About the Hiscox Group 2 Corporate highlights 3 Why invest in Hiscox? 4 Chairman’s statement 6 Chief Executive’s report 13 Hiscox business structure 14 Reinsurance 17 People
Financial summary 50 Independent auditors’ report 51 Consolidated income statement 51 Consolidated statement of comprehensive income 52 Consolidated balance sheet 53 Consolidated statement of changes in equity 54 Consolidated statement of cash flows 55 Notes to the consolidated financial statements 104 Five year summary
Our ambition is to be a highly respected specialist insurer with a diverse portfolio by product and geography. We believe that building balance between catastrophe-exposed business and less volatile local specialty business gives us opportunities for profitable growth throughout the insurance cycle.
Strategic focus 100% = £1,664m Total Group controlled income for 2011
UK retail business delivers good growth and another record profit of £49.0 million (2010: £28.8 million)
Hiscox London Market achieved a profit of £57.6 million (2010: £121.4 million), offsetting catastrophe reinsurance losses with profits in international property, marine, and other specialist lines
Hiscox USA is progressing well with 29% growth in core broker lines and over 6,000 policies sold by the direct business in the first year of operation
Catastrophes such as hurricanes and earthquakes could hit at any time, and naturally would have an impact on our business. Therefore twice a year, in our analysts’ presentations and on our website, we publish estimates of what the Group’s losses would be should such a catastrophe occur.
Our people Specialist expertise that is valued by our customers We are market leaders in many of our specialist areas and our customers value the expertise and cover we provide. What our UK customers said:*
Our business A balanced portfolio that creates opportunity throughout a cyclical market Hiscox’s strategy is to balance the more volatile catastrophe-exposed insurance and reinsurance with steady local specialty insurance. Our diversity by product and geography gives us great flexibility, particularly in a tough commercial environment. We are able to grow and shrink the catastrophe-exposed lines according to market conditions. Currently, rates for reinsurance, which makes up 28% of our income, are healthy. When these rates are no longer favourable, we have the flexibility to shrink this side of the business. Our local specialty insurance business tends to be steadier throughout the insurance cycle and we have successfully grown our retail lines by 7.5% year-on-year over the last five years.
Our performance Strong financial performance Hiscox has a strong record of top-line growth with a focus on ROE. Performance highlights between 2007 and 2011 include: increased gross written premiums by 20.9% to over £1.4 billion healthy combined ratio averaging 87.1% delivered average ROE of 17.3% maintained a progressive dividend policy with compound growth of 9.1%.
capacity has plunged into the market at rates which can only lose them money. The curse of the industry is that we sell a product the cost of which is only discovered years later when the claims roll in. This breeds optimism, and nobody is more optimistic than the new entrant with no legacy problems (they think), but also no legacy book of business or experience. All existing business in the world is already placed with an insurer, and which broker is going to switch it to a new entrant unless they cut the price or widen the terms?
Results The result for the year ending 31 December 2011 was a profit before tax of £17.3 million (2010: £211.4 million) on a gross written premium income of £1,449.2 million (2010: £1,432.7 million). The combined ratio was 99.5% (2010: 89.3%). Earnings per share 5.5p (2010: 47.2p) and net assets per share 323.5p (2010: 332.7p). The return on equity was 1.7% (2010: 16.5%).
The market As usual, the CEO Bronek Masojada will comment in detail on conditions in the general markets and the performance of our various businesses in them. I can see that rates are rising in many of our key areas, especially those which have suffered large losses, which bodes well for 2012. Some comment that the rises are not big enough but they suit me. If we get a great surge in rates, which happens only rarely and then after a major event following a lean period, prices go too high and start coming down almost immediately. In an ideal world rates would bump along at a level at which good underwriters could make money and the bad ones wither and die. Given that the insurance market is remorselessly cyclical, I like small rises which help margins for the good without encouraging foolishness in the bad.
We have built a brand based on trust and service and have been rated as the most trusted insurer in the UK. The value of our brand depends on our integrity and our fair treatment of customers which acts as a sharp pencil in the small of the back of every member of staff to live up to the advertised standard. I would like to thank them all for carrying the flag so well.
We first expanded from Lloyd’s into the UK regions in 1989, then into Europe from 1993. We bought an ailing UK insurance company in 1996 which was on the regulator’s monthly watch list and have turned it into a thriving company which made £49.2 million last year. We have built successful insurance companies in Guernsey and Bermuda, and have started an insurance company in the US which is growing to profitability. We have developed direct businesses in the UK, France and the US. We have grown from a Lloyd’s syndicate to a truly international insurance business, headquartered in Bermuda.
As the Chairman has said, 2011 was a year dominated by natural catastrophes. Earthquakes, floods, tornadoes, hurricanes and a tsunami caused insured losses in excess of $100 billion making it one of the most expensive years on record for the industry. The fact that Hiscox made a profit of £17.3 million for the year (2010: £211.4 million) is a demonstration of the strength and resilience of our Group. The UK, Guernsey and European operations and several of our London Market divisions contributed strong profits, which offset the net £270 million (2010: £165 million) in catastrophe related claims reserved in our London and Bermuda reinsurance units, and the lower investment returns.
Our strategy of balance and diversification has therefore shown its value once again. We will continue, with ever greater effort, to grow our retail-focused businesses around the world and invest in our specialist businesses in London. This will further enhance our capacity to weather future catastrophes and provide attractive returns to shareholders.
Hiscox London Market Our London Market business navigated its way through the thick of the storm in 2011 with amazing resilience thanks to its spread of
Chief Executive’s report business. Profits in international property, marine, and other specialist lines offset reinsurance losses allowing it to make an aggregate profit of £57.6 million (2010: £121.4 million). This is a fantastic achievement given the exposure it had to the global catastrophes of 2011. Revenues increased marginally to £585.4 million (2010: £572.7 million) showing yet again the truth of the mantra “profit is sanity: revenue vanity”. Looking at each business line in turn: Reinsurance: Although underweight in most loss affected areas, this team was impacted by the many natural catastrophes in 2011. The team took advantage of distressed conditions following the events in the first half to expand their writings at the important mid-year renewals. They have also continued to build their partnerships with third-party providers of reinsurance support. The team retains their nerve and are optimistic about 2012.
Hiscox UK: Our UK business has become a powerhouse, achieving another record profit of £49.0 million (2010: £28.8 million) despite a big fall in investment income and the competitive market conditions which prevailed. It had substantial top-line growth of 12.3% to £367.1 million (2010: £327.0 million). This result was driven by a focus on disciplined underwriting and by the strength of the Hiscox brand. Most satisfying has been the performance of our high net worth team. They reaped the rewards of their efforts in 2009 and 2010 when, against prevailing market trends, they maintained discipline, increased prices marginally and as a result made a very healthy profit this year. Their nascent luxury motor account also made a good profit – a real achievement in its third year. The commercial business had a reasonable year, despite being challenged by claims arising from mistakes by some of the professionals we insure which have been revealed by the recession.
Global response: Our team has continued to serve clients around the world in the terrorism, kidnap and ransom, piracy and political risk areas. Piracy remains challenging as prices are inadequate for the risks being run and our book continues to shrink. The Arab Spring created repatriation losses but again the spread of business allowed the division to perform well in the year.
Specialty: This division consists of the bloodstock, contingency, personal accident, specie, media and technology businesses written in the London Market. It had a very good year. The specie and technology accounts benefited from the settlement of some old claims which resulted in substantial releases from reserves. Our contingency team supported the Rugby World Cup organisers in New Zealand as they dealt with the impact of the Christchurch earthquakes on their seminal event, demonstrating our claims handling ability in such an unusual situation. During the course of the year we closed our bloodstock account as poor rating had caused it to shrink to a size where it was no longer viable.
Aviation and space: We have had a presence in the space market for many years and this business continues to perform well. Our aviation venture is now in its second year and we have established a small market presence with a reputation as a considered and disciplined participant.
Despite the economic challenges that Europe faced, and will no doubt face in 2012,
Chief Executive’s report continued we are continuing to invest on the continent. For the past two years we have been building a direct business in France focusing on small commercial lines. In 2012 we will be supporting this direct business with an expanded marketing campaign – in fact our first French television commercial aired in January. Early responses have been positive, and if all goes well we hope to build a direct business to match that in the UK.
Hiscox International Hiscox International has suffered most visibly from the catastrophe losses in 2011. It swung to a loss of £89.5 million (2010: profit of £43.1 million) and its premiums shrank 9.7% to £365.8 million (2010: £405.2 million). As trends in each business unit within the division vary materially I comment on each separately below: Hiscox Bermuda: The focus of our business in Bermuda is overwhelmingly on catastrophe reinsurance so in a year like 2011 it is not surprising that the unit suffered a big loss. Hiscox Bermuda’s disciplined underwriting saw its written premiums reducing by 9.5% to £177.7 million (2010: £196.4 million). It is the nature of reinsurance to be volatile but on average the results are very attractive. Since we created our business in Bermuda in 2006 it has achieved an aggregate combined ratio, including 2011, of around 80% – a very respectable result.
Hiscox Guernsey: This business underwrites kidnap and ransom, piracy, fine art and terrorism and continues to be a star performer. Its revenues declined marginally to £79.8 million (2010: £80.6 million) despite a very disciplined underwriting approach towards piracy. The team made a profit despite suffering a large fine art loss when a painting was being transported from the auction house to a client. This team is concentrating on expanding its distribution and expects to strengthen this in several territories in 2012.
Claims Insurance is basically a promise to pay. Claims are where that promise is tested. In 2011 our UK claims team dealt professionally with the welter of claims resulting from the severe winter freezes, while our Bermuda and London Market claims teams have been at the forefront of adjusting and paying claims arising from the string of natural catastrophes. It is pleasing to see that during all of this they kept their promise with prompt and fair payment of valid claims with a smile.
In 2011 we released £199 million (2010: £133 million) from prior years’ reserves. We have benefited from some legal victories, most prominently in our long running litigation over subrogation from the World Trade Center, and from some large technology and professional liability cases. At the end of 2011 our actuarial analysis shows that we continue to hold the same size margin above best estimate as at the end of 2010.
In the UK we took the big step of insourcing all of the claims from our direct to consumer business, recruiting a small number of staff from our outsource partner and expanding the services which we offer to claimants. Our claims service remains one of the best in the industry and in 2011 we were awarded Post Magazine’s Commercial Lines and Personal Lines claims team of the year. We continue to invest in claims and a priority in 2012 will be Europe. The challenge is to use our skills on a pan European basis as the individual operations remain quite small.
We started the year concerned about a possible increase in interest rates but happy to take some credit risk and we positioned the bond portfolios accordingly. The stance on duration in particular proved to be too cautious in light of the flight to quality that took place in Government bond markets in the second half. Additionally, in some cases, our non government bonds incurred mark to market losses. However, we have the resilience to hold these through periods of market turbulence as we will eventually realise value for them as they move to maturity.
We took advantage of some of the market weakness in the summer to increase our equity weighting slightly. Again, we believe we have a strong enough balance sheet to withstand the volatility that inevitably comes with owning shares and are prepared to do so as long as we can see value in the longer-term.
Looking forward we expect investment returns to remain depressed. We are not tempted by the range of products which may offer higher apparent returns but would rather accept what the market has to offer from conventional sources.
All this operational improvement has been mirrored in improvements in our IT performance. The IT team re-organised themselves during the year to match our business unit structure, allowing for more interaction between teams and greater accountability to the business for delivering specific projects. As a result, we have seen a higher number of projects being completed more efficiently and to a higher standard.
A huge part of Robert’s success has been formed around his ability to recruit great people and he has given them the freedom to build their businesses. One of the most important of these hires was Nicholas Thomson who will be standing down as a Non Executive of our UK based subsidiary boards shortly. Nick joined Robert in 1973, becoming Underwriter of Syndicate 33 from 1976 until 1993 and Director of Underwriting from 1993 until 2001. Nick served as a Hiscox plc Board Director from 1993 until 2001. He has also always served on our UK based subsidiary boards, moving to a Non Executive position in 2001. Nick’s contribution to our underwriting culture has been immense and we will miss the grenades of underwriting and business insight that he rolled down the boardroom table with unfailing regularity.
Outlook We have seen substantial rises in rates for catastrophe reinsurance in loss affected territories such as Japan, New Zealand and Australia, but areas which were already well rated, such as the United States, have seen more modest increases. Unfortunately, catastrophe reinsurance in areas which continue to need price rises such as Europe have remained flat. In non catastrophe areas the trends are more mixed. European insurance pricing remains reasonable in our lines, and in the UK there is some downward pressure in commercial insurance, whilst personal lines are flat albeit at healthy levels. In the US we are seeing modest upward pressure.
In this environment we believe that we can thrive. The UK will continue with its consumer and brand led expansion; Europe will focus on driving growth in current product areas and current territories, developing greater scale and with that improved profitability; the US will continue to drive for scale in current areas and build on the exciting possibilities of its direct business; The London Market, Bermuda and Guernsey insurance businesses will take advantage of areas with rate increases, expanding judiciously in property related lines but continuing to shrink in casualty; overall Reinsurance is even better rated than in previous years and unless the world turns upside down, should return to its usual profitability. I feel excited as I see these plans coming together and am confident the profits they generate will benefit shareholders and staff.
How does reinsurance work? Just as companies buy insurance to cover potential risks to their business, insurance companies themselves also buy insurance (known as reinsurance) to transfer some of their own risk. Reinsurance is a remarkably flexible financial tool that insurers use to manage the downside risk of their insurance portfolios. It can help insurers absorb large losses and reduce volatility in what can be a very unpredictable industry. It can also act as additional capital, allowing insurers to take on more risk when they see the time is right.
Another substantial area of reinsurance underwriting for us is in contracts called ‘pro-rata treaties’, where we participate in a proportional share of an insurer’s premiums and losses. This form of reinsurance often acts as a capital substitute, where clients transfer risk through the purchase of reinsurance to free up capital. Pro-rata treaties also offer us the chance to put our capacity behind specialist insurers writing in classes or territories which we could not otherwise access.
We also write reinsurance on behalf of other (insurance and reinsurance) companies who have entrusted capital to us, and in return we receive an underwriting fee and can earn a profit commission on that business. It’s a good arrangement: it provides us with extra capacity, which we can use to increase our footprint in the market and to grasp new opportunities. But, in the event of a loss, our downside is limited.
Hiscox has been underwriting reinsurance since the 1970s, and a number of the Group’s senior management were reinsurance underwriters, so it is a strong part of our corporate DNA.
This chart shows a modeled range of net loss the Group might expect from any one castastrophe event. The white line between the bars depicts the modelled mean loss.
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How do you use catastrophe models in your business? Catastrophe models can help reinsurers estimate potential losses. We were earlyadopters of models as for decades we have held the belief that analysis and science is the route to profitable underwriting. The first model we used was back in the early 1980s – long before they became common in the industry. It was developed by my predecessor and was based on in-house research and used portable computers with a bus-ticket printer!
2011 was a very costly year for natural catastrophes. How did Hiscox fare? Natural catastrophes in 2011 cost Hiscox around £270 million, yet despite this we made a profit. This is largely due to our long held strategy of balancing the bigger volatile business, such as reinsurance, with smaller steadier insurance business.
As we achieve diversification in the risks we write across the Group as a whole, we do not have to seek diversification in the reinsurance account per se. In reinsurance, diversification can become ‘worsification’ if you are not careful. It can dilute the quality and longer-term profitability of your business if you take on uncorrelated, but inadequately priced risk. Successful reinsurance underwriting is about making sure you take on risk at the right price and has a lot of similarities with investment management. We require to be paid adequately for risk.
The quality of our people has been a key ingredient in our success. Hiscox’s reputation for innovation and dynamism has been built in large part on the energy, professionalism, commitment and expertise of our employees.
A good reputation takes a long time to build, but can be lost very quickly. We place a great emphasis on recruiting the best people, developing their skills and careers and ensuring that they are motivated. Some of the specific actions we take to fulfil each of these principles are described below. The unique personality of Hiscox is expressed through our employees to our clients. We want customers to find us intelligent but not intellectual, bold but not arrogant, thought-provoking but not patronising, different while being straightforward, positive but not pushy, contemporary not stuffy, sophisticated but not superior.
2. Develop excellence Hiscox has a unique underwriting training programme developed by some of our very experienced underwriters. The training, which aims to reinforce Hiscox’s underwriting standards, includes how to underwrite profitably across the cycle and the importance of learning the lessons of history when assessing risks. We also want to instil in our underwriters a restless curiosity, to challenge convention and not simply to accept a practice because that is the way it has always been done in the past. Across the Group a total of 296 delegates completed our underwriting training programme in 2011. Hiscox London Market and Hiscox UK recently achieved Chartered Insurer status as the high standards and professionalism of our staff were recognised by The Chartered Insurance Institute (CII).
The Hiscox Partnership Senior staff members who have made an important contribution to the Group’s success may be appointed as a Hiscox Partner. The Hiscox Partnership, which numbers up to 5% of the total number of staff, is informed of all the strategic decisions and facts and figures of the Group, which enables them to influence the direction and performance of the Group. They also act as mentors to talented young people and ensure that we are operating in a way which is consistent with our values everywhere in the Group. In 2011, six new Partners were appointed.
Employee engagement survey In September, Hiscox conducted its fourth global employee engagement survey. The survey, which was open to all permanent members of staff, looked at how committed employees feel to Hiscox, their managers, their teams and their role. The idea behind it is simple: if employees feel very engaged they are more likely to stay and deliver their very best for the company. Being able to measure levels of commitment enables Hiscox to identify areas where it can improve performance and boost staff retention.
The survey shows Hiscox enjoys high employee engagement as we average in the top 80th percentile when compared with 127 companies based around the world. Particularly pleasing was our ‘intent to stay’ score which is in the 90th percentile.
Profit before tax for the year was £17.3 million (2010: £211.4 million), despite reserving £270 million (2010: £165 million) for catastrophe losses and the volatile investment markets experienced during the year. The Group recorded a post tax return on equity of 1.7% (2010: 16.5%) and earnings per share were 5.5p (2010: 47.2p).
Net asset value per share reduced by 2.8% to 323.5p (2010: 332.7p) driven by smaller profits and the dividend payments made during the year. The Group continues to maintain a progressive dividend policy and total dividend per share rose by 3% to 17.0p (2010: 16.5p).
Gross premiums written of £1.45 billion were up 1.2% compared to the prior year. Strong growth in the local errors and omissions business and specialty lines were offset by reductions in reinsurance and large technology and media lines. The Group’s combined ratio including foreign exchange was 99.5% (2010: 89.3%) due to reserves of £270 million (2010: £165 million) for the large amount of catastrophes during 2011.
Hiscox London Market Gross premiums written increased slightly by 2.2% to £585.4 million (2010: £572.7 million), with growth in specialty lines offset by reductions in reinsurance and large technology and media lines.
Reinsurance purchased was at a similar level to the prior year at 29.4% of gross premiums written (2010: 32.0%). The quota share arrangement with Syndicate 6104 remained in place.
Hiscox UK and Europe Gross premiums written rose by 9.5% to £498.0 million (2010: £454.7 million). Gross premiums written for the UK increased by 12.3% mainly due to good growth in the professional and specialty commercial lines of business. Europe remained broadly constant year to year with gross premiums written of £130.9 million (2010: £127.6 million).
The net claims ratio improved by 3.9% to 46.3% compared to the prior year ratio of 50.2%, where one specific larger loss in Europe was balanced by a better claims experience in the UK. The combined ratio before the impact of foreign exchange improved to 91.0% from 94.8% in the prior year reflecting the improved claims experience during the year.
As a result profit before tax for the year increased by 30.0% to £51.5 million (2010: £39.6 million).
Hiscox International Gross premiums written decreased 9.7% to £365.8 million (2010: £405.2 million). The US reduced premiums by 15.5%, reflecting changes made in 2010, where we exited our inland marine and animal mortality business, and transferred our large technology and media businesses to Hiscox London Market. Bermuda also saw their premium reduce by 9.5% due to a disciplined underwriting approach. Gross premiums written in Guernsey were steady as they continued to underwrite cautiously in piracy lines.
The net claims ratio was heavily impacted by the catastrophe losses on the Australian floods, Japanese earthquake and the resulting tsunami, two further earthquakes in New Zealand, the US tornados in Alabama and Joplin, Hurricane Irene, and the floods in Thailand. The net claims ratio therefore declined to 89.9% (2010: 53.2%). The impact on the combined ratio excluding foreign exchange was a deterioration of 36.4% to 132.8% (2010: 96.4%).
Group investments Hiscox Ltd Report and Accounts 2011 19Group financial performance Hiscox Ltd Report and Accounts 2011 19 information provided to management, under the Solvency II regime.
Net cash outflows from financing activities for the year were £67.3 million (2010: outflow £172.9 million). The outflow is due to payment of dividends to shareholders and the full repayment of the cash borrowing facility outstanding at 2010 of £20 million.
There were no impairments recorded against cash or cash equivalents and no issues regarding recoverability have been identified on these assets. The Group has no direct exposure to sovereign debt in Portugal, Ireland, Italy, Greece or Spain.
At 31 December 2011, $340 million had been drawn by way of Letter of Credit against the Group’s $750 million revolving credit facility, with no cash drawings outstanding (2010: $165 million and £20 million respectively).
The Group’s invested assets at 31 December 2011 totalled £2.87 billion (2010: £2.78 billion). Cash flow remained healthy and the £75 million of Group borrowing that was outstanding at the half year was repaid before year end. The investment result, excluding derivatives, amounted to £25.9 million (2010: £98.8 million) equating to a return of 0.9% (2010: 3.6%).
Investment income in 2011 was forecast to be much reduced from that achieved in 2009 and 2010 and some volatility was to be expected. As it turned out, after a reasonably bright start, investment markets succumbed to a bout of significant turbulence, reminiscent of the latter part of 2008. Investors like certainty, not the indecisiveness served up by politicians in America over raising the debt ceiling and in Europe over the Eurozone crisis. The reality that Greece might default and the loss by the US of its AAA status finally sapped investors’ appetite for risk and triggered a flight to quality. The main beneficiaries of the ensuing risk aversion included the US, UK and German government bond markets. Additionally, with the threat of recession growing, the Federal Reserve and the Bank of England responded with increased monetary stimulus adding further pressure to the downward trend in treasury and gilt yields. Riskier assets, by contrast, including corporate bonds and equities, were shunned by investors with prices marked down amidst a growing lack of liquidity. The performance of Eurozone sovereign bonds diverged dramatically.
Our allocation to risk assets delivered a negative return. Whilst the portfolio of funds performed relatively well in difficult markets, beating a negative benchmark is never entirely satisfactory. Additional resource has been devoted to the selection of our long only and hedge fund managers and a number of changes have been made to their composition. On the whole the long only funds outperformed but some of our hedge funds had a disappointing year by their recent standards. Although volatile, over time we expect our risk assets to contribute to the growth of the Group’s net asset value.
What is the risk? Why do we have it? How is it managed?
Though volatile and potentially costly, this business is compelling for us, as it is capable of earning good margins over the medium to long-term.
One of our Executive Directors – either the Chairman, Chief Executive Officer, Chief Financial Officer or Chief Underwriting Officer – chairs each of these committees, apart from the Operational Risk Committee, which is chaired by the Chief Operations Officer.
This monitoring assesses the level of risk being taken by the Group in pursuing its objectives, and to ensure that this level of risk remains within the parameters set by the Board.
Major risks The major risks facing the Group are designated as being either of ‘principal’ or ‘secondary’ importance. Principal risks are those viewed to be potentially the most damaging for the Group, while secondary risks are not deemed to be critical at this stage. Certain of these risks arise from financial instruments held by the Group and are also discussed in note 3 to the consolidated financial statements.
We are firmly resolved to reject business that is unlikely to generate underwriting profits. Accepting risks below their technical price is detrimental to the industry’s prospects since it drives the prevailing market rates down to a point where underwriting losses mount, insurers’ capital is destroyed causing some businesses to fail, customers to receive poor service and the industry to suffer negative publicity. Hiscox incentivises underwriters on return on equity which rewards staff for profit not revenue. Our appetite for certain lines of business changes according to the prevailing market conditions and the risk appetite of the Group. We regularly monitor pricing levels, producing detailed monthly reports grouping current prices with exposure and trends over the past 12 months. Thus we ensure that we quickly identify and control developing problems created by adverse changes in market conditions. We frequently act as the lead insurer in the co-insurance programmes required to cover significant high value assets, so we have some ability to set market rates rather than follow them.
As an insurance company we are required to hold claims reserves.
Risk management continued 24 Risk management Hiscox Ltd Report and Accounts 2011
We have a conservative investment policy: our overriding concern is to not lose money or to put at risk the Group’s capacity to underwrite. Our policy is designed to maximise returns within an overall risk appetite. Technical funds – those funds held for reserves – are invested primarily in high quality bonds and cash. The high quality and short duration of these funds allows the Group to meet its aim of paying valid claims quickly. These funds, as far as possible, are maintained in the currency of the original premiums for which they are set aside to reduce foreign exchange risk. As many of our insurance and reinsurance liabilities have short time spans, we do not aim to match exactly the duration of our assets and liabilities. Our fixed income fund managers are set benchmarks that approximate the payment profile of our claims while still providing them with some flexibility to enhance returns. A proportion of the Group’s assets are allocated to riskier assets, principally equities. For these assets we take a longterm view so we can achieve the best risk-adjusted returns. The proportion of funds we invest in risk assets will depend on the outlook for investment and underwriting markets. We make an allocation to less volatile, absolute return strategies within our risk assets, so as to balance our desire to maximise returns with the need to ensure capital is available to support our underwriting throughout any downturn in financial markets. Investment risk also encompasses the risk of default of counterparties, which is primarily with issuers of bonds in which we invest. Our third-party investment managers are issued guidelines as to the type and nature of bonds in which to invest.
That we are unable to meet our liabilities to customers or other creditors when they fall due. Also the risk that we incur excessive costs by selling assets or raising finance in a very short time to meet our obligations.
Our investment policy recognises the demands created by our underwriting strategy, so that some investments may need to be realised before maturity or at short notice. Hence a high proportion of our investments are in liquid assets, which reduces our risk of making losses because we may have to sell assets quickly.
Principal risks continued 25Risk management Hiscox Ltd Report and Accounts 2011
Binding authorities give the Group access to a greater volume of business.
All binding authorities we grant are closely controlled through tight underwriting guidelines. We vet all our agents prior to appointment and monitor and audit them regularly. Agents are frequently audited to ensure they meet our standards.
We have a formal disaster recovery plan in place that deals with both workspace recovery and the retrieval of communications, IT systems and data if a major problem occurred. These procedures would enable us to move the affected operations to alternative facilities very quickly. The disaster recovery plan is tested regularly and includes disaster simulation tests.
We are exposed to new and emerging risks, primarily through legal or political decisions. For example, a change in US legislation may result in exposures being included within our coverage that had not been intended by our underwriters, or may require us to cease business in certain US states.
Our sustainability efforts have also been recognised by the City of London Corporation. In 2011, for a third year in a row, our London office received a Clean City Scheme Gold award.
Dealing with customers Hiscox is dedicated to providing its customers with risk management advice to prevent distressing losses such as burglary and fire in the home. Similarly, when a small business client is sued, our expert claims staff bring to bear years of expertise to defend the client or resolve the situation swiftly. The Hiscox philosophy is that insurance is a promise to pay, so should a loss occur, we aim to fully support our customers and to pay their claims as soon as possible.
standards of corporate governance while striving to remain, in essence, a non-bureaucratic organisation. An effective and firm system of internal controls ensures that risks are managed within acceptable limits, but not at the expense of innovation or speed of response. The Group believes that we have got this balance right and, furthermore, that this is one of our greatest strengths. The Group’s policies ensure that we continue to follow a best practice approach to managing people and remain a fair and professional employer. In the unlikely event of an employee having a serious concern relating to the operations of the business, a whistleblowing policy explains to staff how they can confidentially raise their misgivings. Hiscox also subscribes to Public Concern at Work, which provides free legal advice to any employee with a concern about possible danger or malpractice in the workplace.
Rewards and benefits Hiscox encourages employees to share in the success of the Group through performance related pay, bonus, savings-related share option schemes and executive share option schemes. Competitive benefits packages contain health and fitness perks and opportunities for flexible working and career breaks. Towers Watson benchmarks our salary packages against the financial services industry as a whole and against the Lloyd’s market specifically (where applicable) and our salaries are also considered on a country-by-country basis.
The community Hiscox donated £533,000 to charities in 2011. The Group has maintained its involvement in its local communities with the strong support of its employees. In Bermuda, Hiscox supports the Centre Against Abuse which provides shelter, support and tools to those involved in relationship abuse. We assist in the furnishing of the safe house for battered women and their children. Hiscox also supports The Women’s Resource Centre by funding the Centre’s 24 hour hotline. Other support was provided to the Bermuda Senior Islanders’ Centre (a senior citizens social group), and Big Brothers and Big Sisters of Bermuda (a one-to-one mentoring programme). Hiscox USA doubled its donations to $100,000 supporting a variety of charities across the US and helped to organise events where employees volunteered their time. These charities included; City Year (New York), Make-A-Wish (San Francisco) and the Children’s Restoration Network (Atlanta). Hiscox is a member of the Lloyd’s Community programme, which supports local initiatives concerning education, training, enterprise and regeneration. In London, members of our staff help pupils at the Elizabeth Selby Infants School in Tower Hamlets through the Reading Partners’ Scheme. Employees also mentor students at Cambridge Heath Sixth Form.
2% Belgium 3% Other Europe 4% Netherlands 7% Germany 12% France 72% UK
Hiscox Insurance Company Limited has achieved average compound growth in gross premiums written of 13.1% from 1997 to 2011, despite discontinuing almost all of its original business. It has also significantly improved its combined ratio.
At the end of 2011, net assets exceeded £224 million (2010: £197 million).
Hiscox Bermuda has an A.M. Best rating of A (Excellent) and an A (Strong) rating from Fitch. At the end of 2011, net assets exceeded $846 million (2010: $941 million).
Hiscox Insurance Company Inc. Hiscox Insurance Company Inc. was acquired by the Group in 2007 through the purchase of the then parent holding company ALTOHA, Inc.
Hiscox Insurance Company Inc. is rated A (Excellent) by A.M. Best. At the end of 2011, net assets exceeded $58 million (2010: $58 million).
Stuart Bridges joined Hiscox in 1999. He is a Chartered Accountant and has held posts in various financial service companies in the UK and US, including Henderson Global Investors. During the year he was a member of the Financial Regulation and Taxation Committee of the Association of British Insurers, a member of the audit committee of the Institute of Chartered Accountants in England and Wales and Chairman of the Lloyd’s Market Association Finance Committee.
Robert Simon Childs Chief Underwriting Officer and Chairman of Hiscox USA (Aged 60)
Bankers HSBC Bank Bermuda Limited 6 Front Street Hamilton HM 11 Bermuda
Registrars Capita Registrars (Jersey) Limited PO Box 532 St Helier Jersey JE4 5UW
Andrea Rosen joined the Hiscox Ltd Board in 2006. She is a Director of Alberta Investment Management Corporation, Emera Inc. and Manulife Financial Corporation. She was previously Vice Chair of TD Financial Group and President of TD Canada Trust from 2002 to 2005. Prior to this she held various positions within the TD Financial Group from 1994 to 2002, including Executive Vice President of TD Commercial Banking and Vice Chair of TD Securities. She was Vice President of Varity Corporation from 1991 to 1994 and held various positions with Wood Gundy Inc. from 1981 to 1990.
Robert (Bob) McMillan joined the Hiscox Ltd Board in December 2010. He spent 24 years with the Progressive Insurance Corporation where he served in various positions including National Director of Product Development, then claims before becoming National Director of Marketing. He led Progressive’s initiatives in multi-channel distribution, financial responsibility based rating, and immediate response claims. He has received two United States patents related to motor insurance pricing. He has lectured on business innovation at the University of Virginia’s Darden School of Business and at the Harvard Business School. He has been a Non Executive Director of Hiscox Inc. since March 2007.
Daniel Healy joined Hiscox in 2006. He was appointed Executive Vice President and Chief Financial Officer of North Fork Bancorporation in 1992 and a member of its Board of Directors in 2000. He was a partner with KPMG LLP before joining North Fork. He was the Managing Partner of the San José, California and Long Island, New York offices and held other positions in that firm during his tenure. He is Chief Executive Officer of Bond Street Holdings Inc and Florida Community Bank, a subsidiary and holds a Board position with KBW, Inc.. He is also a Senior Adviser to Permira Advisers LLC, an international private equity firm. He was previously Chairman of Herald National Bank.
Daniel Maurice Healy Non Executive Director and Chairman of the Audit Committee (Aged 69)
Dr James Austin Charles King Non Executive Director and Chairman of the Conflict Committee (Aged 73)
Overview and basis of reporting Hiscox Ltd (‘the Company’) is the Bermudian domiciled holding company for the Group. The Company has a premium listing on the London Stock Exchange. The corporate governance framework for companies registered in Bermuda is established by the Company’s constitution together with Companies Act legislation. During 2011, and up to the date of this report and accounts, the Group has complied with the provisions of the UK Corporate Governance Code (formerly the Combined Code) in all material respects.
A copy of the advice is provided to the Company Secretary who will circulate it to all Directors. The Board meets at least four times a year and operates within established Terms of Reference.
The Board’s Terms of Reference include a Schedule of Matters Reserved for Board Decision, a copy of which can be found on the Group’s website: www.hiscox.com. Aside of the opportunity which the Non Executive Directors have to challenge and contribute to the development of strategy in the regular Board meetings the Non Executive Directors also attended the annual Hiscox Partners’ meeting.
The Audit Committee The Audit Committee of Hiscox Ltd is chaired by Daniel Healy and comprises Richard Gillingwater, Ernst Jansen, Dr James King, Bob McMillan, Andrea Rosen and Gunnar Stokholm. The
The Remuneration and Nomination Committee The Remuneration and Nomination Committee comprises Richard Gillingwater, Daniel Healy, Ernst Jansen, Dr James King, Bob McMillan, Andrea Rosen and Gunnar Stokholm. It is chaired by Andrea Rosen. It operates according to Terms of Reference published on the Group’s website and generally meets three times a year.
The Conflicts Committee The Group has a Conflicts Committee which comprises independent Non Executive Directors from within the Group, and is chaired by Dr James King. It meets as and when required. Conflicts of interest may arise from time to time because Syndicate 33, Syndicate 3624 and Syndicate 6104 are managed by a Hiscox-owned Lloyd’s Managing Agency. 27.5% of the Names on Syndicate 33 are third-parties and 72.5% of Syndicate 33 is owned by a Hiscox Group company. 100% of Syndicate 3624 is owned by a Hiscox Group company. 100% of Syndicate 6104 is owned by third-parties. The Conflicts Committee serves to protect the interests of the third-party Syndicate Names. Should such a potential conflict of interest arise, there is a formal procedure to refer the matter to this Committee.
Shareholder communications The Executive Directors communicate and meet directly with shareholders and analysts throughout each year, and do not limit this to the period following the release of financial results or other significant announcements. All Directors attended the Annual General Meeting in 2011.
The Company commissions independent research on feedback from shareholders and analysts on a regular basis following the Company’s results announcements. This research together with the analysts’ research notes are copied to the Non Executive Directors in full. The Chairman attends a number of meetings with shareholders as well as speaking at the analysts’ presentations. In addition, any specific items covered in letters received from major shareholders are reported to the Board. Major shareholders are invited to request meetings with the Senior Independent Director and/or the other Non Executive Directors.
The Committee is provided with data and has access to advice from Towers Watson, independent remuneration consultants. The Company also uses the Towers Watson compensation benchmarking reports.
Remuneration policy The remuneration philosophy is to provide rewards that are competitive in every country in which Hiscox operates and that are consistent with our overall reward principles: competitive base pay; benefits which encourage health and security for the individual and his or her family but are not excessive and are consistent at all levels of the organisation; annual bonus scheme which enables employees to earn attractive bonuses for generating good levels of return on equity; encourage share ownership at all levels of the organisation and require it at senior levels; and contracts and notice periods that are in line with acceptable market practice but limit severance payments made on termination.
As a business Hiscox is focused on generating strong returns on equity and long-term shareholder returns, therefore our reward structure is aligned with this.
Base salary Base salaries are reviewed annually. The Remuneration and Nomination Committee takes into account inflation rate movements by country, market data provided by its own consultants, Towers Watson, and the competitive position of Hiscox salaries (based on the Towers Watson salary reports), in order to set the overall salary budget.
Variable reward Annual cash incentives (bonuses) Hiscox’s remuneration policy is underpinned by the belief that a reasonable portion of total remuneration should be attained through incentive awards, thereby linking rewards directly with performance. The expectation is that successful performance (company and individual) should enable employees to achieve upper quartile total remuneration.
The Hurdle Rate is reviewed annually by using a benchmark which takes account of the mediumterm forward looking investment returns (specifically the 1–3 year Gilt and Treasury yields, cash returns and the general investment environment). The Hurdle Rate is set at 5% above this benchmark rate. If the benchmark rate dropped to zero, or exceeded 7.5% (suggesting a Hurdle Rate of 5% or above 12.5%) we would review this approach. Based on the approach the Hurdle Rate for 2011 was set at 7.5%.
All employees, including Executive Directors, participate in profit related bonus pools. These pools are calculated at a business unit level and for the Group as a whole on the basis of a set percentage of profits in excess of a return on allocated equity hurdle (‘Hurdle Rate’). The Hurdle Rate is currently set at a 7.5%. In the case of Bermuda, the London Market and Guernsey business units the pool is 15% of profits in excess of the Hurdle Rate return on allocated equity. In the case of the UK and Europe, the bonus pool is 15% of profits from the ground up, but this is only released when the business unit’s return on allocated equity exceeds the Hurdle Rate. For businesses in the development phase, such as our US business, bonuses are awarded on achievement of budgets agreed at the beginning of the year.
Formal shareholding guidelines are in place which mean that within five years of becoming an Executive Director, Hiscox Partner (the top 5% of employees in the company) or a member of a subsidiary board, the employee will be
External Non Executive Directorships No external appointments may be accepted by an Executive Director where such appointment may give rise to a conflict of interest. The consent of the Chairman is required in any event. During the year, RRS Hiscox has been a Non Executive Director of Grainger Trust plc and was paid £40,000 for his services and of AGICM Ltd and was paid £5,000, for the period until his resignation on 12 July 2011. RS Childs, SJ Bridges and BE Masojada did not hold any Non Executive Director positions during the year.
Remuneration of Non Executive Directors Non Executive Directors receive an annual fee in respect of their Board appointments together with additional compensation for their further duties in relation to Board committees. All amounts are denominated in US Dollars. The structure of the fees paid is detailed below.
International Sharesave Scheme Other employees 11,584 – (11,584) – – 2.210 – 01-Dec-10 31-May-11
Market price at date of exercise £ Date from which released
Directors The names and details of the individuals who served as Directors of the Company during the year are set out on pages 34 to 35. Details of the Chairman’s professional commitments are included in his biography.
In accordance with the UK Corporate Governance Code all Directors will submit themselves for re-appointment at the Annual General Meeting of the Company.
Political and charitable contributions The Group made no political contributions during the year (2010: £nil). Charitable donations totalled £533,000 (2010: £1,109,000) of which £250,000 (2010: £500,000) was donated to the Hiscox Foundation, a UK registered charity. The policy of the Hiscox Foundation is to assist and improve education, the arts and independent living for disabled and disadvantaged members of society. Further information concerning the Group’s charitable activities is contained in the report on corporate responsibility on pages 28 and 29.
Massachusetts Financial Services Company *Based on voting rights of 388,420,033 as at 24 February 2012.
Annual General Meeting The notice of the Annual General Meeting, to be held at the Fairmont Hamilton Princess Hotel, 76 Pitts Bay Road, Pembroke HM 08, Bermuda on 30 May 2012 at 10:00am (2:00pm (BST)), is contained in a separate circular to shareholders enclosed with this report.
Directors’ report The Directors have pleasure in submitting their Annual Report and consolidated financial statements for the year ended 31 December 2011.
Share capital Details of the structure of the Company’s share capital and changes in the share capital during the year are disclosed in note 24 to the consolidated financial statements.
5p Ordinary Shares number of shares beneficial 5p Ordinary Shares number of shares beneficial
48 Director’s report/Directors’ responsibilities statement Hiscox Ltd Report and Accounts 2011
The Directors responsible for authorising the responsibility statement on behalf of the Board are the Chairman, RRS Hiscox and the Chief Financial Officer, SJ Bridges. The statements were approved for issue on 27 February 2012.
Auditors’ responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit and, under the terms of our engagement letter, to audit the part of the Directors’ remuneration report that is described as having been audited.
Opinion In our opinion: the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as at 31 December 2011, and of its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the EU; and the part of the Directors’ remuneration report which we were engaged to audit has been properly prepared in accordance with Schedule 8 to the UK Companies Act 2006 The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008 No. 410), as if those requirements were to apply to the Company.
Income Gross premiums written 4 1,449,219 1,432,674 Outward reinsurance premiums (275,208) (301,047)
Gross premiums earned 1,428,954 1,435,118 Premiums ceded to reinsurers (283,947) (303,960)
Earnings per share on profit attributable to owners of the Company
Deferred acquisition costs 17 150,050 142,736 Financial assets carried at fair value 19 2,368,636 2,459,107
Financial liabilities 19 – 20,457 Current tax – 29,995 Trade and other payables 27 314,135 348,998
Profit before tax 17,271 211,366 Adjustments for: Interest and equity dividend income (50,333) (61,606) Interest expense 6,698 10,090 Net fair value gains/(losses) on financial assets 30,878 (25,672)
Charges in respect of share based payments 9, 24 8,677 8,047 Other non-cash movements (1,070) 1,323 Effect of exchange rate fluctuations on cash presented separately (1,451) (508)
Cash flows from operations 216,591 265,602 Interest received 50,244 60,332 Equity dividends received 1,531 1,274 Interest paid (6,163) (4,628) Current tax paid (4,003) (51,580)
Cash flows from the acquisition of subsidiaries 33 – (3,662) Cash flows from the sale and purchase of associates 16 729 468 Cash flows from the purchase of property, plant and equipment (2,561) (3,462) Cash flows from the purchase of intangible assets (9,992) (15,591)
Proceeds from the issue of ordinary shares 24 3,215 4,108 Dividends paid to owners of the Company 32 (50,512) (58,460) Net (repayments)/receipts of borrowings (20,000) (118,539)
The consolidated financial statements for the year ended 31 December 2011 include all of the Group’s subsidiary companies and the Group’s interest in associates. All amounts relate to continuing operations.
The Group is generally supportive of the proposed measurement principles for short duration contracts however we have submitted a comment letter to the IASB outlining our concerns and issues with some of the definitions and detail included within the exposure draft. We continue to monitor the progress of the project.
2.2 Basis of preparation The financial statements are presented in Pounds Sterling and are rounded to the nearest thousand unless otherwise stated. They are compiled on a going concern basis and prepared on the historical cost basis except that pension scheme assets included in the measurement of the employee retirement benefit obligation, and certain financial instruments including derivative instruments are measured at fair value. Employee retirement benefit obligations are determined using actuarial analysis. The balance sheet of the Group is presented in order of increasing liquidity.
The Group has financial assets and cash of over £2.87 billion. The portfolio is predominantly invested in liquid short-dated bonds and cash to ensure significant liquidity to the Group and to reduce risk from the financial markets. In addition the Group has significant borrowing facilities in place.
The Group uses the acquisition method of accounting to account for the acquisition of subsidiaries. At the date of acquisition, the Group recognises the identifiable assets acquired and liabilities assumed as part of the overall business combination transaction at their acquisition date fair value. Recognition of these items is subject to the definitions of assets and liabilities in the Framework for the Preparation and Presentation of Financial Statements. The Group may also recognise intangible items not previously recognised by the acquired entity such as customer relationships.
(b) Associates Associates are those entities in which the Group has significant influence but not control over the financial and operating policies. Significant influence is generally identified with a shareholding of between 20% and 50% of an entity’s voting rights. The consolidated financial statements include the Group’s share of the total recognised gains and losses of associates on an equity accounted basis from the date that significant influence commences until the date that significant influence ceases. The Group’s share of its associates’ postacquisition profits or losses after tax is recognised in the income statement for each period, and its share of the movement in the associates’ net assets is reflected in the investments’ carrying values in the balance sheet. When the Group’s share of losses equals or exceeds the carrying amount of the associate, the carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the associate.
(c) Transactions eliminated on consolidation Intragroup balances, transactions and any unrealised gains arising from intragroup transactions are eliminated in preparing the consolidated financial statements. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. In accordance with IAS 21, foreign currency gains and losses on intragroup monetary assets and liabilities may not fully eliminate on consolidation when the intragroup monetary item concerned is transacted between two Group entities that have different functional currencies. Unrealised gains arising from transactions with associates are eliminated to the extent of the Group’s interest in the entity.
IFRS 9 Financial Instruments is due to be effective from 1 January 2015. The standard contains two primary measurement categories for financial assets of amortised cost and fair value. Financial assets are classified in to one of these two categories on initial recognition. A financial asset is measured at amortised cost if the following conditions are met: it is held where the objective is to hold the asset in order to collect contractual cash flows; and, its contractual terms give rise on specified dates to cash flows that are solely payment of principal and interest on the principal outstanding. All other financial assets are to be classified at fair value.
A number of new standards, amendments to standards and interpretations are effective for annual periods beginning after 1 January 2011, and have not been applied in preparing these consolidated financial statements. None of these is expected to have a significant effect on the consolidated financial statements except for IFRS 9 and IAS 19.
2.6 Intangible assets (a) Goodwill Goodwill represents amounts arising on acquisition of subsidiaries and associates. In respect of acquisitions that have occurred since 1 January 2004, goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets and contingent liabilities assumed of the acquired subsidiary or associate at the acquisition date.
(b) Syndicate capacity The cost of purchasing the Group’s participation in the Lloyd’s insurance syndicates is not amortised but is tested annually for impairment and is carried at cost less accumulated impairment losses. Having considered the future prospects of the London insurance market, the Board believes that the Group’s ownership of syndicate capacity will provide economic benefits over an indefinite number of future periods.
When a foreign operation is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale.
administration expenses, as well as investment income from assets backing such liabilities, are used. Any deficiency is immediately charged to profit or loss initially by writing-off DAC and by subsequently establishing a provision for losses arising from liability adequacy tests (‘the unexpired risk provision’). Any DAC written-off as a result of this test cannot subsequently be reinstated.
(e) Outwards reinsurance contracts held Contracts entered into by the Group, with reinsurers, under which the Group is compensated for losses on one or more insurance or reinsurance contracts and that meet the classification requirements for insurance contracts, are classified as insurance contracts held. Contracts that do not meet these classification requirements are classified as financial assets.
2.12 Revenue Revenue comprises insurance and reinsurance premiums earned on the rendering of insurance protection, net of reinsurance, together with profit commission, investment returns, agency fees and other income inclusive of fair value movements on derivative instruments not formally designated for hedge accounting treatment. The Group’s share of the results of associates is reported separately. The accounting policies for insurance premiums are outlined below. Profit commission, investment income and other sources of income are recognised on an accruals basis net of any discounts and amounts such as sales-based taxes collected on behalf of third-parties. Profit commission is calculated 2 Significant accounting policies continued
When the terms and conditions of an equity settled share based employee compensation plan are modified, and the expense to be recognised increases as a result of the modification, then the increase is recognised evenly over the remaining vesting period. When a modification reduces the expense to be recognised, there is no adjustment recognised and the pre-modification expense continues to be applied. The proceeds received net of any directly attributable transaction costs are credited to share capital and share premium when the options are exercised.
Subrogation reimbursements are also considered as an allowance in the measurement of the insurance liability for claims and are recognised in other assets when the liability is settled. The allowance is the assessment of the amount that can be recovered from the action against the liable third-party.
2.14 Deferred tax Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. However, if the deferred income tax arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss, it is not recognised. Deferred tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the Group controls the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future.
2.15 Employee benefits (a) Pension obligations The Group operated both defined contribution and defined benefit pension schemes during the year under review. The defined benefit scheme closed to future accrual with effect from 31 December 2006 and active members were offered membership of the defined contribution 2 Significant accounting policies continued 2.13 Insurance contracts continued (g) Salvage and subrogation reimbursements continued
possibility of withdrawal; or providing termination benefits as a result of an offer made to encourage voluntary redundancy.
(e) Profit sharing and bonus plans The Group recognises a liability and an expense for bonuses and profit sharing, based on a formula that takes into consideration the profit attributable to the Company’s shareholders after certain adjustments. The Group recognises a provision where a contractual obligation to employees exists or where there is a past practice that has created a constructive obligation.
2 Significant accounting policies continued 2.15 Employee benefits continued (d) Termination benefits continued
and approved by the Board in advance of each underwriting year. The Board continually reviews its underwriting strategy throughout each underwriting year in light of the evolving market pricing and loss conditions and as opportunities present themselves. The Group’s underwriters and management consider underwriting risk at an individual contract level, and also from a portfolio perspective where the risks assumed in similar classes of policies are aggregated and the exposure evaluated in light of historical portfolio experience and prospective factors. To assist with the process of pricing and managing underwriting risk the Group routinely performs a wide range of activities including the following: regularly updating the Group’s risk models; documenting, monitoring and reporting on the Group’s strategy to manage risk; developing systems that facilitate the identification of emerging issues promptly; utilising sophisticated computer modeling tools to simulate catastrophes and measure the resultant potential losses before and after reinsurance; monitoring legal developments and amending the wording of policies when necessary; regularly aggregating risk exposures across individual underwriting portfolios and known accumulations of risk; examining the aggregated exposures in advance of underwriting further large risks; and developing processes that continually factor market intelligence into the pricing process.
The Board exercises oversight of the development and operational implementation of its risk management policies and procedures, and ongoing compliance therewith, partially through its own enquiries but primarily through a dedicated internal audit function, which has operational independence, clear terms of reference influenced by the Board’s Non Executive Directors and a clear upwards reporting structure back into the Board. The Group, in common with the non-life insurance industry generally, is fundamentally driven by a desire to originate, retain and service insurance contracts to maturity. The Group’s cash flows are funded mainly through advance premium collections and the timing of such premium inflows is reasonably predictable. In addition, the majority of material cash outflows are typically triggered by the occurrence of insured events non-correlated to financial markets, and not by the inclination or will of policyholders.
The principal sources of risk relevant to the Group’s operations and its financial statements fall into two broad categories: insurance risk and financial risk both of which are described in notes 3.1 and 3.2 below. The Group also actively manages its capital risks as detailed in note 3.3.
3 Management of risk The Group’s overall appetite for accepting and managing varying classes of risk is defined by the Group’s Board. The Board has developed a governance framework and has set Group wide risk management policies and procedures which include risk identification, risk management and mitigation and risk reporting. The objective of these policies and procedures is to protect the Group’s shareholders, policyholders and other stakeholders from negative events that could hinder the Group’s delivery of its contractual obligations and 2 Significant accounting policies continued 2.22 Use of critical estimates, judgements and assumptions continued
from one year to the next. The events are extreme and as yet untested, and as such these estimates may prove inadequate as a result of incorrect assumptions, model deficiencies, or losses from unmodeled risks. This means that should a realistic disaster actually eventuate, the Group’s final ultimate losses could materially differ from those estimates modeled by management. The Group’s estimated exposure to certain industry events is summarised below. These estimates have been made using modeled assumptions and management judgement and given the nature of risks underwritten may be materially different from actual losses suffered depending on the size and nature of the event.
Overleaf is a summary of the gross and net insurance liabilities for each category split by region of risk.
3 Management of risk continued 3.1 Insurance risk continued i) Underwriting risk continued
The specific insurance risks accepted by the Group fall broadly into the following main categories: reinsurance inwards, marine and major asset property, other property risks, professional indemnity casualty and casualty other insurance risks. These specific categories are defined for risk review purposes only as each contain risks specific to the nature of the cover provided. They are not exclusively aligned to any specific reportable segment in the Group’s operational structure or the primary internal reports reviewed by the chief operating decision maker. The following describes the policies and procedures used to identify and measure the risks associated with each individual category of business.
The provision of insurance to cover allegations made against individuals acting in the course of fiduciary or managerial responsibilities, including directors’ and officers’ insurance is one example of a casualty insurance risk. However the Group’s specific exposure to this specific risk category is relatively limited. The Group’s casualty insurance contracts mainly experience low severity attritional losses. By nature, some casualty losses may take longer to settle than the other categories of business.
The majority of the Group’s casualty exposures are written on a claims made basis. However the final quantum of these claims may not be established for a number of years after the event. Consequently a significant proportion of the casualty insurance amounts reserved on the balance sheet may not be expected to settle within 24-months of the balance sheet date.
Other property risks The Group provides home and contents insurance, together with cover for art work, antiques, classic cars, jewellery, collectables and other assets. The Group also extends cover to reimburse certain policyholders when named insureds or insured assets are seized for kidnap and a ransom demand is subsequently met. Events which can generate claims on these contracts include burglary, kidnap, seizure of assets, acts of vandalism, fires, flooding and storm damage. Losses on most classes can be predicted with a greater degree of certainty as there is a rich history of actual loss experience data and the locations of the assets covered, and the individual levels of security taken by owners are relatively static from one year to the next. The losses associated with these contracts tend to be of a higher frequency and lower severity than the marine and other major property assets covered above.
The Group’s home and contents insurance contracts are exposed to weather and climatic risks such as floods and windstorms and their consequences. As outlined earlier the frequency and severity of these losses do not lend themselves to accurate prediction over the short-term. Contract periods are therefore not normally more than one year at a time to enable risks to be regularly re-priced.
For this reason the Group accepts major property insurance risks for periods of mainly one year so that each contract can be re-priced on renewal to reflect the continually evolving risk profile. The most significant risks covered for periods exceeding one year are certain specialist lines such as marine and offshore construction projects which can typically have building and assembling periods of between three and four years. These form a small proportion of the Group’s overall portfolio.
Geographic focus Specific UK mandates 39 44 Global mandates 61 56
Debt and fixed income assets are predominantly invested in high quality corporate, government and asset backed bonds. The investments typically have relatively short durations and terms to maturity. The portfolio is managed to minimise the impact of interest rate risk on anticipated Group cash flows.
At 31 December 2011, the Group holds asset-backed and mortgage-backed fixed income instruments in its investment portfolio however has minimal direct exposure to sub-prime asset classes. Together with the Group’s investment managers, management continues to monitor the potential for any adverse development associated with this investment exposure through the analysis of relevant factors such as credit ratings, collateral, subordination levels and default rates in relation to the securities held. The Group has no direct exposure to sovereign debt in Portugal, Ireland, Italy, Greece or Spain. Note 3.2d shows the Group’s positions at 31 December 2011 for government issued, government supported and bank debt exposures. The Group did not experience any material defaults on debt securities during the year.
(a) Reliability of fair values The Group has elected to carry all financial investments at fair value through profit or loss as they are managed and evaluated on a fair value basis in accordance with a documented strategy. With the exception of unquoted equity investments, all of the financial investments held by the Group are available to trade in markets and the Group therefore seeks to determine fair value by reference to published prices or as derived by pricing vendors using observable 3 Management of risk continued 3.1 Insurance risk continued Reserving risk continued
policyholder. The creditworthiness of reinsurers is therefore continually reviewed throughout the year.
The Committee considers the reputation of its reinsurance partners and also receives details of recent payment history and the status of any ongoing negotiations between Group companies and these third-parties. This information is used to update the reinsurance purchasing strategy. Individual operating units maintain records of the payment history for significant brokers and contract holders with whom they conduct regular business. The exposure to individual counterparties is also managed by other mechanisms, such as the right of offset where counterparties are both debtors and creditors of the Group. Management information reports detail provisions for impairment on loans and receivables and subsequent write-off. Exposures to individual intermediaries and groups of intermediaries are collected within the ongoing monitoring of the controls associated with regulatory solvency.
The concentrations of credit risk exposures held by insurers may be expected to be greater than those associated with other industries, due to the specific nature of reinsurance markets and the extent of investments held in financial markets. In both markets, the Group interacts with a number of counterparties who are engaged in similar activities with similar customer profiles, and often in the same geographical areas and industry sectors. Consequently, as many of these counterparties are themselves exposed to similar economic characteristics, one single localised or macroeconomic change could severely disrupt the ability of a significant number of counterparties to meet the Group’s agreed contractual terms and obligations.
The fair value of debt and fixed income assets in the Group’s balance sheet at 31 December 2011 was £2,171 million (2010: £2,285 million). These may be analysed as follows: Nature of debt and fixed income holdings
The Group also mitigates credit counterparty risk by concentrating debt and fixed income investments in highly liquid instruments, including a particular emphasis on government bonds issued mainly by North American countries and the European Union, excluding those from Portugal, Greece, Ireland, Italy and Spain.
The largest counterparty exposure within AAA rating at 31 December 2011 is with the UK Treasury, and for AA rating is with the US Treasury. During the year, the US Treasury was downgraded from AAA to AA, which led to the significant shift from AAA to AA assets in the above table. At 31 December 2010, the largest counterparty exposure within AAA rating was the US Treasury. Catastrophe bonds included within ‘other/not rated’ are rated BB and B. A significant proportion of ‘other/not rated’ reinsurance assets at 31 December 2011 and 31 December 2010 are supported by Letter of Credit guarantees issued by financial institutions with Standard & Poor’s or equivalent credit or financial strength ratings of A or better.
At 31 December 2011 the Group held no material debt and fixed income assets that were past due or impaired beyond their reported fair values, either for the current period under review or on a cumulative basis (2010: £nil). For the current period and prior period, the Group did not experience any material defaults on debt securities.
The positions at 31 December 2011 in respect of government issued and supported debt are shown in the table below. The Group has no direct government exposure to Portugal, Italy, Ireland, Greece or Spain.
Included above are £1,049m in relation to holdings in debt securities and £122m held as cash equivalents, having a maturity of less than three months at the time of purchase. Of the amount held as cash equivalents, £88m is held in UK Treasury bills and £26m is held in a UK Government bond.
Additionally, the geographical location and credit quality of individual bank borrowers are closely monitored. An analysis of the Group’s exposure to bank counterparties by country and credit rating is detailed below as at 31 December 2011. Bank debt held by the Group is mostly senior unsecured and covered bonds. The subordinated bonds are all classed as lower tier 2 capital.
Included in the bank debt table above, are £222m in relation to holdings in debt securities and £5m held as cash equivalents.
(e) Liquidity risk The Group is exposed to daily calls on its available cash resources mainly from claims arising from insurance and reinsurance contracts. Liquidity risk is the risk that cash may not be available to pay obligations when due at a reasonable cost. The Board sets limits on the minimum level of cash and maturing funds available to meet such calls and on the minimum level of borrowing facilities that should be in place to cover unexpected levels of claims and other cash demands.
The main focus of the investment portfolio is on high-quality short duration debt and fixed income securities, and cash. There are no significant holdings of investments with specific repricing dates. Notwithstanding the regular interest receipts and also the Group’s ability to liquidate these securities and the majority of its other financial instrument assets for cash in a prompt and reasonable manner, the contractual maturity profile of the fair value of these securities at 31 December was as follows: Fair values at balance sheet date analysed by contractual maturity
Between one and two years 473,904 10,088 3,686 – 487,678 816,842 Between two and five years 816,665 – 5,580 – 822,245 654,638 Over five years 265,897 – – – 265,897 290,083
3 Management of risk continued 3.2 Financial risk continued (e) Liquidity risk continued
Liquidity requirements to settle estimated profile of net claim liabilities on balance sheet
Property – marine and major assets 29,233 17,715 17,753 1,720 66,421 *Includes a diverse mix of certain specialty lines such as kidnap and ransom, terrorism, bloodstock and other risks which contain a mix of property and casualty exposures.
Details of the payment profile of the Group’s borrowings, derivative instruments and other liabilities is given in notes 19 and 27.
Details of all foreign currency derivative contracts entered into with external parties are given in note 21. All foreign currency derivative transactions with external parties are managed centrally. Included in the tables below are net non-monetary liabilities of £169 million (2010: £142 million) which are denominated in foreign currencies.
The currency profile of the Group’s assets and liabilities is as follows: As at 31 December 2011 Sterling
Loans and receivables including insurance receivables 145,876 226,133 125,488 10,225 507,722
Property, plant and equipment 11,379 7,710 653 – 19,742 Investments in associates 6,302 – 584 – 6,886 Deferred tax – 14,077 – – 14,077
Financial assets carried at fair value 598,779 1,648,985 174,224 37,119 2,459,107
Financial liabilities 20,457 – – – 20,457 Current tax 29,995 – – – 29,995
to support the Funds at Lloyd’s requirement and there were no cash drawings (2010: $165 million and £20 million respectively) to support general trading activities; external Names – 27.5% of Syndicate 33’s capacity is capitalised by thirdparties paying a profit share of approximately 17.5%; Syndicate 6104 at Lloyd’s – with a capacity of £37 million for the 2011 year of account (2010 year of account: £45 million). This Syndicate is wholly backed by external members and takes pure years of account quota share of Syndicate 33’s international property catastrophe reinsurance account; gearing quota shares – historically the Group has used reinsurance capital to fund its capital requirement for short-term expansions in the volume of business underwritten by the Syndicate; and qualifying quota shares – these are reinsurance arrangements that allow the Group to increase the amount of premium it writes in hard markets.
Gearing The Group currently utilises short-to medium-term gearing as an additional source of funds to maximise the opportunities from strong markets and to reduce the risk profile of the business when the rating environment shows a weaker model for the more volatile business. The Group’s gearing is obtained from a number of sources, including: Letter of Credit and revolving credit facility – the Group’s main facility was replaced during 2010 for a total of $750 million which may be drawn as cash (under a revolving credit facility), Letter of Credit or a combination thereof, providing that the cash portion does not exceed $450 million. This facility was secured during 2010 by the Company’s subsidiary Hiscox plc. The Letter of Credit availability period ended on 31 December 2011. This enables the Group to utilise the Letter of Credit as Funds at Lloyd’s to support underwriting on the 2010, 2011 and 2012 years of account. The revolving credit facility has a maximum threeyear contractual period for repayment. At 31 December 2011 US$340 million was drawn by way of Letter of Credit
All amounts reported below represent transactions with external parties only. In the normal course of trade, the Group’s entities enter into various reinsurance arrangements with one another. The related results of these transactions are eliminated on consolidation and are not included within the results of the segments. This is consistent with the information used by the chief operating decision maker when evaluating the results of the Group. Performance is measured based on each reportable segment’s profit before tax.
reinsurance and the regulatory environment. This modeling takes into account transactional costs and tax, in addition to the necessary capital ratios. It proves the capital efficiency of Lloyd’s, despite a tax disadvantage against offshore entities, and the cost advantage of processing smaller premium business outside of Lloyd’s.
During 2011, the Bermuda Monetary Authority (BMA) introduced a group solvency capital requirement. A dry-run of the impact of these new requirements was conducted by the BMA, over groups which they have regulatory oversight. The Hiscox Group participated in this assessment and found that the capital requirements fairly reflected the risks contained within the Group. The capital requirements necessary to maintain a financial strength of an A rating will continue to be the main determinate of capital strategy for the Group.
Share of (loss)/profit of associates *Interest revenues included total £48,802,000 (2010: £60,332,000).
4 Operating segments continued (a) Profit before tax by segment continued
(d) Geographical information The Group’s operational segments underwrite business domestically in Bermuda and from locations in the UK and Ireland, the US, Guernsey, France, Germany, Belgium, the Netherlands, Spain, Portugal.
Annualised return on equity (%) 1.7 16.5 7 Investment result The total result for the Group before taxation comprises: Note
Investment result – financial assets 8 25,942 98,849 Fair value (losses)/gains on derivative financial instruments 21 (1,447) 1,400
(b) Investment return London Market UK and Europe International Corporate Centre 2011 Total
Agency related income 6,769 6,816 Profit commission 7,383 10,616 Other underwriting income – catastrophe bonds 1,006 1,280 Other income 2,164 3,367
Interest and expenses associated with bank borrowings 1,960 3,117 Interest and charges associated with Letters of Credit 35 3,933 3,216 Interest charges on experience account 804 3,748 Interest charges arising on finance leases 36 1 9 11 Auditors’ remuneration Fees payable to the Group’s main external auditors, KPMG, its member firms and its associates (exclusive of VAT) include the following amounts recorded in the consolidated income statement: Group
Amounts receivable by the auditor and associates in respect of: 1. The auditing of accounts of any associate of the Group 908 848 2. Audit-related assurance services 77 74 3. Taxation compliance services 8 3 4. All taxation advisory services not falling within part 3 – – 5. Internal audit services – – 6. All assurance services not falling within parts 1 to 5 55 – 7. All services relating to corporate finance transactions entered into, or proposed to be entered into, by or on behalf of the Group or any of its associates not falling within parts 1 to 6
8. All non-audit services not falling in parts 2 to 7* – 10
Total auditors’ remuneration expense 1,048 935 * Non-audit services with fees greater than £50,000 must be pre-approved by the Audit Committee which is composed solely of independent Non Executive Directors.
Overall impact of foreign exchange related items on net assets 18,876 27,213
The Group did not enter into any economic hedging derivative contracts during the current or prior year.
As part of a business combination in 2007, the Group acquired insurance authorisation licences for 50 US states. This intangible asset has been allocated for impairment testing purposes to one individual CGU, being the Group’s North American underwriting businesses. The carrying value of this asset is tested for impairment based on its fair value which reflects the total costs to acquire the licences in each state. The results of that testing show that no impairment is due.
Other intangible assets relate to the costs of acquiring rights to customer contractual relationships with additions in the current and prior year relating to software licence and development costs. Customer contractual relationships are amortised on a straight line basis over the useful economic life.
Capitalised software and development costs are amortised when the assets become available for use on a straight line basis over the expected useful life of the asset. The carrying value of software and development costs is reviewed for impairment on an ongoing basis by reference to the stage and expectation of a project. No impairment is due as at 31 December 2011.
At 31 December 2011 there were £8,873,000 of assets under development on which no amortisation has been charged (2010: £4,817,000).
Assets with a net book value of £nil were held under finance leases (2010: £99,000). The total depreciation charge for the year in respect of assets held under finance leases was £4,000 (2010: £24,000) and is included in other expenses.
At 31 December 2011 there were no assets under development upon which no depreciation has yet been charged (2010: £nil).
Additions during the year – 318 Disposals during the year (729) (527) Share of post-tax profit/(loss) recognised for the period 223 (223)
Associates incorporated in the UK from 25% to 37% 5,984 3,294 5,041 198
On 23 March 2011, the Group sold its holding in Plexstar Insurance Services Ltd, resulting in a loss of £33,000. Further consideration is due to be received during 2012, estimated to be £200,000.
During 2010, the Group disposed of its 40% holding in HIM Capital Holdings Ltd recognising a gain of £458,000. Also in December 2010, the Group increased its holding in Blyth Valley Ltd to 100% as referred to in note 33. The company was treated as a subsidiary of the Group from this date.
Acquisition costs expensed to the income statement (314,385) 44,593 (269,792) (317,645) 47,754 (269,891)
The deferred amount of insurance contract acquisition costs attributable to reinsurers of £15,641,000 (2010: £17,048,000) is not eligible for offset against the gross balance sheet asset and is included separately within trade and other payables (note 27).
The amounts expected to be recovered before and after one year, based on historical experience, are estimated as follows: Within one year 265,525 236,541 After one year 226,990 226,224
Amounts due from reinsurers in respect of outstanding premiums and claims already paid by the Group are included in loans and receivables (note 20). The Group recognised a gain during the year of £52,000 (2010: gain of £4,487,000) in respect of previously impaired balances.
Debt and fixed income securities 2,170,588 2,284,513 Equities and shares in unit trusts 173,432 154,862 Deposits with credit institutions 12,848 4,280
Total investments 2,356,868 2,443,655 Catastrophe bonds 11,639 15,452 Derivative financial instruments 21 129 –
The Group’s investment in catastrophe bonds consists of £11.6 million (2010: £15.5 million), comprising of 16 catastrophe bonds (2010: 13) with credit ratings of BB and B. The issuers of these securities have used the proceeds to collateralise certain catastrophe reinsurance obligations mainly in US and European wind and earthquake risks. The investment in these contracts is therefore at risk of loss, in whole or in part if a covered catastrophe occurs with the maximum loss being equal to the total investment.
The entire amount of the Group’s borrowings from December 2010, all being Pound Sterling, was repaid during the year and there is no amount outstanding at 31 December 2011.
Total investments 2,356,868 2,443,655 20 Loans and receivables including insurance receivables
Prepayments and accrued income 8,387 7,656 Other loans and receivables: Net profit commission receivable 13,792 15,276 Accrued interest 10,149 11,888 Share of Syndicates other debtors’ balances 19,726 23,230 Other debtors including related party amounts 26,948 15,881
Foreign exchange forward contracts 20,223 10,070 10,500 430 Interest rate futures contracts 64,407 16,557 16,582 25 Credit default swaps 25,398 – 2 2
Interest rate futures contracts During the year the Group continued short selling a number of government bond futures and sovereign futures denominated in a range of currencies to informally hedge substantially all of the interest rate risk on specific long portfolios of the matching currencies denominated corporate bonds. All contracts are exchange traded and the Group made a loss on these futures contracts of £1,796,000 (2010: £117,000) as included in note 7.
Equity index futures During the year, the Group purchased a number of equity index futures in order to hedge equity market exposure pending the acquisition of shares in unit trusts. All contracts were exchange traded and the Group made a profit of £433,000 (2010: £nil) as included in note 7.
22 Fair value measurements In accordance with the Amendments to IFRS 7 Financial Instruments: Disclosures, the fair value of financial instruments based on a three-level fair value hierarchy that reflects the significance of the inputs used in measuring the fair value is provided below.
Financial assets Debt and fixed income securities 516,528 1,767,985 – 2,284,513 Equities and shares in unit trusts 70 147,866 6,926 154,862 Deposits with credit institutions 4,280 – – 4,280 Catastrophe bonds – 15,452 – 15,452
The levels of the fair value hierarchy are defined by the standard as follows: Level 1 – fair values measured using quoted prices (unadjusted) in active markets for identical instruments; Level 2 – fair values measured using directly or indirectly observable inputs or other similar valuation techniques for which all significant inputs are based on observable market data; Level 3 – fair values measured using valuation techniques for which significant inputs are not based on market observable data.
Level 2 of the hierarchy contains US Government agencies, corporate securities, asset backed securities and mortgage backed securities and catastrophe bonds. The fair value of these assets are based on the prices obtained from both investment managers and investment custodians as discussed above. The Group records the unadjusted price provided and validates the price through a number of methods including a comparison of the prices provided by the investment managers with the investment custodians and the valuation used by external parties to derive fair value. Quoted prices for US Government agencies and corporate securities are based on a limited number of transactions for those securities and as such the Group considers these instruments to have similar characteristics to those instruments classified as Level 2. Also included within Level 2 are units held in traditional long funds and long and short special funds and over the counter derivatives.
Balance at 1 January 4,260 – – 4,260 Total gains or losses through profit or loss* 842 – – 842
The Group holds its cash deposits with a well diversified range of banks and financial institutions.
Employee share option scheme – ordinary shares issued 1,811 2,794 Scrip dividends 3,503 –
In accordance with IFRS 2 the Group recognises an expense for the fair value of share option and performance share plan award instruments issued to employees, over their vesting period through the income statement. The expense recognised in the consolidated income statement during the year was £8,677,000 (2010: £8,047,000). This comprises charges of £8,361,000 (2010: £7,619,000) in respect of performance share plan awards and £316,000 (2010: £428,000) in respect of share option awards. The Group has applied the principles outlined in the Black-Scholes option pricing model when determining the fair value of each share option instrument and discounted cash flow methodology in respect of performance share plan awards.
The range of principal Group assumptions applied in determining the fair value of share based payment instruments granted during the year under review are: Assumptions affecting inputs to fair value models 2011 2010
Annual risk free rates of return and discount rates (%) 0.9-1.9 1.8-2.0 Long-term dividend yield (%) 4.24-4.59 3.9-4.14 Expected life of options (years) 3.25 3.25 Implied volatility of share price (%) 29 29-30 Weighted average share price (p) 397.0 340.4
Gross Claims reported and claim adjustment expenses 938,498 802,254 Claims incurred but not reported 964,073 904,150 Unearned premiums 597,689 573,463
Net Claims reported and claim adjustment expenses 750,525 670,557 Claims incurred but not reported 739,218 661,654 Unearned premiums 518,002 484,891
The amounts expected to be recovered and settled before and after one year, based on historical experience, are estimated as follows: Within one year 1,160,744 1,008,399 After one year 847,001 808,703
26.1 Insurance contracts assumptions (a) Process used to decide on assumptions The risks associated with insurance contracts are complex and subject to a number of variables that complicate quantitative sensitivity analysis. Uncertainty over the timing and amount of future claim payments necessitate the holding of significant reserves for liabilities that may only emerge a number of accounting periods later.
For all risks, the Group uses several statistical methods to incorporate the various assumptions made into the ultimate cost of claims. There is close communication between the actuaries involved in the estimation process and the Group’s underwriters to ensure that all parties are aware of material factors relating to outstanding claims reserves. Adjustments are made within the claims reserving methodologies to remove distortions in the historical claims development patterns from large or isolated claims not expected to re-occur in the future. An allowance is also made for the current rating and inflationary environment.
Liability for accident years before 2002 recognised on Group’s balance sheet **This represents the claims element of the Group’s insurance liabilities.
Liability recognised in respect of prior accident years at 100% level *The foreign exchange adjustment arises from the retranslation of the estimates at each date using the exchange rate ruling at 31 December 2011.
Liability for accident years before 2002 recognised on Group’s balance sheet **This represents the claims element of the Group’s insurance liabilities and reinsurance assets.
Total at beginning of year (1,706,404) 374,193 (1,332,211) (1,549,323) 328,890 (1,220,433) Claims and loss adjustment expenses for year (830,368) 132,470 (697,898) (733,074) 162,077 (570,997) Cash paid for claims settled in the year 650,510 (95,433) 555,077 598,179 (120,088) 478,091 Exchange differences and other movements (16,309) 1,598 (14,711) (22,186) 3,314 (18,872)
Claims reported and loss adjustment expenses (938,498) 187,973 (750,525) (802,254) 131,697 (670,557) Claims incurred but not reported (964,073) 224,855 (739,218) (904,150) 242,496 (661,654)
Current year claims and loss adjustment expenses (1,126,667) 229,314 (897,353) (864,128) 160,277 (703,851) Over/(under) provision in respect of prior year claims and loss adjustment expenses 296,299 (96,844) 199,455 131,054 1,800 132,854
Creditors arising out of direct insurance operations 58,346 52,368 Creditors arising out of reinsurance operations 152,866 181,159
The amounts expected to be settled before and after one year are estimated as follows: Within one year 300,976 338,541 After one year 13,159 10,457
The standard rate of corporation tax in Bermuda is 0% whereas the effective rate of tax for the Group is -22.5% (2010: 15.4%). A reconciliation of the difference is provided below: Profit before tax 17,271 211,366 Tax calculated at the standard corporation tax rate applicable in Bermuda: 0% (2010: 0%) – – Effects of Group entities subject to overseas tax at different rates 21,620 28,866 Impact of overseas tax rates on: Effect of rate change (3,654) (1,377) Expenses not deductible for tax purposes 11,665 273 Tax losses for which no deferred tax asset is recognised (2,651) 9,639
Trading losses in UK entities – 12,959 – 12,959 Trade and other payables 990 (465) – 525 Intangible assets – Syndicate capacity 3,881 (537) – 3,344 Reinsurance premiums (5,376) 5,376 – –
* The solvency regulations in the UK require certain entities within the Group to establish an equalisation provision, to be utilised against abnormal levels of future losses in certain lines of business. The regulations prescribe that the provision is increased every year by an amount that is calculated as a percentage of net premiums written for those lines of business during the financial year subject to a maximum percentage. The amount of each annual increase is a deductible expense for tax purposes, and the equalisation provision is taxed when released. Equalisation provisions are not permitted under IFRS which therefore results in the temporary difference for tax purposes. Following a change in the legislation at the end of 2008, Lloyd’s Corporate Members are also entitled to a tax deduction for claims equalisation losses although this is not a solvency requirement for Lloyd’s. The Group has provided for the deferred tax liability on its Corporate Members’ claims equalisation reserve during the year.
Deferred tax assets of £25,748,000, relating to losses arising in overseas entities, which depend on the availability of future taxable profits in excess of profits arising from the reversal of other temporary differences are recognised above. Business projections indicate it is probable that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within five years. £23,555,000 of the tax losses to which these assets relate will expire after 15 years or later; the balance of tax losses carried forward has no time limit.
The amount of deferred tax asset expected to be recovered after more than 12 months is £25,748,000.
30 Employee retirement benefit obligations The Company’s subsidiary, Hiscox plc, operates a defined benefit pension scheme based on final pensionable salary. The scheme closed to future accrual with effect from 31 December 2006 and active members were offered membership of a defined contribution scheme from 1 January 2007. The funds of the defined benefit scheme are controlled by the trustee and are held separately from those of the Group. The employer’s expense for the defined contribution scheme is taken to the income statement.
The gross amount recognised in the Group balance sheet in respect of the defined benefit scheme is determined as follows: Present value of scheme obligations 155,685 146,737 Fair value of scheme assets (140,517) (144,056)
Deficit for funded plans 15,168 2,681 Unrecognised net actuarial losses (27,247) (12,310) Unrecognised surplus deemed irrecoverable 12,079 9,629
On 8 July 2010, the UK Government announced its decision to replace the Retail Prices Index (‘RPI’) with the Consumer Prices Index (‘CPI’) as an inflation measure used to determine the minimum statutory increases to be applied to the revaluation of deferred pensions and to the increase of pensions in payment.
The majority of the scheme’s debt and fixed income assets are held through the ownership of units in managed credit funds issued by Standard Life Assurance Limited which invest in a broad spread of high quality corporate bonds with derivatives used in controlled conditions to extend durations in some cases.
A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme obligations – – – – 2,783 (3,310) (1,223) Experience gains/(losses) on scheme assets (5,596) 6,075 (3,678) (18,107) 75 6,480 10,764
The triennial valuation carried out as at 31 December 2008, resulted in a deficit position of £5.1 million and excludes the impact of the equalisation of scheme obligations. The cost of equalisation of scheme obligations of £11.8 million was recognised in 2009 and paid in full in 2010. The Group agreed to fund the £5.1 million deficit paying instalments over four years. During the year the Group made a third instalment of £1.7 million to the defined benefit scheme (2010: £1.7 million). 61% of any scheme surplus or deficit calculated is recharged or refunded to Syndicate 33.
The expected return on scheme assets is based on historical data and management’s expectations of long-term future returns. While management believes that the actuarial assumptions are appropriate, any significant changes to those could affect the balance sheet and income statement. Whilst an additional one year of life expectancy for all scheme members might be expected to reduce the present value of unfunded obligations at 31 December 2011 by approximately £1,396,000 (2010: £80,000), the Group considers that the most sensitive and judgemental assumptions are the discount rate and inflation.
Effect of a change in discount rate Use of discount rate of 5.15% 15,168 7,223 –
Effect of an increase in inflation Use of CPI inflation assumption of 3.35% 15,168 17,975 –
Weighted average number of ordinary shares in issue (thousands) 383,602 379,064 Adjustments for share options (thousands) 15,610 14,662
Weighted average number of ordinary shares for diluted earnings per share (thousands) 399,212 393,726
Diluted earnings per share has been calculated after taking account of 15,029,986 (2010: 13,996,961) options and awards under employee share option and performance plan schemes and 579,518 (2010: 665,060) options under SAYE schemes.
During 2010, the Group disposed of its 40% holding in HIM Capital Holdings Limited recognising a gain on disposal of £458,000.
(b) In the prior year, Hiscox plc entered into a new Letter of Credit and revolving credit facility with Lloyds TSB Bank, for a total $750 million which may be drawn in cash (under a revolving credit facility), Letter of Credit or a combination thereof, providing that the cash portion does not exceed $450 million. In addition, the terms also provide that upon request the facility may be drawn in a currency other than US Dollar. At 31 December 2011 $340 million (2010: $165 million) was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and no cash drawings were outstanding (2010: £20 million).
(c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2010: £50,000) with NatWest Bank plc to support its consortium activities with Lloyd’s.
(d) The managed syndicates are subject to the New Central Fund annual contribution, which is an annual fee calculated on gross premiums written. This fee was 0.5% for 2011 and 2010. In addition to this fee, the Council of Lloyd’s has the discretion to call a further contribution of up to 3% of capacity if required.
Hiscox plc* Holding company Great Britain Hiscox Insurance Company Limited General insurance Great Britain Hiscox Insurance Company (Guernsey) Limited* General insurance Guernsey Hiscox Holdings Inc. Insurance holding company USA (Delaware) ALTOHA Inc. Holding company USA (Delaware) Hiscox Insurance Company Inc. General insurance USA (Illinois) Hiscox Inc. Underwriting agent USA (Delaware) Hiscox Insurance Company (Bermuda) Limited* General insurance and reinsurance Bermuda Hiscox Dedicated Corporate Member Limited Lloyd’s corporate Name Great Britain Hiscox Holdings Limited** Insurance holding company Great Britain Hiscox Insurance Holdings Limited Insurance holding company Great Britain Hiscox Syndicates Limited Lloyd’s managing agent Great Britain Hiscox Underwriting Group Services Limited Service company Great Britain Hiscox Capital Ltd* Reinsurance Bermuda Hiscox Underwriting Ltd Underwriting agent Great Britain Hiscox Europe Underwriting Limited Insurance intermediary Great Britain *Held directly.
**Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd at 31 December 2011 (2010: 54,560).
Profit for the year after tax 21,272 178,800 280,497 70,808 191,248
Financial assets carried at fair value 2,368,636 2,459,107 2,413,300 2,081,772 1,747,827
To request a copy of the 2011 Hiscox corporate brochure visit www.hiscox.com
Photography: Portraits © John Ross and Matthew Septimus Cover © NASA/GSFC/METI/ ERSDAC/JAROS, and U.S./ Japan ASTER Science Team
Hiscox Ltd 4th Floor Wessex House 45 Reid Street Hamilton HM 12 Bermuda