Strategic report 1 Group highlights 2 Our Group 4 Our brands 6 Our segments 8 Our routes to market 10 Our investment case 12 Chairman’s statement 15 Chief Executive Officer’s review 18 Market overview 19 Strategy 22 Our business model 24 Our key performance indicators 26 Finance review 38 Operating review 44 Risk management 50
Financial statements 122 Contents 123 Independent Auditor’s report 131 Consolidated financial statements 136 Notes to the consolidated financial statements 182 Parent Company financial statements 184 Notes to the Parent Company financial statements
Other information 189 Additional information 191 Glossary and appendices 195 Forward-looking statements disclaimer 196 Contact information
3. A reduction in the ratio represents an improvement as a proportion of net earned premium, while an increase in the ratio represents a deterioration. See glossary on page 191 for definitions.
We give people the protection they need to do the things they love in life.
Our strength lies in the diversity of our propositions, offering a range of products, powerful brands and multiple routes to market, underpinned by a determination always to aim higher for our customers, people, shareholders and wider stakeholders.
Direct Line stands for speed, simplicity and a common-sense human touch. We sell products direct to customers by phone and online.
Direct Line customers want a premium product with exceptional customer care that is tailored to their needs at a competitive price.
Churchill is one of Britain’s most recognisable brands, providing car, home, business, pet and travel insurance. Our products are available by phone and online, including price comparison websites.
Green Flag customers receive an award-winning breakdown service at a much cheaper price than its two biggest rivals.
Direct Line for Business understands that our customers’ businesses are their livelihoods, so the right type of cover is vital. Our policies cover a range of trades, from start-ups, to growing businesses, from renting out a property to working as a single tradesman. We sell products direct via phone and online.
Privilege customers want a quick and efficient service at the best price.
NIG is our commercial insurance brand dedicated to the broker market and is focused on a number of specialisms including small and medium-sized enterprises, agriculture and real estate.
DLG Auto Services is the Group’s UK network of bodyshops, repairing around 90,000 accident damaged vehicles every year, and supports our seven day repair proposition for Direct Line customers.
We are Britain’s leading personal motor insurer measured by in-force policies1, mainly represented through our well-known brands Direct Line, Churchill and Privilege, and also through our partners.
We are one of Britain’s leading personal home insurers measured by in-force policies1. We reach our customers by selling home insurance products through our brands Direct Line, Churchill and Privilege, and our partners RBS, NatWest and Prudential.
Note: 1. Number of new policies sold through Churchill and Privilege for Motor and Home in 2018. 2. www.directlinegroup.co.uk/en/brands/dlg-partnerships.html
Direct We partner with big brands to offer insurance to their customers and look for ways to be innovative to give people choice about how they insure the things they love.
Motor partnerships customers drove their new car away with our complimentary insurance2 1 million
In 2018, the Group delivered profit before tax of £582.6 million (2017: £539.0 million). The Group’s diversified product and channel portfolio, disciplined underwriting and our engaged employees have helped us to achieve this commendable result.
Leadership Your Board seeks to ensure that decisions are of the highest standard. It challenges strategic proposals, performance delivery and management responsibilities.
to market losses due to credit spread widening and continued capital expenditure as the Group invests with the aim of improving its capabilities and efficiency.
The Board also resolved to pay a special interim dividend of 8.3 pence per share. After both dividends, the solvency capital ratio will be 170% as at 31 December 20181.
Brexit Brexit, when the UK is due to leave the EU, is scheduled to take place on 29 March 2019. Although the Group is predominantly a UK business, it does, for example, have exposure to financial markets and it imports goods and services in order to fulfil insurance claims, including from the EU. The Group has been monitoring events carefully and proactively taken steps to mitigate the likely impact on the Group to the extent we consider it to be appropriate and proportionate to do so, given the considerable uncertainties; however, in the event of a disruptive Brexit the Group will not be immune. We have more information on this in the Risk section, on page 48.
CEO succession Following a rigorous search process, the Group was delighted to announce, on 26 February 2019, that Penny James, Chief Financial Officer (“CFO”) had been selected to succeed Paul Geddes as Chief Executive Officer (“CEO”) with effect from the conclusion of the Annual General Meeting (“AGM”) on 9 May 2019. Paul will step down as a member of the Board and will leave the Group at the end of July 2019.
Penny joined the Board on 1 November 2017 and succeeded John Reizenstein as CFO on 1 March 2018. Penny’s deep understanding of our sector, combined with outstanding leadership skills, financial and risk expertise and deep strategic thinking, gives the Board confidence that Penny is ideally suited to leading the delivery of the Group’s short-term strategic imperatives, including technological and business transformation, and the development of the next stage of our strategy.
This year marks the 10th anniversary of Paul’s appointment as CEO. In that time Paul has made a huge contribution to the Group and the Company is deeply indebted to him for his strong leadership. During his tenure, Paul has been leading the management team which successfully separated the business from the Royal Bank of Scotland Group, floated it on the London Stock Exchange and turned it into a successful FTSE 100 company. The Board thanks Paul for his enormous contribution and wishes him well for the future.
Dividends and capital management The Group’s solvency capital ratio prior to all proposed dividends was 194%, resulting from good capital generation from the business and lower capital requirements due in part to increasing the level of reinsurance purchased by the Group in recent years. This was partially offset by higher unrealised mark
Linking remuneration to performance We remain committed to ensuring that executive pay is aligned with the Company’s strategy of targeting sustainable shareholder and customer value. This is primarily achieved by the Annual Incentive Plan (“AIP”) and Long Term Incentive Plan (“LTIP”) being aligned to performance measures shareholders consider important. This is underpinned by the delivery of a significant proportion of remuneration through shares and shareholding requirements.
The Group maintains active relationships with its insurance regulators through constructive dialogue. The Board promotes an open and collaborative culture, and provides oversight of the Group’s conduct with customers. It oversees the Group’s culture and the conduct policy, which aims to ensure that fair customer outcomes are achieved and that employees behave with integrity. The Group also has an Employee Code of Conduct which sets out standards to which our employees are required to adhere.
Board and Committee membership changes Further to the announcement of the new CEO you will recall from my statement last year that John Reizenstein and Andrew Palmer stepped down from the Board at the conclusion of the AGM in May 2018.
Clare Thompson, independent NED, has decided to step down from the Board at the conclusion of the 2019 AGM. Having served as a Director since 2012, Clare has made an immense contribution to the Group. Her experience and wisdom have been invaluable in helping the Board and senior management to deliver excellent results for shareholders and customers. She leaves the Board with our thanks and best wishes for the future.
The Chairs of three Board Committees also changed during 2018. Gregor and Mark were appointed as Chair of the Audit Committee and Investment Committee respectively replacing Andrew Palmer. Danuta Gray also replaced Clare Thompson as Chair of the Remuneration Committee.
I would like to thank each member of the Board for their significant contribution, commitment and service, and look forward to working with them in 2019 as the Group continues to strive to build on its success to date.
In Direct Line we launched another two new unique propositions – in Home and Motor. Our new Motor proposition removed one of our customers’ greatest frustrations and protected their no claim discount on no-fault claims. We now offer a combination of nine Direct Line propositions that our customers cannot get anywhere else in the market.
Moving towards best in class in the price comparison website market We see a real opportunity in strengthening our capabilities on price comparison websites. We increased our focus in 2018 and created a new trading hub in Motor and Home to support this. We made some tactical pricing changes driven by improved anti-fraud capabilities and this helped increase Churchill and Privilege Motor new business volumes by 18%. We believe there is an opportunity to strengthen margins in this channel.
Investing in technology Whilst we have already made significant progress in delivering our Direct Line for Business systems, most of our transformational work has been going on behind the scenes on our core personal lines technology, as we continued our ambitious programme to build our latest generation IT capabilities.
We continue to make good progress on our alternative pricing project which we expect to give us new capability by applying new data science methods and machine learning. We believe this approach will enable us to deepen our competitive footprint with more granular and flexible pricing capabilities. Testing is progressing well and we are aiming to launch in Q2 2019 under a new brand.
Improving our efficiency In order to be able to give our customers the best value for money, we recognise it is imperative to operate efficiently. Over the past five years, we’ve made significant strides in reducing our costs, such as through improved marketing efficiency, where we reduced marketing spend by over 30% whilst returning our direct own brands to growth, and reducing our number of sites by nearly a half and annual rental costs by around 40%.
Over the past two years we have been expanding our robotic process automation capability and are now managing concurrently 28 processes and approximately 500,000 automated transactions each quarter. But we don’t intend to stop there and have already identified a strong pipeline of processes to add to our existing portfolio and which has the potential to increase our transaction volume capability by a further 500,000 in 2019.
Leveraging our scale via partnerships In Home, we leveraged our capabilities in digital and data to streamline the customer experience. Our improved capabilities in digital are helping us have conversations with potential new partners.
In Travel, we are building a new system that is designed to enable customers to self-serve and interact with us day or night, offering greater support and helping us renew our partnerships with RBS Group and Nationwide.
Investing in our talented people The success of the business is due to the commitment and dedication of our people who use their expertise to serve our customers. We rightly celebrate our diversity and are united in our customer focus. This focus is reflected in our unique propositions and the fact that on average we manage one claim every single minute of every single hour, every day of the year. The freezing weather earlier in the year hit many drivers, households and businesses hard, and the way our people helped our customers get their lives back on track during this difficult period demonstrated the value of our insurance cover and gives customers a reason to keep coming back to us. Nearly 10,000 of our people now own shares in our company which gives them a real sense of ownership and investment in our future success. Our engagement scores
Overall, our current-year combined operating ratio was stable, demonstrating the value in the Group’s diversified product base and channel portfolio, as well as lower operating expenses.
Regulation The Group has continued to operate within a highly dynamic and evolving regulatory landscape, where there are a number of reviews and initiatives, including those that have been announced by the UK Government, the FCA and the PRA.
In 2018 both the FCA and PRA have been focused on Brexit preparations and the implementation of the Senior Managers and Certification Regime. The PRA’s focus continues to be on the pillars of its financial risk framework, namely reserving, pricing, reinsurance and investments. The FCA has also been focused on pricing practices including the launch of its market study. The Group is supportive of the FCA’s market study. At this early stage however, the outcomes are not yet known.
The insurance market is very competitive with high levels of switching and lots of introductory discounts which leads to most people shopping around for the best deal. For those customers who don’t shop around it is crucial that insurers have active pricing processes for all their long-term customers. We have had these measures in place for several years and increasing numbers of long-standing customers have seen their renewal premium either frozen or reduced as a result. We worked closely with the Association of British Insurers on their pricing principles and actions on premiums which we hope will embed best practice across the whole industry.
Outlook The Group targets a combined operating ratio of 93% to 95% for 2019 and over the medium term, normalised for weather. Over time, the Group expects to increase the contribution from current-year underwriting as the contribution from prior-year reserve releases reduces. The latter is predominantly as a result of increasing the level of reinsurance purchased by the Group in recent years which has reduced the risk profile of the Group.
As I prepare to hand over the reins to Penny not only do I look back over the last ten years with great pride, I also look to the future with great excitement for our customers, people and shareholders. Over the next 12 months, as we begin the roll-out of our new core personal lines IT applications, we plan to increase our flexibility to deal with changing business requirements, offer more self-service and deliver more straight-through processing. This combined with our leading brands and great people will help Direct Line Group with its mission to make insurance much easier and better value for its customers.
Find out more about our Strategy on pages 19 – 21
We have once again added to our accident and repair centre network, helping us to manage costs.
We have launched a combination of nine new Direct Line propositions unique in the insurance market.
Direct Line for Business has extended its proposition to target over 500 small and micro trades.
Digital innovation allows insurers to interact with consumers in new, more effective ways.
We are driving performance through advanced analytics, for instance by creating better understanding of rescue claims in our Green Flag business.
New systems enable customers to access quicker self-service at lower cost and pricing to become fairer and more accurate.
We have invested in a range of cloud-enabling security measures and have been working closely with a range of peer groups to tackle security risks affecting the entire industry.
Pricing The Financial Conduct Authority has launched a General Insurance Pricing Practices Market Study.
We have signed up to the Association of British Insurers’ guiding principles and action points to help with how renewal premiums are dealt with, building on our review of long-term and potentially vulnerable customers. Increasing numbers of long-standing customers have seen their renewal premium either frozen or reduced.
Great retailer We have compelling brands and multiple customer propositions and deliver a strong customer experience which we constantly evolve to meet the needs of our customers.
Lead and disrupt By embracing the future, we aim to shape it and launch new products and services which anticipate consumer trends so that we continue our tradition of disruptive change.
Data and technology We aim to harness the power of technology and the scale of our data to make things easier for our customers and our people.
Capital and risk management We maintain an appropriate level of capital and solvency to manage our customers’ pool of risks while understanding, monitoring and managing our own existing and emerging risks within carefully defined parameters.
Partnerships We are leveraging our manufacturing strength through our digital capabilities to seek to develop innovative and profitable partnerships.
Read about our progress in 2018 on pages 20 – 21
Over the next few years we also plan to wind down and then remove our existing mainframe, while growing our use of the cloud. This is planned to give us flexibility in the future to deal with changing business requirements and changes in technology.
Accident repair centres We continued to expand our network of accident repair centres and now have 20 sites across the UK, giving us more capability to deliver our seven day repair proposition for Direct Line customers. This year alone, we repaired over 85,000 vehicles, building on our excellent record of customer service. By investing in the latest technology we are preparing the business for the future by better understanding how technology will affect the design and manufacture of cars.
Renewal pricing principles The lack of barriers to shopping around for insurance brings substantial benefits to consumers who benefit from cheaper prices. However, we recognise that whilst shopping around can bring benefits to those who do it, it does create differences between new customer premiums and subsequent renewal premiums.
Find out more in our Market overview on page 18 85,000+ vehicles repaired breakdowns responded to in 2018 – that’s 1 every 49 seconds
Our multi-brand, multi-product and multi-channel business offers different propositions to maximise choice for customers. We believe this approach enables us to provide good value for customers and sustainable returns for our shareholders.
Multiple channels so that customers can choose how they wish to engage with us
Eight brands so that our customers can choose the proposition that suits them
Find out more on pages 19 – 21 Find out more on pages 4 – 9
We target sustainable returns for our shareholders through a combination of investing in future capabilities, improving efficiency and careful risk management.
Pricing We seek to ensure our prices reflect the risks being underwritten by using data and actuarial techniques.
Find out more on pages 26 – 37 Find out more on pages 24 – 25
Delivering strong performance These key performance indicators assess our performance against our strategy.
D ef in iti on The return generated on the capital that shareholders have in the business. This is calculated by dividing adjusted earnings by average tangible equity.
A risk-based measure expressing the level of capital resources held as a percentage of the level of capital that is required under solvency II.
Engagement is about being proud to work for Direct Line Group and helping us to succeed. It means that employees are not just happy or satisfied, but doing something to help us achieve our company goals.
Changes to our KPIs in 2018 Our metrics are reviewed annually and updated as appropriate to ensure they remain an effective measure of delivery against our objectives. For 2018, the review of these metrics resulted in the following changes: – Combined operating ratio has been split into its loss ratio, commission ratio and expense ratio elements to give greater clarity of its composition
Key for combined operating ratio Expense ratio Commission ratio Loss ratio
A measure of financial year underwriting profitability. A Combined operating ratio (“COR”) of less than 100% indicates profitable underwriting. In addition to net claims, expense and commission ratios measure the cost of doing business and the COR is the sum of these costs divided by net earned premium, excluding instalment and other operating income and investment return.
A im We aim to achieve at least a 15% RoTE per annum over the long term.
To make the Group best for employees and best for our customers. We gauge employee engagement through our employee opinion survey and we aim to improve this year on year.
Customer claims experience programmes and improved propositions have contributed to an increase in our overall brand score.
While the proportion of complaints received reduced compared to 2017 we recognise we have more to do to reduce these.
re m un er at io n We base the LTIP awards partly on RoTE over a three-year performance period.
The AIP awards include a weighting to a balance of employee metrics, including engagement.
See page 90 See page 90 See page 89 See pages 89 and 96 See pages 89 and 90 See pages 89 and 98 See pages 89 and 97 See pages 89 and 97
– Operating profit decreased by £41.1 million compared to 2017, primarily due to reductions in prior-year reserve releases and investment return as expected. Operating profit included a £55 million benefit from moving to an assumed 0% Ogden discount rate (2017: £49 million benefit relating to Ogden).
– Profit before tax increased by 8.1% to £582.6 million (2017: £539.0 million) as the decrease in operating profit was more than offset by the non-repeat of finance costs in relation to the debt repurchased in 2017.
– Final ordinary dividend of 14.0 pence per share, an increase of 2.9% on 2017. Special dividend of 8.3 pence per share. Total dividends of 29.3 pence per share (2017: total dividends of 35.4 pence per share including a special dividend of 15.0 pence per share).
– Strong capital position with solvency capital ratio of 170% (after proposed dividends) reflecting prudence given current political and economic uncertainties.
– Reiteration of financial targets for 2019 and over the medium term of achieving a combined operating ratio in the range of 93% to 95% normalised for weather. In 2019, targeting operating expenses below £700 million. Reiteration of ongoing target of achieving at least a 15% return on tangible equity.
Underwriting profit 255.1 288.1 Instalment and other operating income 192.0 179.3 Investment return 154.6 175.4 Operating profit 601.7 642.8 Finance costs (19.1) (103.8) Profit before tax 582.6 539.0
Profit after tax 473.7 434.0 Key metrics Current-year attritional loss ratio3 72.5% 69.4% Loss ratio3 61.8% 56.0% Commission ratio3 6.5% 9.1% Expense ratio3 23.4% 25.7% Combined operating ratio3 91.7% 90.8% Return on tangible equity4 21.5% 23.0% Investment income yield4 2.5% 2.5% Net investment income yield4 2.0% 2.1% Investment return yield4 2.4% 2.6% Basic earnings per share (pence) 33.5 31.8 Diluted earnings per share (pence) 33.1 31.5 Return on equity 17.3% 16.6% Dividend per share5
– interim (pence) 7.0 6.8 – final (pence) 14.0 13.6 – total ordinary (pence) 21.0 20.4 – special (pence) 8.3 15.0 – total (pence) 29.3 35.4
Notes: 1. Exit from Sainbury’s in respect of new business. 2. Results for the year ended 31 December 2018 are based on total Group operations including restructuring costs and the Run-off segment. Comparative data has been re-presented accordingly to include restructuring costs and Run-off profits within the Motor segment.
3. A reduction in the ratio represents an improvement as a proportion of net earned premium, while an increase in the ratio represents a deterioration.
Strong results in a competitive market 26 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Of which: Current-year operating profit 197.3 207.4 Prior-year reserve releases 404.4 435.4
Underwriting profit decreased to £255.1 million (2017: £288.1 million) predominantly due to lower prior-year reserve releases of £31.0 million. Increased weather-related claims of £75 million, mainly associated with the major freeze event in Q1 2018 (2017: £13 million weather-related claims), were mostly offset by the non-repeat in 2018 of the £56.9 million impairment charge in 2017 in relation to IT projects.
Following Royal Assent of the Civil Liability Act 2018, which introduced a new framework for setting the personal injury discount rate, the Group reviewed the Ogden discount rate for reserves for large bodily injury claims and selected an assumed rate of 0% for reserving purposes. This has resulted in a release of £54.8 million in 2018 and this release was split across the Motor and Commercial segments. Given the Group’s lower reinsurance retention in recent years, the majority of the reserve release related to prior years. In 2017, the Motor segment benefited from a reserve release of £49.0 million resulting from a lower than expected increase in claims costs following the change in the Ogden discount rate to minus 0.75%.
Instalment and other operating income increased to £192.0 million (2017: £179.3 million) and included a £9.6 million gain on sale of a property in Bristol.
Direct Line for Business 499 468 NIG and other 256 240
Total in-force policies reduced to 15.0 million (31 December 2017: 15.7 million), primarily due to lower partner volumes in Home, following the exit from the Nationwide and Sainsbury’s partnerships, and reductions in Rescue and other personal lines, as a result of lower packaged bank account volumes. Own brands in-force policies grew to 7.1 million (31 December 2017: 6.9 million) with growth in Motor, Green Flag and Direct Line for Business, which partly offset the overall reduction.
Own brands 412.6 409.7 Partnerships (excluding Nationwide and Sainsbury’s) 181.7 195.6 Partnerships (Nationwide and Sainsbury’s) 12.6 193.8
Travel 143.9 143.4 Pet 72.4 74.8 Other personal lines 43.1 41.6 Rescue and other personal lines 422.8 421.1
Gross written premium of £3,211.9 million (2017: £3,392.1 million) decreased by 5.3% primarily due to the exit from the Nationwide and Sainsbury’s partnerships in Home. Direct own brands gross written premium of £2,223.0 million (2017: £2,184.1 million) grew by 1.8%.
The Group’s combined operating ratio of 91.7% (2017: 90.8%) increased by 0.9 percentage points primarily due to a higher loss ratio which was partly offset by improvements in commission and expense ratios. Weather returned to close to normal levels in 2018 after a benign 2017 and this offset the non-repeat in 2018 of the £56.9 million non-cash impairment charge incurred in 2017. Normalised for weather and adjusted for the Ogden discount rate change, the combined operating ratio was approximately 93.5%, towards the lower end of the Group’s medium-term target of 93% to 95%.
The loss ratio was 5.8 percentage points higher at 61.8% (2017: 56.0%) and reflected lower prior-year reserve releases, increases in Home and Commercial loss ratios due to the major freeze event in Q1 2018 and a reversal of benign motor conditions in 2017.
Loss ratio – current-year attritional 79.7% 52.0% 67.1% 68.8% 69.4% Loss ratio – prior-year reserve releases (21.7%) (3.0%) (1.7%) (18.9%) (13.9%) Loss ratio – major weather events1 n/a 1.6% n/a n/a 0.4%
Prior-year reserve releases continued to be significant at £404.4 million (2017: £435.4 million), were equivalent to 13.1% of net earned premium (2017: 13.9%) and were concentrated towards more recent accident years. Reserve releases in 2018 included a £51.4 million Ogden rate-related prior-year reserve release (2017: £49.0 million release). Assuming current claims trends continue, prior-year reserve releases are expected to reduce further in future years, although they are expected to remain a significant contribution to profits.
The Group’s current-year combined operating ratio remained broadly steady at 104.8% (2017: 104.7%) as increases in attritional loss ratios were offset by reductions in commission and expense ratios.
3. Amortisation and impairment of other intangible assets includes a £1.5 million impairment charge for year ended 31 December 2018 (2017: £56.9 million), which relates to capitalised software development costs for ongoing IT projects primarily relating to development of new systems.
Operating expenses reduced by £84.1 million to £722.2 million (2017: £806.3 million) resulting in an expense ratio of 23.4% (2017: 25.7%). Excluding an impairment of intangible assets of £56.9 million in 2017, operating expenses reduced by 3.6% as reductions in staff costs and other operating expenses were partially offset by an increase in marketing spend in Motor and Commercial to drive brand awareness. The Group continued to invest in its significant IT programme and operational efficiency improvements while supporting business growth and investment in future capability.
The Group will apply IFRS 16 ‘Leases’ from 1 January 2019. If the Group had applied this standard in 2018, the impact would have been a reduction in operating expenses of approximately £5 million and an increase in finance costs of approximately £7 million.
Instalment income 119.9 116.4 Other operating income: Vehicle replacement referral income 7 17.2 16.9 Revenue from vehicle recovery and repair services 7 11.7 11.3 Legal services income 7 11.2 11.0
Instalment and other operating income increased by £12.7 million, with increased instalment income of £3.5 million due to higher Motor gross written premium partly offset by a reduction in Home due to the exit from Nationwide and Sainsbury’s partnerships. Other operating income increased by £9.2 million, primarily relating to a one-off gain on disposal of the Bristol property of £9.6 million.
Investment income yield1 2.5% 2.5% Net investment income yield1 2.0% 2.1% Investment return yield1 2.4% 2.6%
Note: 1. See glossary on pages 190 and 191 for definitions and Appendix A –
Operating profit 601.7 642.8 Finance costs (19.1) (103.8) Profit before tax 582.6 539.0
Note: 1. Results for the year ended 31 December 2018 are based on total Group operations including restructuring costs and the Run-off segment. Comparative data has been re-presented accordingly to include restructuring costs and Run-off segment profits within the Motor segment.
Operating profit by segment All divisions were profitable in 2018 with Motor increasing profits by £18.8 million compared to 2017. Home reported reduced operating profits primarily due to the major freeze event in Q1 2018. Commercial also experienced higher weather costs in 2018 although attritional claims performance improved. Rescue and other personal lines reported slightly lower profits. Rescue operating profit of £40.2 million (2017: £43.5 million) is included in the Rescue and other personal lines result.
Effective corporation tax rate The effective tax rate for 2018 was 18.7% (2017: 19.5%), which was lower than the standard UK corporation tax rate of 19.0% (2017: 19.25%) driven primarily by tax relief for the Tier 1 coupon payments offset by disallowable expenses.
Return on tangible equity decreased to 21.5% (2017: 23.0%) due primarily to a £31.5 million decrease in adjusted profit after tax to £457.1 million (2017: £488.6 million). Profit after tax in 2018 was adjusted for coupon payments in respect of Tier 1 notes, while profit after tax in 2017 was adjusted to add back finance costs for the one-off subordinated debt buy-back.
Operating activities before investment of insurance assets generated a cash inflow of £4.2 million (2017: £204.0 million generated). The decrease primarily reflected a reduction in insurance liabilities and trade payables partially offset by a reduction in insurance and other receivables.
Investment of insurance assets generated a cash inflow of £468.1 million (2017: inflow of £341.9 million). The increased inflow of £126.2 million is primarily due to the proceeds on disposal of financial investments.
The Board has recommended a final dividend of 14.0 pence per share (2017: 13.6 pence), an increase of 0.4 pence per share (2.9%), in line with business growth. This reflects the Board’s continued confidence in the Group’s earnings and the progress the business continued to make.
The Board has taken into account the high level of political and economic uncertainty, including in relation to Brexit, and considers it appropriate for the time being to maintain a prudent solvency capital ratio towards the upper end of the solvency capital ratio risk appetite range of 140% to 180%. The Board will keep this position under review as it monitors developments in the political and economic environment. In normal circumstances, the Board expects the Group to operate around the middle of its solvency capital ratio risk appetite range.
Capital analysis The Group is regulated under solvency II requirements by the PRA on both a Group basis and for the Group’s principal underwriter, U K Insurance Limited. In its results, the Group has estimated its solvency II own funds, SCR and solvency capital ratio as at 31 December 2018.
Capital position At 31 December 2018, the Group held a solvency II capital surplus of approximately £0.89 billion above its regulatory capital requirements, which was equivalent to an estimated solvency capital ratio of 170%, post the proposed final and special dividends.
The Group’s SCR and solvency capital ratio are as follows: Solvency capital requirement (£ billion) 1.26 1.39 Capital surplus above solvency capital requirement (£ billion) 0.89 0.91 Solvency capital ratio post-dividend 170% 165%
Capital surplus at 1 January 0.91 0.91 Capital generation excluding market movements 0.47 0.54 Market movements (0.06) – Capital generation 0.41 0.54 Change in solvency capital requirement 0.13 0.01 Surplus generation 0.54 0.55 Capital expenditure (0.15) (0.10) Management capital action – 0.03 Capital distribution – ordinary dividends2 (0.30) (0.28) Capital distribution – special dividends2 (0.11) (0.20) Net surplus movement (0.02) – Capital surplus at 31 December 0.89 0.91
During 2018, the Group’s own funds decreased from £2.30 billion to £2.15 billion. The Group generated £0.41 billion of solvency II capital offset by £0.15 billion of capital expenditure and capital distribution of £0.41 billion for the 2018 dividend. The increased capital expenditure reflects the significant investment the Group is making in building future capability including the development of the latest generation core personal lines IT systems. In 2019, the level of expenditure is expected to be approximately £175 million, reducing to less than £150 million in 2020. Thereafter, expenditure levels are expected to reduce further.
The Group’s SCR has reduced by £0.13 billion in the year. Model and parameter changes reduced the SCR by £0.07 billion. Exposure changes, as a result of the exited Home partnerships, a reduction in solvency II technical provisions including an assumed change in the Ogden discount rate to 0%, and lower assets under management, led to a reduction in the SCR of £0.06 billion.
Motor small bodily injury deterioration equivalent to accident years 2008 and 2009 (7pts) (7pts) One-off catastrophe loss equivalent to the 1990 storm (8pts) (9pts) One-off catastrophe loss based on extensive flooding of the River Thames (8pts) (9pts) Change in reserving basis for PPOs to use a real discount rate of minus 1%1 (10pts) (13pts) 100bps increase in credit spreads2 (11pts) (11pts) 100bps decrease in interest rates with no change in the PPO real discount rate (1pt) (3pts)
Tier 1 capital before foreseeable dividends 1.76 2.04 Foreseeable dividends (0.31) (0.39) Tier 1 capital – unrestricted 1.45 1.65 Tier 1 capital – restricted 0.35 0.35
The special dividend will be payable from surplus capital generated from continuing operations of the Group.
Total shareholders’ equity 2.57 2.72 Goodwill and intangible assets (0.57) (0.47) Change in valuation of technical provisions (0.15) (0.13) Other asset and liability adjustments (0.09) (0.08) Foreseeable dividends (0.31) (0.39) Tier 1 capital – unrestricted 1.45 1.65 Tier 1 capital – restricted 0.35 0.35
Note: 1. The 2017 comparative period has been updated to reflect the amounts in the
Leverage The Group’s financial leverage increased by 0.7 percentage points, but remained conservative at 19.1% (2017: 18.4%). The increase was primarily due to the reduction in shareholders’ equity. While the Tier 1 notes issued during 2017 are presented as equity in the balance sheet, the Group considers this to be part of its total leverage.
The Group will continue to exercise judgement around the Ogden discount rate used in its reserves. Risks and uncertainties here are significant but the move to introduce additional asset classes into the assumed claimant portfolio points towards a higher rate than minus 0.75%. The Group has therefore made a judgement that it is likely that the Ogden discount rate will change and has selected an estimate of 0% to value its lump sum bodily injury reserves. An allowance for further movements in the Ogden rate is made within the Group’s solvency II balance sheet and capital requirements. Details of the IFRS sensitivity analysis to the assumed Ogden discount rate are shown overleaf.
Note: 1. Results for the year ended 31 December 2018 are based on total Group operations including restructuring costs and the Run-off segment. Comparative data has been re-presented accordingly to include Run-off segment profits within the Motor segment.
2. These sensitivities reflect one-off impacts at 31 December and should not be interpreted as predictions. 3. The sensitivities relating to an increase or decrease in the real discount rate used for PPOs illustrate a movement in the time value of money from the assumed level of 0% for reserving. The PPO sensitivity has been calculated as the direct impact of the change in the real discount rate with all other factors remaining unchanged. 4. Ogden discount rate sensitivity has been calculated as the direct impact of a permanent change in the discount rate with all other factors remaining unchanged.
Investment portfolio The investment strategy aims to deliver several objectives, which are summarised below: – to ensure there is sufficient liquidity available within the investment portfolio to meet stressed liquidity scenarios
Tier 2 sub-debt (swapped fixed to floating) Commercial real estate loans and cash Floating
Surplus − tangible equity Investment-grade credit, cash and government debt securities
Asset allocation and benchmarks The current strategic asset benchmarks for the Group are detailed in the following table: At 31 December Benchmark holding
Notes: 1. Asset allocation at 31 December 2018 includes investment portfolio derivatives, which have been included and have a mark-to-market asset value of £11.8 million included in investment grade credit (31 December 2017: mark-to-market asset value of £55.1 million). This excludes non-investment derivatives that have been used to hedge interest on subordinated debt and operational cash flows.
Tax policy and governance The Group’s tax policy has been reviewed and approved by the Audit Committee. The Group Tax team supports the Chief Financial Officer in ensuring the policy is adhered to at an operational level.
Total tax contribution The Group’s direct and indirect tax contribution to the UK Exchequer is significantly higher than the UK corporation tax that the Group pays on its profits. The Group collects taxes relating to employees and customers on behalf of the UK Exchequer and other national governments. It also incurs a significant amount of irrecoverable value added tax relating to overheads and claims.
Insurance premium tax collected 400.6 VAT collected 12.2 Employees’ PAYE and national insurance contribution 99.2 Total 512.0
Corporation Tax £114.4m Irrecoverable VAT £287.4m Employer’s national insurance contribution £39.2m Other taxes £8.7m £449.7m
Insurance premium tax collected £400.6m VAT collected £12.2m Employees’ PAYE and NIC £99.2m £512.0m
Overview In 2018, the Group grew its Motor policy count at target margins, in an increasingly competitive market, demonstrating the value that customers place on our brands and propositions.
Whilst the current-year attritional loss ratio was up by 1.8 percentage points, the current-year combined operating ratio was broadly stable (excluding the effect of the £56.9 million impairment of intangible assets in 2017), and operating profit was up 4.7%.
Note: 1. By original channel. 2. Average incepted written premium excluding insurance premium tax for total
In total, prior-year reserve releases were £42.3 million lower year on year at £276.3 million, and included £47.9 million relating to the change in the assumed Ogden discount rate (2017: £49.0 million release). Bodily injury claims reserves continued to develop favourably.
Motor’s reported combined operating ratio improved by 0.9 percentage points to 88.9% (2017: 89.8%). This was primarily as a result of the improvement in the expense ratio, following the non-repeat in 2018 of 2017’s impairment of intangible assets.
16,618 customers have benefited from Direct Line’s ‘No Blame’ proposition which provides that a policyholder’s No Claim Discount is not affected if their car is damaged in any of these circumstances: – Potholes or poor road maintenance – Fire and/or theft of/or from the car – Hit whilst parked – Flood – If you hit or were hit by a wild or domestic animal
This ensures that our customers are not being punished for something that is not their fault and are able to keep their hard earned no claims discount intact. Just another way that we are making insurance much easier and better value for our customers.
Performance In-force policies for Home’s own brands were broadly stable compared with 2017 at 1.8 million policies, while partnerships volumes reduced by 40.7% predominantly due to the exit from the Nationwide and Sainsbury’s partnerships. Excluding Nationwide and Sainsbury’s, partnership volumes reduced by 2.4% in 2018.
Gross written premium was 24.1% lower than 2017, predominantly due to the reduction in partnerships. Own brands gross written premium rose by 0.7% with increases across all brands. New business volumes were lower during the second half of 2018 as shopping levels slowed following the anniversary of the introduction of the new rules requiring the previous year’s premium to be included on renewal documents. Retention in Home own brands continued to be strong.
Home own brands average written premium3 increased slightly by 0.4% compared with 2017, with a 3.5% price increase offset by a reduced risk mix.
The commission ratio of 9.4% was 8.3 percentage points lower than for 2017, reflecting lower commission and profit share payments to partners resulting from the exit from the Nationwide and Sainsbury’s partnerships and changes to other partnership commission arrangements.
Home’s combined operating ratio increased by 4.2 percentage points to 93.6% (2017: 89.4%) with higher loss and expense ratios, in part offset by an improved commission ratio. The loss ratio was 11.2 percentage points higher at 61.8% compared to 2017 primarily as a result of the major weather events in Q1 2018. The impact of weather in Q1 was approximately £65 million (2017: £13 million), and no additional major weather events were experienced for the remainder of the year. Normalised for weather, the combined operating ratio was approximately 2.0 percentage points better than last year at 92% (2017: approximately 94%).
Our technician will leave the customer with clear next steps on when they will be contacted and what action they are recommending. During the first visit claims evidence is also captured on video and reported back to the office to speed up the process, all contributing to a fast response.
Overview The Rescue and other personal lines segment consists of Rescue products which are sold through the Green Flag brand and other personal lines insurance, including Travel and Pet, which are sold through own brands and partnership arrangements.
Green Flag continued to position itself as the market disrupter, with the launch of a new advertising campaign in the year. Travel claims inflation remained in line with medium to long-term expectations during 2018. Less volatile currency movements drove lower claims inflation and this was reflected in lower premium inflation than in previous years. Brexit uncertainty remains a risk, however, with the impact on customers and claims with the possible withdrawal of the European Health
The Rescue Me service on the Green Flag app is making a stressful situation a little less hassle for our customers. Using the app customers can: – Request a rescue which will pinpoint their location so they don’t have to worry about providing directions
– An intuitive online tool asks small and medium-sized enterprise owners four or five questions about their business that are used to personalise the rest of their journey according to their trade and individual circumstances
– Each cover option gets broken down in the policy, showing individual prices and giving business owners full transparency when buying their policy
Direct Line for Business continued to roll out a range of innovative propositions for small and micro businesses, including the launch of its Office, Professionals and Retail insurance products. Direct Line for Business also launched
– Total gross written premium increased by 1.9% with direct own brands increasing by 7.7% – Strong performance in Direct Line for Business, with new propositions rolled out on its innovative technology platform targeting small businesses – NIG premium stable year on year as it focused on delivering its strategy and improving margins
Gross written premium £511.0m £501.5m Of which: DL4B £132.0m £122.6m NIG and other £379.0m £378.9m
Loss ratio 51.8% 49.9% Commission ratio 18.9% 19.1% Expense ratio 24.8% 24.4% Combined operating ratio 95.5% 93.4% Operating profit £60.0m £74.0m a national marketing campaign to increase awareness of its offering amongst its target market.
In NIG, the focus continued to be on profitability and delivering on its service proposition to be ‘Effortless to Trade With’.
Performance Commercial in-force policies increased by 6.6% compared with 2017 to 755,000. This reflected strong growth in both Direct Line for Business and NIG and other. Gross written premium increased by 1.9% to £511.0 million.
The combined operating ratio for Commercial increased by 2.1 percentage points to 95.5% (2017: 93.4%), primarily due to a 1.9 percentage points increase in the loss ratio as a result of the major weather events in Q1 2018 and the reduction in prior-year reserve releases, partially offset by an improvement in the current-year attritional claims ratio. The impact of weather events in 2018 was approximately £10 million.
Our First Line of Defence is management who are responsible for owning and managing risks to achieve our business objectives on a day-to-day basis. The Second Line of Defence is the Risk function which is responsible for the design
We have a comprehensive risk management framework in place to ensure we have a strong understanding of the risks we run in the course of our business; and appropriate controls are in place with the aim of ensuring we remain within risk appetite.
These key risk indicators are qualitative and quantitative, and forward and backward-looking. We review our risk appetite statements and key risk indicators annually.
Principal risks and uncertainties We carefully assess the principal risks facing us. Principal risks are defined as having a residual risk impact of £40 million or more on a 1-in-200 years basis, taking into account customer, financial and reputational impacts. Principal risks Management and mitigation examples
– We set our reserves using the latest internal and external data and trends
– Catastrophe and motor excess of loss reinsurance limits our exposure to events and large losses
– We estimate technical reserves using various actuarial and statistical techniques. Management’s best estimate of total reserves is set at not less than the actuarial best estimate
The risk of loss resulting from fluctuations in the level and in the volatility of market prices of assets, liabilities and financial instruments.
– We have an investment strategy approved by the Board – We diversify asset classes including by country of risk, and by investing in US dollar assets to broaden the pool of available assets
– To limit exposure to credit spread risk, we tightly control individual asset exposures as shown in spread risk sensitivities
This includes the risks associated with inadequately diversified portfolios of assets and/or obligations.
– Credit limits are set for each counterparty and we actively monitor credit exposures
O p er a ti o n a l r is k
The principal risks within this category are information security, partnership contractual obligations, change, outsourcing and technology and infrastructure risks.
The risks arising out of changes to laws, regulatory rules, policy or interpretation, or to supervisory expectations or approach, that have an adverse operational and financial impact as a result of reputational damage, regulatory or legal censure, fines or prosecutions, and any other type of non-budgeted operational risk losses, associated with the Group’s conduct and activities.
– We use specific risk management tools and resources to help manage our exposure to regulatory risk
– Our conduct risk management framework is designed to deliver fair outcomes to customers and minimise our risk exposure
The risk of direct or indirect impact on the earnings, capital, or value of the business as a result of the strategies not being optimally chosen, implemented or adapted to changing conditions.
Potential effects of Brexit The UK is scheduled to exit from the EU on 29 March 2019. At the date of this report there is considerable uncertainty as to how and even whether there will be a Brexit, or at least as to when it will take effect and on what terms. Accordingly there is corresponding uncertainty as to the effect of Brexit on the Group.
Following the EU referendum result in 2016, which saw the UK vote to leave the EU, the Group established a Brexit Working Group comprising representatives from across the Group. It was identified that there was a risk that the UK could enter a prolonged period of reduced growth due to Brexit, potentially reducing insurance sales and the value of our investment portfolio. Whilst our operations are based mainly in the UK, Brexit-related issues which could impact adversely on the Group could include: changes to the value of sterling which impact claims and non-claims supplier costs; inflation; impacts on credit spreads which in turn could impact on the Group’s investments and capital; recruitment and retention of people; impacts on the speed of delivery and cost of goods and services required by the business including for fulfilling insurance claims made by customers, for example because of delays at borders caused by increased border regulations and by additional costs caused by increased tariffs and devaluation of sterling; availability of reinsurers authorised to write business in the UK; data transfers; the removal of the European Health Insurance Card (“EHIC”) leading to greater reliance on travel insurance; travel disruption; increased use of Green Cards (internationally recognised certificates that act as proof of insurance, including in the EU); potential changes to direct and indirect tax; and the regulatory impact on our capital position.
The Group has proactively considered a variety of possible implications of a disruptive ‘hard’ Brexit, including of a financial and operational nature; for example: The impact on the Group’s investment portfolio and in particular credit spreads relating to its debt securities and therefore Group solvency: A sensitivity analysis relating to its credit spread is provided in note 3.3.2 to the financial statements (on page 151). The Group has also considered Brexit in its Investment Committee, and further information is provided on the work of the Investment Committee on page 87. A disruptive Brexit could impact adversely on the Group’s investments and therefore capital and the solvency capital ratio and the appropriateness of paying dividends.
– Liability risks arise when parties, who have suffered losses from climate change, seek to recover from those they believe may have been responsible. There is some potential exposure to liability risk through commercial liability insurance. However, Pollution and Professional Indemnity covers, which carry the highest risk, are almost fully reinsured.
There are also potential physical, transition and liability risks arising through the investment portfolio. During 2018 a significant new initiative was approved to strengthen further the Group’s investment strategy with regard to environmental, social and governance issues. More information can be found in the Investment Committee’s report on page 87.
Technological developments change consumer needs for insurance New car technologies, such as crash-prevention aids, car sharing and driverless cars, could significantly affect the size and nature of the insurance market and the role of insurers. The Group continues to build strong collaborative relationships with key manufacturers, and has established an ‘In-Car Technology’ programme to help manage the response to developing car technology.
Fairness and pricing practices The FCA is conducting a market study into Fair Pricing in Financial Services and the Competition and Markets Authority has announced plans to take forward a ‘package of reforms’ to address the ‘loyalty penalty’ for long-standing home insurance customers, but has concluded that it will not be conducting its own market study at this time.
Viability statement In accordance with provision C.2.2 of the 2016 UK Corporate Governance Code, the Directors have assessed the prospects of the Group for a period longer than the minimum 12 months required by the going concern statement.
The Strategic report, on pages 1 to 59, sets out the Group’s financial performance, business environment, outlook and financial management strategies. It covers how the Group measures its regulatory and economic capital needs, and deploys capital. You can find discussion about the Group’s principal risks and risk management in this section. Note 3 to the consolidated financial statements starts on page 146 and sets out financial disclosures relating to the Group’s principal risks. This covers insurance, market and credit risk, and the Group’s approach to monitoring, managing and mitigating exposures to these risks.
When reviewing the strategic plan, the Board considered the Group’s prospects over the period that the plan covered and the conclusions of the ORSA, based on the Group’s anticipated activities as set out in the strategic plan. This review included reviews of solvency, liquidity, assessment of principal risks, and risk management over a three-year period, with a further two years of indicative planning. The first year following approval of the strategic plan has greater certainty, so it was used to set detailed budgets across the Group. Outcomes for the subsequent years in the plan are less certain. However, the plan provides a robust planning tool for strategic decisions. The Board recognises that, in a strategic plan, uncertainty increases over time and, therefore, future outcomes cannot be guaranteed or accurately predicted.
Our stakeholders The Board believes that adopting a business model that is sustainable in the long term and based on high ESG standards is important for promoting the success of the Company. In discussing and approving the Group’s strategic and financial plan, the Board considers the potential impact on all stakeholders in the business, including employees, customers, suppliers, the communities with which we interact and the environment, as well as the shareholders for whom we aim to continue generating returns on investment. You can find more detail about the stakeholder matters discussed by the Board when considering the strategic plan on page 66.
Our culture as a business flows from the beliefs underpinning the five pillars of our approach to Responsibility, which are set out in this section.
We aim to drive sustainable outcomes for our stakeholders and in order to deliver this we have developed a five pillar strategy which resonates with our collaborative culture and values. Our approach to environmental, social and governance matters is delivered through our five pillars and the table below shows where information can be found in this annual report and accounts. Pillars
Non-financial information statement This diagram sets out where stakeholders can find information in our Strategic report that relates to non-financial matters, as required under the new regulations1 on reporting non-financial information.
Principal risks and impact on business activity pages 44 to 49
Our people Investing in our talented people, encouraging everyone to aim higher
More information about the activities of each of the Committees can be found in the Committees’ reports on pages 76 to 87.
The Remuneration Committee determines remuneration for senior management and reviews workforce remuneration.
The Nomination Committee monitors developments in governance and investor ESG expectations, as well as being responsible for Board succession planning.
Board The Direct Line Group Board oversees all of the Group’s ESG activity. It has delegated particular aspects of this supervision to its Committees.
Our approach to responsibility is structured around five pillars: Our customers
We recognise that our customers are always raising their expectations and one of our values is to “aim higher”. The relationship between NPS and customer retention shows there’s a direct link between customer experience and our success as a business and that’s why this year we launched an initiative designed to help us identify, meet and exceed customer expectations when we make decisions and choices about how we run our business.
One claim every single minute of every single hour, every day of the year
See page 52 See pages 53 – 54 See page 55 See pages 56 – 59 See pages 60 – 121 52 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Our society Brake and PACTS We continue to engage with important partners in the road safety debate, including road safety charity Brake, the Parliamentary Advisory Council for Transport Safety (“PACTS”) and the Department for Transport.
We celebrated the successes at Brake’s annual parliamentary reception with hundreds of Brake supporters, volunteers and parliamentarians.
An astounding £60,000 was raised for Cancer Research UK, who carry out work that accelerates new cancer treatments and tests for UK patients, and patients across the world, to ultimately save more lives.
– Almost 90% of the investments in the infrastructure debt portfolio are in schools, hospitals and other social infrastructure assets
During 2018 a significant new initiative was approved to strengthen further the Group’s ESG credentials: – In the first half of 2019, the majority of investment grade bond mandates will transition to be managed against ESG weighted indexes
One of Direct Line Group’s teams competing in Mind’s Retail Challenge.
Shotgun As Britain’s leading personal motor insurer we want, for both our customers and society, to keep Britain’s roads safe. This is particularly true for young drivers where inexperience often leads to more accidents.
There is clearly demand for Shotgun, which rewards drivers for good driving. With over 27,000 downloads since launch, we’ve analysed 3.6 million car journeys covering 32.8 million miles, helping young drivers to be safer on our roads.
This year several of our people supported our national charity Mind, by taking part in a Retail Challenge, where teams competed against each other to raise the most money for the Mind shop they worked in.
Emissions You can find information on Group-wide greenhouse gas (“GHG”) emissions in the chart below – and more details of our emissions in the Directors’ report on page 120.
Waste We remain focused on improving our waste management systems. In 2018, 98% of total waste produced across the Group was recycled or recovered for energy use. This compares with 72% last year.
Climate change The Group’s use of catastrophe reinsurance mitigates against many of the worst potential physical risks from climate change, and the Group regularly reassesses its use of catastrophe models with the objective of ensuring they fully capture climate-related risks.
Efforts to mitigate against climate change are driving a de-carbonisation of the economy, including a transition towards electric vehicles. While this does not fundamentally change the business model, the Group continues to develop the new processes, skills and technical knowledge required to keep pace with changes in vehicle technology.
Our planet Environmental credentials Our ‘Reduce, Reuse, Recycle’ strategy guides the Group in meeting its environmental objectives. Simple changes have proven successful: – Targeting a 30% reduction in energy consumption by 2020 against a 2013 baseline
– Introducing ‘travel free weeks’ reducing our CO2 emissions – Diverting 100% of office waste from landfill – Maintaining our commitment to source 100% of our electricity from renewable sources
That’s why we have partnered with a company called Simply Cups, which works with companies to help them separate the plastic film that can make recycling difficult. We have successfully introduced a pilot in our Bromley office where dedicated recycling points are encouraging our people to use them throughout the building. Simply Cups collects our cups and sends them to a specialist processor which enables us to recycle 20,000 cups per month.
Environmental Champions To further entrench the importance of sustainability across the Group we have appointed 10 ‘Environmental Champions’ in our core sites. Working with the Institute for Environmental Management they have received accredited training, increasing their awareness of how sustainability issues affect the workplace. They are using this knowledge to discuss a range of environmental issues and drive change across the Group.
Our Head Office in Bromley is successfully recycling 20,000 coffee cups per month.
It is one of the reasons why we have such an engaged and motivated workforce, with 90% of employees taking part in our employee opinion survey this year.
We are nothing without our people. We employ thousands of people throughout the UK who use their skills and expertise to help make insurance much easier and better value for our customers.
Yet again we saw positive results, with an increase in our full engagement score from 78% to 81% – 36 percentage points higher than when we first ran the survey in 2014.
Best Companies results We came third in the ‘Best Big Companies to Work For’ award in the prestigious Sunday Times list 2019. This has come from a collective belief that having a great team of highly engaged people pulling in the same direction will deliver better results for customers, and in turn, great results for shareholders. For more information see www.b.co.uk/the-lists/big-companies.
I help monitor and oversee the risk management decisions the business needs to take. I love the breadth of what we do as a team, we’re always thinking differently.
– Shared parental leave and pay mirrors our maternity and adoption benefits; our employees can ask to split their leave into shorter periods with periods of work in between, to help settle back in as easily as possible
– Up to 12 weeks’ full pay as part of a phased return to work following a period of maternity/adoption/shared parental leave for all employees
– Improving efficiency with extra vehicle checks for our Green Flag business
– Using dedicated social media pages to alert customers to fraud trends
Colleagues have also benefited from free share awards. In March 2018 colleagues received a £500 free share award to celebrate the Group’s anniversary of its launch on the London Stock Exchange; this is in addition to three separate share awards made in previous years. These schemes are equivalent to an Employee Stock Purchase Plan and Employee Stock Ownership Plan in the US.
Women in Finance Charter The Group made significant progress against the Women in Finance Charter commitment of 30% females in senior leadership positions by 2019, and in 2018 we achieved 28%. This improvement has come from a combination of external hires (utilising methods such as gender balanced shortlists), and internal promotions, which will continue by utilising the Group’s new cross functional talent mobility forum.
Hampton Alexander Review The Hampton Alexander Review set targets for FTSE 350 companies to have at least 33% women on their Board and in leadership positions by 2020. The Group is ranked 13th in the FTSE 100 for female Board representation, with 42% of the Board being female. This exceeds the target ahead of time. Within the FTSE 350 Non-Life Insurance sector, we are ranked 1st for female Board representation and 4th for combined Executive Committee and direct reports to the Board.
Diversity and inclusion Building a diverse and inclusive culture takes multiple initiatives to work together. We remain focused on bringing in new methods to improve our performance, ensuring that all employees take ownership in communicating the importance of inclusive behaviour.
We are building inclusive leadership programmes for all managers to assist them in managing their teams. Senior leadership teams are also setting specific diversity commitments aligned to their function’s needs, including, but not limited to, recruitment and performance decisions.
Pay In April the Group reviewed its pay structure and introduced a new company-wide minimum base salary of £18,000 for full-time colleagues, 6% higher than the Living Wage and 18% higher than the National Minimum Wage.
Annual Incentive Plan The Group’s AIP ensures that all our people are judged on the basis of delivering against our Customer Experience and People agendas. We know that a good customer experience means that people are more likely to recommend us to others. This is why the Group’s Customer Experience agenda is focused on making it easy for customers when they take out cover, need to make a claim or require complaints to be resolved swiftly. We are only able to deliver this due to our people, which is why we place a sharp focus on diversity and inclusion and regularly engage with our people throughout the year. The AIP therefore ensures a strong link between pay and the Group’s performance on these specific metrics.
There are a number of steps we have put in place to help us all feel comfortable discussing mental health and raise awareness: – Our Mental Health First Aider’s programme, training over 135 mental health first aiders, meaning we now have at least one on every floor, in every site. This has been supported by training our people managers on mental health and resilience through our ‘Engage’ programme
Graduate and apprenticeship programmes Our graduate programme continues to develop the next generation of leaders. We currently have over 100 graduates placed across the business, gaining first hand experience in areas such as Underwriting, Risk, Claims and customer facing roles. Regular rotation gives them deep insight into the Group’s overall business strategy and changing consumer needs.
Statement of the Directors in respect of the Strategic report The Board reviewed and approved the Strategic report on pages 1 to 59 on 4 March 2019.
– Ran successful lunchtime sessions, exercise classes, holistic treatments and mindfulness sessions during Mental Health Awareness Week
Strong and robust corporate governance is integral to the creation of long-term value for our shareholders and stakeholders.
For our people, our customers, our shareholders and our wider stakeholders; make decisions based on what is right, not what is easy; demonstrate personal and professional integrity; do what’s right for the long-term sustainability of our business.
Treat it like it’s OUR business; take the initiative, if you can see a better way, go and make a difference; take decisions, be accountable for your actions in whatever role you perform; take responsibility for your personal development and performance.
Strive to be the best in every area of the business; be ambitious, courageous and innovative; relentlessly challenge and improve; seek and embrace change; learn from our mistakes; persevere, always deliver our promises and don’t settle for second best.
Be real, authentic and true to yourself; have open and honest conversations with all audiences in an adult-to-adult manner; listen, seek to understand and respect diversity of views; be open, call out issues we see; share information and keep things as simple as possible.
Collaborate across all levels and functions; leverage the skills, knowledge and experience, irrespective of hierarchy, to deliver the best possible results; develop relationships based on trusting each other, partnerships and win-wins; recognise and celebrate success.
Further information on our diversity policy, our approach to succession planning and Board appointments can be found on pages 83 and 84.
Culture and values The Board recognises the importance of its role in setting the tone of the Group’s culture and embedding it throughout the Group. The Board aims to create an open and collaborative culture that encourages the Group to make decisions that are best for our shareholders, whilst having regard to the interests of our other stakeholders. I believe that the values and the Code of Business Conduct set by the Board are central to the Group’s culture and contribute to the Group’s objectives of long-term success and sustainable shareholder value.
Dear shareholders and other stakeholders, On behalf of the Board, I am pleased to present the Corporate Governance report for the year ended 31 December 2018.
After serving as a NED for more than six years, Clare Thompson has also decided to step down from the Board at the conclusion of the 2019 AGM.
Biography Mark is Chair of the Investment Committee. He has extensive experience and knowledge of the financial services sector, particularly in life and general insurance. Additionally, he has detailed understanding of the retail sector and customer service. Mark was Group CFO and Executive Director at Legal & General until August 2017. During his 18-year career at Legal & General, he held a variety of senior roles including CEO of the Savings business, Managing Director of the With-Profits business, and Resources & International Director. Before joining Legal & General, Mark held senior financial and business development roles at ASDA and Kingfisher. Mark is an Associate of the Institute of Chartered Accountants in England and Wales.
Current external appointments Mark is the Chief Executive Officer of Merian Global Investors Limited.
Current external appointments Paul is a member of the ABI Board and a NED of Channel Four Television Corporation.
Current external appointments Danuta is Chair Designate and a NED of St. Modwen Properties plc. She is also Senior Independent Director (“SID”) of Aldermore Group plc and a Non-Executive Member of the Defence Board of the UK Ministry of Defence.
Biography Mike is Managing Director, Personal Lines. He joined Direct Line in 2014 and has over 10 years’ insurance industry experience. Under his leadership, the Personal Lines division has delivered strong growth, improved profitability and strengthened its competitive position. Mike was previously CEO of RSA Group’s Scandinavian businesses, Codan A/S and Trygg-Hansa, and before that UK Managing Director of Personal Lines at RSA, responsible for the MORETH>N, Partnerships and Broker businesses. Before joining RSA, Mike had many general management, marketing and customer growth roles across several industries including the energy, telecoms and retail sectors.
Biography Sebastian is Chair of the Corporate Social Responsibility Committee. He has extensive experience in retail and consumer practice at large groups and has a detailed understanding of the UK consumer markets, products and brands. Sebastian was Group Chief Executive of Dixons Carphone plc from August 2014 to April 2018. Before that, he was CEO of Synergy Insurance Services Limited and subsequently gained wide retail experience as Strategy Director responsible for developing and implementing the turnaround strategy at Mothercare.
Biography Gregor is Chair of the Audit Committee. He has wide-ranging experience of financial services, including significant finance, audit, risk management and distribution experience gained in the insurance and investment management sectors. Gregor worked with EY for 23 years, including 10 years as a partner in the financial services practice. Following this, he was Finance Director for the Insurance division of Lloyds Banking Group plc, which included Scottish Widows, from 2009 to 2012. Gregor is a member of the Institute of Chartered Accountants of Scotland.
Current external appointments Gregor is Deputy Chairman of Alliance Trust PLC, Chairman of Intrinsic Financial Services Limited and is a NED of FNZ Group. He is also Honorary Treasurer of the charity International Alert.
Current external appointments Clare is Senior Independent Director of the British United Provident Association (“BUPA”).
Biography Richard is the SID. He was Non-Executive Chairman of Brit Syndicates Limited and Executive Chairman of Cunningham Lindsey from 2014 to 2018. Prior to this, he was Chief Executive of Lloyd’s of London from 2006 to 2013. He was also a NED of Partnership Assurance Group plc, now part of Just Group plc, between 2013 and 2016 and was Chairman of the Remuneration Committee from 2014 to 2016. Richard previously worked for over 10 years at the London-based International Petroleum Exchange, the second largest energy trading exchange, re-branded ICE Futures, as both CEO and Vice-Chairman. He has extensive insurance industry experience and insight into prudential regulation. Prior to the International Petroleum Exchange, Richard held a range of senior positions at British Petroleum and was a research scientist for the Science and Engineering Research Council.
Current external appointments Richard is Executive Chairman of the Specialty division at the Ardonagh Group. Richard serves as a member of the PRA Practitioner Panel, Bank of England.
Experience and qualifications Simon is responsible for leading the Group’s HR function, Internal & External Communications and Public Affairs. He is also responsible for delivering the Group’s People and Corporate Social Responsibility (“CSR”) strategies. Simon is a Fellow of the Chartered Institute of Personnel and Development. Simon has spent the majority of his career as a leader in customer-centric businesses. Before moving into HR, Simon held several commercial business roles in the fast-moving consumer goods and financial services sectors. Simon is also a trustee of the KidsOut UK charity.
Experience and qualifications Humphrey has over 25 years’ experience as a solicitor. He is responsible for the Group Legal function and oversees a range of areas of legal advice and services. Humphrey’s experience includes advising on corporate and commercial matters, steering corporate transactions in the UK and internationally, managing legal risk and dealing with corporate governance issues. Before joining the Group, Humphrey was Group Legal Director at RSA and prior to that he was a corporate lawyer with the City law firm, Ashurst Morris Crisp.
Paul Geddes chairs the Executive Committee. In addition to Paul Geddes, Mike Holliday-Williams and Penny James, the Committee comprises the following: Joined
Experience and qualifications Steve has nearly 30 years’ experience of the insurance industry. He is responsible for leading the Group’s Claims, Information Technology, Information Security, Procurement and Business Services functions. Steve’s previous roles include Director of Strategic and Technical Claims at RSA, Director of Claims and Customer Service at Capita, and Director of Operations at AMP. Steve is also Chairman of the Motor Insurers’ Bureau.
Experience and qualifications José has over 25 years’ experience of the insurance industry. He is responsible for the Group’s Risk Management and Compliance function and is a Fellow of the Institute of Actuaries. José was previously Global Chief Risk Officer and Group Chief Actuary at HSBC Insurance. Before joining HSBC, José worked for Zurich Insurance, first in its London Market Operations, then as Chief Actuary International Business Division (Asia, Latin America and Africa) and lastly as Chief Actuary in the UK.
Corporate Governance report This report explains the Board’s role and activities, and how corporate governance operates throughout the Group.
It is open to all shareholders to raise any issues they wish with the Chairman, the SID and the Chair of the Remuneration Committee. The Board has therefore concluded that it has complied with the main and supporting principles under section E.1 of the Code regarding dialogue with shareholders.
Further details of how the Company applied the Code’s principles and complied with its provisions can be found on the following pages of this report and the Directors’ remuneration report: – Leadership – page 66 – Effectiveness – page 70 – Accountability – page 74 – Remuneration – page 75 – Relations with shareholders – page 75
In discussing and approving its strategic and financial plan, the Board carefully considers the potential impact on all of the Group’s stakeholders, and other relevant matters, whilst seeking to ensure that the plan promotes the success of the Company for the benefit of its members as a whole. Specific matters discussed by the Board include: – investments in capability to be made during the plan period to make insurance easier and better value for our customers, supporting the longer-term success of the Group and enabling it to respond to long-term trends in the markets in which it operates; – engaging with our people to improve our diversity, inclusion, wellbeing and development, providing them with a more productive work environment and the support they need through our flexible working and wellbeing strategies; – the Group’s Code of Business Conduct which supports the Board’s commitment to the highest possible standards of integrity in business relationships with our suppliers and partners; – the Group’s ESG philosophy that long-term sustainability is good for all our stakeholders, as part of which our Responsibility strategy supports positive relations with our communities, an appropriate approach to the environment, our partnership with Brake on road safety and our emphasis on mental health; and
– the importance of maintaining the strong and positive reputation of our brands and the significant investment being made to improve customer journeys, through which the Group demonstrates its high standards of business conduct.
Notes: 1. Attendance is expressed as the number of scheduled meetings attended out of the number of such meetings possible or applicable for the Director to attend. 2. Due to other prior commitments, Andrew Palmer was unable to attend the February 2018 Remuneration Committee meeting and Gregor Stewart was unable to attend the April 2018 Board meeting. Papers were circulated to all Directors before the meetings and those unable to attend could raise issues and give comments to the Chairman in advance of the meetings.
Board composition As at the date of this report, the Board comprised the Chairman, who was independent when appointed to the Board; three Executive Directors; and eight independent NEDs, including the SID. The current Directors served throughout all of 2018, except for Mark Gregory and Gregor Stewart who were appointed on 1 March 2018 and Fiona McBain who was appointed on 1 September 2018; Andrew Palmer and John Reizenstein also served during the year, retiring from the Board at the conclusion of the AGM on 10 May 2018.
Biographical details of the Directors of the Company as at the date of this report are set out on pages 62 to 64.
Structure of the Board, Board Committees and executive management The diagrams on pages 68 and 69 summarise the role of the Board, its Committees and the responsibilities of the Chairman, the SID, the NEDs, the CEO and the Executive Committee. The Board and Board Committees have unrestricted access to management and external advisers to help discharge their responsibilities. The Board and Board Committees are satisfied that, in 2018, sufficient, reliable and timely information was received to perform their responsibilities effectively. Each Committee plays a vital role in helping the Board to operate efficiently and consider matters appropriately.
More information on how the Board has regard for the Group’s wider stakeholders can be found on page 66.
Operations The Board supervises the Group’s operations, with a view to ensuring they are effectively managed, that effective controls are in place, and that risks are assessed and managed appropriately.
The Audit Committee: – Monitors the integrity of the Group’s financial statements – Oversees and challenges the effectiveness of the Group’s systems of financial and other controls
– Monitors the work and effectiveness of the Group’s internal and external auditors and actuaries
– Responsible for reviewing and approving various formal reporting requirements and promoting a risk awareness culture within the Group
– Oversees the level and structure of remuneration arrangements for senior executives, approves share incentive plans, and recommends them to the Board and shareholders
The CSR Committee: – Provides oversight and advice on how the Group conducts its business responsibly, including matters relating to environmental, employee engagement and wellbeing, community involvement, ethics and diversity
The SID: – Acts as a sounding board for the Chairman and an intermediary for the other Directors when necessary
– Use their wider business experience to help develop the Group’s strategy
Board meetings The activities undertaken by the Board in 2018 were intended to help promote the long-term success of the Company. Scheduled Board meetings (set out on the timeline above) focused on four main themes in 2018: Strategy & execution, including: approving and overseeing the Group’s key strategic targets and monitoring the Group’s performance against those targets; reviewing customer experience and trends and monitoring the Group’s performance against external brand metrics; reviewing and approving key projects aimed at developing the business or rationalising costs; considering growth opportunities; and reviewing the individual strategy of key business lines.
Financial performance and investor relations, including: setting financial plans, annual budgets and key performance indicators, and monitoring the Group’s results against them; considering the Group’s reserving position; approving the solvency II narrative reports; approving financial results for publication; approving main reinsurance arrangements and motor reinsurance renewal; and reviewing broker reports on the Group, alongside feedback from investor meetings.
In addition to routine business, the Board considers and discusses key issues that impact on the business as they arise. The CEO and CFO spend a considerable amount of time with the different business areas ensuring that the Board’s aims are being correctly disseminated throughout the Group, and that our peoples views and opinions are reported back to the Board.
The NEDs meet with key management outside the Board and Committee fora to obtain a wider view of the Group’s activities and attend meetings of the Group’s ERB to engage with staff and report their views back to the Board.
Strategy day The Board sets aside time each year outside the annual Board calendar to hold a strategy day giving the Directors the opportunity to focus solely on strategic matters. In June 2018, the Board held a session offsite to set and monitor progress against the Group’s strategy and to discuss the strategic challenges and opportunities the Group faces in the future, including advances in motor and connected home technology.
Board inductions All new Directors appointed to the Board undertake an induction programme aimed at ensuring they develop an understanding and awareness of our businesses, people and processes, and of their roles and responsibilities as Directors of the Company. The programmes are tailored to suit each Director and include: – provision of relevant current and historical information about the Company and the Group; – visits to operations around the Group; – induction briefings from Group functions; and – one-to-one meetings with Board members, senior management and the Company’s advisers.
Key for Board meetings & activity in 2018 Board meetings Induction
Penny James, who joined the Board as CFO-designate in November 2017, completed her induction programme before succeeding John Reizenstein as CFO on 1 March 2018.
Business unit visits During 2018, NED visits to operational business units in Bromley, London, Bristol, Leeds, Doncaster and Farnham were arranged to meet the management teams and better understand how the business operates. In September, the Board visited the Group’s Bristol site to interact with our people in the HR, Legal Services, Customer Operations and Experience, Business Solutions and Direct Line for Business teams.
The diagram below summarises the split of responsibilities for the different parts of the Group’s governance framework.
Policy owner approves Minimum standards subject to non-objection from the Risk Management Committee.
The Group’s governance framework is detailed in the Group’s High Level Control and System of Governance Framework document. This document details how the Group meets solvency II and PRA requirements to identify Key Functions and to have and maintain a Responsibilities Map in respect of the PRA and FCA Senior Managers and Certification Regime requirements. The Board reviews these documents annually.
To do this, the Company Secretary maintains a register of conflicts and any conflicts that the Board has authorised.
The search process for the replacement CEO, which began in 2018 and culminated in the appointment of Penny James with effect from 9 May 2019, involved engaging MWM Consulting, which is also a signatory to the Voluntary Code and has no other connection to the Company.
The Group is a signatory to the Women in Finance Charter which aspires to see gender balance at all levels across financial services firms. The Group is committed to seeking to increase female representation at senior management level to 30% by the end of 2019. As at 31 December 2018, women represented 28% of the Group’s senior management population. The charts on pages 58 and 59 provide a clearer picture of the diversity of the Board, senior managers and employees.
Additional 2018 diversity initiatives The Board acknowledges that diversity includes but is not limited to gender and aims to increase demographic and philosophical differences at Board level and throughout the Group.
The Board advocates the importance of cultural and ethnic diversity and aims to increase the ethnic diversity across the Group including at Board and senior management level. The Board and senior management continue to support the DNA network which champions diversity and inclusion within our organisation through strands relating to generational divide, unconscious bias, belief, Black, Asian and minority ethnics, gender, sexual orientation, disability, working families and neuro-diversity.
The Board has oversight of diversity initiatives carried out through the remit of the CSR Committee, which received regular updates on the ‘build an inclusive culture’ strand of our CSR strategy during 2018. Further details on diversity initiatives can be found in the People and culture report on page 58 and in the CSR Committee report on page 85.
Jane Hanson and Mike Biggs have served on the Board since December 2011 and April 2012 respectively. At the Board’s request, they have agreed to continue serving as NEDs and resolutions for their re-election as Directors will be proposed to the 2019 AGM. The Board is satisfied that Jane and Mike remain independent in judgement and character, continue to make a significant contribution to the proceedings of the Board and its Committees and that the extension of their terms of appointment will provide valuable continuity as work on refreshing the Board progresses.
You can find out more about these activities and the Nomination Committee’s work during the year on pages 83 to 84.
Accountability An explanation of how the Board complies with the Code in relation to accountability is set out below, except for the following matters, which are covered elsewhere in the Annual Report & Accounts: – how the Company seeks to generate value over the long term is explained in the business model on pages 22 and 23, and the strategy for delivering Company objectives is on pages 19 to 21; and
The Board has delegated responsibility to the Audit Committee to oversee the management of the relationship with the Company’s External Auditor. You can find details of the Audit Committee’s role, activities and relationship with the External Auditor in the Committee report on pages 78 to 79.
Responsibility for preparing the Annual Report & Accounts The Board’s objective is to give shareholders a fair, balanced and understandable assessment of the Company’s position and prospects and business model and strategy. The Board is also responsible for maintaining adequate accounting records and seeks to ensure compliance with statutory and regulatory obligations.
The Directors confirm that they consider that the Annual Report & Accounts, taken as a whole, are fair, balanced and understandable and provide the information that shareholders need to assess the Group’s position and performance, business model and strategy. In arriving at this conclusion, the Board was supported by a number of processes, including the following: – management drafted the Annual Report & Accounts to ensure consistency across sections, and a steering group comprising a team of cross-functional senior management provided overall governance and co-ordination; – a verification process, to ensure the content was factually accurate; – members of the Executive Committee reviewed drafts of the Annual Report & Accounts; – the Company’s Disclosure Committee reviewed an advanced draft of the Annual Report & Accounts; and
The frameworks for risk management and internal control were in place for the financial year under review and up to the date of this report. They are regularly reviewed by the Board and comply with the Financial Reporting Council’s updated guidance on Risk Management, Internal Controls and Related Financial and Business Reporting.
The Group operates a Three Lines of Defence model. You can find out more about this in the Risk management section on page 44.
The Board Risk Committee regularly reviews significant risks and how they might affect the Group’s financial position; comparisons to agreed risk appetites; and what the Group does to manage risks outside its appetite.
Assessing principal risks The Board determines the nature and extent of the risks that it is willing to take to achieve its strategic objectives. The Directors robustly assessed the principal risks facing the Company, including risks that would threaten its business model, future performance, solvency or liquidity. You can find a description of these risks, and their management or mitigation, on pages 46 and 47.
This confirmation is based on the Board Risk Committee’s twice-yearly review and challenge of the Group’s Material Risk Assessment and the Board’s review and approval of the Group’s risk appetite statements. The Risk Assessment identifies risks quantified as having a residual risk impact of £40 million or more based on a 1-in-200 years likelihood. The quantifications are produced through stress and scenario analysis, and the capital model. Each directorate’s bottom-up risk identification and assessment supplements the Risk Assessment. The Risk Assessment also plays a key role in developing the ORSA and assessing the Group’s strategic plan.
Relations with shareholders The Board believes that engaging regularly with the Company’s shareholders is vital to the Group’s success. Communicating and engaging with investors means the Board can express clearly its strategy and performance and receive regular feedback from investors. It also gives the Company the opportunity to respond to questions and suggestions.
The Chairman, SID and NEDs are available to attend meetings with major shareholders at their request. In 2018, the Chairman met some of the Company’s major shareholders and discussed corporate governance topics including executive remuneration.
During 2018, the CEO and the CFO met with key shareholders following announcements of results and reported shareholders’ views back to the Board.
The Investor Relations team helps the Directors to communicate with investors. The Directors, in conjunction with senior management and the Investor Relations team, participated in varied forms of engagement, including investor meetings, seminars and conferences throughout the year. Management hosted analysts at its Bristol offices in October 2018 to bring to life the Group’s various customer-centric and agile ways of working.
The CEO and CFO hosted conference calls for the Group’s quarterly results and presentations for its 2017 full year results in February 2018 and its 2018 half year results in August 2018. In addition, the CEO and CFO provided a short video summarising the key messages of the Group’s 2017 full year results which is available on the Company’s website.
The Directors, in conjunction with senior management and the Investor Relations team, met with debt investors in the course of the Group’s normal investor conferences and roadshows throughout 2018. In addition to this, the CFO hosted a meeting with debt investors in September 2018.
At the AGM, the CEO presents the Group’s financial results. The Chairman then invites shareholders to ask questions about the meeting’s business, before proposing the AGM’s formal business. All Directors who wish to continue to serve will be put forward for election or re-election at the AGM. The Chairman, the Committee Chairs and the remaining Directors and members of the Executive Committee are also available to talk with shareholders at the end of the meeting.
The Articles of Association of the Company and the letters of appointment of the NEDs and the Chairman are available for inspection at the Company’s registered office and AGM.
Committee skills and experience Gregor Stewart was appointed Chair of the Committee in May 2018. In line with the Code, all members of the Committee are independent, and the Audit Committee as a whole is deemed to have competence relevant to the insurance and financial services sectors in which the Group operates.
All Committee members are members of the Institute of Chartered Accountants in England and Wales, with the exception of Gregor Stewart who is a member of the Institute of Chartered Accountants of Scotland. They also have recent and relevant financial experience across a number of different insurance businesses, enabling them to contribute diverse expertise to the Committee’s proceedings. To keep their skills current and relevant, in addition to Board training, members of the Committee have received training during the period on matters including IFRS 17 and solvency II technical provisions.
Areas of focus in the reporting period – The Committee reviewed how, International Financial Reporting Standard (“IFRS”) IFRS 17 ‘Insurance Contracts’, which relates to recognition, measurement, presentation and disclosure of insurance contracts, is expected to apply to the Group for annual reporting periods beginning on or after 1 January 2022. It is expected to have a significant impact on accounting for insurance contracts. The Committee received training dedicated to the key aspects of IFRS 17 and the likely areas of impact on the Group.
– The Board delegated oversight of the changes to the financial reporting system to the Committee. Throughout 2018 the Committee received updates on the programme and the implications of the new IFRSs on the financial statements.
Financial reporting The Committee considered the integrity of the Group financial statements and all external announcements relating to its financial performance. In 2018, this included the Group’s 2017 Annual Report & Accounts, the Solvency and Financial Condition Report and its 2018 Half Year Report.
When considering the 2018 Annual Report & Accounts, the Committee focused on the significant judgements and issues which could be material to the financial statements. These included the matters set out in the table on page 77.
The Committee challenged the judgements being made and also discussed these matters with the External Auditor.
In 2018, the Committee reviewed and challenged the level of reserves. In addition, it monitored developing trends in risks that could materially impact them. On an ongoing basis it received updates from the Actuarial Director on how estimates of reserves matched the claims paid.
Ogden discount rate The Committee considered the process, estimates and judgements made in recommending the new Ogden discount rate. The Civil Liability Act 2018 received Royal Assent on 20 December 2018. The Act details how the UK Government will set the rate used in the assessment of damages for large bodily injury claims. The Actuarial Director considered the new discount rate setting process, after looking at information published by the UK Government on the factors which would be considered when the new rate was set. The Actuarial Director proposed that the rate used by the Group in assessing the level of reserves be changed from minus 0.75% to 0%.
The Audit Committee approved the Actuarial Director’s proposal to change the rate used in assessing the level of reserves. In addition, the Committee reviewed the implementation process. The application of the new reserving rate led to a release of £55 million reserves. The Committee continues to monitor the factors that impact the Ogden discount rate and a new rate will be set in accordance with the Act by the middle of 2019.
In 2018, the Committee considered major accounting estimates and judgements in respect of assets held at fair value and was satisfied with the carrying value of investments and the basis for their valuation.
External Auditor tenure During the year, the Committee discussed the position on its external audit services contract and examined a number of options regarding the timing of tendering for the external audit, including the mandatory rotation of the Group’s audit firm. This took into account the reforms of the audit market by the Competition and Markets Authority and the EU, under which Deloitte can continue as the Company’s External Auditor until 31 December 2023. The Committee considered whether it was appropriate to tender the external audit contract for the year ending 31 December 2020 and concluded it was not appropriate. The Committee also confirmed that it will continue to comply with the regulations governing auditor rotation.
During 2018, following a tender process, the Committee appointed PwC to carry out an external quality assessment of Group Audit in accordance with guidelines issued by the Chartered Institute of Internal Auditors. The scope of the assessment was to assess Group Audit against the CIIA requirements, including the Effective Internal Audit in Financial Services Code in the Financial Sector and best practice. The assessment concluded that the function has achieved the highest rating of compliance with CIIA standards and the CIIA Financial Services Code. A number of recommendations were made by PwC to support the function in continuing to evolve and keep pace with the future challenges and expectations it faces both internally and externally. The Committee endorsed the report and recommendations for continuing improvement and the findings have been incorporated into an action plan. In addition, the Committee concluded that the function had appropriate resources.
The Actuarial Director, external actuarial advisers, External Auditor and Group Head of Audit meet privately with the Audit Committee, in the absence of management.
Auditor independence and non-audit services policy The Group has a Minimum Standard in relation to Independence of External Auditors. This establishes parameters for preventing or mitigating anything that compromises the External Auditor’s independence or objectivity. The Minimum Standard includes a formal process for the approval of non-audit services by the External Auditor.
Effectiveness of the external audit process and re-appointing Deloitte as External Auditor In 2018, the Committee assessed the External Auditor’s effectiveness. This was in addition to regularly questioning the External Auditor during its meetings. The Committee assessed the External Auditor through: (i) a detailed questionnaire completed by key stakeholders; (ii) discussing matters with the CFO; (iii) formally reviewing the External Auditor’s independence; (iv) assessing whether the agreed audit plan was fulfilled; and
(v) consideration of the FRC’s review of the audit of the Group’s principal subsidiary.
– In March 2018, members of the Committee and management participated in a strategy session, which considered macro risks and the role of the Committee. The session reviewed developments in areas such as the global economy and the impacts of US and UK fiscal policy, Brexit and the potential impacts on the insurance market. Committee members considered market and regulatory developments, as well as the development and measurement of risk culture, taking into account the Group’s ongoing initiatives in these areas. In light of these discussions, the Committee considered its own role with the aim of ensuring continued alignment with the key risks facing the Group.
Main activities during the year Risk monitoring and oversight At each scheduled meeting, the Committee received a report from the Chief Risk Officer which provided an overview and assessment of the Group’s risk profile. It detailed the key activities undertaken by the Risk function to further embed risk management across the Group, provided outputs of regular risk monitoring and details of specific risk issues. The Committee also received details of the Group’s current and forwardlooking solvency position. The Committee received regular reports regarding the three strategic risk appetite statements: maintain capital adequacy; stable and efficient access to funding and liquidity; and maintain stakeholder confidence.
The Committee monitored the Group’s exposure against these risk appetite statements and the lower level risk appetite statements, considered key risk indicators and assessed the key drivers that affected status against risk appetite. The Committee reviewed and questioned the justification of the assessment of certain risks and the robustness of management action plans to address areas close to or outside tolerance. During the year, the oversight of change risk was a central focus for the Committee, which challenged management on progress of both the portfolio and individual programmes.
Customer and conduct The Group aims to make insurance much easier and better value for its customers by delivering on its commitments, fixing things when they go wrong and ensuring that fairness is a natural outcome of what the Group does. In order to help achieve these aims, the Customer Conduct Committee reviews, challenges and oversees customer and conduct matters across the Group. The purpose of the Customer Conduct Committee is to help ensure that the desired outcomes are achieved for the Group’s customers. The Customer Conduct Committee’s findings and any recommendations for improvement are provided to the Committee and Board on a regular basis.
The Committee reviewed and challenged reports relating to the Group’s conduct towards its customers, seeking assurance that customer outcomes were fair and appropriate and to determine that the Group was operating within its defined conduct risk appetite, as set by the Board.
The Committee reviewed regular updates on regulatory developments and interactions, particularly in relation to the FCA and PRA. The Committee also reviewed the actions being undertaken to ensure compliance with the SM&CR, which included a comprehensive review of the Group’s High Level Control and System of Governance Framework document and updating the detailed management responsibilities map. The regime, which came into effect on 10 December 2018, now covers employees who are considered to be performing functions which are of specific importance to the sound and prudent management of the firm. The Committee considered regular reports on the Group’s actions to prevent financial crime, including reviewing the annual Financial Crime Report.
The Committee received regular updates on the Group’s multi-year transformation programmes. The Committee received detailed updates following external reviews of the programmes and challenged management on the progress which had been made so far, as well as on the plans going forward. The Committee continued to monitor and examine the oversight and challenge of the major change initiatives by the Risk function and reviewed the outputs of the assurance work undertaken by the Risk function and Group Audit.
Throughout the year the Committee received reports on the internal model, including independent validation results and the internal model owners’ report. This outlined the scope of the capital model, key outputs, risk drivers, significant parameters, expert judgements and key assumptions. The Committee challenged management on the assumptions in relation to the reinsurance decision-making process in the context of the Group’s risk appetite as a result of reviewing the internal model owners’ report.
Risk governance Every year, the Committee reviews and approves the Enterprise Risk Management Framework, which includes details of the Group’s Policies and Minimum Standards. The Committee reviewed and challenged each Group Policy as part of the Group’s solvency II requirements and recommended them for approval by the Board. The Committee also considered the results of the annual Group assessment of the effectiveness of the internal control environment undertaken by each business division, as well as monitoring controls on an ongoing basis.
Whistleblowing The Committee reviewed the arrangements by which employees may, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters (“whistleblowing”). The Committee also reviewed reports relating to whistleblowing including individual cases, anonymised to ensure arrangements are in place for the proportionate and independent investigation of such matters and for appropriate follow-up action. The Committee probed management and was satisfied that the whistleblowing process met the necessary standards and that it was adequately designed, operated effectively and adhered to regulatory requirements.
In addition to monthly one-to-one meetings with the Chair, the Chief Risk Officer also met privately with the Committee without management being present.
Board and Committee changes On 1 March 2018, Mark Gregory and Gregor Stewart joined the Board as NEDs and Penny James assumed responsibility as Chief Financial Officer. John Reizenstein and Andrew Palmer retired from the Board following the conclusion of the 2018 AGM and, on 1 September 2018, Fiona McBain joined the Board as a NED.
The Committee monitors the membership of the Board’s Committees to ensure that each Committee has a suitable balance of skills as well as taking into consideration the length of service of the members.
Board appointment process The Committee is responsible for reviewing and recommending to the Board any changes as necessary. During the year, the Committee oversaw the formal, rigorous and transparent process which resulted in the appointments of Mark Gregory, Gregor Stewart and Fiona McBain as NEDs.
Main activities during the year CEO succession At the time of the announcement that Paul Geddes would step down as CEO in the summer of 2019, the Committee revisited the succession plan for the Board and launched the process of identifying his successor, which included refreshing the role profiles, taking into account the Group’s medium and long-term strategic and cultural leadership requirements, and the selection and appointment of external executive search specialists.
Areas of focus in the reporting period – During 2018, the majority of the Committee’s time was devoted to monitoring and recommending changes to the composition of the Board and its Committees. The Committee led the recruitment of three independent NEDs and reviewed the skills and experience that the Board needs to be able to challenge and support senior management in developing and executing the Group’s strategy.
– Following the announcement that Paul Geddes will be stepping down as CEO of the Group in the summer of 2019, the Committee launched an internal and external search for his successor.
– With the aim of improving gender and other diversity in the Group’s senior management, the Committee continued to encourage management to grow its talent pipeline, both by developing existing employees and by hiring new talent. This is being achieved by the systematic assessment of potential, bespoke personal coaching and development plans for high-potential employees.
Egon Zehnder prepared a list of candidates of appropriate merit from diverse backgrounds for each of the positions. The Committee agreed a shortlist for the roles and a series of interviews took place. Once the preferred candidates had been identified and had given their consent to act as Directors, and following regulatory approval, the Committee recommended the appointment of Mark Gregory, Gregor Stewart and Fiona McBain to the Board subject to regulatory approval.
Jane Hanson and Mike Biggs have served on the Board for longer than six years and, in accordance with the Code, the extension of their terms of appointment has been the subject of a particularly rigorous review by the Committee. Mike Biggs, as Chairman of the Board and Chair of the Committee, was not involved in his own review.
As announced on 5 March 2019, Clare Thompson has decided, after serving as a NED for over six years, to step down from the Board at the conclusion of the AGM on 9 May 2019 and, accordingly, will not be submitting herself for re-election.
Diversity The Board believes that an effective board with a broad strategic perspective embraces a diversity of gender, race, skills, experience, as well as regional, socio-economic, educational and professional background, among other differences. In its search for candidates, the Board aims only to engage with executive search firms which are signatories to the Voluntary Code of Conduct for Executive Search Firms.
The Board supports the targets set in the Hampton-Alexander Review. As at the date of this report, female representation on the Board was 42% (2017: 36%). The Board remains committed to progressing women into senior roles and aims to increase female representation at executive level through associated development programmes for high-potential females.
Main activities during the year The Committee monitors the implementation of the Group’s CSR strategy through regular updates on the different focus areas and challenges the robustness of, and progress against, targets relating to each strand of the CSR strategy. The Committee also ensures that best practice and thinking across the market are considered as part of the Group’s own CSR approach.
Build an inclusive culture Throughout 2018, the Committee reviewed management’s initiative to build an inclusive culture through diversity and inclusion. The Committee supported management’s plans to focus on wellbeing and mental health. Priority areas during 2018 included: extending the roll-out of mental health training to all people managers; providing access to resilience workshops and webinars for all employees; and introducing Mental Health First Aiders on every floor of every site to be points of contact for employees who are experiencing a mental health issue or emotional distress.
The Committee recognises the importance of maintaining the highest standards of ethical conduct and behaviour in our business practice and in the workplace. The Committee examined the content and effectiveness of the Group’s Code of Business Conduct to ensure that it reflected the Group’s position in relation to CSR and diversity and inclusion.
The Committee also reviewed the Group’s policy on compliance with the Modern Slavery Act 2015 and how third-party suppliers complied with the Act’s requirements.
The CSR strategy considers energy use, waste management and resource use within the Group’s operations, and environmental and social matters in the Group’s supply chain. The Committee reviewed and supported the key 2018 objectives relating to the replacement of relevant plant and equipment at office locations with more energy-efficient equipment, the optimisation of the Building Energy Management System, the introduction of a scheme in the Group’s Bromley office to recycle coffee cups and the implementation of further energy saving opportunities in the Group’s auto repair centres.
The Committee continues to challenge management’s approach to CSR initiatives to ensure that it is both authentic and strategic, and that management continues to focus on initiatives with real potential to improve lives.
During the first half of 2019, the changes are expected to be reflected in investment decision-making across all relevant credit portfolios.
Market developments At each scheduled meeting, the Committee received a market update from the Director of Investment Management and Treasury. The updates covered: economic conditions in the UK, the US and the Eurozone; market levels for key asset classes (notably credit); the outlook for interest rates and inflation; and developing issues viewed as appropriate to be brought to the attention of the Committee. The impact on assets of developments in international trading relations and the weakness of the retail sector were of particular note during 2018. The Committee also monitored the continuing development of interest rate policies set by the Bank of England and the US Federal Reserve and the impact on the hedged yields of US Dollar credit assets held in the portfolio.
– An investment framework which included an ESG lens for the Group’s investment grade credit portfolios was developed and adopted.
Main activities during the year Brexit One of the principal risks considered by the Committee during 2018 was the economic and financial market implications of the UK leaving the EU. For planning purposes, in view of uncertainty about the progress of negotiations with the EU, the implications of both an orderly transition and a ‘no deal’ exit had to be considered.
Sustainable investing At the April and July meetings of the Committee, a framework for including an ESG lens into investment decision-making for the investment grade credit portfolios was debated and agreed.
The Group’s future investing framework will incorporate a focus on ESG-weighted indices which will tilt the composition of the portfolio towards higher holdings and weightings of issuers with strong ESG scores. Investment managers will be encouraged to invest more in ‘green’ bonds where such bonds are available and of comparable credit quality. Limited negative screening will be applied and investments will not be made in companies which carry out activities which the Committee does not consider appropriate.
Executive Directors’ pay to the Group’s business strategy and demonstrable success and the interests of our shareholders.
– Setting an appropriate framework for remuneration for the Board with sufficient flexibility so that the Group can attract and retain the best people for the organisation.
Remuneration at a glance – summarising the remuneration arrangements for Executive Directors 92 to 93 Annual report on remuneration – detailing pay outcomes for 2018 and covering how the Group will implement remuneration in 2019 94 to 113 Summary of policy approved at the 2017 AGM 114 to 117
Pay outcomes for 2018 All-employee pay in 2018 We could not be successful without the hard work and dedication of our talented people, at all levels of the organisation. It is important to us that we ensure all our people are rewarded fairly and have an interest in the success of the Group.
In 2018 we focused our pay budget specifically on those in lower paid roles, ensuring that all employees with satisfactory performance received a pay increase of at least £650. We also increased minimum salaries across the Group to £17,000 or £18,000 (depending on contracted hours), which were adopted for all roles except apprenticeship schemes. This meant that the average pay increase for employees below Senior Leadership was around 3.2%, but was around 5% for our lowest paid frontline roles. Our minimum salaries were positioned approximately 6% above the Living Wage Foundation rate for non-London roles, and approximately 18% higher than the Government’s National Wage at the time.
We want our employees to have ownership of the Group and its success, and in 2018 we issued our fourth all-employee free share award since our IPO. Outside our Senior Leadership, 86% of our people own shares in the Company, thus ensuring alignment at all levels between the work they do and the success in which we share.
Performance across the People measures was particularly strong for the year and the Committee awarded a maximum out-turn for this element. The Customer measures were assessed as being on target. The Committee is pleased to report this year that management have made significant progress on the technology transformation agenda on which the Personal objective was measured, and awarded an out-turn of 70% for this element. Full details on the outcomes for the year are included on pages 96 – 99.
We therefore awarded bonuses of 68% of the maximum to the Executive Directors. In line with the Remuneration Policy, 40% of any AIP award is automatically deferred into a Deferred Annual Incentive Plan award.
On 20 December 2018 the Civil Liability Act passed into law which confirmed the new process for the setting of the Ogden discount rate. Following the introduction of the new rate setting process, the Group considered the Ogden discount rate it uses to calculate its liabilities which led to an increase from minus 0.75% to 0% (pending the Government publishing the final rate which will be set by the middle of 2019 at the latest).
Following the commitment made by the Committee (and disclosed in the 2016 Remuneration Report), the Committee considered the impact of the Ogden-related reserve releases made since February 2017 in terms of the impact on the 2016 AIP out-turn. Had they been attributed to the 2016 financial year, this would have resulted in a maximum pay-out for the financial element of the AIP and a potential increase to 2016 bonuses of up to 45% of maximum. The Committee reviewed this result in the context of balancing the desire to ensure the outcome was fair to participants while being appropriately aligned with the shareholder experience. In striking this balance it concluded that it was appropriate to make an overall increase of 20% to the bonus payment for 2016 (below the 45% formulaic calculation).
Finally, the Committee noted that the Ogden rate change in February 2017 was exceptional in that there had not been a change for over 10 years. Now that the new rate setting mechanism has been implemented, the Committee considers that the impact of future Ogden discount rate changes to be part of the normal management of reserves and so it is unlikely in the normal course of events that special allowance will be made in the AIP out-turn for a change in Ogden discount rate.
Consistent with the regulations, due to the different timings of the performance periods for RoTE and TSR, the TSR element of the 2016 awards due to vest during 2019 will be reported separately next year. Accordingly, we have included an estimated value of the RoTE vesting outcomes for 2016’s awards plus the TSR vestings from the 2015 awards in the single figure remuneration table for 2018 for the Executive Directors.
UK Corporate Governance Code 2018 and the new CEO pay ratio disclosure There have been several changes to the UK Corporate Governance Code which affect the remit of this Committee: communication with employees about Directors’ remuneration (in addition to the workforce consultation requirements); policy on post-employment shareholding requirements; and the alignment of pension contributions for Directors to those of the workforce. The Committee worked hard to be in compliance with these requirements for when they came into effect on 1 January 2019 and the Committee will report details on how we have met these requirements in our 2020 report. We have also chosen to adopt early the new disclosure requirements on the CEO’s pay relative to the wider workforce as part of our efforts to strengthen the transparency in our approach to the alignment of Directors’ pay with that of the wider workforce.
Approval of the Directors’ Remuneration Report for 2017 at the AGM in May 2018 At the Direct Line Group plc AGM held in May 2018 the resolution approving the Directors’ Remuneration Report was passed by 76.6% of the votes cast in favour of the resolution. The resolution, which only required a simple majority to be approved and is advisory in nature, was therefore convincingly approved by shareholders. However, this was significantly lower than the percentage of votes in favour of resolutions that the Company has historically received and as a result the Group have been included on the Investment Association’s register of companies that have more than 20% of votes cast against a resolution at a general meeting. All of the remuneration arrangements described within the 2017 report were in line with the Remuneration Policy approved by shareholders at the AGM in 2017. The main issue raised by some of the proxy voting agencies on the Remuneration Report was the increase in remuneration for the new Chief Financial Officer compared with that of her predecessor. Consequently, the proxy voting agencies recommended an automatic vote against the Remuneration Report in 2017.
Approach to pay in 2019 No change to the overall approach to pay is anticipated for 2019. The updated Remuneration Policy will be put to shareholders in 2020.
No increase will be awarded to the CEO in view of the fact that he will be leaving the Group during 2019.
The CEO-designate will not receive a salary increase before her appointment as CEO on 9 May 2019 (see below).
No change will be made to either the weightings or the approach to assessment of the metrics under the AIP.
We are not proposing any changes to the performance conditions for the 2019 awards under the LTIP. Likewise the target RoTE scale of 17.5% to 20.5% will remain at the same level as in 2018 and reflects an appropriate performance range in the context of the Group’s planned underlying RoTE performance.
In setting Penny’s remuneration, we benchmarked her salary against the FTSE 51-100 and positioned her salary below the current CEO’s salary level. There will be no change to her participation in the Company’s AIP up to a maximum of 175% of salary and the LTIP up to 200% of salary. We have however taken the opportunity to set Penny’s pension contribution at 9% of salary (reduced from the existing pension contribution rate of 25% of salary), in line with that of the wider workforce which will be our policy for all new Executive appointments. The Committee will be considering the reduction of pension contribution for all Executive Directors as part of the remuneration policy review during 2019. The details of Penny’s remuneration, which will take effect from 9 May 2019, are set out on page 112.
Any payments relating to Paul Geddes’ departure will be in accordance with the Remuneration Policy approved by shareholders at the Company’s 2017 AGM and will be disclosed in the Directors’ Remuneration Report to be contained in the Company’s Annual Report and Accounts for the year ending 31 December 2019.
Shareholding at year end This chart illustrates the number of shares held at the end of 2018 by the Executive Directors against the share ownership guidelines of 200% of salary.
AIP achievement This chart illustrates the actual amounts earned from the AIP and reflecting performance in 2018. 60% of the amount is payable in March 2019 and 40% will be deferred into shares for three years.
– CEO-designate pension contribution to be reduced to 9% of salary (effective from appointment on 9 May 2019)
– New CFO to be appointed – The pension contribution rate will be in line with that of the wider workforce for all new Executive Director appointments
– The reduction of pension contribution for all Executive Directors in line with that of the wider workforce will be considered as part of the policy review during 2019
– At least 50% of bonus is based on financial measures. The Committee considers various non-financial and strategic performance measures. It bases its judgement on the payment outcome at the end of the performance period on its assessment of the level of stretch inherent in targets
– Any payment is subject to an additional gateway assessment, including assessing risk factors
– No change to the maximum opportunity – No change to the weightings or measures used for 2019 – The targets are commercially sensitive and will be disclosed in next year’s report.
– The Plan allows for awards with a maximum value of 200% of base salary per financial year
The Committee retained FIT Remuneration Consultants LLP (“FIT”) as its independent adviser until the end of 2018. FIT is a signatory to the Remuneration Consultants Group’s Code of Conduct. The Committee appointed FIT when preparing for the IPO.
FIT’s total fees for remuneration-related advice in 2018 were £110,349 exclusive of VAT. FIT charged its fees based on its standard hourly rates for providing advice.
Following a competitive tender process, the Committee appointed PwC as its independent adviser from 1 January 2019. PwC is a member of the Remuneration Consultants Group and, as such, operates under the code of conduct in relation to executive remuneration consulting in the UK. The Committee is satisfied that the advice received is objective and independent. PwC also provides other advice to the Group covering accounting, tax and immigration services. The total fees (charged on an hourly basis) for the provision of remuneration advice to the Committee in relation to the 2018 financial year were £8,000 exclusive of VAT.
Implementing policy and pay outcomes relating to 2018 performance Single figure table (Audited)
3. Annual bonus – includes amounts earned for performance during the year, but deferred for three years under the DAIP. For more information, see page 106.
These deferred awards are not subject to any conditions, except continuous employment. However, awards remain subject to malus and clawback. 4. 2015 LTIP awards RoTE – the expected vesting outcome figures for the RoTE portion of the awards granted under the LTIP in 2015 and reported in 2017 have been updated. These updates are based on the actual vesting of the RoTE portion of the awards and a share price of £3.75300 and £3.34400 on 25 March 2018 and 26 August 2018 respectively, compared to the three-month average share price of £3.65557 used in reporting this figure in the 2017 report. The revised figures include the actual number of dividends accrued on this portion of the award at vesting. This results in an adjusted reportable decrease of approximately £292,700 for Paul Geddes, £177,160 for John Reizenstein, and £149,439 for Mike Holliday-Williams with a corresponding decrease of the single figure for 2017 reflected in the table above. Further information on LTIP awards can be found on pages 107 to 108.
5. SIP – includes the value of matching shares under the SIP. 6. The 2017 annual bonus figure for Penny James includes a payment of £840,841 made in lieu of the bonus forfeited at her previous employer and is pro rated for the period 1 January to 31 October 2017 (before Penny joined the Group). This is in line with the estimated payment shown in last year’s report and therefore this figure has not been updated.
7. The 2017 estimated long-term incentive figure for Penny James in respect of the first tranche of her buy-out awards, which vested in May 2018 and which was reported in 2017, has been updated. This value is based on an actual level of vesting of 95.835% and the share price on 2 May 2018 of £3.658. Details of this award are disclosed on page 109.
9. Penny James was appointed to the Board on 1 November 2017 and also became employed on that date. 10. Mike Holliday-Williams was appointed to the Board on 1 February 2017. His salary, benefits and pension for 2017 have been pro rated accordingly. 11. John Reizenstein stepped down from the Board at the AGM on 10 May 2018. His remuneration for the purposes of this table has been pro rated accordingly, with LTIPs vesting by reference to performance conditions met while he was on the Board in 2018. Details of John’s salary, pension and benefits paid following his cessation as an Executive Director on 10 May 2018 until the date of his retirement on 7 September can be found on page 112.
Each Executive Director has confirmed they have not received any other items in the nature of remuneration, other than those already disclosed in the single figure table.
Paul Geddes 68% of maximum £982,569 Penny James 68% of maximum £803,250 Mike Holliday-Williams 68% of maximum £570,337 John Reizenstein 68% of maximum £180,226
The financial performance measure is profit before tax. The Committee established a target performance level at the start of the year. The only adjustment from the reported accounting position, as explained in the letter from the Committee Chair, was to exclude the assumed benefit as a result of the Ogden discount rate change. In the table below, we have disclosed the target set for profit before tax performance. The actual profit before tax performance includes the adjustment to reported profit before tax as described above.
The formulaic outcome from 2018 performance against the financial measure was 64%, giving a total of 35% out of 55% attributable to this element. A summary of the assessment is provided in the following table.
Measure Threshold 10% Target 60% Maximum 100% 2018 Actual 2018 Achievement
Customers are at the heart of the Group’s strategy and success. As part of our customer strategy, and to ensure that the business strives to achieve a sustained and competitive level of overall service to our customers, the Board sets challenging customer-centric KPIs. These key customer metrics focus on continuous improvement of the customer experience. The Committee considered that overall the Group had continued to improve on an already strong performance against stretching targets. The Group’s brands perform well (mainly top quartile) across the majority of insurance customer experience benchmarking studies.
Having considered performance against targets and an assessment of the quality of performance achieved, the Committee judged the Customer measures to be on target and agreed an out-turn of 60%, giving a total of 9% out of 15% attributable to this element. A detailed assessment of the Customer measures is set out below. Measure Assessment
Net Promoter Score (NPS) Improvement of customer advocacy across Direct Line Group
– Churchill NPS was relatively flat over the year, and was below the target set for 2018; we launched campaigns focused on meeting key customer needs for target segments.
– An improved perception of ‘price’ and ‘value for money’ supported the significantly increased Renewal NPS for the year during which several of our best ever months were recorded.
– Rescue NPS performance ended the year below the target set as the result of a challenging H1 due to extreme weather events, with improved performance across H2.
– The volume of complaints in Personal Lines and Commercial reduced significantly in 2018, exceeding the stretch targets for both areas.
– We introduced and rolled out a specialist bereavement team to assist the families of deceased customers.
– Claims complaints were adverse to target due to higher than forecast volumes caused by extremes in weather in the first half of 2018, with performance stabilising throughout the second half of 2018.
– We were unable to meet the ambitious targets set in this area in a year when the ‘Beast from the East’ and increased volume challenged capacity across claims and networks.
– However several programmes contributed to improvements for customers, including: – earlier identification of total loss vehicles in Motor which resulted in faster payments, a key driver of improved Ease for customers.
– Travel ‘Return to Green’ plan (all KPIs at target levels) successfully delivered against a challenging landscape.
Succession – We continue to develop our senior leaders, collectively and as individuals, to ensure we continue to strengthen our succession depth.
– 52 (87%) of our senior leaders have completed personal assessments and profiles carried out to enable individual development planning in 2018 and development of the senior leadership team as a whole, and have attended mental health awareness training.
– We continue to focus on building an inclusive organisation, valuing diversity and uniqueness. 93% of our people responded positively that they feel they can ‘bring all of themselves to work’ in our 2018 survey.
– We achieved a strong 2* accreditation in the Sunday Times ‘Best Big Companies to Work For’ survey and are extremely proud to have been ranked in third place overall in our first year of entry.
– About 250 of our people managers completed Engage training focused on helping them develop more authentic relationships with their people.
This element relates to an objective that is shared across the Executive Committee and set by the Remuneration Committee. The shared objective for 2018 focused on the Company’s key technology transformation and the changes it is making to its IT infrastructure, as well as other areas of the general change agenda. There has been significant progress on the stability and performance of the broader technology landscape and with the management of overall change across the organisation. Taking performance against each Executive Director’s individual performance objectives and the above challenges into account, and the material progress seen over the past two years, the Committee determined that the Executive Directors should each receive awards of 70% of the maximum available, giving a total of 14% out of 20% attributable to this element. Further details of the assessment of the Personal element is set out below.
– Following the launch of our bespoke Direct Line for Business insurance products, Hair & Beauty and Bed & Breakfast, Direct Line for Business launched Office, Professional and Retail. Although a few weeks later than scheduled, this release is the largest of our bespoke offerings to date, and supported by a national Small and Medium-sized Enterprises marketing campaign, has shown month on month improvements in gross written premiums in H2.
– The Company saw satisfactory progress in implementing and embedding Change controls across the business. – The EU General Data Protection Regulation programme was implemented successfully and notably delivered our compliance strategy ahead of time against tight deadlines.
2015 LTIP awards (vested in 2018) Awards under the LTIP granted in March and August 2015 vested during 2018. They were subject to relative TSR performance over the three-year vesting period, and RoTE performance in 2015, 2016 and 2017.
The 2018 single remuneration figure includes the value of the 2015 TSR elements (which vested in March and August 2018). Details of the targets and performance achieved are set out in the table below.
The Committee was satisfied that the financial and risk underpins were met at the end of the vesting period and therefore the performance achieved against the targets and the vesting of the awards is as follows: Award Performance measure Weighting Threshold Maximum Actual performance Achievement Outcome
2016 LTIP awards (vesting in 2019) Awards under the LTIP granted in March and August 2016 will vest during 2019. They are subject to relative TSR performance over the three-year vesting period, and RoTE performance in 2016, 2017 and 2018. The RoTE performance period for these awards ended on 31 December 2018 and performance in respect of this element is set out in the table below. Performance under the relative TSR measure will be assessed at the end of the vesting periods in March 2019 and August 2019 respectively and will be disclosed in the 2019 Directors’ Remuneration Report. This is subject to the Committee’s satisfaction that the financial and risk underpins have been met at the end of the vesting period.
Consistent with the regulations, the expected RoTE vesting outcomes (together with the TSR elements from the 2015 awards) are included in the 2018 single remuneration figures for the Executive Directors based on the three-month average share price to 31 December 2018. You can find details of this on page 95. Award Performance measure Weighting Threshold Maximum Actual performance Achievement Outcome
Percentage vested by reference to performance achieved Number of shares vested
Share plan interests exercised during the year to 31 December 2018
The table below shows the Non-Executive Directors’ beneficial interests in the Company’s shares.
4. Fiona McBain was appointed the Board with effect from 1 September 2018. 5. Andrew Palmer stepped down from the Board at the AGM on 10 May 2018 and this represents his holding at that date. 6. Gregor Stewart was appointed to the Board with effect from 1 March 2018.
Fees Taxable Benefits2 Total 2018 £’000 2017 £’000 2018 £’000 2017 £’000 2018 £’000 2017 £’000
Notes: 1. Non-Executive Directors are not eligible to participate in any of the Group’s bonus or share incentive schemes or to join any Group pension scheme. 2. The values shown under ‘Taxable Benefits’ above comprise the value of taxable travel and subsistence expenses reimbursed by the Company (including any gross-up for tax and National Insurance Contributions due).
CEO pay ratio The Committee has chosen to adopt early the CEO pay ratio disclosure requirements which would otherwise come into effect from next year’s Directors’ Remuneration Report. Over the coming year, the Committee will determine the appropriate methodology (Option A, B or C) to be used in future years, considering the robustness of the calculation methodology, the consistency of the method going forward as well as operational time constraints. For the purposes of this year’s disclosure, the April 2018 gender pay gap data has been used to identify the three appropriate employees for comparison with the CEO (Option B). Further detail on this methodology is set out below.
The remuneration figures for the employee at each quartile were determined with reference to 31 December 2018.
Under Option B, the latest available gender pay gap data is used to identify the best equivalent for three Group employees whose hourly rates of pay are at the 25th, 50th and 75th percentiles for the Group and their total pay and benefits figure for 2018 is then calculated. A sample of employees with hourly pay rates either side of the initially identified individuals are also reviewed to ensure that the appropriate representative employees are selected. The table below sets out the salary and total pay and benefits for the three identified quartile point employees: 25th percentile (P25) Median (P50) 75th percentile (P75)
Percentage change in Chief Executive Officer’s pay for 2017 to 2018 The table below shows the Chief Executive Officer’s year on year percentage change in salary, taxable benefits and bonus, compared to the average pay for all other employees.
Notes: 1. Based on the change in average pay for employees employed in the year ended 31 December 2018 and the year ended 31 December 2017. 2. There were no changes in benefits provision between 2017 and 2018. There has been a change in the assumptions used to calculate the all-employee average benefits figure, making the year on year change appear high to last year. If the treatment was the same as previous years, this would result in a 5% benefits increase from 2017 for all employees.
3. For employees other than the Chief Executive Officer, this includes average amounts earned under the AIP, and other variable incentive schemes, including monthly and quarterly incentive schemes operated in certain parts of the Group.
AGM voting outcomes The table shows the percentage of shareholders voting for or against, and the percentage of votes withheld, relating to the resolutions to approve the 2017 Directors’ Remuneration Report which was put to shareholders at the 2018 AGM on 10 May 2018.
Notes: 1. Executive Directors are expected to retain all the ‘after tax’ Ordinary Shares they obtain from any of the Company’s share incentive plans until they achieve a shareholding level that is equal to 200% of base salary.
2. There have been no share buy-backs since the IPO. The dividends paid information has been taken from note 14 to the consolidated financial statements. The overall expenditure on pay has been taken from note 10 and therefore, consistent with market practice, it has not been calculated in a manner consistent with the single figure in this report.
7. The dates of the three-day averaging period used to determine the number of shares granted on 26 March 2018 were 21, 22 and 23 March, being the three days preceding the grant. The dates of the three-day averaging period used to determine the number of shares granted on 28 August were 22, 23 and 24 August.
8. The performance period for the awards granted on 26 March 2018 will end on 31 December 2020 for the RoTE element and 25 March 2021 for the TSR element. The performance period for the awards granted on 28 August 2018 will end on 31 December 2020 for the RoTE element and 27 August 2021 for the TSR element.
All awards made from August 2017 include an additional two-year holding period before awards may be released. The Company’s normal policy is to grant awards twice a year, after the Group announces its full and half-year results. The value of each grant of awards is set at 50% of the annual policy level. This means the total combined face value of awards per year to each of the Executive Directors equates to 200% of base salary.
3. The closing market price on the dates of the vesting of the awards was £3.728 on 26 March 2018 and £3.371 on 28 August 2018. 4. Awards under the LTIP vested at 84.8% of the maximum potential on 26 March 2018 and 60.0% of the maximum potential on 28 August 2018. 5. Dividends added post-vesting are shown to 31 December 2018, although these are not realised until exercise. 6. Mike Holliday-Williams exercised 116,832 options on 26 March 2018 when the share price was £3.728 resulting in a notional gain of £435,550 and 84,837 options on 29 August 2018 when the share price was £3.32 resulting in a notional gain of £273,175.
7. John Reizenstein exercised 136,489 options on 26 March 2018 when the share price was £3.728 resulting in a notional gain of £508,831, 971,146 options on 28 August 2018 when the share price was £3.371 resulting in a notional gain of £3,273,733 and 101,094 options on 29 August 2018 when the share price was £3.32 resulting in a notional gain of £335,632.
Paul Geddes Chief Executive Officer to 9 May 2019 831 831 – Penny James Chief Financial Officer to 9 May 2019
Paul Geddes Chief Executive Officer 175% 40% Penny James CEO-designate 175% 40% Mike Holliday-Williams MD Personal Lines 150% 40%
Customer A range of customer metrics including Net Promoter Score and complaints 15% 15%
People A range of people measures including succession, diversity and engagement 10% 10%
Personal Objectives for each Executive Director, including shared objectives across the Executive Committee 20% 20%
As in previous years, all AIP outcomes will be determined after the Committee establishes a payment gateway. To do this, the Committee must be satisfied that it is appropriate to permit a bonus award at all, or at a given level. The gateway involves some subjectivity about performance. This may result in positive or negative moderation of each AIP performance measure or the overall bonus outcome. The targets are commercially sensitive and will be disclosed in next year’s report.
The list on the following page sets out the gateway criteria for the AIP for 2019.
– Additional customer context, for example, conduct, experience, brand and franchise health – Capital strength and affordability – Risk management within risk appetite – The Group’s relative performance to that of its peers – The wider economic environment – Exceptional events, such as abnormal weather – Any regulatory breaches and/or reputational damage to the Group – Committee satisfaction that paying the bonus does not cause major reputational concerns
Performance conditions for LTIP awards LTIP awards to be granted in 2019 will continue to be subject to performance against these performance conditions: – 60% based on RoTE over a three-year performance period (2019, 2020 and 2021) – 40% based on relative TSR performance against the constituents of the FTSE 350 (excluding investment trusts) over a three-year performance period, starting on the date of grant. The starting and closing TSR will be averaged over a three-month period.
The LTIP awards will also vest only to the extent that the Committee is satisfied that the outcome of the TSR and RoTE performance conditions reflects the Group’s underlying financial performance from the date of grant until vesting. When considering these matters, the Committee will also consider whether there have been any material risk failings.
The LTIP will continue to be subject to the application of malus and clawback and an additional two-year holding period post vesting which facilitates post-employment shareholding requirements. The Committee will be considering the application of a post-employment shareholding requirement in more detail as part of the Remuneration Policy review during 2019.
Pension and benefits A pension contribution of 25% of base salary will be paid to the CEO in 2019 (until date of leaving). The pension contribution for the CEO-designate will be reduced from the current level of 25% of salary to 9% of salary (from date of appointment) in line with the wider workforce. A pension contribution of 15% of salary will be paid to the MD Personal Lines in 2019; this level of contribution remained unchanged following his promotion to the Board in 2017. Pension contribution rates will be in line with those of the wider workforce for all new Executive appointments. The reduction in pension contributions for the current Executive Directors, in line with those of the wider workforce, will be considered as part of the policy review during 2019. No Directors participate in any defined benefit pension arrangements operated by the Company.
Appointment of new Chief Executive Officer On 26 February 2019, Penny James, the current CFO, was appointed CEO-designate to succeed Paul Geddes. Penny will become CEO from the conclusion of the AGM on 9 May 2019. Penny’s annual salary will be £800,000. This salary is in line with the FTSE 51-100 CEO benchmark and below the current CEO’s salary level.
Retirement of Executive Director (Audited) John Reizenstein, the former CFO, retired on 7 September 2018 having stepped down from the Board as an Executive Director at the end of the AGM on 10 May 2018. Following his cessation as a Director of the Company, John’s salary, pension and benefits were paid in monthly instalments until the end of his employment as follows: Pay component Salary
John’s planned retirement was announced in September 2017 and the Committee confirmed his ‘good leaver’ status, without the exercise of any discretion, at that time. He has, therefore, retained share awards granted to him up to that date (for details of all awards see pages 106 and 108). LTIP awards made in 2016 and 2017 have been time pro rated to reflect the period from their date of grant to the end of his period of employment. No LTIP awards were made to him in 2018. John has also been made an award under the AIP for the period to the AGM on 10 May 2018, details of which can be found on page 96.
The Board reviewed and approved this report on 4 March 2019.
Policy report The following is a copy of the main table from the policy approved by shareholders at the 2017 AGM. The full policy is available in the Directors’ Remuneration Report of the 2016 Annual Report and Accounts.
– This is the core element of pay that reflects the individual’s role and position within the Group. It is payable for doing the expected day-to-day job
– When reviewing base salaries, the Committee typically takes the following into account: – level of skill, experience and scope of responsibilities, individual and business performance, economic climate, and market conditions; – the median market pay in the context of companies of a similar size, particularly FTSE 31-100 companies, as they are considered to reflect the size and complexity of the Group; – the practice of insurance peers such as Admiral Group, Aviva, esure Group, Hastings Group, Legal & General, Old Mutual, Phoenix Group, Prudential, RSA Insurance Group, Standard Life and companies of a similar size to DLG as appropriate; and
– The maximum pension contribution is set at 25% of base salary per annum
– Executive Directors receive a benefits package generally set by reference to market practice in companies of a similar size and complexity, particularly FTSE 31-100 companies. Benefits currently provided include a company car or car allowance, private medical insurance, life insurance, health screening and income protection
– The costs of benefits provided may fluctuate from year to year, even if the level of provision has remained unchanged. An annual limit of 10% of base salary per Executive Director has been set for the duration of this policy (plus an additional amount of up to 100% of salary in respect of relocation expenses). The Committee will monitor the costs in practice and ensure the overall costs do not increase by more than the Committee considers to be appropriate in all the circumstances
– The principles for setting base salary are similar to those applied to other employees in the Group. However, the specific benchmarking groups used to review external market relativities may differ across employee groups
– The Committee will keep the percentage deferred and terms of deferral under review. This will ensure levels are in line with regulatory requirements and best practice and may be changed in future years but will not, in the Committee’s view, be changed to be less onerous overall
– For awards made after adopting the new policy at the 2017 AGM, Executive Directors will be subject to an additional two-year holding period following the three-year vesting period, during which time awards may not normally be exercised or released. During the additional holding period the awards will continue to accrue dividends. Following the holding period awards will cease to accrue dividends if not exercised
– Performance is measured against targets set at the beginning of the performance period, which may be set by referring to the time of grant or financial year
– To align the interests of Executive Directors with those of shareholders
– Not applicable 116 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
– For Executive Directors, at least 40% of the award is deferred into shares under the Deferred Annual Incentive Plan (the “DAIP”). This typically vests three years after grant (with deferred awards also capable of being settled in cash at the discretion of the Committee, for example, when it gives rise to legal difficulties to settle in shares). The remainder of the award is paid in cash following the year end
– The AIP remains a discretionary arrangement. The Committee reserves discretion to adjust the out-turn (from zero to the cap), should it consider it appropriate
LTIP – Aligning executives’ interests with those of shareholders to motivate and incentivise delivering sustained business performance over the long term
– For awards to be granted in 2017, vesting will continue to be determined based on two measures: RoTE and relative TSR performance against the FTSE 350 (excluding investment trusts). The Committee may apply different performance measures and targets for future awards, provided not less than 50% of the award shall be subject to one or more financial measures, and not less than 25% shall be subject to a relative TSR measure
The Directors present their report for the financial year ended 31 December 2018.
Interest capitalised by the Group None Unaudited financial information None Long-term incentive plan involving one Director only 109 Directors’ waivers of emoluments 109 Directors’ waivers of future emoluments Not applicable Non pro-rata allotments for cash (issuer) Not applicable Non pro-rata allotments for cash (major subsidiaries) None Listed company is a subsidiary of another company Not applicable Contracts of significance involving a director Not applicable Contracts of significance involving a controlling shareholder Not applicable Details of shareholder dividend waivers 119 Controlling shareholder agreements Not applicable
Dividends The Board recommends a final dividend of 14.0 pence per share to shareholders. Subject to shareholder approval at the Company’s 2019 AGM, this will become payable on 16 May 2019 to all holders of Ordinary Shares on the Register of members at close of business on 5 April 2019. A special interim dividend has been declared of 8.3 pence per share and will have the same record and payment dates as the final dividend for 2018.
The Company’s Articles of Association set out the Directors’ powers. You can view these on the Company’s website at www.directlinegroup.co.uk. The Directors’ powers are also subject to relevant legislation and, in certain circumstances, authority from the Company’s shareholders. You can find details of the Directors’ remuneration, service contracts, employment contracts and interests in the shares of the Company in the Directors’ remuneration report on pages 88 to 117.
Share capital The Company has a premium listing on the London Stock Exchange. As at 31 December 2018, the Company’s share capital comprised 1,375,000,000 fully paid Ordinary Shares of 10 10/11 pence each.
The Trustee of the Employee Benefit Trust has waived its right to dividends on all shares within the Trust. You can find out more about the number of shares held by the employee share plan trusts in note 35 on page 176. The Company is only aware of the dividend waivers and voting restrictions mentioned above.
Each general meeting notice will specify the time for determining a shareholder’s entitlement to attend and vote at the meeting. This will not be more than 48 hours before the time fixed for the meeting (which may exclude non-working days). To be valid, all proxy appointments must be filed at least 48 hours before the time of the general meeting. In calculating this time period, no account shall be taken of any part of a day that is not a working day.
APG Asset Management N.V 3.35% 3.26% Artemis Investment Management LLP 4.79% 4.81% BlackRock, Inc. 10.13% 10.14% Standard Life Aberdeen plc 8.08% 8.32% T.Rowe Price Associates, Inc 5.79% 4.52%
Political donations The Group made no political donations during the year (2017: nil).
Our DNA focuses on a number of strands including employees with disabilities. It identifies areas where we can improve and help people to continue working for us. We reasonably adjust employees’ working environments and equipment, and roles and role requirements. We also ensure that everyone can access the same opportunities.
Greenhouse gas emissions In order to comply with the Companies Act 2006 (Strategic and Directors’ Report) Regulations 2013, the Group has followed the 2013 UK Government environmental reporting guidance for GHG emissions; used the UK Government’s greenhouse gas conversion factors; and adopted the financial control approach to setting the organisational boundaries of responsibilities for GHG emissions. In applying the GHG Protocol Corporate Accounting and Reporting Standard (revised edition) we have calculated emissions associated with electricity consumption using both the location-based Scope 2 and market-based Scope 2 calculation methodologies. GHG emissions are classified as direct or indirect, and divided into Scope 1, Scope 2 and Scope 3 emissions. Direct GHG emissions are those from sources that the Group owns or controls. Indirect GHG emissions are those that are a consequence of the Group’s activities, but occur at sources owned or controlled by another organisation. The Group has considered the seven main GHGs, reported in tonnes of carbon dioxide equivalent (“CO2e”), and set 2013 as the base year.
Intensity metric: tonnes CO2e/million GBP net earned premium (£m) 8.5 5.5 5.2 -38.2 Scope 3 (Only T&D losses from electricity) 1,774 876 675 -62.0 Total (Scope 1, 2 & 3 – T&D losses) 31,683 18,275 16,894 -46.7 Intensity metric: tonnes CO2e/Million GBP net earned premium (£m) 9.0 5.8 5.5 -39.2
The Finance review on pages 32 to 34 describes the Group’s capital management strategy, which covers how it measures its regulatory and economic capital needs and deploys capital.
Having made due enquiries, the Directors reasonably expect that the Company and the Group have adequate resources to continue in operational existence for at least 12 months from 4 March 2019 (the date of approval of the financial statements). Accordingly, the Directors have adopted the going concern basis in preparing the financial statements.
Auditor Deloitte has expressed its willingness to continue in office as the External Auditor. A resolution to reappoint Deloitte will be proposed at the forthcoming AGM. You can find an assessment of the effectiveness and recommendation for reappointing Deloitte in the Audit Committee report on page 79.
The Directors are responsible for keeping adequate accounting records that: are sufficient to show and explain the Company’s transactions and disclose, with reasonable accuracy, the Company’s financial position at any time; and enable them to ensure the financial statements comply with the Companies Act 2006. Additionally, the Directors are responsible for safeguarding the Company’s assets and, hence, taking reasonable steps to prevent and detect fraud and other irregularities. The Directors are responsible for maintaining and ensuring the integrity of the corporate and financial information included on the Company’s website at www.directlinegroup.co.uk. Legislation in the UK governing preparing and disseminating financial statements may differ from legislation in other jurisdictions.
– the Annual Report and the financial statements, taken as a whole, are fair, balanced and understandable, and provide the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.
Notes to the Parent Company financial statements 1. Accounting policies 184 2. Investment in subsidiary undertakings 185 3. Other receivables 186 4. Current and deferred tax 186 5. Derivative financial instruments 187 6. Financial investments 187 7. Cash and cash equivalents 187 8. Share capital and capital reserves 187 10. Subordinated liabilities 188 12. Trade and other payables 188 14. Share-based payments 188 15. Risk management 188 16. Directors and key management remuneration 188 17. Post balance sheet event 188 122 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
– the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
We have audited the financial statements which comprise: – the Consolidated Income Statement; – the Consolidated and Parent Company Statements of Comprehensive Income; – the Consolidated and Parent Company Balance Sheets; – the Consolidated and Parent Company Statements of Changes in Equity; – the Consolidated Cash Flow Statement; and – the related notes 1 to 41 on the Consolidated financial statements and related notes 1 to 17 on the Parent Company financial statements, excluding the capital adequacy disclosures in note 3 calculated in accordance with the Solvency II regime which are marked as unaudited.
Materiality The materiality that we used for the Group financial statements was £28 million which approximates 5.2% of three-year average profit before tax.
We are also required to report whether the Directors’ statement relating to the prospects of the Group required by Listing Rule 9.8.6R(3) is materially inconsistent with our knowledge obtained in the audit.
Valuation of insurance reserves Refer to page 77 (Audit Committee Report), page 138 (Accounting policies) and page 174 (Financial statements).
Furthermore, a key market factor occurring in 2018 was the Civil Liability Act, which came into force on 20 December 2018 after passing Royal Assent. Going forward this Act will result in the Government determining the Ogden discount rate, which is currently minus 0.75%, with reference to ‘low risk’ rather than ‘very low’ or ‘zero risk’ investments. The Government will also now conduct regular rate reviews at least every five years. In response to this legislative change the Group has moved to valuing its lump sum bodily injury reserves using an Ogden discount rate of 0%, rather than minus 0.75%, on the basis that the Civil Liability Act requires the Government to set the discount rate with reference to low risk rather than very low risk investments. The selection of the new rate required significant judgement by management and has resulted in a reduction in the insurance reserves of £55 million.
Having done this, we worked with those specialists to: – assess and challenge the methodologies and key assumptions, and their underlying rationale, adopted by the Group, including the potential risk of increased claims inflation caused by Brexit; – review the estimated impact on reserves of recent paid and incurred claim developments using our in-house reserve software; – inspect the Group’s actuarial models and perform sensitivity testing and peer benchmarking on key assumptions; – assess management’s rationale for adopting a best estimate Ogden discount rate of 0%, and challenge its reasonableness in light of market benchmarking; and – assess and challenge the methodology of the Group’s Ogden sensitivity model. Key observations We have determined the estimate for the ultimate value of large bodily injury claims to be reasonable. In making this determination we observed that the frequency and severity assumptions used in determining the ultimate value are reasonable, albeit slightly prudent.
Key audit matter description We have identified a key audit matter over the valuation of intangible assets totalling £354.1 million (2017: £258.8 million) as detailed in note 17. Our key audit matter specifically addresses those intangible assets relating to strategic projects that aim to improve the customer experience, support growth and increase efficiency across the Group.
– challenged management on the reasonableness of the future cash flows for the assets. Whilst performing our work we leveraged our knowledge of the system based on our testing over the components of the capital expenditure.
Valuation of investments not held at fair value Refer to page 77 (Audit Committee Report), page 139 (Accounting policies) and page 171 (Financial statements).
Key audit matter description Investments that are not held at fair value are carried at amortised cost and represent a higher credit risk relative to the majority of DLG’s investment portfolio. Our work primarily focused on the valuation of the Group’s commercial real estate loan, infrastructure debt and private placement bond portfolios. Having recognised a £6 million (2017: £10 million) impairment on a non-performing loan in the year, these investments totalled £592.2 million (2017: £589 million) and represented 12.5% (2017: 11.7%) of the Group’s investment portfolio.
The Group satisfies the exemption criteria within IFRS 4 Insurance Contracts and has decided to defer the application of IFRS 9 Financial Instruments until the expected effective date of the new insurance contracts standard IFRS 17 on 1 January 2022. Under IAS 39 Financial Instruments: Recognition and Measurement, management judgement continues to be required in determining if an incurred loss event has occurred and there is significant uncertainty in determining the fair value of the loans in the instance an event has occurred. As a result, we identified the valuation of investments not held at fair value as a key audit matter.
Materiality £28.0 million (2017: £28.0 million). £25.2 million (2017: £25.2 million).
We also considered this measure to be suitable having compared to other benchmarks: our materiality equates to 4.8% (2017: 5.1%) of statutory profit before tax, 0.9% (2017: 0.8%) of gross earned premium and 1.1% (2017: 1.1%) of equity.
Group materiality is used for setting audit scope and the assessment of uncorrected misstatements. Materiality is set for each significant component in line with the components proportion of the chosen benchmark. This is capped at the lower of 90% of Group materiality and the component materiality determined for a standalone audit. The main UK insurance trading entity, UK Insurance Limited, which makes up 100% of Group gross earned premium and 73% of Group statutory profit before tax, is scoped to a component materiality of £25.2 million (2017: £25.2 million).
An overview of the scope of our audit The scope of our Group audit was determined by obtaining an understanding of the Group and its environment, including groupwide controls, and assessing the risks of material misstatement at the Group level.
At the Group level we also tested the consolidation process and carried out analytical procedures to confirm our conclusion that there were no significant risks of material misstatement of the aggregated financial information of the remaining components not subject to audit or audit of specified account balances. The Group audit team also performs the audit of the in-scope UK entities.
The Directors are responsible for the other information. The other information comprises the information included in the Annual Report, other than the financial statements and our auditor’s report thereon.
– Audit Committee reporting – the section describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee; or
Audit response to risks identified As a result of performing the above, we identified valuation of insurance reserves and valuation of intangible assets as key audit matters. The key audit matters section of our report explains these matters in more detail and also describes the specific procedures we performed in response to those key audit matters.
– the strategic report and the Directors’ report have been prepared in accordance with applicable legal requirements. In the light of the knowledge and understanding of the Group and the Parent Company and their environment obtained in the course of the audit, we have not identified any material misstatements in the strategic report or the Directors’ report.
Other matters Audit tenure Following the recommendation of the Audit Committee, we were appointed by the Board of Directors of the Royal Bank of Scotland Group plc on 21 March 2000 to audit the financial statements for the year ending 31 December 2000 and subsequent financial periods. The period of total uninterrupted engagement including previous renewals and reappointments of the firm is 19 years, covering the years ending 31 December 2000 to 31 December 2018.
Consistency of the audit report with the additional report to the Audit Committee Our audit opinion is consistent with the additional report to the Audit Committee we are required to provide in accordance with ISAs (UK).
Use of our report This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the full extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
COLIN RAWLINGS FCA (SENIOR STATUTORY AUDITOR) for and on behalf of Deloitte LLP Statutory Auditor London, United Kingdom 130 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
132 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 £m 2017 £m
Cash and cash equivalents 27 1,154.4 1,358.6 Assets held for sale 28 – 4.2 Total assets 9,386.1 9,948.2
The financial statements were approved by the Board of Directors and authorised for issue on 4 March 2019. They were signed on its behalf by: PENNY JAMES CHIEF FINANCIAL OFFICER
Shares acquired by employee trusts – (19.6) – – – – (19.6) – (19.6) Credit to equity for equity-settled share-based payments (note 35) – – – – – 14.8 14.8 – 14.8 Shares distributed by employee trusts – 19.8 – – – (19.8) – – – Tax on share-based payments – – – – – 1.0 1.0 – 1.0 Issue of Tier 1 notes – – – – – – – 346.5 346.5
Net cash generated from operating activities before investment of insurance assets 37 4.2 204.0 Cash generated from investment of insurance assets 37 468.1 341.9 Net cash generated from operating activities 472.3 545.9 Cash flows used in investing activities Purchases of property, plant and equipment 18 (13.3) (22.4) Purchases of goodwill and other intangible assets 17 (142.4) (73.2) Proceeds on disposals of assets held for sale 13.8 – Proceeds on disposal of property, plant and equipment 0.1 0.3 Net cash used in investing activities (141.8) (95.3) Cash flows used in financing activities Net proceeds from issue of Tier 1 notes 31 – 346.5 Repayment of subordinated liabilities – (326.8) Dividends and appropriations paid 14 (503.8) (225.3) Finance costs (19.3) (31.7) Purchase of employee trust shares (19.5) (19.6) Net cash used in financing activities (542.6) (256.9) Net (decrease) / increase in cash and cash equivalents (212.1) 193.7 Cash and cash equivalents at the beginning of the year 27 1,304.5 1,110.8 Cash and cash equivalents at the end of the year 27 1,092.4 1,304.5
1. Accounting policies Basis of preparation As required by the Companies Act 2006 and Article 4 of the EU IAS Regulation, the consolidated financial statements are prepared in accordance with IFRSs issued by the IASB as adopted by the EU. The Company’s financial statements have been prepared in accordance with and in full compliance with IFRSs as issued by the IASB. The Company has elected to prepare its parent entity financial statements in accordance with FRS 101 ‘Reduced Disclosure Framework’.
The Company’s financial statements and the consolidated financial statements are presented in sterling, which is the functional currency of the Company.
Adoption of new and revised standards The Group has adopted the following new amendments to IFRSs and International Accountings Standards (“IASs”) that became mandatorily effective for the Group for the first time during 2018 however these had no material impact on the consolidated financial statements or performance.
IFRS 15 ‘Revenue from Contracts with Customers’ introduces new recognition and disclosure requirements. Entities are required to recognise revenue as goods and services are transferred to the customer in proportion to the total consideration it expects to receive in exchange for those services. The Group has adopted the standard on a fully retrospective basis. This has not had a material impact on the consolidated financial statements.
Amendments to IFRS 4: ‘Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts’ was issued on 12 September 2016 and endorsed by the EU on 3 November 2017. These amendments permitted insurers who satisfied certain criteria to defer the effective date of IFRS 9 ‘Financial Instruments’, to coincide with the expected effective date of IFRS 17 ‘Insurance Contracts’, to 1 January 2022. The IASB permitted this option having considered potential asset and liability mismatching and temporary profit and loss volatility caused by introducing these new standards in different periods within a short period of time.
When first published, Amendments to IFRS 4 required insurance entities to evaluate whether their activities were predominantly connected to insurance as at its annual reporting date immediately preceding 1 April 2016, providing an option to defer adoption of IFRS 9 if liabilities connected to insurance comprised a predominant proportion of its total liabilities as at that date. The Group concluded that it satisfied the criteria that the carrying value of its liabilities connected to insurance was greater than 90% of the carrying value of its total liabilities at 31 December 2015. In making this conclusion, the Group determined that the subordinated debt of £521.1 million and derivative liabilities of £46.4 million represented liabilities connected with insurance but not liabilities arising from contracts within the scope of IFRS 4. There have been no significant changes in the Group’s activities since this assessment to require a reassessment of the criteria.
In note 3.3.3 the Group has disclosed the carrying amount of financial assets at the end of the reporting period by credit risk rating grade, as defined in IFRS 7 ‘Financial Instruments: Disclosures’. The fair value and the carrying amount of financial assets that meet the solely payments of principal and interest criteria and, at the end of the reporting period do not have a low credit risk, was £393.9 million.
IFRS 9 information that relates to entities within the Group that is not provided in the Group’s consolidated financial statements can be obtained from their individual financial statements. This information will be available from Companies House once the individual financial statements have been approved and filed with Companies House.
IFRIC 22 ‘Foreign Currency Transactions and Advance Consideration’ clarifies how to determine the date of the transaction for the exchange rate to be used on the initial recognition where an entity pays or receives consideration in advance for foreign currency denominated contracts.
1.1 Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and the entities that are controlled by the Group at 31 December 2018 and 31 December 2017. Control exists when the Group is exposed, or has rights, to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. In assessing if the Group controls another entity, the existence and effect of the potential voting rights that are currently exercisable or convertible are considered.
Where necessary, adjustments have been made to the financial statements of subsidiaries to bring the accounting policies used into line with those used by the Group. The policies set out below have been applied consistently throughout the years ended 31 December 2018 and 31 December 2017 to items considered material to the consolidated financial statements.
1.2 Foreign currencies The Group’s consolidated financial statements are presented in sterling which is the presentational currency of the Group. Group entities record transactions in the currency of the primary economic environment in which they operate (their functional currency), translated at the foreign exchange rate ruling at the date of the transaction.
Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date. Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in the income statement.
Other operating income Vehicle replacement referral income Vehicle replacement referral income comprises fees recognised at a point in time in respect of referral income received when a customer or a non-fault policyholder (claimant) of another insurer has been provided with a hire vehicle from a preferred supplier.
Legal services income Legal services income represents the amount charged to clients for professional services provided during the year including recovery of expenses but excluding value added tax. Income relating to variable legal services fees is recognised on a best estimate basis.
Other income Commission fee income in respect of services is recognised at a point in time on satisfaction of related performance obligations. Where fees have a variable element, income is recognised on a best estimate of the total consideration expected. Income is stated excluding applicable sales taxes.
1.5 Insurance claims Insurance claims are recognised in the accounting period in which the loss occurs. Provision is made for the full cost of settling outstanding claims at the balance sheet date, including claims incurred but not yet reported at that date, net of salvage and subrogation recoveries. Outstanding claims provisions are not discounted for the time value of money except for claims to be settled by PPOs established under the Courts Act 2003.
Depreciation is charged to the income statement on a straightline basis so as to write off the depreciable amount of property, plant and equipment over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and leasehold buildings 50 years or the period of the lease if shorter
1.11 Investment property Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. Investment property is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties adjusted for the specific characteristics of each property. Any gain or loss arising from a change in fair value is recognised in the income statement.
1.12 Financial assets Financial assets are classified as AFS, HTM designated at fair value through profit or loss, or loans and receivables.
Available-for-sale When a decline in the fair value of a financial asset classified as AFS has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in the income statement. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on AFS equity instruments are not reversed through profit or loss, but those on AFS debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event.
The Group’s defined benefit pension scheme, as described in note 25, was closed in 2003. Scheme liabilities are measured on an actuarial basis, using the projected unit credit method, and discounted at a rate that reflects the current rate of return on a high quality corporate bond of equivalent term and currency to the scheme liabilities.
Scheme assets are measured at their fair value. Any surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). The current service cost and any past service costs, together with the net interest on net pension liability or asset, is charged or credited to operating expenses. Actuarial gains and losses are recognised in full in the period in which they occur outside the income statement and presented in other comprehensive income under ‘Items that will not be reclassified subsequently to the income statement’.
Deferred tax liabilities are generally recognised for all taxable temporary timing differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised.
1.20 Share-based payment The Group operates a number of share-based compensation plans under which it awards Ordinary Shares and share options to its employees. Such awards are generally subject to vesting conditions that vary the amount of cash or shares to which an employee is entitled.
The IASB issued IFRS 16 ‘Leases’ in January 2016 to replace IAS 17 ‘Leases’ and will be effective for reporting periods beginning on or after 1 January 2019, applied by the Group fully retrospectively from this date. IFRS 16 sets out the principles for recognition, measurement and disclosure of leases and requires lessees to account for all leases under a single on-balance sheet model similar to the accounting for finance leases under IAS 17. There are two exemptions: for leases of a low value and for leases of a short-term nature of 12 months or less. At the start of the lease a lessee will recognise a liability for the lease payments and an asset, representing the right to use the asset during the lease term. Lessees will be required to separately recognise the interest on the lease liability and the depreciation expense on the right-ofuse asset. Lessor accounting under IFRS 16 is substantially unchanged from the current approach under IAS 17.
The actual impacts may differ from the amounts presented above when the Group presents its first financial statements from the initial date of application.
The Group conducted a high-level assessment of the three aspects of IFRS 9 and based on current information, the impact of applying the expected loss model for the first time is currently immaterial. The Group does not expect any other significant impact on its financial statements. The Group satisfies the exemption criteria within IFRS 4 and has decided to defer the application of IFRS 9 until the expected effective date of the new insurance contracts standard IFRS 17, on 1 January 2022, applying the temporary exemption from applying IFRS 9 as introduced by the amendments to IFRS 4.
The core of IFRS 17 is the general model, supplemented by an optional simplified premium allocation approach which is permitted for the liability for the remaining coverage for short duration contracts (one year or less). The general model measures insurance contracts using the building blocks of: 142 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
FINANCIALS V6.1 WWW.DIRECTLINEGROUP.CO.UK 143 discounted probability weighted cash flows; an explicit risk adjustment; and a contractual service margin representing the unearned profit of the contract which is recognised as revenue over the coverage period.
IFRIC 23 ‘Uncertainty over Income Tax Treatments’ was issued in June 2017 and provides interpretation when there is uncertainty over income tax treatments under IAS 12 ‘Income Taxes’. This is effective from 1 January 2019.
Amendments to IAS 19 ‘Employee Benefits’: Plan Amendment, Curtailment or Settlement was issued in February 2018. The amendments clarify the accounting when a plan amendment, curtailment or settlement occurs. This is effective from 1 January 2019.
In December 2017 the IASB issued ‘Annual Improvements to IFRS Standards 2015-2017 Cycle’ with an effective date of 1 January 2019, which included the following three amendments: IFRS 3 ‘Business Combinations’ and IFRS 11 ‘Joint Arrangements’ – the amendments to IFRS 3 clarify that when an entity obtains control of a business that is a joint operation, it remeasures previously held interests in that business; the amendments to IFRS 11 clarify that when an entity obtains joint control of a business that is a joint operation, the entity does not remeasure previously held interests in that business.
In October 2018 the IASB issued ‘Amendments to IFRS 3 Business Combinations’ – this will permit a simplified assessment of whether an acquired set of activities and assets is a group of assets rather than a business. This is effective from 1 January 2020.
2.1 Impairment provisions – financial assets The Group makes a judgement that financial assets are impaired when there is objective evidence that an event or events since initial recognition of the assets have adversely affected the amount or timing of future cash flows from the asset. The determination of which events could have adversely affected the amount or timing of future cash flows from the asset requires judgement. In making this judgement, the Group evaluates, among other factors, the normal price volatility of the financial asset, the financial health of the investee, industry and sector performance, changes in technology and operational and financing cash flow or whether there has been a significant or prolonged decline in the fair value of the asset below its cost. Impairment may be appropriate when there is evidence of deterioration in these factors.
On a quarterly basis, the Group reviews whether there is any objective evidence that a financial asset is impaired based on the following criteria: – actual, or imminent, default on coupon interest or nominal; – adverse movements in the credit rating for the investee / borrower; – price performance of a particular AFS debt security, or group of AFS debt securities, demonstrating an adverse trend compared to the market as a whole; and
– an event has occurred that could be reliably estimated and which had an impact on the financial asset or its future cash flows.
Had all the declines in AFS asset values met the criteria above at 31 December 2018, the Group would suffer a loss of £21.0 million (2017: £6.5 million), being the transfer of the total AFS reserve for unrealised losses to the income statement. These movements represent mark-to-market movements and where there is no objective evidence of any loss events that could affect future cash flows, no impairments have therefore been recorded for these movements.
Judgement is applied to determine whether intangible assets are impaired. In making this judgement, the Group considers: the projection of the economic benefits associated with each asset; subsequent re-measurement of these benefits through the development cycle and into use; the projected ultimate cost of each asset at each point through the development cycle due to specification changes; and the likelihood of obsolescence of any component parts. Details of intangible assets are shown in note 17.
2.4 General insurance: outstanding claims provisions and related reinsurance recoveries The Group makes provision for the full cost of outstanding claims from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling costs. Outstanding claims provisions net of related reinsurance recoveries at 31 December 2018 amounted to £2,900.7 million (2017: £3,144.5 million).
Net of reinsurance Approved PPO claims provisions 247.6 640.0 248.4 653.5
In the majority of cases, the inflation agreed in the settlement is the Annual Survey of Hours and Earnings SOC 6115 inflation published by the Office for National Statistics, for which the long-term rate is assumed to be 4% (2017: 4%). The Group has estimated a rate of interest used for the calculation of present values as 4% (2017: 4%), which results in a real discount rate of 0% (2017: 0%). The Group will continue to exercise judgement around the inflation and discount rates used to calculate these insurance reserves.
3.2 Risk and capital management modelling The Board has ultimate responsibility for ensuring that the Group has sufficient funds to meet its liabilities as they fall due. The Group carries out detailed modelling of its assets, liabilities and the key risks to which these are exposed. This modelling includes the Group’s own assessment of its SCR, using its Partial Internal Model approved by the PRA in 2016. The SCR quantifies the insurance, market, credit, operational and liquidity risks that the regulated entities are undertaking.
The risk management section of the strategic report also sets out all the risks assessed by the Group as principal risks. Detailed below is the Group’s risk exposure arising from its insurance activities and use of financial instruments specifically in respect of insurance risk, market risk, credit risk, operational risk and liquidity risk.
The Group is mainly exposed to the following insurance risks: Reserve risk Reserve risk relates to both premium and claims. This is the risk of understatement or overstatement of reserves arising from: – the uncertain nature of claims; – data issues and changes to the claims reporting process; – operational failures; – failure to recognise claims trends in the market; and – changes in underwriting and business written so that past trends are not necessarily a predictor of the future.
PPOs3 Impact of an increase in the discount rate used in the calculation of present values of 100 basis points 50.7 54.6 Impact of a decrease in the discount rate used in the calculation of present values of 100 basis points (70.1) (75.1) Ogden discount rate4 Impact of the Group reserving at a discount rate of 1% compared to 0% (2017: 0% compared to minus 0.75%) 56.2 68.4 Impact of the Group reserving at a discount rate of minus 1% compared to 0% (2017: minus 1.5% compared to minus 0.75%) (76.3) (102.9)
4. Ogden discount rate sensitivity has been calculated on the direct impact of a permanent change in the discount rate with all other factors remaining unchanged. The Group will consider the statutory discount rate when setting its reserves but not necessarily provide on this basis, as is the case at the year ended 31 December 2018. This is intended to ensure that reserves are appropriate for current and potential future developments.
– a process is in place to deal with major weather and other catastrophic events, known as the ‘Surge Demand Plan’. A surge is the collective name given to an incident which significantly increases the volume of claims reported to the Group’s claims functions. The plan covers surge demand triggers, stages of incident, operational impact, communication and management information monitoring of the plan.
Underwriting risk This is the risk that future claims experience on business written is materially different from the results expected, resulting in current-year losses. The Group predominantly underwrites personal lines insurance including motor, residential property, roadside assistance, creditor, travel and pet business. The Group also underwrites commercial risks primarily for low-to-medium risk trades within the small and medium-sized enterprises market. Contracts are typically issued on an annual basis which means that the Group’s liability usually extends for a 12-month period, after which the Group is entitled to decline to renew or can revise renewal terms by amending the premium or other policy terms and conditions such as the excess as appropriate.
148 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 3. Risk management continued When underwriting policies, the Group is subject to concentration risk in a variety of forms, including: – geographic concentration risk – the Group purchases a catastrophe reinsurance programme to protect against a modelled 1 in 200-years catastrophe loss. The programme is structured with the retention and limits expressed as percentages of gross earned premium. At 31 December 2018 this was the equivalent of £969.0 million (114% of gross earned premium of the previous 12 months) in excess of a retained deductible of £126.5 million (14.9% of gross earned premium); – product concentration risk – the Group’s business is heavily concentrated in the UK general insurance market. However, the Group offers a diversified portfolio of products and a variety of brands sold through a range of distribution channels to its customers; and
– changes in the external legal, regulatory, social or economic environment altering the definition and application of reinsurance policy wordings or the effectiveness or value for money of reinsurance.
The Group uses reinsurance to: – protect the underwriting result against low-frequency, high-severity losses through the transfer of catastrophe claims volatility to reinsurers; – protect the underwriting result against unforeseen volumes of, or adverse trends in, large individual claims in order to reduce volatility and to improve stability of earnings; – reduce the Group’s capital requirements; and/or – transfer risk that is not within the Group’s current risk appetite.
The market value of the Group’s financial investments with fixed coupons is affected by the movement of interest rates. For the majority of investments in US Dollar corporate bonds, excluding £405.2 million of short duration high yield bonds (2017: £403.9 million), the Group hedges the exposure of this portfolio to the US Dollar interest rate risk using swaps.
Property risk This is the risk of loss arising from sensitivity of assets and financial investments to the level or volatility of market prices, rental yields, or occupancy rates of properties. At 31 December 2018, the value of these property investments was £322.1 million (2017: £309.3 million). The property investments are located in the UK.
150 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 3. Risk management continued Currency risk This is the risk of loss from changes in the level or volatility of currency exchange rates.
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 2,735.3 51.1 – – 51.1 Designated as hedging instruments: Foreign exchange contracts (forwards) 17.3 1.0 – – 1.0
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 579.9 11.3 – – 11.3 Designated as hedging instruments: Interest rate swaps 113.1 0.5 (0.1) 0.3 0.7 150 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Notes: 1. These sensitivities exclude the impact of taxation. 2. The income statement impact on financial investments is limited to floating rate instruments and interest rate derivatives used to hedge a portion of the portfolio.
The income statement is not impacted in relation to fixed rate instruments, in particular AFS debt securities, where the coupon return is not impacted by a change in prevailing market rates, as the accounting treatment for AFS debt securities means that only the coupon received is processed through the income statement with fair value movements being recognised through total equity.
5. The subordinated liabilities and associated interest rate swap are excluded from the sensitivity analysis. 6. The sensitivities set out above have not considered the impact of the general market changes on the value of the Group’s insurance liabilities or retirement benefit obligations. They reflect one-off impacts at 31 December and should not be interpreted as predictions.
3.3.3 Credit risk This is the risk of loss resulting from default in cash inflows and/or changes in market value of issuers of securities, counterparties and any debtors to which the Group is exposed. The Group is mainly exposed to the following credit risk factors: – counterparty default risk; and – concentration risk.
– consumer credit – exposure from offering monthly instalments on annual insurance contracts.
152 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 3. Risk management continued The Group cedes insurance risk to reinsurers but, in return, assumes counterparty default risk against which a reinsurance bad debt provision is assessed. The financial security of the Group’s panel of reinsurers is therefore important and both the quality and amount of the assumed counterparty default risk are subject to an approval process whereby reinsurance is only purchased from reinsurers that hold a credit rating of at least A– at the time cover is purchased. The Group’s leading counterparty exposures are reviewed on a quarterly basis by the Head of Reinsurance and Corporate Insurance. The Group aims to contract with a diverse range of reinsurers on its contracts to mitigate the credit and/or non-payment risks associated with its reinsurance exposures.
Reinsurance assets 1,208.7 – – – 1,208.7 Insurance and other receivables 836.0 39.6 0.3 – 875.9 Derivative assets 48.2 – – – 48.2 Debt securities 4,246.6 – – – 4,246.6 Infrastructure debt 289.6 – – – 289.6 Commercial real estate loans 201.6 – – – 201.6 Cash and cash equivalents1 1,154.4 – – – 1,154.4
The table below analyses the distribution of infrastructure debt by industry sector classifications.
The tables below analyse the credit quality of financial and insurance assets that are neither past due nor impaired (excluding debt securities analysed above). The tables include reinsurance exposure, after provision. The Group’s approach to reinsurance counterparty default risk is detailed on page 151.
Technology and infrastructure risk This is the risk that the IT infrastructure is insufficient to deliver the Group’s strategy.