fair value changes are recognised immediately in the income statement. Changes in the value of derivative and other financial instruments formally designated as hedges of net investments in foreign operations are recognised in the currency translation reserve to the extent they are effective; gains or losses relating to the ineffective portion of the hedging instruments are recognised immediately in the consolidated income statement.
Claims and associated expenses are charged to profit or loss as incurred based on the estimated liability for compensation owed to contract holders or third parties damaged by the contract holders. They include direct and indirect claims settlement costs and arise from events that have occurred up to the balance sheet date even if they have not yet been reported to the Group. The Group does not discount its liabilities for unpaid claims. Liabilities for unpaid claims are estimated using the input of assessments for individual cases reported to the Group and statistical analysis for the claims incurred but not reported, and an estimate of the expected ultimate cost of more complex claims that may be affected by external factors e.g. court decisions.
(d) Liability adequacy test At each balance sheet date, liability adequacy tests are performed by each segment of the Group to ensure the adequacy of the contract liabilities net of related DAC. In performing these tests, current best estimates of future contractual cash flows and claims handling and administration expenses, as well as investment income from assets backing such liabilities, are used. Any deficiency is immediately charged to profit or loss initially by writing-off DAC and by subsequently establishing a provision for losses arising from liability adequacy tests (‘the unexpired risk provision’).
(g) Salvage and subrogation reimbursements Some insurance contracts permit the Group to sell property acquired in settling a claim (i.e. salvage). The Group may also have the right to pursue third parties for payment of some or all costs (i.e. subrogation). Estimates of salvage recoveries are included as an allowance in the measurement of the insurance liability for claims and salvage property is recognised in other assets when the liability is settled. The allowance is the amount that can reasonably be recovered from the disposal of the property.
The amount recognised in the balance sheet in respect of defined benefit pension plans is the present value of the defined benefit obligation at the balance sheet date less the fair value of plan assets, together with adjustments for unrecognised actuarial gains or losses and past service costs. Plan assets exclude any insurance contracts issued by the Group. To the extent that a surplus emerges on the defined benefit obligation, it is only recognisable on the asset side of the balance sheet when it is probable that future economic benefits will be recovered by the scheme sponsor in the form of refunds or reduced future contributions. The Group is not currently required to make ongoing, regular contributions and does not forsee future refunds with sufficient probability for the scheme’s current reported surplus to be recognised as an asset on the balance sheet.
(c) Share based compensation The Group operates a number of equity settled share based employee compensation plans. These include both the approved and unapproved share option schemes, and the Group’s performance share plans, outlined in the Directors’ remuneration report together with the Group’s save as you earn (‘SAYE’) schemes.
2.16 Financial liabilities Financial liabilities are initially measured at fair value. The Group’s borrowings are financial liabilities and were previously designated on inception as being held at fair value through profit or loss if they were managed and evaluated on a fair value basis in accordance with a documented strategy or if they eliminate or significantly reduce a measurement or recognition inconsistency.
All borrowings drawn after 6 May 2008 are now remeasured at amortised cost at each balance sheet date thereafter using the effective interest method. Any difference between the remeasured amortised cost carrying amount and the ultimate redemption amount is recognised in the income statement over the period of the borrowings.
The Group hedged elements of its net investment in certain foreign entities through foreign currency borrowings that qualified for hedge accounting from 3 January 2007 until their replacement on 6 May 2008; accordingly gains or losses on retranslation are recognised in equity to the extent that the hedge relationship was effective during this period. Accumulated gains or losses will be recycled to the income statement only when the foreign operation is disposed of. The ineffective portion of any hedge is recognised immediately in the income statement.
2.19 Provisions The Group is subject to various insurance related assessments and guarantee fund levies. Provisions are recognised where there is a present obligation (legal or constructive) as a result of a past event that can be measured reliably and it is probable that an outflow of economic benefits will be required to settle that obligation.
2.20 Leases (a) Hiscox as lessee Leases in which significantly all of the risks and rewards of ownership are transferred to the Group are classified as finance leases. At the commencement of the lease term, finance leases are recognised as assets and liabilities at the lower of the fair value of the asset and the present value of the minimum lease payments. The minimum lease payments are apportioned between finance charges and repayments of the outstanding liability, finance charges being charged to each period of the lease term so as to produce a constant rate of interest on the outstanding balance of the liability.
There are several sources of uncertainty that need to be considered in the estimation of the insurance liabilities that the Group will ultimately pay for valid claims. These include but are not restricted to: inflation; changes in legislation; changes in the Group’s claims handling procedures; and judicial opinions which extend the Group’s coverage of risk beyond that envisaged at the time of original policy issuance. The Group seeks to gather corroborative evidence from all relevant sources before making judgements as to the eventual outcome of claims, particularly those under litigation, which have occurred and been notified to the Group but remain unsettled at the balance sheet date.
Estimates are continually evaluated based on entity specific historical experience and contemporaneous developments observed in the wider industry when relevant, and are also updated for expectations of prospective future developments. Although the possibility exists for material changes in insurance liabilities estimates to have a critical impact on the Group’s reported performance and financial position, it is anticipated that the scale and diversity of the Group’s portfolio of insurance business considerably lessens the likelihood of this occurring. Note 26 to the consolidated financial statements provides a greater analysis of the main methods used by the Group when formulating estimates of the insurance claims liabilities at each balance sheet date.
With regard to employee retirement benefit scheme obligations, the amounts disclosed in these consolidated financial statements are sensitive to judgemental assumptions regarding mortality, inflation, investment returns and interest rates on corporate bonds, many of which have been subject to specific recent volatility. This complex set of economic variables may be expected to influence the liability obligation element of the reported net balance amount to a greater extent than the reported value of the scheme assets element. For example, if the recent cuts in official UK interest rates are replicated with lower yields emerging in UK corporate bond indices, a significant uplift may occur in the reported net scheme deficit through the reduced effect of discounting outweighing any expected appreciation in asset values. A sensitivity analysis is given at note 30.
3.1 Insurance risk Insurance risk is transferred to the Group by contract holders through the underwriting process. The Group’s exposure to insurance risk arises from the possibility that an insured event occurs, and a claim is subsequently submitted by the insured for payment. Management of insurance risk on a day-to-day basis is the responsibility of the Chief Underwriting Officer, who receives assistance from the management information and risk modelling departments. The Board sets the Group’s underwriting strategy for accepting and managing insurance risk prospectively, seeking to exploit identified opportunities and taking cognisance of other relevant anticipated market conditions. Specific underwriting objectives such as aggregation limits, reinsurance protection thresholds, geographical disaster event risk exposures and line of business diversification parameters are prepared and reviewed by the Chief Underwriting Officer in order to translate the Board’s summarised underwriting strategy into specific measurable actions and targets. These actions and targets are reviewed and approved by the Board in advance of each underwriting year. The Board continually reviews its underwriting strategy throughout each underwriting year in light of the evolving market pricing and loss conditions and as opportunities present themselves.
Realistic disaster scenarios are extreme, hypothetical events selected by Lloyd’s to represent major events occurring in areas with large insured values. They also reflect the areas that represent significant exposures for Hiscox. The Group compiles estimates of losses arising from realistic disaster events using statistical models alongside input from its underwriters. The selection of realistic disaster scenario events is adjusted each year and they are not therefore necessarily directly comparable from one year to the next. The events are extreme and as yet untested, and as such these estimates may prove inadequate as a result of incorrect assumptions, model deficiencies, or losses from unmodelled risks. This means that should a realistic disaster actually eventuate, the Group’s final ultimate losses could materially differ from those unaudited estimates modelled by management. The Group’s estimated concentration of insurance risk, determined in relation to the broad categories of insurance liabilities reserved on the balance sheet, is summarised in the tables on page 59.
The Group’s underwriters and management consider insurance risk at an individual contract level, and also from a portfolio perspective where the risks assumed in similar classes of policies are aggregated and the exposure evaluated in light of historical portfolio experience and prospective factors. To assist with the process of pricing and managing insurance risk the Group routinely performs a wide range of activities including the following: regularly updating the Group’s risk models; documenting, monitoring and reporting on the Group’s strategy to manage risk; developing systems that facilitate the identification of emerging issues promptly; utilising sophisticated computer modelling tools to simulate catastrophes and measure the resultant potential losses before and after reinsurance; monitoring legal developments and amending the wording of policies when necessary; regularly aggregating risk exposures across individual underwriting portfolios and known accumulations of risk; examining the aggregated exposures in advance of underwriting further large risks; and developing processes that continually factor market intelligence into the pricing process.
The Group’s insurance contracts include provisions to contain losses such as the ability to impose deductibles and demand reinstatement premiums in certain cases. In addition, in order to manage the Group’s exposure to repeated catastrophic events, relevant policies frequently contain payment limits to cap the maximum amount payable from these insured events over the contract period.
One tool for managing insurance risk is reinsurance. Reinsurance protection such as excess of loss cover is purchased at an entity level and is also considered at an overall Group level to mitigate the effect of catastrophes and unexpected concentrations of risk. However, the scope and type of reinsurance protection purchased may change depending on the extent and competitiveness of cover available in the market.
Estimated concentration of gross and net Types of insurance risk in Group insurance liabilities on balance sheet by
Frequency and severity of claims The specific insurance risks accepted by the Group fall broadly into four main categories: reinsurance inwards, marine and major property risks, other property risks and casualty insurance risks. These specific categories are defined for risk review purposes only and are not exclusively aligned to any specific reportable segment in the Group’s operational structure or the primary internal reports reviewed by the chief operating decision maker. A discussion of the frequency and severity of claims for each of those categories is given below. The Group has no significant exposure to asbestos risks or life insurance business.
59Notes to the financial statements Hiscox Ltd Report and Accounts 2008
Typical property covered by marine and other major property contracts include fixed and moveable assets such as ships and other vessels, cargo in transit, energy platforms and installations, pipelines, other subsea assets, satellites, commercial buildings and industrial plants and machinery. These assets are typically exposed to a blend of catastrophic and other large loss events, and attritional claims arising from conventional hazards such as collision, flooding, fire and theft. Climatic changes may give rise to more frequent and severe extreme weather events (for example earthquakes, windstorms and river flooding etc.) and it may be expected that their frequency will increase over time.
Other property risks The Group provides home and contents insurance, together with cover for art work, antiques, classic cars, jewellery, collectables and other assets typically held by affluent individuals. The Group also extends cover to reimburse certain policyholders when named insureds or insured assets are seized for kidnap and a ransom demand is subsequently met. Events which can generate claims on these contracts include burglary, kidnap, seizure of assets, acts of vandalism, fires, flooding and storm damage. Losses on most classes can be predicted with a greater degree of certainty as there is a rich history of actual loss experience data and the locations of the assets covered, and the individual levels of security taken by owners, are relatively static from one year to the next. The losses associated with these contracts tend to be of a higher frequency and lower severity than the marine and other major property assets covered above.
Casualty insurance risks The casualty underwriting strategy attempts to ensure that the underwritten risks are well diversified in terms of type and amount of potential hazard, industry and geography. However, the Group’s exposure is more focused towards marine and professional and technological liability risks rather than human bodily injury risks, which are only accepted under limited circumstances. Claims typically arise from incidents such as errors and omissions attributed to the insured, professional negligence and specific losses suffered as a result of electronic or technological failure of software products and websites. The provision of insurance to cover allegations made against individuals acting in the course of fiduciary or managerial responsibilities, including directors’ and officers’ insurance, is one example of a casualty insurance risk. However the Group’s specific exposure to this specific risk category is relatively limited. The Group’s casualty insurance contracts mainly experience low severity attritional losses.
Certain marine and property insurance contracts such as those relating to subsea and other energy assets, and the related business interruption risks, can also take longer than normal to settle. This is because of the length of time required for detailed subsea surveys to be carried out and damage assessments agreed together with difficulties in predicting when the assets can be brought back into full production.
Debt and fixed income securities 605,222 1,323,377 – 1,928,599 Equities and shares in unit trusts 2,043 122,282 539 124,864 Deposits with credit institutions 22,392 – 5,877 28,269 Derivative instrument assets – – 40 40 61Notes to the financial statements Hiscox Ltd Report and Accounts 2008 3 Management of risk continued 3.2 Financial risk Overview The Group is exposed to financial risk through its ownership of financial assets including loans and receivables, financial liabilities and reinsurance assets. These items collectively represent a significant element of the Group’s net shareholder funds.
Reliability of fair values The Group has elected to carry all financial investments at fair value through profit or loss as they are managed and evaluated on a fair value basis in accordance with a documented strategy. With the exception of unquoted equity investments, all of the financial investments held by the Group are available to trade in public markets and the Group therefore seeks to determine fair value by reference to published price quotations in the most active financial markets in which the assets trade. The Group seeks to determine the fair value of financial assets primarily with reference to their closing bid market prices at the balance sheet date. The ability to obtain quoted bid market prices may be reduced in periods of diminished liquidity, such as those prevailing for certain categories of asset-backed and mortgage-backed fixed income instruments affected by the continued market dislocation that commenced during the second half of 2007. In addition, those quoted prices that may be available may represent an unrealistic proportion of market holdings or individual trade sizes that could not be readily available to the Group. In such instances fair values may be determined or partially supplemented using other observable market inputs such as prices provided by market makers such as dealers and brokers, and prices achieved in the most recent regular transaction of identical or closely related instruments occurring before the balance sheet date but updated for relevant perceived changes in market conditions. Throughout 2008 the Group has witnessed substantial declines in observable market values for many fixed income assets such as corporate, municipal and asset backed bonds. In some cases the extent and duration of declines witnessed appears to arise as a response to global macroeconomic and liquidity concerns and not as a result of specific issuer events or credit concerns.
At 31 December 2008, the Group holds asset-backed and mortgage-backed fixed income instruments in its investment portfolio but has minimal direct exposure to sub-prime asset classes. Together with the Group's investment managers, management continues to monitor the potential for any adverse development associated with this investment exposure through the analysis of relevant factors such as credit ratings, collateral, subordination levels and default rates in relation to the securities held.
In October 2008, the IASB issued an Exposure Draft on Improving Disclosures about Financial Instruments, Proposed amendments to IFRS 7. The Exposure Draft was in response to the requirement by users of financial statements to enhance the disclosures over the fair value measurement of financial instruments. This was particularly relevant in light of the current market conditions. On 5 March 2009, the IASB issued the amendments to IFRS 7 with an effective date for annual periods beginning on or after 1 January 2009.
Level 3 – Valuation techniques for which any significant input is not based on observable market data.
Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued Reliability of fair values continued
The fair value of unquoted equity investments is determined by reference to recent observable market transactions and other valuation factors including the discounted value of expected future cash flows. The carrying value of unquoted equity investments included in the Group’s balance sheet at £4,151,000), representing less than 1% of the total financial assets carried at fair value.
Nature of equity and unit trust holdings Directly held equity securities – 3 Units held in funds – traditional long only 68 77 Units held in funds – long and short and special strategies 32 20
Geographic focus Specific UK mandates 29 40 Global mandates 71 60
The fair value of debt and fixed income assets in the Group’s balance sheet at 31 December million). These may be analysed as follows: 31 December 31 December
One method of assessing interest rate sensitivity is through the examination of duration-convexity factors in the underlying portfolio. Using a duration-convexity based sensitivity analysis, if market interest rates had risen by 100 basis points at the balance sheet date, the fair value might have been expected to decrease by £31 million (2007: decrease of £22 million) assuming that the only balance sheet area impacted was debt and fixed income financial assets.
Duration is the weighted average length of time required for an instrument’s cashflow stream to be recovered, where the weightings involved are based on the discounted present values of each cashflow. A closely related concept, modified duration, measures the sensitivity of the instrument’s price to a change in its yield to maturity. Convexity measures the sensitivity of modified duration to changes in the yield to maturity.
The concentrations of credit risk exposures held by insurers may be expected to be greater than those associated with other industries, due to the specific nature of reinsurance markets and the extent of investments held in financial markets. In both markets, the Group interacts with a number of counterparties who are engaged in similar activities with similar customer profiles, and often in the same geographical areas and in industry sectors. Consequently, as many of these counterparties are themselves exposed to similar economic characteristics, one single localised or macroeconomic change could severely disrupt the ability of a significant number of counterparties to meet the Group’s agreed contractual terms and obligations.
Key areas of exposure to credit risk include: reinsurers’ share of insurance liabilities; amounts due from reinsurers in respect of claims already paid; amounts due from insurance contract holders; and counterparty risk with respect to cash and cash equivalents, and investments including deposits and derivative transactions.
3 Management of risk continued 3.2 Financial risk continued (c) Credit risk continued
The Group also mitigates credit counterparty risk by concentrating debt and fixed income investments in high quality instruments, including a particular emphasis on government gilts issued mainly by European Union and North American countries.
Debt and fixed income securities 20 1,116,903 106,754 158,157 62,718 1,444,532
A significant proportion of the Group’s investments are in highly liquid assets which could be converted to cash in a prompt fashion and at minimal expense. The deposits with credit institutions largely comprise short dated certificates for which an active market exists and which the Group can easily access. The Group’s exposure to equities is concentrated on shares and funds that are traded on internationally recognised stock exchanges.
Between one and two years 593,371 – – – 593,371 385,986 Between two and five years 669,819 – – – 669,819 563,052 Over five years 407,273 – – – 407,273 282,110
Perpetual notes and other non-dated instruments 61,297 – – – 61,297 48,069
The Group’s equities and shares in unit trusts and perpetual notes and other non-dated instruments have no contractual maturity terms but could also be orderly liquidated for cash in a prompt and reasonable timeframe within one year of the balance sheet date if so required.
Within Between one Between two Over 2008 one year and two years and five years five years Total
Property – marine and major assets 71,590 41,561 39,787 6,630 159,568
Within Between one Between two Over 2007 one year and two years and five years five years Total
Details of the payment profile of other Group liabilities is given in notes 20 and 27.
(e) Currency risk The Group operates internationally and its exposures to foreign exchange risk arise primarily with respect to the US Dollar and the Euro. These exposures may be classified in two main categories: 1) Structural foreign exchange risk through taking net investments in subsidiaries with different functional currencies to the Group; and 2) Operational foreign exchange risk through routinely entering into insurance, investment and operational contracts, as a Group of international insurance entities serving international communities, where rights and obligations are denominated in currencies other than each respective entities’ functional currency.
The Group’s exposure to structural foreign exchange risk primarily relates to the US Dollar net investments made in its domestic operation in Bermuda and its overseas operation in Guernsey and the US. Other structural exposures also arise on a smaller scale in relation to net investments made in European operations. The Group’s risk appetite permits the acceptance of structural foreign exchange movements within defined aggregate limits and exchange rate parameters which are monitored centrally. Exchange rate derivatives are used when appropriate to shield the Group against significant movements outside of the defined range.
In the prior year and up to 6 May 2008 the Group financed a portion of its net investment in the Bermuda and Guernsey insurance operations using US Dollar borrowings to which hedge accounting was applied for the vast majority of the periods under review (see note 20).
The currency profile of the Group’s assets and liabilities is as follows: Sterling US Dollar Euro Other Total
Employee retirement benefit obligations – – – – – Deferred tax 68,649 – – – 68,649
Financial assets carried at fair value 411,908 1,130,080 165,258 40,581 1,747,827
Financial liabilities – 91,764 – – 91,764 Current tax 24,711 – – – 24,711
(f) Limitations of sensitivity analysis The sensitivity information given in notes (a) to (e) above demonstrates the estimated impact of a change in a major input assumption while other assumptions remain unchanged. In reality, there is normally significant levels of correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results. The same limitations exist in respect to the retirement benefit scheme sensitivities presented at note 30 to these financial statements. Furthermore, estimates of sensitivity may become less reliable in unusual market conditions such as instances when risk free interest rates fall towards zero.
3.3 Capital risk management The Group’s primary objectives when managing its capital position are: to safeguard its ability to continue as a going concern, so that it can continue to provide long-term growth and progressive dividend returns for shareholders; to provide an adequate return to the Group’s shareholders by pricing its insurance products and services commensurately with the level of risk; the attainment of an efficient cost of capital; and to comply with all regulatory requirements by a significant margin.
Notes to the financial statements continued 3.3 Capital risk management continued
The funds raised through Letters of Credit and loan facilities have been applied to support both the 2009 year of account for Syndicate 33 and the capital requirements of Hiscox Insurance Company (Bermuda) Limited, formed in 2005.
Financial strength The financial strength ratings of the Group’s insurance company subsidiaries is outlined below: Standard A.M. Best Fitch & Poor’s
The Group used its own integrated modelling expertise to produce the ICA calculations. The results mirrored those driving the existing internal capital setting process.
The assessed capital requirement for the business placed through Hiscox Insurance Company Limited is driven by the level of resources necessary to maintain an A rating.
4 Operating segments The Group’s four operating segments are: Global Markets comprises the results of Syndicate 33, excluding Syndicate 33’s fine art, UK regional events coverage, non-US household business and underwriting result of Hiscox Inc. It includes the results of the larger retail TMT business written by Hiscox Insurance Company Limited.
Corporate Centre comprises the investment return, finance costs and administrative costs associated with Group management activities. In respect of the current year under review, Corporate Centre also includes the majority of foreign currency items on economic hedges and intragroup borrowings. These relate to certain foreign currency items on economic hedges and intragroup borrowings, further details of which are given at note 14. Corporate Centre forms a reportable segment due to its investment activities which earn significant external coupon revenues.
The Group’s wholly owned subsidiary, Hiscox Syndicates Limited, oversees the operation of Syndicate 33 at Lloyd’s. The Group’s percentage participation in Syndicate 33 can fluctuate from year to year and consequently, presentation of the results at the 100% level removes any distortions arising therefrom.
The combined ratio is an underwriting ratio and as such the costs of the Corporate Centre are not included in the total combined ratio calculation. The impact on profit before tax of a 1% change in each component of the segmental combined ratios is: Year to 31 December 2008 Year to 31 December 2007
(b) 100% operating result by segment Year to 31 December 2008 Year to 31 December 2007
(c) Segmental analysis of assets and liabilities The segment assets and liabilities at 31 December and the capital expenditure for the year then ended are as follows: Global UK and Corporate Intragroup items Markets Europe International Centre and eliminations Total
The following table provides an analysis of the Group’s gross premium revenues earned by material geographical location of external parties: Year to 31 December 2008 Year to 31 December 2007
Global UK and Corporate Global UK and CorporateGross premium revenues Markets Europe International Centre Total Markets Europe International Centre Total
The Group has not reported segmental details of non-current assets excluding financial instruments and including loans and receivables, rights and obligations under insurance and reinsurance contracts, investments in associates and subsidiaries on the grounds of the relevance of these items to the Group’s operations and the usefulness of such information to users.
Notes to the financial statements continued 5 Net asset value per share
Profit for the period excluding foreign currency items on economic hedges and intragroup borrowings 125,928 191,248 Annualised return on equity excluding foreign currency items on economic hedges and intragroup borrowings (%) 16.4 28.8 7 Investment result The total result for the Group before taxation comprises: Investment income including interest receivable 94,678 90,259 Net realised gains on financial investments at fair value through profit or loss 4,743 10,105 Net fair value (losses)/gains on financial investments at fair value through profit or loss (127,053) 423
Investment result – financial assets 8 (27,632) 100,787 Fair value gains/(losses) on derivative instruments and borrowings 20, 22 (52,978) (1,110)
8 Analysis of return on financial investments (i) The weighted average return on financial investments for the year by currency was: US Dollar (2.5) 5.5
Debt and fixed income securities (8,288) (0.9) 7,367 3.4 (7,490) (2.3) 4,384 5.4 (4,027) (0.3) Equities and shares in unit trusts – – (25,529) (41.9) (5,552) (16.2) (7,186) (18.0) (38,267) (28.4) Deposits with credit institutions/
Managing agency expenses 19,513 28,870 Overseas underwriting agency expenses 28,787 23,811 Connect agency expenses 13,343 14,492 Investment expenses 1,899 1,250 Other Group expenses including central overheads 15, 16 12,957 13,846
Notes to the financial statements continued 12 Auditors’ remuneration Fees payable to the Group’s main external auditor, KPMG, its member firms and its associates (exclusive of VAT ) include the following amounts recorded in the consolidated income statement: Fees payable to the Company’s auditor for the audit of the Group’s consolidated financial statements 262 201
Fees payable to the Company’s auditor and its associates for other services: The audit of subsidiaries pursuant to legislation 519 345 Other services pursuant to legislation 75 50 All other services* 75 93
Fees payable to other external auditors in respect of the Company’s subsidiaries in the United States pursuant to legislation during 2008 13 Net foreign exchange gains/(losses) The net foreign exchange gains/(losses) for the year include the following amounts: Exchange gains recognised in the consolidated income statement 109,755 8,401
Exchange gains/(losses) classified as a separate component of equity 150,582 (2,869)
Overall impact of foreign exchange related items before tax Note £000 £000 £000 £000
Net unearned premiums and deferred acquisition costs adjustment† – 50,525 50,525 14,438 Foreign exchange losses on intragroup borrowings (note 14) (8,463) – (8,463) – Other foreign exchange gains/(losses) – 67,693 67,693 (6,037)
†Net unearned premiums and deferred acquisition cost adjustment arises as a result of a foreign exchange mismatch caused by those items being translated only at the historical exchange prevailing at the original transaction date and not retranslated again at the year end rate.
14 Foreign currency items on economic hedges and intragroup borrowings The Group has highlighted two separate charges on the consolidated income statement to enable readers to obtain a fuller understanding of their impact and that of related amounts recognised directly in other comprehensive income: Consolidated Consolidated statement of Total income comprehensive impact on statement income equity
The Group recorded unrealised losses of £42,540,000 before and after tax in respect of US Dollar currency option collar contracts which were contracted in September and October 2008 to serve as informal hedges of part of the Group’s net investment in its Bermuda and Guernsey insurance operations. The translated Pound Sterling value of the US Dollar capital held in these operations appreciated significantly during the year generating currency translation gains. The collar contracts acquired enabled the Group to largely protect approximately £47,568,000 of 2008 foreign exchange gains earned up to the dates at which the contracts were effected, at zero initial cost. The US Dollar continued to strengthen subsequent to the purchase of the derivatives generating further translation gains of £67,591,000. The unrealised losses are therefore viewed by the Directors as economically linked to the underlying currency translation gains recognised separately within total comprehensive income. Formal hedge accounting designation was not achievable due to the specific effectiveness requirements of IAS 39.
Foreign exchange losses of £8,463,000 before tax (£12,580,000 after tax) were recorded on certain loan arrangements, denominated in US Dollars, between Group companies. In most cases, as one party to each arrangement has a functional currency other than the US Dollar, foreign exchange losses arise which are not eliminated through the income statement on consolidation. Implicit offsetting gains are reflected instead on retranslation of the counterparty company’s closing balance sheet through other comprehensive income and into the Group’s currency translation reserve within equity.
Additions in year on business combinations 1,909 – 1,225 – 3,134 Other additions – – – 5,230 5,230 Disposal on sale of subsidiary – – – – – Amortisation charges – – – (259) (259)
Goodwill is allocated to the Group’s cash generating units (‘CGUs’) identified according to country of operation and business segment. At 31 December 2008 and 2007 the Group’s goodwill net book amount is all attributable to UK based operations. Accumulated amortisation and impairment of goodwill relates to the amortisation charged prior to the Group’s adoption of IFRS.
The Group’s intangible asset relating to Syndicate capacity has been allocated, for impairment testing purposes, to one individual cash generating unit being the active Lloyd’s corporate member entity. The Group has considered the recoverable amount from the active Lloyd’s corporate member entity on a value in use basis. This calculation uses cash flow projections based on financial forecasts approved by management covering a five-year period. Cash flows beyond the five-year period are extrapolated based on an average level of return and annual growth estimated at 2% (2007: 2%) consistent with the industry long-term average. A pre-tax discount factor of 7% (2007: 7%) has been applied to projected cash flows as part of the exercise. The results of this exercise indicate that the recoverable amount significantly exceeds the intangible’s carrying value and would not be sensitive to reasonably possible changes in assumptions. The Group’s weighted average cost recognised on the balance sheet is significantly below the average open market price witnessed in the recent Lloyd’s of London Syndicate 33 capacity auctions in Autumn 2008.
In 2007 and 2008, the Group recognised intangible assets totalling £6,308,000 relating to insurance authorisation licences for 50 US states acquired in the business combination of ALTOHA Inc. (note 33). This intangible asset has been allocated for impairment testing purposes to one individual cash generating unit being the Group’s North American underwriting businesses. The Group has considered the recoverable amount of this cash generating unit on a consistent basis to the active Lloyd’s corporate member entity outlined above.
The amortisation charge for the year includes £nil (2007: £40,000) relating to capitalised software costs and is included in other expenses in the income statement. The net book value of capitalised software costs at 31 December 2008 was £5,230,000 (2007: £nil). There are no charges for impairment during the current or prior financial year.
At 31 December 2008 there were £5,230,000 of assets under construction on which no amortisation has been charged (2007: £nil).
The Group’s land and buildings assets relate to freehold property in the United Kingdom.
Additions during the year 5,438 1,393 Share of post-tax profit recognised for the period 260 81
Total at the end of 2008 14,047 10,098 7,697 1,145 100% results
The additions during the current year relate to equity investments made in Senior Wright Indemnity Ltd and Media Insurance Brokers. Cash consideration of £5,438,000 (2007: £1,273,000) was paid.
The deferred amount of insurance contract acquisition costs attributable to reinsurers of £4,994,000 (2007: £5,639,000) is not eligible for offset against the gross balance sheet asset and is included separately within trade and other payables (note 27).
Reinsurers’ share of insurance liabilities 495,251 283,414 Provision for non-recovery and impairment (7,531) (3,326)
Amounts due from reinsurers in respect of outstanding premiums and claims already paid by the Group are included in loans and receivables (note 21). The Group recognised a loss during the year of £4,205,000 (2007: gain of £452,000) in respect of impaired balances.
Borrowings from credit institutions (see below) 90,278 90,278 91,457 91,764 Derivative instrument liabilities 22 – 53,072 – –
The Group’s borrowings from credit institutions at 31 December 2008 and 2007 are denominated in US Dollars. The entire amount from December 2007 was repaid during the year and the amount outstanding at 31 December 2008 is all expected to be repaid within one year of the balance sheet date. The movement in fair value of financial liabilities during 2008 includes net principal repayments of £3,508,000, £835,000 of foreign exchange gains recognised directly in equity (see note 13 and below), £2,022,000 foreign exchange losses and £nil of fair value losses (2007: £nil of net principal repayments, £1,400,000 of foreign exchange gains and £302,000 of fair value gains). The amounts recognised as fair value gains and losses are attributable to changes in applicable benchmark interest rates.
The amount of financial liabilities payable on maturity is not materially different to the cost disclosed above.
The hedging relationship commenced on 3 January 2007 and was entirely effective throughout the entire period up until 6 May 2008.
Investments at 31 December are denominated in the following currencies at their fair value: Debt and fixed income securities
Gross receivables arising from insurance and reinsurance contracts 441,752 329,156 Less provision for impairment (560) (1,392)
There is no significant concentration of credit risk with respect to loans and receivables, as the Group has a large number of internationally dispersed debtors. The Group has recognised a gain of £832,000 (2007: loss of £517,000) for the impairment of receivables during the year ended 31 December 2008.
Gross contract Fair value Fair value Net balance notional amount of assets of liabilities sheet position
Derivative contract assets included on balance sheet 000 £000 £000 £000
The Group had no derivative assets or liabilities at 31 December 2007.
Event linked future contracts In June 2008 the Group commenced trading event linked future contracts which are transacted on Chicago Climate Futures Exchange. The contracts have fixed maturity dates and are structured such that cash inflows are binary in nature and are triggered by the occurrence of specific natural events in specific geographical zones which cause pre-determined losses to the insurance industry in excess of a specified amount. The Group itself does not have to suffer losses to receive a payment once the industry loss strike amount on each contract has been reached. Consequently the contracts are not accounted for as insurance contracts in accordance with IFRS 4.
The Group made a gain on event linked future contracts of £45,000 (2007: £nil) as included in note 7.
Interest rate future contracts In August 2008 the Group commenced short selling a number of Pound Sterling government bond futures and Euro sovereign futures to informally hedge substantially all of the interest rate risk on a specific long portfolio of Sterling and Euro denominated corporate bonds. All positions taken were closed out before maturity using offsetting trades and no closing assets or liabilities existed at 31 December 2008. The contracts are exchange traded. The Group made a loss on these futures contracts of £360,000 (2007: £nil) as included in note 7.
Cash and cash equivalents include amounts of US$17,775,000 (2007: US$14,985,000) held in escrow to settle deferred consideration on acquisitions.
Employee share option scheme – proceeds from shares issued 169 4,463 – Dividends to owners of the Company – – (46,756)
In accordance with IFRS 2 the Group recognises an expense for the fair value of share option and performance share plan award instruments issued to employees, over their vesting period through the income statement. The expense recognised in the Consolidated Income Statement during the year was £5,269,000 (2007: £5,689,000). This comprises charges of £4,960,000 (2007: £4,352,000) in respect of performance share plan awards and £309,000 (2007: £1,337,000) in respect of share option awards. The Group has applied the principles outlined in the Black-Scholes option pricing model when determining the fair value of each share option instrument and discounted cash flow methodology in respect of performance share plan awards.
Movements in the number of share options during the year and details of the balances outstanding at 31 December 2008 are shown in the Directors’ remuneration report.
Additional details on the Group’s share option schemes are shown in the Directors’ remuneration report accompanying these financial statements.
28,300,742 ordinary shares of 5p each were purchased by Hiscox Ltd in open market transactions during the current year (2007: 4,365,305) and are held in treasury. In addition, 1,000,000 ordinary shares of 5p each were purchased and held in trust. Retained earnings have been reduced by £65,066,000 being the consideration paid for these transactions. Included within this amount are transaction cost expenses of £125,000 (2007: £23,000) directly related to the purchases.
The highest price paid per share was 260p, the lowest price paid was 191.5p and the average price paid was 221.7p per share. At 31 December 2008 Hiscox Ltd held 32,666,047 shares in treasury. Additional details are shown in note 37 to these financial statements in respect of additional Hiscox Ltd shares held by subsidiaries.
Recoverable from reinsurers Claims reported and loss adjustment expenses 180,406 137,868 Claims incurred but not reported 245,897 84,804 Unearned premiums 61,417 57,416
Net Claims reported and loss adjustment expenses 705,499 504,384 Claims incurred but not reported 635,926 488,831 Unearned premiums 448,271 440,584
The gross claims reported, the loss adjustment expenses liabilities and the liability for claims incurred but not reported are net of expected recoveries from salvage and subrogation. The amounts for salvage and subrogation at the end of 2008 and 2007 are not material.
For all risks, the Group uses several statistical methods to incorporate the various assumptions made in order to estimate the ultimate cost of claims. The reserves for outstanding claims are actuarially estimated primarily by using both the Chain Ladder and BornhuetterFerguson methods. There is close communication between the actuaries involved in the estimation process and the Group’s underwriters to ensure that, when applying both estimation techniques, both parties are cognisant of all material factors relating to outstanding claims, and allowance is also made for the rating environment.
The Chain Ladder method is adopted for mature classes of business where sufficient claims development data is available in order to produce estimates of the ultimate claims and premiums by actuarial reserving Group and underwriting year or year of account for the managed Syndicate. This methodology produces optimal estimates when a large claims development history is available and the claims development patterns throughout the earliest years are stable.
(b) Claims development tables The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The Group analyses actual claims development compared with previous estimates on an accident year basis. This exercise is performed to include the liabilities of Syndicate 33 at the 100% level regardless of the Group’s actual level of ownership, which has increased significantly over the last six years. Analysis at the 100% level is required in order to avoid distortions arising from reinsurance to close arrangements which subsequently increase the Group’s share of ultimate claims for each accident year three years after the end of that accident year.
26 Insurance liabilities and reinsurance assets continued 26.1 Insurance contracts assumptions continued (b) Claims development tables continued
at end of accident year 749,648 437,736 493,451 748,759 1,253,261 643,855 864,188 1,210,449 6,401,347 six years later 876,086 419,824 – – – – – – 1,295,910 seven years later 877,941 – – – – – – – 877,941
Current estimate of cumulative claims 877,941 419,824 475,401 753,543 1,378,982 593,856 774,105 1,210,449 6,484,101 Less: Attributable to external Names (218,191) (86,594) (106,885) (174,815) (346,205) (123,730) (150,454) (240,694) (1,447,568)
Total Group liability to external parties included in balance sheet – gross** 1,767,728
at end of accident year 358,257 296,566 391,129 626,722 731,748 569,946 748,640 837,864 4,560,872 six years later 490,038 277,270 – – – – – – 767,308 seven years later 492,765 – – – – – – – 492,765
Liability recognised in respect of prior accident years at 100% level 45,329
Total net liability to external parties included in the balance sheet* 1,341,425 *This represents the claims element of the Group’s insurance liabilities and reinsurance assets.
Total at end of year (1,767,728) 426,303 (1,341,425) (1,215,887) 222,672 (993,215)
Claims reported and loss adjustment expenses (885,905) 180,406 (705,499) (642,252) 137,868 (504,384) Claims incurred but not reported (881,823) 245,897 (635,926) (573,635) 84,804 (488,831)
Current year claims and loss adjustment expenses (828,940) 226,808 (602,132) (562,223) 78,953 (483,270) (Under)/over provision in respect of prior year claims and loss adjustment expenses 130,469 (7,717) 122,752 63,655 (3,750) 59,905
Obligations under finance leases 36 439 457 Share of Syndicate’s other creditors’ balances 2,714 2,681 Social security and other taxes payable 10,919 4,067 Other creditors 9,493 13,704
The principle subsidiaries of the Company and the country in which they are incorporated are listed in note 37.
The amounts charged in the consolidated income statement comprise the following: Current tax (credit)/expense (32,341) 26,891 Deferred tax expense 29 66,713 19,060
The tax expense on the Group’s profit before tax differs from the theoretical amount that would arise using the average tax rate applicable to profits of the consolidated companies as follows: Profit before tax 105,180 237,199 Tax calculated at the standard corporation tax rate applicable in the UK* of 28.5% (2007: 30%)** 29,976 71,160 Effects of: Expenses not deductible for tax purposes (1,259) (1,296) Group entities subject to overseas tax at lower rates 14,771 (24,843) Tax losses for which no deferred tax asset is recognised 260 1,092 Other items 1,480 (2,064) Change of deferred tax rate (653) (1,374) Prior year tax adjustments (10,203) 3,276
Tax charge for the period 34,372 45,951 *The principal charge to current tax arises in respect of the Group’s UK subsidiaries. **The UK corporation tax rate changed from 30% to 28% on 1 April 2008.
The movement on the total net deferred tax liability is as follows: Income statement charge (66,713) (19,060) Transfer from deferred tax to current tax 1,445 19,850 Release from/(charge to) equity 6,370 (2,074)
Trade and other payables 15,462 (11,412) – – 4,050 Retirement benefit obligations 9,476 (9,476) – – –
Insurance contracts – equalisation provision* (6,043) (660) – – (6,703) Other items – – – – –
*The solvency regulations in the UK require certain entities within the Group to establish an equalisation provision, to be utilised against abnormal levels of future losses in certain lines of business. The regulations prescribe that the provision is increased every year by an amount that is calculated as a percentage of net premiums written for those lines of business during the financial year subject to a maximum percentage. The amount of each annual increase is a deductible expense for tax purposes, and the equalisation provision is taxed when released. The entities within the Group that are affected by this requirement continue to prepare their individual financial statements, for statutory filing and tax purposes, in accordance with UK GAAP which permits the recognition of equalisation provisions on the balance sheet. Equalisation provisions are not permitted under IFRS which therefore results in the temporary difference for tax purposes.
Deferred income tax assets are recognised for tax losses carried forward to the extent that the realisation of the related tax benefit through the future taxable profits is probable. During the period, management revised its assumptions about the recoverability of carried forward unused tax losses to be recognised as deferred tax assets. Management’s assessment is that it is now probable that enough taxable profit will be available to allow part of the benefit to be utilised. Part of the balance has therefore now been provided. The Group has not provided for deferred tax assets totalling £7,628,000 (2007: £8,104,000) in relation to losses in overseas companies of £21,230,000 (2007: £23,667,000). This is as a result of the transfer of these subsidiaries to Hiscox Ltd from Hiscox plc. In accordance with IAS 12, all deferred tax assets and liabilities are classified as non-current.
30 Employee retirement benefit obligations The Company’s subsidiary, Hiscox plc, operates a defined benefit pension scheme based on final pensionable salary. The scheme closed to future accrual with effect from 31 December 2006 and active members were offered membership of a defined contribution scheme from 1 January 2007. The funds of the defined benefit scheme are controlled by the trustee and are held separately from those of the Group.
The gross amount recognised in the Group balance sheet in respect of the defined benefit scheme is determined as follows: Present value of funded obligations 101,615 106,793 Fair value of scheme assets (115,166) (127,576)
The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit actuarial cost method. A formal full actuarial valuation is performed on a triennial basis, most recently at 31 December 2005, and updated at each intervening balance sheet date by the actuaries. The triennial actuarial value at 31 December 2008 is currently being completed. The present value of the defined benefit obligation is determined by discounting the estimated future cash flows using interest rates of AA rated corporate bonds that have terms to maturity that approximate to the terms of the related pension liability.
The scheme assets are invested as follows: Debt and fixed income assets 71,670 69,702
The movement in liability recognised in the Group’s balance sheet is as follows: At beginning of year – 3,801 Total expense charged/(credited) in the income statement of the Group 10 – (3,801) Contributions paid – –
A reconciliation of the fair value of the scheme assets is as follows: Opening fair value of scheme assets 127,576 133,660 Expected return on scheme assets 7,720 7,711 Difference between expected and actual return on scheme assets (18,107) 75 Contributions by the employer – – Settlements with scheme members – (11,687) Benefits paid (2,023) (2,183)
Gross liability recognised on balance sheet – – 3,801 16,677 34,718
Other principal actuarial assumptions are as follows: Discount rate 6.70 5.80 Expected return on scheme assets 6.90 6.09 Inflation assumption 3.00 3.60 Pension increases 3.00 3.60
During the year the Group made no contributions to the defined benefit scheme (2007: £nil). The Group has agreed that further additional contributions will be made if necessary but none are currently expected to be made in 2009 given the current level of underlying scheme surplus. 61% of any scheme surplus or deficit calculated is recharged or refunded to Syndicate 33.
While management believes that the actuarial assumptions are appropriate, any significant changes to those could affect the balance sheet and income statement. Whilst an additional one year of life expectancy for all scheme members might be expected to reduce the present value of unfunded obligations at 31 December 2008 by approximately £3m, the Group considers that the most sensitive and judgmental assumptions are the discount rate and inflation.
Weighted average number of ordinary shares in issue (thousands) 377,506 395,308 Adjustments for share options (thousands) 13,351 13,530
Weighted average number of ordinary shares for diluted earnings per share (thousands) 390,857 408,838
Diluted earnings per share has been calculated after taking account of 13,003,000 (2007: 13,014,000) options and awards under employee share option and performance plan schemes and 348,000 (2007: 516,000) options under SAYE schemes.
Interim dividend for the year ended: 31 December 2008 of 4.25p (net) per share 15,615 – 31 December 2007 of 4.0p (net) per share – 15,868
Final dividend for the year ended: 31 December 2007 of 8.0p (net) per share 31,141 – 31 December 2006 of 7.0p (net) per share – 27,723
Notes to the financial statements continued 32 Dividends paid to owners of the Company continued
On 16 August 2007, the Group acquired 100% of the share capital of ALTOHA Inc. in the USA. The total consideration was £29,052,000 which included contingent consideration of £7,530,000. No goodwill arose on acquisition.
Intangible assets of £5,083,000 were initially recognised in respect of the US State authorisation licences held by ALTOHA Inc.’s consolidated operations. During 2008, further cash consideration of £1,225,000 was paid in finalisation of their ultimate purchase value.
35 Contingencies and guarantees The Group’s subsidiaries are like most other insurers, continuously involved in legal proceedings, claims and litigation in the normal course of business. The Group does not believe that such actions will have a material effect on its profit or loss and financial condition.
(c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2007: £50,000) with NatWest Bank plc to support its consortium activities with Lloyd’s.
(e) As Hiscox Insurance Company (Bermuda) Limited is not an admitted insurer or reinsurer in the US, the terms of certain US insurance and reinsurance contracts require Hiscox to provide Letters of Credit or other terms of collateral to clients. On 1 December 2006, Hiscox entered into a Letter of Credit Reimbursement and Pledge Agreement with Citibank for the provision of a Letter of Credit facility in favour of US ceding companies. The agreement was a three year secured facility that allowed Hiscox to request the issuance of up to US$300 million in Letters of Credit. Letters of Credit issued under these facilities are collateralised by pledged cash and cash equivalents of Hiscox Bermuda. Letters of Credit under this facility totalling approximately US$83 million were issued with an effective date of 31 December 2008 (2007: US$38 million).
36 Capital and lease commitments Capital commitments The Group’s capital expenditure contracted for at the balance sheet date but not yet incurred for property, plant and equipment was
The aggregate minimum lease payments required by the Group under non-cancellable operating leases, over the expected lease terms, are as follows: No later than one year Land and buildings 5,621 4,705 Office equipment 144 141
The total future aggregate minimum lease rentals receivable by the Group as lessor under non-cancellable operating property leases are as follows: No later than one year 468 468 Later than one year and no later than five years 1,521 1,872 Later than five years – 117
Notes to the financial statements continued 37 Principal subsidiary companies of Hiscox Ltd at 31 December 2008
38 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 35 to 42. A number of the Group’s key personnel hold insurance contracts with the Group, all of which are on normal commercial terms and are not material in nature.
(a) Syndicate 33 at Lloyd’s Hiscox Syndicates Limited, a wholly owned subsidiary of the Company, received management fees and profit commissions for providing a range of management services to Syndicate 33 in which Hiscox Dedicated Corporate Member Limited, and in the prior year the corporate member subsidiaries of Hiscox Select Insurance Fund PLC also participated.
Amounts receivable from Syndicate 33 at 31 December excluding profit commission accrued 745 1,402
(c) Internal reinsurance arrangements During the current and prior year, there were reinsurance arrangements between Hiscox Dedicated Corporate Member Limited, Hiscox Insurance Company Limited, Hiscox Insurance Company (Guernsey) Limited and Hiscox Insurance Company (Bermuda) Limited.
Profit for the year after tax 70,808 191,248 163,846 48,630 63,948
Net asset value per share (p) 258.1 209.5 173.2 147.7 125.7
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