Our strategy supports our aspiration to be the leading personal and small business general insurer in the UK. That is why our customers are at the centre of everything we do.
Other information 172 Additional information 174 Glossary 176 Forward-looking statements disclaimer Contact information p22p20p18
• Gross written premium from ongoing operations1 up 1.7% to £3,152.4 million, with 4.8% growth in Motor for 2015 and 7.1% in the fourth quarter. Motor and Home own brands in-force policies1 up 1.4%
• Operating profit from ongoing operations increased to £520.7 million for 2015 (2014: £506.0 million). Combined operating ratio1 from ongoing operations of 94.0% for 2015, an improvement of 1.0 percentage point
• Results benefited from our disciplined underwriting, prior-year reserve releases from ongoing operations of £378.9 million (2014: £397.6 million) which were higher than expected, together with lower costs, partially offset by higher claims from major weather events and lower volumes
• Improved customer retention rates for motor and home products, and Net Promoter Score for Direct Line brand
• Reduced total costs1 for ongoing operations by 4.6% in 2015 while investing in technical pricing, claims management and self-service initiatives
• Doubled Motor telematics insurance in-force policies; and growth in Commercial in-force policies through eTrade and direct channels
• Invested in digital capability, including the roll out of new quote and buy journeys for Home and Green Flag insurance products, and development of next generation of customer systems
We protect small and medium-sized enterprises (“SMEs”) through our brands, NIG, Direct Line for Business and Churchill, and through our partners RBS and NatWest. NIG sells its products exclusively through brokers operating across the UK. Direct Line for Business provides business, van and landlord insurance products direct to customers. Churchill sells van insurance direct to customers and through price comparison websites (“PCWs”).
Rescue and other personal lines We are one of the leading providers of rescue and other personal lines insurance in the UK2,3 with 8.3 million in-force policies. This includes providing roadside assistance and recovery for customers through Green Flag, the UK’s thirdlargest roadside recovery provider2. We also offer customers protection for their pets and holidays, and we are the third largest insurer in the UK for these insurance products3.
Combined operating ratio 3.4m In-force policies £109.9m Operating profit £485.3m Gross written premium
Research Survey (FRS) 6 months ending December 2015, 13,729 adults interviewed for motor insurance and 13,148 for home insurance 2. Mintel Vehicle Recovery – UK, September 2015 3. Mintel Pet Insurance – UK, August 2015 and Mintel Travel Insurance – UK, February 2015
Direct Line for Business is an extension of our Direct Line brand. It is our direct commercial insurance brand for small businesses that have straightforward commercial insurance requirements.
Note: 1. The Royal Bank of Scotland Group plc, including National Westminster Bank plc www.directlinegroup.com 5
Our changing environment We operate in a dynamic environment and the way we interact with customers is evolving. Customer expectations of insurance are being shaped by changes both inside and outside the industry with technology and regulation important parts of this. Providing excellent customer service and managing claims remain key aspects.
New services and escalating risk The retail world continues to digitalise. Insurance needs to keep pace with customers who expect great service using different types of devices, and to interact directly with products and services themselves. Customers are willing to buy multiple products from one source, where businesses can provide what the customer needs and wants.
We prefer to adopt a conservative approach to claims reserving in order to hold sufficient funds to pay customer claims. This may result in subsequent releases from these reserves, which contribute to our annual profit.
Everyone, from our front-line staff to employees in support and central functions, helps ensure we meet customers’ needs. Without our people, we could not generate value for customers and sustainable returns for our shareholders.
Our shareholders are a big part of our business model. They invest in the business expecting to achieve a good level of return. So we aim to give our shareholders value by generating sustainable business profits. We reinvest part of this profit in the business or add to capital and, where appropriate, distribute the remainder to shareholders as dividends.
We transfer insurance risk through reinsurance in our normal business activities. External experts review our insurance claims reserves regularly. We mitigate risks by implementing our Group policies and minimum standards. These are reviewed regularly to ensure we are in line with the risk appetite that the Board sets.
“ Returns to shareholders remained a key priority for the Board. Cumulative dividends represent approximately 60% of the share price at the initial public offering.”
The Group achieved a return on tangible equity (“RoTE”) of 18.5% for 2015. An increase of 39.9% in the share price to 407.5 pence at 31 December 2015, together with dividend payments, provided a total shareholder return (“TSR”) of 46.9% for the year. Since the initial public offering (“IPO”), the Group has delivered good results each year, enabling the Board to declare cumulative dividends, including special interim dividends, equivalent to approximately 60% of the IPO price. The delivery of this level of return to shareholders is reflected in the level of awards vesting under the long-term incentive plan (“LTIP”). More information on awards is given in the letter from the Chair of the Remuneration Committee, see page 70.
Leadership Your Board seeks to ensure that decisions are of the highest standard. It challenges strategic proposals, performance delivery and management responsibilities. See page 51.
Effectiveness The effectiveness of your Board’s and its Committees’ performance is considered annually in effectiveness reviews. See page 53.
Remuneration Your Remuneration Committee ensures a close correlation between creating value for shareholders, and remunerating Executive Directors and senior executives appropriately. See pages 57 and 70.
Solvency II We are assessing the Group’s solvency capital requirements (“SCR”) using the standard formula until such time that the Group-wide partial internal model is approved by the Prudential Regulation Authority (“PRA”). At 31 December 2015, the Group held a capital surplus of £794.6 million above its capital requirements. This was equivalent to a pro forma1 Solvency II capital coverage ratio of 147.4%. Following approval, which is expected in mid-2016, we will disclose the recalibrated risk appetite range based on our Solvency II internal model which will take into account the sensitivities of the Group’s capital position on this basis. Whilst receiving internal model approval will remove a key uncertainty in relation to the Group’s capital position, the Board does not currently expect the recalibration of the risk appetite range to lead to a step change in the appropriate level of capital to be held.
Migrating IT infrastructure The migration of our IT infrastructure away from RBS Group, while giving rise to many challenges, is now essentially complete. Your Board provided oversight of this substantial change. Ongoing focuses of the Board’s supervision include the development of future capability and the monitoring of risks associated with IT systems’ stability, cyber security and the internal control environment.
Regulation, conduct and culture We maintain active relationships with our regulators. Your Board oversees the Group’s conduct risk policy and culture, which aim to ensure that we treat customers appropriately and that employees behave with integrity. We recognise that we have more to do to improve processes for our customers; however, your Board is pleased with improvements derived from our customer programmes. We continue to focus on this, as we develop new digital capabilities, core systems and new ways of interacting with our customers.
I am grateful to Andrew Palmer, an Independent Non-Executive Director (“NED”) and Chair of our Audit Committee, for having agreed to act as our SID while a search for a new SID was undertaken. At the same time, Priscilla Vacassin, NED and Chair of the Remuneration Committee, was appointed as a member of the Nomination Committee. Clare Thompson, NED and Chair of the Corporate Social Responsibility (“CSR”) Committee, was appointed as Chair of the Investment Committee, of which she was already a member.
Employees I would also like to thank our employees for their hard work and commitment this year. I am always struck by their positive attitudes and energy. Their pride and dedication to supporting our customers helped our business progress in 2015, and has put us in a strong position.
“ Our customers are benefiting from the many improvements we’ve been making including new propositions and enhanced customer service. This has resulted in more customers coming to our brands and renewing with us.”
Desmond, Eva and Frank storms We recognise that events like the flooding across the North of England and parts of Scotland are a reminder of just how important it is to have the right insurer and it gives us the opportunity to show our customers the benefit of being insured by one of our brands. When the floods hit we immediately put our emergency response plan into action. We had a visible presence on the ground with a network of almost 200 claims advisers and loss adjustors assessing damage, distributing emergency payments and putting customers in alternative accommodation as quickly as possible. Following the efforts of our people, who worked tirelessly on the ground and on the phones to process over 5,000 claims, the cost to our business was approximately £130 million, but I am very proud of the way we responded and supported our customers during this time.
We also refreshed the Churchill brand, emphasising the ‘depend on the dog’ strapline in new TV advertisements. The refresh also highlighted its protective nature, such as the promise to pay a claim even if our customers are hit by an uninsured driver.
Additionally, we invested in our pricing capabilities across our Personal Lines and Commercial businesses. This is aimed at broadening our footprint and improving our competitiveness.
We have continued growing our telematics offering, more than doubling our policy numbers in 2015. Our work analysing data for over 400 million miles of motoring is giving us pricing insights, which we expect will benefit us and our customers.
Investing in data and technology Consumers are surrounded by emerging technologies. So we want to make sure our systems can support future developments. We have now essentially finished the migration of our IT systems from RBS Group. This has been a complex and challenging programme, and we are still working to improve the performance of our IT systems across the board. At the same time, we are building the next generation of systems that can help us interact with our customers in a digitally efficient way. Furthermore, like businesses worldwide, we are increasing our focus on cyber security.
Developing our culture and capability Our people continue to be a foundation of our business. They have been instrumental in delivering the changes we needed to realise our goals. In 2014, to mark three years since our IPO and recognise their dedication, we told our employees that they would receive free shares, on top of the shares they received at the time of the IPO. In view of our performance in 2015, we made a further award of around £250 of free shares to all eligible employees. We are pleased that overall our people are engaged in developing our business and can share in its success.
Our latest total engagement levels have risen to 60%, which is a 15 percentage points rise compared to 2014. We have a series of action plans evolving, so we will continue gathering feedback from our people to ensure we are focusing on areas where we need to improve.
Our clear and concise strategic direction We have articulated our strategy around a simple mission: to make insurance much easier and better value for our customers. We believe that delivering this strategy will allow us to grow sustainably, whilst targeting at least a 15% return on tangible equity.
How we performed in 2015 Work to differentiate our brands has continued with enhancements for the Direct Line brand’s customers. Following a succession of initiatives during 2015, Direct Line customers now benefit from a seven day car repair service, guaranteed hire car as standard on comprehensive motor policies, an eight hour turnaround to dispatch certain lost or damaged household goods and the removal of amendment fees from all Direct Line branded products.
Churchill’s branding has also been refreshed with a campaign to highlight its dependability. We have reinforced the product and service to differentiate it from other brands, including on PCWs. This, together with an increased trading capability across Churchill and Privilege, has contributed to an improvement in Motor and Home own brands PCW sales.
These improved propositions, as well as a focus on improving customer experience and reducing complaints, have contributed to an increase in our Direct Line brand’s Net Promoter Score, along with further improvements in retaining customers in our Motor and Home own brands.
Our objectives for 2016 Improving customer experience remains a key target, with a focus on cross-channel distribution, while reducing complaints and improving the customer renewal process.
We have given our customers additional self service options within claims management where certain stages of Motor, Home, pet and travel claims can be managed online. This has improved efficiency and led to faster settlement times. We’re continuing to aim to beat market claims inflation.
We are importing relevant Personal Lines capabilities into our Commercial operations, including improved Van technical pricing and the launch of webchat for the broker market.
Our objectives for 2016 We continue to strive to improve operating efficiency and aim to reduce total costs in absolute terms in 2016 compared to 2015. The rate of reduction will be lower in 2016 than in 2015 due in part to the cost of the Flood Re levy.
Efficiency and flexibility to deliver better claims and customer service at lower cost www.directlinegroup.com 15
We aim to remain a leading competitor in our chosen markets by providing quality propositions and value for money. Where there are opportunities, we will look to launch new and exciting products and services. These will aim to put us at the forefront of disruptive market changes.
How we performed in 2015 We continue to build on our current strong market position by identifying and investing in market developments we believe can contribute to future growth. In particular, we’re focusing on growing our telematics-based motor insurance product, more than doubling our telematics customers in the year to 78,000. As of the fourth quarter of 2015, 28% of our under 25 year olds’ driver Motor premium was from telematics products. This growth has been achieved with the help of wider market appreciation of the benefits of telematics for younger drivers, recognition of our straightforward, self-install product and improved distribution through PCWs. Retention has proved strong amongst better drivers. Furthermore, the Group has launched an app-based over 25s offering and has supported a major motor manufacturer by using telematics as a key part of a new car customer proposition.
In Commercial, we continue to be recognised for our leading capabilities in eTrade and direct Commercial insurance, both of which are expected to be growing parts of the commercial market place. Commercial products are now more widely available to customers directly, with the launch of Churchill Van on two of the major PCWs. Commercial’s product offering has been extended with the roll-out of professional indemnity for Direct Line for Business and cyber cover for NIG’s customers distributed through the broker channel. These new products are fully reinsured.
We aim to harness the power of technology to make things easier for our customers and our people. By implementing integrated systems that are flexible and efficient, we can reduce costs while improving customer interactions such as self-service. We also enjoy a wealth of data from being a major insurer for a number of years, which we can use to make our business better for our customers.
Consumers are surrounded by emerging technologies, so we continued to develop our next generation of systems that can help us interact with our customers in a digitally efficient way.
Our objectives for 2016 We are targeting improved performance and cost effectiveness from our IT systems.
• ‘Idea Lab’ launched with more than 6,000 employees active on it. They submitted more than 1,500 business development ideas in the first month alone and 4,000 entries have been received to date
Our capital management policy seeks to maintain an appropriate level of capital and solvency to support our business, whilst growing dividends annually in real terms.
We’re delivering improved customer experience and satisfaction This year, we built on Direct Line’s new positioning. For example, we made the bold move to include a guaranteed hire car as standard for all Direct Line Motor customers, a benefit that customers can only get with our motor insurance product.
We’re delivering efficiency and improving processes for our customers We aim to reduce costs by improving and embedding efficiency throughout the business.
Smart & efficient manufacturer increase in productivity from nitro-thermal painting spraying system vehicle repair SMS text updates sent
Motor customers can now upload images of damage to their vehicles and track repairs on an online portal, plus we have also introduced a service to repair cars within seven days for Direct Line customers.
This highly flexible cover for landlords and buy-to-let owners gives them the confidence of knowing their properties are protected.
Lead & disrupt the market new Landlord insurance in-force policies downloads of smartphone Landlord app
Read more about our rewards for performance on page 70, and for definitions see the glossary on pages 174 and 175.
We aim to make an underwriting profit. For 2016, we expect to achieve a COR in the range of 93% to 95% for ongoing operations, assuming a normal annual level of claims from major weather events.
See Finance review page 41. See Finance review page 42. See Finance review page 41. See Finance review page 39.
We base LTIP awards partly on RoTE over a three-year performance period.
This is a broad measure of earnings and reflects the results of the Run-off segment and restructuring and other one-off costs, in addition to underlying operating profit. The AIP awards have a weighting to these other financial measures.
Net Promoter Score is an index that measures the willingness of customers to recommend products or services to others. It is used to gauge customers’ overall experience with a product or service and the customer’s loyalty to a brand.
We target capital coverage to remain within our risk appetite. We also aim to maintain a rating in the ‘A’ range from our credit rating agencies. Both of these aims were satisfied in 2015.
Our aim is to improve this incrementally to achieve high levels of customer loyalty and retention rates.
AIP awards relating to 2015 include a weighting relating to cost targets.
The AIP awards include a weighting to a balance of customer metrics.
2. On an aggregated 12 months rolling basis, with 2013 rebased to 100. 3. For the Group’s principal underwriter, U K Insurance Limited; it excludes discontinued operations.
Managing our risks Our business is risk, so managing this effectively and efficiently is critical to the success of our strategy.
Our risk governance structure The Board sets and monitors adherence to the risk strategy, risk appetite and risk framework. It has established a risk management model that separates responsibilities into Three Lines of Defence.
Our First Line of Defence is responsible for ownership and management of risks to the achievement of business objectives on a day-to-day basis. The Second Line of Defence is responsible for the provision of proportionate oversight and challenge of risks, events and management actions.
Risk appetite Our risk appetite statements define the opportunities and associated risks we are prepared to accept to achieve our business objectives – see table on the next page. To monitor whether the business remains within risk appetite, the statements are aligned to key risk indicators (“KRIs”) which are used to drive risk-aware decision making.
The Group is recalibrating its risk appetite range in relation to the Solvency II internal model and expects to disclose the output of this later in 2016.
Second Line of Defence Risk and Compliance oversight, challenge and support of First Line
The ERMF enables us to run the business with the requisite understanding of our risks and controls, as well as having appropriate oversight in place to manage risks proactively. It is aligned to the Three Lines of Defence model and is intended to provide a coherent, robust, fit for purpose, end-to-end approach for managing all material risks. A central component of the ERMF is our policy framework, which includes policies and minimum standards. These inform the business how it needs to conduct activities to remain within risk appetite.
The Board approves our strategy, risk appetite and policies, and the Board Risk Committee approves the Enterprise Risk Management Strategy and Framework.
Overarching risk objective The Group recognises that its long-term sustainability is dependent on having sufficient economic capital to meet its liabilities as they fall due, thus protecting its reputation and the integrity of its relationship with policyholders and other stakeholders.
As part of this, its appetite is for general insurance risk, focusing on personal lines retail and SME insurance in the UK. The Group has appetite for non-insurance risks, as appropriate, to enable and assist it to undertake its primary activity of insurance.
1. Maintain capital adequacy The Group seeks to maintain sufficient economic capital consistent with our strategic aim of achieving a standalone credit rating in the ‘A’ range.
The Group aims to meet both planned and unexpected cash outflow requirements, including those requirements that arise following a one-in-200 years insurance, market or credit risk event.
The risk of loss due to fluctuations in the timings, amount, frequency and severity of an insured event relative to the expectations at the time of underwriting. See pages 123 to 124.
• Underwriting guidelines are set for all transacted business and pricing refined by analysing comprehensive data
• Catastrophe and motor excess of loss reinsurance limits our exposure to events and large losses
The risk of loss resulting from fluctuations in the level and in the volatility of market prices of assets, liabilities and financial instruments. See pages 124 to 126.
− diversification of the types of assets, limits on the amount of illiquid investments, and tight control of individual credit exposures
The risk of loss resulting from fluctuations in the credit standing of issuers of securities, counterparties and any debtors to which we are exposed. See pages 126 to 130.
• We only purchase reinsurance from reinsurers with at least an ‘A-’ rating
The risk of loss due to inadequate or failed internal processes, people, systems or from external events.
The risks leading to reputational damage, regulatory or legal censure, fines or prosecutions and other types of non-budgeted operational risk losses associated with our conduct and activities.
Chief Financial Officer, Chief Risk Officer and Managing Director of Personal Lines
• Specific risk management tools and resources are used to help manage our exposure to regulatory risk
• Risk-based monitoring is designed to ensure we use our resources effectively
• We have a strong culture of considering customers’ perspectives, and delivering the right outcomes for our customers is central to how we operate
The risk of direct or indirect adverse impact on the earnings, capital, or value of our business as a result of the strategies not being optimally chosen, implemented or adapted to changing conditions.
• Emerging risks are identified and managed using established governance processes and fora
Brand and reputational risk is now considered within the drivers of other risk types such as regulatory and conduct, operational and strategic risks.
Emerging risks Our definition of emerging risk is newly developing or changing risks that are often difficult to quantify, but may materially affect our business. We have further defined emerging risks as highly uncertain risks that are external to our business. We record emerging risks within an Emerging Risk Register. These are reported to the Risk Management Committee and Board Risk Committee for them to review, challenge, approve and feed into the Board’s strategic planning process.
Our emerging risks processes aim to: • Achieve ‘first mover advantage’ by recognising risks and associated opportunities early
Changes to traditional insurance business models New market entrants and changes in consumer expectations could result in significant changes to the structure of the general insurance market and require us to update our business model.
Approach Our CSR strategy provides the framework for managing the different ways we connect with society. The strategy has four strands. As shown in the graphic, they are ‘Helping to make our society safer’, ‘Proud to be here’, ‘Recognised as part of our communities’ and ‘Reduce, Reuse and Recycle’.
We manage our strategy through our CSR Advisory Group, which comprises senior managers from across the business. Our sustainability team supports the Advisory Group. Individual members of our Executive Committee are accountable for each strand of the strategy. The CSR Committee’s role is to oversee our approach. See page 63.
Road safety Despite increasing traffic on our roads, the number of serious accidents has reduced significantly since the turn of the century. Unfortunately, this trend has stalled in 2014. As Britain’s biggest car insurer, we believe we can have a vital role to play in making our roads safer.
PACTS We launched the Road Safety Dashboard with the Parliamentary Advisory Council for Transport Safety (“PACTS”). This pioneering tool uses Department of Transport statistics to produce an index that ranks the road safety record of individual parliamentary constituencies. This is the first time the data has been used to this level. We aim to encourage Members of Parliament to do more for road safety in their local constituencies.
Department for Transport We have proactively engaged with the Department for Transport on various topics, including telematics technology, driverless cars and the concept of a graduated driving licence.
Young drivers Last year, the CSR Committee held a strategy session to consider how we might best use our expertise and experience to reduce deaths and life-changing injuries on the UK’s roads.
New drivers only tend to fine-tune their decision-making when they no longer have an instructor in the car. In particular, deciding how fast they should or can go relies on experience of road conditions and predicting how other road users behave.
Young drivers’ first 1,000 miles are key. This is when the gap between perceived and actual driving competence, and hence risk, is greatest. So we have set ourselves the ambitious goal of cutting deaths in the first 1,000 miles to zero.
Safer young drivers We want to cut deaths in the first 1,000 miles of driving to zero Young drivers have an unacceptably high risk of death when they first take to the road: • 1.5% of drivers are 17 to 19 years old, but they are involved in 12% of all fatal crashes
We’ll start by developing a behavioural change campaign aimed directly at young drivers in 2016.
We believe talking at young people or trying to shock them does not work. To engage them we need to find a way to add to their driving experience. So we are looking to use our telematics technology to produce a smartphone app. We will support this with a communication and reward campaign that leverages peer pressure. It will also engage young drivers by making road safety conversations more relevant to them. If successful, we aim to make the app available to all newly-qualified young drivers in the UK.
Reduce, Reuse and Recycle We aim to manage our operations sustainably. As outlined below, we have progressed well. Looking ahead, we are focusing on our property and claims supply chain, where there is potentially more opportunity to improve.
Emissions You can find information on Group-wide greenhouse gas (“GHG”) emissions in the chart – and more details of our emissions in the Directors’ report on page 98. We were delighted to win two awards at the Carbon Disclosure Project UK Results event last year. The awards recognised how we improved our performance and enhanced our disclosure of our emissions-related information.
Waste Our system of sorting waste at source and introducing new signage has helped us increase the waste we recycle. In 2015, we recycled approximately 40% of waste from our office sites. We also recycled 54% of waste from our 15y14y13y
Paper use We have used new technology to reduce the amount of printer and copier paper we use. Our office paper is made from recycled material.
We are now focusing on reducing the paper we use to produce customer policy documents and are looking at ways to send customers these documents electronically. In 2015, we used 829 tonnes of paper for policy documents.
Proud to be here We approved a new people strategy in 2015. This supports our new business strategy, particularly regarding culture and our employees’ capabilities. In 2015, we focused on pride in Direct Line Group, encouraging and celebrating the strength of our workforce.
Note: 1. Emissions for continuing operations. This excludes discontinued operations, the Group’s former International division. Total Group scope 1 and 2 emissions including discontinued operations were 23,143 tonnes (2014: 28,759 tonnes; 2013: 30,624 tonnes).
Our diversity and inclusion practices are in line with the Universal Declaration of Human Rights. Our Ethical Code for Suppliers requires that all our suppliers adhere to the core International Labour Organization standards.
During 2015, our Diversity Network Alliance became more visible throughout the business and externally. The team had a branded presence at various Pride events and a week-long internal focus on work-life balance. It also placed articles on our intranet and discussions on other internal platforms covering many diversity and inclusion issues. Many of our locations organised health and wellbeing events to advise on health and raise mental health awareness.
To make it easier for our deaf and profoundly deaf customers to communicate with us, we introduced a Video Relay Service. This enables customers to connect to a sign interpreter. The interpreter then contacts our call centre and relays the conversation.
Recognised as part of our communities We believe that our people’s feelings about working for the Group link to our reputation in the community. So we seek to align our giving with our employees’ interests.
Community and social committees To engage our people, we run a network of CASCs, which comprise local volunteers. The CASCs receive central funding and support. Within an agreed framework, they are free to create their own programme of events and activities at their sites. They are also free to build relationships with local charities and voluntary organisations. Examples of events include: • 450 employees from seven offices spending an evening manning phone lines for Comic Relief, taking 8,000 calls. Hundreds more fundraised on the day
Volunteering We encourage all employees to volunteer individually or as a team through our ‘One Day initiative’. For example, our Finance team supported the Brook Lane Community Garden in Bromley. The team spent a day renovating the open space. This supported the Garden’s aim to enable people of all ages to learn cultivation skills and manage habitats that support wildlife. Our Employee Opinion Survey revealed that 32% of staff volunteered or fundraised in company time last year.
Matched giving and grants In 2015, our employees donated £144,000 through our payroll giving scheme and we donated a further £97,000 in matched giving. We also provided £51,000 in grants to organisations for which our employees fundraise or volunteer.
• In-force policies increased by 1.0% during 2015 with growth in each quarter following enhancement to own brands propositions
• Gross written premium increased by 4.8% as premium inflation returned to the motor market, with growth accelerating during the year
• COR improved by 3.8 percentage points reflecting a better current-year attritional loss ratio from a refinement in the risk margin approach and reduced large bodily injury claims
Performance Total in-force policies increased by 1.0% during 2015. Own brands grew by 1.3% whilst partner in-force policies fell by 3.5%. Gross written premium increased by 4.8% in comparison to 2014, as premium inflation returned to the market alongside ongoing claims inflation.
Effect on premium income of changes in price and risk mix1
Improvements in the Group’s trading capability across Churchill and Privilege, and better price competitiveness in an inflating market all contributed to the improved performance. The growth in gross written premium accelerated during the year with growth of 7.1% in the fourth quarter. Risk-adjusted prices increased by 7.7% compared with the fourth quarter of 2014, whilst for the full year risk-adjusted prices were 5.8% higher than in 2014. Annual premium inflation in 2015 reflected expected claims inflation in addition to a catch up for higher than expected claims inflation during the previous period.
The COR for the Motor division improved by 3.8 percentage points reflecting a better loss ratio while the expense and commission ratios were stable. The loss ratio improvement was due to a lower current-year attritional loss ratio. Stable prioryear reserve releases represented a similar percentage of net earned premium, and primarily relate to large bodily injury claims. Prior-year reserve releases in 2015 were £266.8 million (2014: £278.4 million) and are expected to be lower in 2016.
Outlook The market remained highly competitive during 2015 and in early 2016. While premium rates in the market have increased, this should be viewed in the context of rising claims costs and higher levels of IPT. Against this backdrop, Motor continues to adopt a disciplined approach to managing the trade-off between margin and volumes, whilst continuing to identify opportunities to improve efficiency. Meanwhile, Motor is continuing to invest in building future capability.
• Gross written premium was 3.6% lower primarily due to partnerships, while own brands fell 1.9%
• Operating profit was broadly stable at £109.9 million, despite higher than normal claims from major weather events
Effect on premium income of changes in price and risk mix – own brands
Two of the Group’s Home partners, Nationwide Building Society (“NBS”) and Sainsbury’s have recently reviewed their insurance arrangements. In respect of NBS, Home will no longer underwrite home insurance for its customers from early 2017, while in respect of Sainsbury’s, Home will no longer write new business from February 2017. Arrangements for the Sainsbury’s renewal book will follow contractual terms. Whilst these developments are disappointing, it is the nature of the partnership market that relationships will be reviewed periodically and in the case of Sainsbury’s, it is reviewing its current insurance operating arrangements. In 2015, NBS and Sainsbury’s accounted for 25.5% of Home’s gross written premium, albeit they contributed a considerably lower proportion of Home’s operating profit.
In Home, the COR improved to 92.2% despite higher than normal claims costs from major weather events. The weather impact in 2015 was higher than expected with claims costs from major weather events of approximately £90 million (2014: £63 million). The Home division normally expects in the region of £80 million of annual claims from major weather events. Prior-year reserve releases were lower than last year at £41.9 million (2014: £49.8 million).
The current-year attritional loss ratio, excluding claims costs from major weather events, improved by 3.5 percentage points on 2014. This reflected the strength of Home’s pricing approach and retention performance. Home claims trends remained benign with 2015 underlying inflation, excluding major weather events, lower than the long-term average. In particular, claims from accidental damage and theft remained low.
Performance In-force policies for Rescue declined by 1.1% to 3.9 million in comparison to the prior year through lower partner volumes. The reduction in in-force policies for other personal lines of 3.6% across 2015 primarily reflected lower packaged bank account volumes.
Outlook Rescue and other personal lines continued to create additional value for the Group and represent an opportunity to meet customers’ broader insurance needs. While competition was recently stronger in the rescue market, initiatives aim to position Green Flag well for 2016. We also aim to roll out improvements to our claims capability in Pet and Travel to enhance our service while updating our customer propositions.
• COR increased by 5.7 percentage points and operating profit decreased by £26.2 million, both impacted by higher than normal claims from weather
Premium rates have been under pressure from a competitive market place across all channels, especially during the fourth quarter following the rise in IPT. Commercial continues to maintain its underwriting discipline and seeks to balance the retention of customers with rate inflation.
Commercial has further enhanced its product coverage with the launch of Professional Indemnity cover for Direct Line for Business’s customers, and Cyber cover for NIG’s customers distributed through the broker channel. These products are fully reinsured.
The Commercial COR of 104.5% was 5.7 percentage points higher than 2014 and affected by above average claims from weather events, including those in December which cost approximately £40 million. Overall, weather-related claims and large claims were approximately £25 million more than expected. Adjusting for this, the COR would have been 99% as underlying claims and the loss ratio have remained broadly stable in comparison to the previous year. Prior-year reserve releases of £56.6 million increased on the previous year (2014: £53.7 million).
Overall, operating profit was £20.8 million, a reduction of £26.2 million compared with 2014, as higher than normal claims from weather impacted profitability. Adjusting for weather-related claims and large losses, operating profit would have been similar to 2014.
Outlook The Commercial market became more competitive during the year. In the fourth quarter, rate increases on renewed business across the division’s main lines were at the lowest level for a number of years. The market trend towards direct and etrade channels for small business insurance is expected to continue and Commercial is well placed to take advantage of this.
• Return on tangible equity1 of 18.5% for 2015 (2014: 16.8%). Profit before tax for continuing operations increased to £507.5 million (2014: £456.8 million)
• Reduced total costs1 by 4.6% in 2015 while building on technical pricing and claims management initiatives
Ongoing operations1 In-force policies1 (thousands) 16,068 16,302 Gross written premium1 3,152.4 3,099.4 Net earned premium1 2,920.8 2,987.1 Underwriting profit 175.2 148.1 Instalment and other operating income 150.8 147.3 Investment return1 194.7 210.6 Operating profit1 – ongoing 520.7 506.0
Run-off1 73.1 55.3 Restructuring and other one-off costs (48.7) (69.6) Operating profit 545.1 491.7 Finance costs1 (37.6) (37.2) Gain on disposal of subsidiary − 2.3 Profit before tax 507.5 456.8 Tax (108.3) (97.5) Profit from discontinued operations, net of tax 181.2 13.3 Profit after tax 580.4 372.6
Underwriting profit 175.2 148.1 Instalment and other operating income 150.8 147.3 Investment return 194.7 210.6 Operating profit 520.7 506.0
In 2015, operating profit from ongoing operations increased to £520.7 million (2014: £506.0 million) primarily due to an improvement in the underwriting result, while the investment return decreased. The underwriting result improved significantly to £175.2 million (2014: £148.1 million) principally due to a better current-year attritional claims performance and reduced costs, partially offset by a higher level of claims costs from major weather events and lower volumes. This result included higher than expected prior-year reserve releases of £378.9 million (2014: £397.6 million). Investment return was lower primarily due to lower assets under management (“AUM”) impacting investment income and a reduction in net realised and unrealised gains.
Own brands 3,459 3,415 Partnerships 248 257 Motor total 3,707 3,672
Own brands 1,719 1,693 Partnerships 1,699 1,833 Home total 3,418 3,526
Rescue 3,932 3,976 Other personal lines 4,356 4,517 Rescue and other personal lines 8,288 8,493
Total in-force policies for ongoing operations during 2015 reduced by 1.4% to 16.1 million (31 December 2014: 16.3 million). The fall primarily related to other personal lines, within the Rescue and other personal lines division, and Home partnerships. Commercial grew in-force policies by 7.2% across the period, while Motor increased marginally. Gross written premium of £3,152.4 million increased by 1.7% compared with 2014 (£3,099.4 million).
Notes: 1. Rescue in-force policies have been revised to exclude partner post-accident vehicle recoveries.
The movement in the current-year attritional loss ratio is a key indicator of underlying accident year performance as it excludes prior-year reserve movements and claims from major weather events in the Home division. The Group’s current-year attritional loss ratio improved by 1.4 percentage points to 69.4% in 2015 (2014: 70.8%) with improvements in Motor and Home partially offset by a deterioration in Rescue and other personal lines, and in Commercial primarily because of higher weather claims.
Prior-year reserve releases from ongoing operations continued to be significant at £378.9 million (2014: £397.6 million) and were equivalent to 13.0% of net earned premium (2014: 13.3% of net earned premium). Reserve releases were higher than expected in 2015 and the overall level for 2016 is expected to remain significant, albeit lower than in 2015.
Total operating expenses 689.1 705.4 Claims handling expenses 195.6 222.3 Total costs 884.7 927.7
The total costs for ongoing operations of £884.7 million were 4.6% lower than the previous year (2014: £927.7 million). The Group’s expense ratio was stable at 23.6%, with the effect of the reduction in operating expenses offset by the impact of lower net earned premium. Reductions in underlying costs have been achieved in a number of areas including marketing, technology and property. The reduction in claims handling expenses was primarily as a result of improved efficiencies in a number of areas, including head office functions that support claims operations. Costs in the second half of 2015 were lower than the prior year, but higher than in the first half. This was mainly due to write offs on redundant software, property, plant and equipment.
Instalment and other operating income from ongoing operations of £150.8 million increased 2.4% on the prior year (2014: £147.3 million). Other operating income increased, while instalment income was stable. The increase in other income was due primarily to the inclusion of a full year of legal services income in 2015.
Investment income 165.6 171.7 Net realised and unrealised gains 29.1 38.9 Investment return – ongoing 194.7 210.6
Note: 1. Vehicle recovery includes post-accident and pay-on-use recovery. Repair services constitute the provision of non-insurance related repairs.
The investment income yield for continuing operations in 2015 was 2.4%, in line with the yield achieved in 2014. Portfolio actions to diversify the portfolio in 2015 and prior years, including infrastructure debt, commercial property and high yield debt instruments, have helped offset yield pressure from the continuing low interest rate environment. The Group will continue to diversify its investment portfolio appropriately and based on current yield curves, which reflect delays in market expectations for a base rate rise, the Group currently forecasts an investment income yield of 2.5% for 2016 and 2.6% for 2017.
Run-off The Run-off segment generated a profit of £73.1 million in 2015 compared with £55.3 million in 2014. Improved experience from large bodily injury claims led to higher prioryear reserve releases in comparison to the previous year. It is expected that the Run-off segment will continue to contribute positively to operating profit in future years, albeit at a lower level than in 2015.
Finance costs Finance costs remained stable at £37.6 million (2014: £37.2 million).
Taxation The effective tax rate for continuing operations in 2015 was 21.3% (2014: 21.3%), which was higher than the standard UK corporation tax rate of 20.25% (2014: 21.5%), primarily due to disallowable expenses.
RoTE increased to 18.5% (2014: 16.8%) due to a lower equity base, from the sale of the Group’s International division, and higher profit from ongoing operations.
Earnings per share Basic earnings per share for continuing operations of 27.9 pence increased by 16.3% (2014: 24.0 pence). This reflected the reduction in restructuring and other one-off costs and the improved operating profits from the Run-off segment and ongoing operations.
Adjusted diluted earnings per share, from ongoing operations, increased by 4.3% to 26.6 pence (2014: 25.5 pence) reflecting the increase in operating profit.
2. Investment return includes net gains and is calculated on income divided by the average AUM based on the opening and closing balance for Group – continuing operations.
Dividends The Board is proposing a final dividend of 9.2 pence per share making the total regular dividends for 2015 13.8 pence per share. This represents 4.5% growth over the 2014 regular dividends and is in line with the Group’s aim to grow the regular dividends annually in real terms, see page 96 for the Group’s dividend policy.
Cash flow Net cash generated from operating activities totalled £42.6 million (2014: £410.6 million used by operating activities). This reflected an increase in cash generated from operations to £149.8 million (2014: £315.2 million used by operations), primarily due to a decrease in insurance payables of current and prior-year claims.
The movement in net cash generated from investing activities in 2015 of £190.8 million from £216.0 million used in 2014 primarily represented the sale of discontinued operations.
Net assets 2,630.0 2,810.5 Goodwill and other intangible assets (524.8) (517.5) Disposal group – intangible assets − (5.6) Tangible net assets 2,105.2 2,287.4 Net asset value per share (pence) 192.2 188.2 Tangible net asset value per share (pence) 153.8 153.1
Reserving Financial management includes the central aspect of estimating claims reserves. Uncertainty is an inherent part of insurance and requires judgement when assessing claims liabilities. The Group considers the class of business, the length of time to notification of a claim, the validity of the claim against a policy, and the claim value. Claims reserves could settle at a range of outcomes, and settlement certainty increases over time. However, for bodily injury claims, the uncertainty is greater due to the length of time taken to settle these claims. Annuity payments for injured parties also increase this uncertainty.
Total ongoing 3,220.2 3,374.8 Run-off 382.4 523.8 Discontinued operations − 393.6 Total Group 3,602.6 4,292.2
• Motor reinsurance to protect against a single or an accumulation of large claims. The retained deductible has been reduced to an indexed level of £1 million per claim providing an enhanced and substantial level of protection against large motor bodily injury claims
• To back inflation-linked PPO liabilities with growth assets and other appropriate long-term assets expected to generate long-term returns in line with the inflating cost of claims
At 31 December 2015, total unrealised gains, net of tax, on AFS investments were £5.4 million (31 December 2014: £94.4 million). Due to the reduction in unrealised gains, net realised gains from the fixed income debt securities portfolio for 2016 are expected to be lower than in 2015.
During 2015, the Group reviewed its investment strategy resulting in approval to implement mandates in commercial real estate loans, subordinated financial debt and global credit. The subordinated debt mandate replaces holdings of similar securities previously contained in the Group’s general investment grade mandates. All new mandates will be investment grade. In addition, a further 2% allocation to the existing high-yield mandate was approved, increasing this to a maximum of 6%. The mandates are funded primarily from reductions in government debt securities and existing holdings in investment grade securities. In 2015, the primary addition to the investment portfolio was the £253.4 million further investment in infrastructure debt. Given market pricing, additional investment in commercial property during 2015 was limited to one property acquisition.
Investment risk is, in part, mitigated by the following characteristics within the investment portfolio: • All holdings within the short duration US Dollar high-yield portfolio have a credit rating of BB or B. The Group’s strategy does not permit any debt securities to be held below B-. At year end, actual exposure to the energy and midstream sector was 8.4% of the high-yield portfolio
• The infrastructure debt portfolio is made up of UK assets only, which are purchased via the secondary market post the construction phase of the project concerned.
• The investment property portfolio consists presently of 26 UK based properties. The Group’s strategy does not permit any overseas holdings. The portfolio is predominantly based in the South East and invested mainly in the prime (rather than secondary) sector of the market. The mandate targets a real return objective resulting in 41% of current leases producing inflation-linked rental income
Derivatives are permitted only for risk mitigation and efficient portfolio management within the investment portfolio. Derivatives used include interest rate swaps, for example to hedge exposure to US Dollar interest rate movements, and forward currency contracts to hedge assets denominated in US Dollars back to Sterling. Separately, interest rate swaps have also been used to change the interest rate liability on the Group’s debt issuance to a floating-rate basis.
Corporate2 4,155.9 117.1 4,092.7 118.2 Supranational2 140.1 2.6 176.2 4.9 Local government2 104.9 1.7 120.3 2.4 Credit 4,400.9 121.4 4,389.2 125.5 Securitised credit2 350.8 6.0 419.6 6.1 Sovereign2 442.7 12.7 993.7 22.4 Total debt securities 5,194.4 140.1 5,802.5 154.0 Infrastructure 329.6 4.4 76.2 0.1 Cash3 947.3 6.8 865.4 5.2 Investment property 347.4 17.8 307.2 16.2 Total Group 6,818.7 169.1 7,051.3 175.5
Where the Board believes the Group has capital that is surplus to requirements, it looks to return it to shareholders.
Solvency II Solvency II is the new solvency framework of the capital adequacy regime for the European insurance industry. It establishes a revised set of EU-wide capital requirements and risk management standards with the aim of increasing protection for policyholders. Solvency II was implemented on
Notes: 1. Continuing operations 2. Asset allocation at 31 December 2015 includes investment portfolio derivatives, which have been netted and have a mark-to-market liability value of £45.7 million of which £40.0 million is in corporate debt securities, £0.4 million in local government and £5.3 million in securitised credit (31 December 2014: markto -market liability value of £27.8 million of which £24.4 million is in corporate debt securities, £0.1 million in supranationals, £0.4 million in local government, £2.8 million in securitised credit and £0.1 million in sovereign). This excludes non-investment derivatives that have been used to hedge subordinated debt, operational cash flows and the disposal of the International division.
Tier 1 capital after foreseeable dividends represents 72.8% of own funds and 107.2% of pro forma solvency capital requirement (“SCR”). Tier 2 capital relates solely to the Group’s £500 million subordinated debt issue in 2012.
Tier 1 capital before foreseeable dividends 2,045.2 Foreseeable dividends (247.5) Tier 1 capital 1,797.7 Tier 2 capital 614.9 Tier 3 capital 58.2 Own funds 2,470.8
Shareholders’ equity 2,630.0 Goodwill and intangible assets (524.8) Change in valuation of technical provisions 202.9 Other asset and liability adjustments (262.9) Foreseeable dividends (247.5) Tier 1 capital 1,797.7 Tier 2 capital: subordinated debt 614.9 Tier 3 capital: deferred tax asset 58.2 Own funds 2,470.8
Paul Geddes John Reizenstein Chief Executive Officer Chief Financial Officer 29 February 2016 29 February 2016
Notes: 1. Calculated on a pro forma basis, assuming expected changes to hedging arrangements were in effect at 31 December 2015 2. Figures are estimated and based on preliminary regulatory returns for 31 December 2015.
3. Adjusted for final and second special interim dividends 4. Total financial debt as a percentage of capital employed www.directlinegroup.com 45
I am pleased to report that Dr Richard Ward was appointed a Non-Executive Director (“NED”) and the Senior Independent Director (“SID”) on 18 January 2016. He brings a deep knowledge of the insurance industry to the Group. I would also like to thank Andrew Palmer for agreeing to act as SID while we were in the process of completing Richard’s appointment.
As we announced on 16 February, Priscilla Vacassin has decided to step down from the Board with effect from 1 March 2016. Clare Thompson has agreed to act as interim Chair of the Remuneration Committee from 1 March. At the same time she will step down as Chair and member of the CSR Committee and the Investment Committee and as a member of the Board Risk Committee. Andrew Palmer will be appointed as Chair of the Investment Committee and Sebastian James as Chair of the CSR Committee with effect from the same date.
Key matters I highlight the following key governance and shareholder matters from the Corporate Governance report, which the Board considered during the year.
Solvency II Preparation for the transition to the Solvency II regulatory regime was a priority for the Board, the Board Risk Committee and the Audit Committee during the year. Additionally, the Remuneration Committee considered how Solvency II might affect senior managers’ remuneration.
Sale of the International division The sale of the International division completed at the end of May. The Board resolved to return substantially all of the net proceeds to shareholders through a special dividend, which was paid on 24 July 2015.
Work together Collaborate across all levels and across all functions; leverage the skills, knowledge and experience, irrespective of hierarchy, to deliver the best possible results; develop relationships based upon trusting each other, partnerships and win-wins; recognise and celebrate success.
UK Corporate Governance Code We, the Board of Direct Line Group, are committed to the principles of the UK Governance Code issued by the Financial Reporting Council. I am pleased to report that we have complied with substantially all of the provisions of the UK Corporate Governance Code (September 2014). You can find further details in the Corporate Governance report.
The way we do business The way we do business and our underlying values are central to the Group’s success. Our Code of Business Conduct governs the way we treat our stakeholders, and our values determine our behaviours. Both determine how we do business throughout the Group and define our corporate identity. They also influence our business relationships and reputation, which are key to our long-term success.
Say it like it is Be real, authentic and true to self; have adult to adult conversations with all audiences; listen, seek to understand and respect diversity of views; be open, call out issues we see; share information and keep things as simple as possible.
48 Direct Line Group Annual Report & Accounts 2015 1 Mike Biggs (63), Chairman of the Board (appointed April 2012) (N and R)
Biography Mike is also Chair of the Nomination Committee. He has over 40 years’ experience of the UK and international financial services sector. He is a respected figure in the insurance industry and well regarded by City investors.
Mike was previously Chairman of Resolution Limited, then a FTSE 100 UK life assurance business, and has acted as Chief Executive Officer and Group Finance Director of Resolution plc. He was previously Group Finance Director of Aviva plc.
He has a Masters degree in History from the University of Oxford, and is an Associate of the Institute of Chartered Accountants of England and Wales.
External appointments Paul is the Senior Independent Director of the Association of British Insurers Board.
Biography John is an experienced Chief Financial Officer and former banker. He has extensive City and financial services experience.
John was previously an Executive Director at the Co-operative Insurance Society, CIS General Insurance and The Co-operative Bank. He was Chief Financial Officer of these organisations between 2003 and 2007, and subsequently Managing Director, Corporate and Markets. Before this, John spent more than 20 years in investment banking with UBS and Goldman Sachs. He is an Economics graduate of the University of Cambridge.
External appointments John is a trustee and Director of Farm Africa. He is also an alternate representative of the Association of British Insurers on the Panel on Takeovers and Mergers.
4 Jane Hanson (48), Non-Executive Director (appointed December 2011) (A, B, C, I and +)
She spent her early years with KPMG, working in the financial sector, later becoming responsible for delivering corporate governance, internal audit and risk-management services in the north of England. Jane has also held a number of executive roles, including Director of Audit, and Risk and Governance Director at Aviva’s UK Life business.
Before joining Dixons Retail, Sebastian was Chief Executive Officer of Synergy Insurance Services Limited and subsequently gained wide retail experience as Strategy Director responsible for developing and implementing the turnaround strategy at Mothercare. After completing an MBA at INSEAD and an MA at the University of Oxford, he started his career at The Boston Consulting Group.
External appointments Sebastian is Group Chief Executive of Dixons Carphone plc and is also a trustee of the charities Save the Children and Dixons Carphone Foundation.
Biography Andrew is Chair of the Audit Committee. He was Senior Independent Director from the AGM in 2015 until the Group appointed Dr Richard Ward on 18 January 2016. He has performed various senior roles in the financial services and insurance industries. Additionally, he has insight into corporate governance developments and best practice in financial reporting. This comes largely through his membership of the Financial Reporting Review Panel of the Financial Reporting Council.
In 2009, Andrew retired from Legal & General Group plc, where he was the Group Finance Director. He is a Fellow of the Institute of Chartered Accountants in England and Wales.
External appointments Andrew is a Trustee of the Royal School of Needlework, a Trustee and Treasurer of Cancer Research UK, and a Non-Executive Director of Royal London Mutual Insurance Society Limited. He is also a member of the Financial Reporting Review Panel of the Financial Reporting Council.
7 Clare Thompson (61), Non-Executive Director (appointed September 2012) (A, B, C, I and +)
Biography Clare is Chair of the Corporate Social Responsibility Committee and the Investment Committee. She has extensive experience and knowledge gained from roles across the professional services industry. These include Lead Audit Partner at PwC, where she guided companies through change and advised insurance organisations. In her later role, she gained significant experience of general and life insurance.
Clare was a partner at PwC from 1988 to 2011. During her 23 years as a partner, she held several senior and high-profile roles, particularly in the insurance sector. She is a graduate of the University of York with a degree in Mathematics, and a Fellow of the Institute of Chartered Accountants in England and Wales.
Biography Priscilla is Chair of the Remuneration Committee. She has extensive experience developing organisational values, and creating the leadership, succession, development and remuneration structures required to support corporate strategy. As she has worked as a practitioner and an adviser, Priscilla understands the technical and market complexity of remuneration.
9 Dr Richard Ward (59), Non-Executive Director and Senior Independent Director (appointed January 2016) (N and +)
Biography Dr Richard Ward joined Cunningham Lindsey as Executive Chairman in June 2014. Cunningham Lindsey is the leading global provider of claims management and risk service solutions.
Richard has a 1st Class Honours degree in Chemistry, and a PhD in Physical Chemistry from Exeter University.
Paul Geddes chairs the Executive Committee. In addition to Paul Geddes and John Reizenstein, the committee comprises the following: 1 Jonathan Greenwood, Managing Director of Commercial (joined 2000)
Experience and qualifications Mike was previously Chief Executive Officer of RSA Group’s Scandinavian businesses, Codan A/S and Trygg-Hansa. Before joining RSA, Mike worked in the energy, telecoms and retail sectors. He started his career at WHSmith plc, before moving to various Centrica-owned businesses, including British Gas and Onetel. He has also served as Managing Director of MORETH>N and holds an EMBA from Ashridge Business School.
Experience and qualifications Simon joined the Group in September 2014. He was previously Group HR Director for O2, and responsible for all of Telefonica global digital businesses. Before this, he held various senior global HR roles at Diageo, including responsibility for Spain, Africa and several UKbased leadership positions. Before moving into HR, Simon held several commercial business roles in the fast-moving consumer goods and financial services sectors.
Experience and qualifications José was previously Global Chief Risk Officer at HSBC Insurance. Before joining HSBC, José held senior actuarial roles at Zurich Insurance and was a consultant with KPMG in London. José is a Mathematics graduate from Brunel University and a Fellow of the Institute of Actuaries.
The Board’s specific duties are set out in the Schedule of Matters Reserved for the Board, which contains items reserved for the Board to consider and approve, including: • The Group’s strategic aims and objectives
• The internal controls and risk-management system, including the Group’s risk appetite statements
In addition to the schedule of Matters Reserved, each Board Committee has written terms of reference defining its role and the standing authority delegated to it. You can find out more about the Board Committees in the Board Committees’ section from pages 58 to 69.
Board composition As at the date of this report, the Board comprises the Chairman, who was independent when appointed to the Board; the Chief Executive Officer; the Chief Financial Officer; and six independent NEDs. Every current Director served throughout the reporting period, except for Richard Ward, who was appointed to the Board on 18 January 2016.
Structure of the Board The Board and its Committees have been established to ensure that an appropriate balance of skills, experience, independence, sector knowledge and diversity exists to enable the Directors to discharge their duties and responsibilities effectively.
Chairman and Chief Executive Officer The Board has agreed role profiles for the Chairman, Mike Biggs, and the Chief Executive Officer, Paul Geddes. These clearly define their roles and responsibilities. This is to ensure no one person has unlimited powers of decision making.
The Chairman’s priority is leading the Board and ensuring its effectiveness. The Chief Executive Officer’s priorities are managing the Group, and delivering the Group’s strategy and financial results.
Senior Independent Director Richard Ward is the SID. The role of the SID is: to be a sounding board for the Chairman; to act as an intermediary for the other Directors when necessary; and to be available to shareholders if they have any concerns they cannot resolve through normal channels. His responsibilities also include evaluating the Chairman’s performance annually.
NEDs The NEDs objectively and constructively challenge management. They also use their wider business experience to help develop the Group’s strategy.
Information and support All Directors can access assistance and advice from the Company Secretary. The Board is satisfied that it receives information of appropriate quality and in a timely manner, to enable the Directors to discharge their duties. Directors may seek external independent professional advice at the Company’s expense, if they need it to discharge their duties.
Conflicts of interest The Company’s Articles of Association allow the Board to authorise matters where there is, or may be, a conflict between the Group’s interests and the direct or indirect interests of a Director, or between the Director’s duties to the Group and another person. This is in accordance with the Companies Act 2006.
To do this, the Company Secretary maintains a register of conflicts, and any conflicts that the Board has authorised. The Board reviews this register regularly.
Board activities during 2015 At each scheduled meeting, the Board receives updates from the Chief Executive Officer, Chief Financial Officer and the Chief Risk Officer. The officers update the Board on the operational performance against the agreed plan, financial performance and risk management. The Board also has an annual planner of agenda items. This ensures the Board considers matters in a timely manner during the financial year.
• Overseeing the prudent management of the Group’s capital, ensuring that capital reserves remain robust, while enabling the return of surplus capital to investors through special dividends
• Approving and monitoring a comprehensive programme of investment in technology, organisational restructuring and cultural change. This programme aims to improve customer experience, making it easier to do business with the Group, and helping the Group provide outstanding customer service
• Overseeing the Group’s regulatory relationships and preparations for implementing Solvency II
Chairman Mike Biggs 9 of 9 100% Senior Independent Director Andrew Palmer 9 of 9 100% Glyn Jones 4 of 4 100% NEDs Jane Hanson 9 of 9 100% Sebastian James 9 of 9 100% Clare Thompson 9 of 9 100% Priscilla Vacassin 9 of 9 100% Executive Directors Paul Geddes 9 of 9 100% John Reizenstein 9 of 9 100%
A tailored induction programme, comprising 16 sessions, was prepared for Richard Ward. The programme will focus on the Group’s businesses, strategic and transformational priorities, regulatory and governance frameworks, capital and financial management, and risk framework.
The main Board training and development activities in the year under review included: • Training on topics including customer behaviour, the Group’s investment portfolio, and cyber risk
• NED visits to operational business units to meet the management teams and better understand how the business operates. These included visits to the Human Resources, Risk, Legal, Audit and Actuarial teams in Bromley
Direct Line Group’s approach to diversity The Board carefully considered the diversity of its members from various perspectives. It also sought to ensure that Directors had the relevant knowledge, skills, experience and, where necessary, independence to help the Group deliver its strategy.
The Company believes in the benefits of diversity. At the date of this report, of the Board’s nine members, three are women. However, while the Board will strive to consider diversity when choosing new members, it is committed to appointing the most appropriate candidates.
Relating to the Board, its Committees and individual Directors, the questionnaire focused on: • The flow of information, including the quality and sufficiency of reports, management information and training
• Administration, including how many and how often meetings occurred; paper volumes; the quality of systems and processes; and Board and Committee support
The Chairman discussed the outcome of the effectiveness review with the NEDs and Chief Executive Officer. The SID gave feedback on the Chairman’s performance, with input from his fellow NEDs.
Governance framework and structure The Board is responsible for ensuring there is an appropriate system of governance throughout the Group. This includes a robust system of internal controls and a sound risk management framework. The Group’s governance framework is detailed in the High Level Control and System of Governance document. The Board reviews this document annually.
The core elements are the: • Matters Reserved to the Board and the Board Committees’
• Group Policy Framework, which comprises policies that the Board approves. Minimum Standards interpret these policies into a set of operational requirements and these are implemented throughout the Group
The Chief Executive Officer The Board is ultimately responsible for the Company’s success. However, the Board has authorised Paul Geddes, the Chief Executive Officer, to manage the Group’s day-to-day operations and deliver its strategic objectives.
In turn, Paul Geddes has delegated certain elements of his authority to Executive Committee members. This helps ensure that senior executives are accountable and responsible for managing their businesses and functions. Such delegation also involves ensuring the senior executives have the appropriate financial and other authorities needed to manage those business areas.
Executive Committee The Executive Committee is the principal management committee that helps the Chief Executive Officer manage the Group day to day. It helps him: set performance targets; implement the Board-determined Group strategy and direction; and monitor key objectives and commercial plans to help achieve the Group’s targets. It also helps him evaluate new business initiatives and opportunities, and considers reports on operational matters that are material to the Group or have cross business implications.
The Directors confirm that they consider that the Annual Report & Accounts, taken as a whole, is fair, balanced and understandable, and provides the information shareholders need to assess the Group’s position and performance, business model and strategy. In arriving at this conclusion, the Board was supported by a number of processes, including the following: • Management drafted the Annual Report & Accounts to ensure consistency across sections, and a steering group comprising a team of cross-functional senior management provided overall governance and co-ordination
• A verification process, to ensure the content was factually accurate
• Members of the Executive Committee reviewed drafts of the Annual Report & Accounts
• The Audit Committee reviewed the substantially final draft before consideration by the Board
• How the Board has assessed the Group’s longer-term viability and the adoption of the going concern basis in the financial statements follows below
• The Board has delegated the Audit Committee to oversee managing the relationship with the Company’s external Auditor. You can find details of the Committee’s role, activities and relationship with the internal and external auditors in the Audit Committee report on pages 58 to 60
The Group’s financial position is also covered in that section, including a commentary on cash and investment levels, reserves, currency management, insurance liability management, liquidity and borrowings. Additionally, note 3 to the consolidated financial statements describes capital management needs and policies and also covers insurance, market, liquidity and credit risks which may affect the Group’s financial position.
This confirmation is based on the Directors’ twice-yearly review and challenge of the Group’s Material Risk Assessment (“MRA”), and their review and approval of the Group’s risk appetite statements. The MRA identifies risks quantified as having a residual risk impact of £40 million or more based on a 1-in-200-years likelihood period. The quantifications are produced through stress and scenario analysis, and the internal economic capital model. Each directorate’s bottom-up risk identification and assessment supplements the MRA. The MRA also plays a key role in developing the Own Risk and Solvency Assessment (“ORSA”) and assessing the Group’s strategic plan.
The Board, with the assistance of the Board Risk Committee and the Audit Committee as appropriate, monitored the Company’s risk management and internal control systems, and reviewed their effectiveness. The monitoring and review covered all material controls, including financial, operational and compliance controls. The Board and its Committees are overseeing the ongoing work to improve the performance across the board of the Group’s IT systems, including focusing on risks relating to IT systems’ stability, cyber security and the internal control environment.
The Board was also supported in its review of the annual Control Environment Certification process. As part of this, each directorate self-assessed its risks and whether its key controls were adequate and effective. The Risk and Group Audit functions reviewed and challenged these findings. The Group then combined the overall findings into a Group-level assessment, which the Chief Executive Officer approved. The system reported on the controls’ nature and effectiveness, and other management processes that manage these risks.
The Directors acknowledge that any internal control system can manage, but not eliminate the risk of not achieving business objectives. It can only provide reasonable, not absolute, assurance against material misstatement or financial loss.
On behalf of the Board, the Audit Committee regularly reviews the effectiveness of the Group’s internal control systems. Its monitoring covers all material controls. Principally, it reviews and challenges reports from management, the Group Audit function and the external Auditor. This enables it to consider how to manage or mitigate risk in line with the Group’s risk strategy.
Relations with shareholders The Board believes that engaging regularly with the Company’s shareholders is vital to the Group’s business. Communicating and engaging with investors means the Board can stay up to date on opinions. It also gives the Company the opportunity to answer questions and concerns.
Annual General Meeting The Board sees the Company’s AGM as a good opportunity for private shareholders to talk directly with the Board. All shareholders can attend the AGM if they wish. All Directors attended the AGM in 2015.
At the AGM, the Chief Executive Officer presents the Group’s financial results. Next, the Chairman proposes the AGM’s formal business. The AGM’s facilitators encourage shareholders to ask questions about the meeting’s business. The Chairman, the Committee Chairs and the remaining Directors and members of the Executive team are also available to talk with shareholders at the end of the meeting.
The Audit Committee’s role The Committee is responsible for overseeing and challenging the effectiveness of the Group’s systems of financial and other controls. It also monitors the work and effectiveness of the Group’s internal and external auditors and actuaries.
You can find the Audit Committee’s terms of reference at www.directlinegroup.com .
Andrew Palmer (Chair) 5 of 5 100% Jane Hanson 5 of 5 100% Glyn Jones1 2 of 2 100% Clare Thompson 5 of 5 100%
Financial reporting During the year, the Committee reviewed the preliminary announcement of the Group’s 2014 financial results, the 2014 Annual Report & Accounts, and the 2015 Half Year Report. The Committee then recommended them to the Board for approval.
The Committee also advised the Board whether the financial statements, taken as a whole, were fair, balanced and understandable and provided sufficient information to enable the reader to assess the Group’s performance, business model and strategy.
When considering the Annual Report & Accounts for 2015, the Committee focused on the significant risks and judgements which could be material to the financial statements. These included: Reserve valuation – The Committee reviewed the actuarial best estimates of the level of reserves with external consultants. Further information on reserves is given below.
Reinsurance recoverables – The Committee considered the proposed methodology for an impairment provision.
Goodwill and other intangible assets – The Committee considered the carrying value of goodwill and other intangible assets and whether any impairment provision was required.
Transformation projects – The Committee considered major change projects including the IT migration from RBS Group systems.
The Committee considered reports prepared by management on the significant estimates and judgements that were material to the financial statements and challenged the judgements being made. The Committee also discussed these matters with Deloitte, the External Auditor.
It also considers an appropriate balance between internal and external actuarial review. Consultants appointed to provide actuarial reviews of reserves are subject to approval by the Committee. The external actuarial review was carried out by PricewaterhouseCoopers LLP for the Directors of Direct Line Insurance Group plc and its relevant affiliates1.
Internal control and Group Audit During the year, the Audit Committee reviewed the adequacy and effectiveness of the Group’s internal control systems.
The Group’s Financial Reporting Control Framework (“FRCF”) is part of its wider internal controls system. It addresses financial reporting risks. The Board delegates supervision of the FRCF to the Audit Committee. The Chief Financial Officer is responsible for the FRCF on a daily basis.
The Committee considered the Group’s internal controls and processes for identifying and responding to risks.
Solvency II During the year, the Committee held four additional meetings to consider matters relating to the Solvency II governance and Internal Model Approval Process (“IMAP”) application. At those meetings, the Committee considered: • Reports to the PRA for the preparatory reporting stage of Pillar III as at 31 December 2014 and 30 September 2015
The Committee monitored the performance of the work of and relationship with the External Auditor during the year. Deloitte LLP were appointed as Auditor to the Group at IPO in 2012. Deloitte LLP, as the auditor of the RBS Group, audited the Group as a division of RBS between 2000 and 2012. The Company cannot reappoint Deloitte LLP as its auditor after June 2023. This complies with the transitional rules for audit tendering and auditor rotation, as set out in the Competition & Markets Authority’s (“CMA”) Order and the EU Audit Regulation. Note: 1. The relevant affiliates are U K Insurance Limited and Churchill Insurance Company Limited.
The Committee has fully considered how the EU Audit Regulation and the CMA’s Order on mandatory audit contract tendering affect the Group. Under the CMA Order, the Group will conduct a competitive tender and enter into a new audit services contract before June 2023. The Committee will tender the audit contract for the year ended 31 December 2021 at the latest. The Committee considers that this is in the best interests of the shareholders as it will coincide with the next audit partner’s rotation and therefore limit operational disruption during a time of significant regulatory and organisational change over the next few years. However, in conjunction with the results of the annual assessment of the Auditor’s effectiveness, this position will be reviewed again in 2016.
Auditor independence and non-audit services policy The Group has an Independence of External Audit minimum standard. This established parameters for preventing or mitigating anything that compromises the External Auditors’ independence or objectivity, by virtue of them providing the Group with non-audit services. The Committee reviews and refreshes the standard annually to make sure it remains appropriate.
During the year, the Committee approved fees of £0.9 million to Deloitte LLP for services unrelated to audit work. The following is a breakdown of fees paid to Deloitte LLP for the year ended 31 December 2015.
Audit fees1 1.9 67.9% Non-audit fees 0.9 32.1% Total fees for audit and other services 2.8
The non-audit fee of £0.9 million relates to audit-related assurance services, tax services and an IT project.
Effectiveness of the external audit process and reappointing Deloitte as External Auditors In 2015, the Audit Committee assessed the External Auditors’ effectiveness. This was in addition to regularly questioning the Auditor during its meetings. The Audit Committee assessed the Auditor through: a detailed questionnaire which key stakeholders completed; discussing matters with the Chief Financial Officer; formally reviewing Deloitte LLP’s independence; and assessing whether it fulfilled the agreed audit plan.
The Financial Reporting Council’s Audit Quality Review team selected to review the audit of the 2014 Group financial statements as part of their 2015 annual inspection of audit firms. The focus of the review and their reporting was on identifying areas where improvements were required rather than highlighting areas performed to or above the expected level. The Chairman of the Audit Committee received a full copy of the findings of the Audit Quality Review team and discussed these with Deloitte. The Committee confirms that there were no significant areas for improvement identified within the report. The Committee is also satisfied that there is nothing within the report which might have a bearing on the audit appointment.
The Committee, after taking into account all of the information available, concluded that Deloitte LLP had performed its obligations effectively and appropriately as External Auditor to the Group.
The Audit Committee subsequently recommended to the Board that the Group reappoint Deloitte LLP as External Auditor. The Group will put a resolution regarding this to the shareholders at the 2016 AGM.
The Audit Committee’s effectiveness The Company Secretary facilitated the Committee’s review of its effectiveness during the year. The Company Secretary also prepared a report based on responses from Committee members and other stakeholders to a pre-agreed questionnaire. After reviewing and discussing the report, the Committee concluded that it was operating effectively, and has access to sufficient resources to perform its duties.
The Board Risk Committee’s role The Committee is responsible for overseeing and advising the Board on the Group’s current and potential future risk exposures, and its strategic approach to managing risk. The Committee recommends risk appetite and tolerance levels to the Board, and supports the Board in promoting a risk-aware culture across the Group.
The Committee has unrestricted access to management and external advisers to help discharge its duties. It is satisfied that during 2015 it received sufficient, reliable and timely information to perform its responsibilities effectively.
• Review and recommend the ORSA process and report to the Board
• Review the Group’s procedure for detecting internal and external fraud
Committee composition, skills and experience The Committee comprised four independent NEDs: Jane Hanson, Andrew Palmer, Clare Thompson and Priscilla Vacassin. You can find their biographies on pages 48 and 49.
Meetings The Board Risk Committee held six scheduled meetings in 2015. One of these was a joint meeting with the Remuneration Committee. Additionally, six sub-committee meetings were held to consider Solvency II and IMAP matters. This table shows attendance at the scheduled meetings: Scheduled meetings
On behalf of the Board, the Committee also monitored the Company’s risk management systems, and reviewed their effectiveness. The monitoring and review involved examining an assessment of the control environment and material controls at Group level, based on directorate-level risk and control selfassessments. These assessments were subject to challenge by the Risk and Group Audit functions.
The Committee considered the Group’s broader operational risk control environment and commissioned reviews by the Risk function on controls relating to major third-party suppliers and the execution of pricing changes. In addition, the Committee considered the Group’s cyber risk assessment and associated controls, as well as the governance structures across the Group.
Financial risk At each meeting, the Committee monitored the Group’s performance against the financial risk appetite through the Chief Risk Officer’s report. The Committee also considered risks in the strategic plan against risk appetite.
Solvency II and IMAP One of the Committee’s main considerations in 2015 was preparing for the implementation of Solvency II. This is the European Insurance Industry’s new framework for ensuring capital adequacy. It involves using a forward-looking risk assessment based on ORSA principles. The Committee also monitored and challenged progress on the Group’s IMAP application.
During the year, the Committee reviewed and considered Solvency II matters, including: • The 2015 IMAP validation framework, scope and process, including an independent assessment and the resolution of validation issues and delivery against regulatory deadlines
• The Group’s Solvency Capital Requirement (“SCR”), including the key assumptions and dependencies within the calculation methodology such as the materiality limits and the approach to catastrophe modelling
• The ongoing application of, and controls over, the IECM including recommendation for Board approval of the defined management actions and the validation approach for 2016
The Committee considered, challenged and approved the Annual Risk and Compliance Plan. It also reviewed an ‘Assessment of Risk Behaviours and Attitudes’ across the Group, which is part of an ongoing process to drive continued improvement in these areas by providing feedback on current state, highlighting areas of good practice and areas for focus.
Additionally, the Committee held a Risk Strategy day. During the event, the Committee considered the Group’s approach to the management of risk, the risk oversight model and the operation of the Three Lines of Defence model in the Group.
Clare Thompson (Chair) 3 of 3 100% Paul Geddes 3 of 3 100% Jane Hanson 3 of 3 100% Sebastian James 3 of 3 100% Angela Morrison 3 of 3 100%
• Being recognised as part of our communities – Jon Greenwood
You can find out more about the Group’s CSR approach and priorities in the CSR section on pages 30 to 33.
Helping to make our society safer During the year, the Committee held a strategy session to consider how the Group could best use its expertise and experience to reduce deaths and life-changing injuries on the UK’s roads. The overall aim is to cut deaths in the first 1,000 miles of driving to zero, by engaging young drivers and helping them to drive more safely. The Committee received regular progress reports on, and provided valuable insight into, this initiative. You can find further details on this initiative and the manifesto in the CSR section on page 31.
Proud to be here The primary objective of this strand was to improve employee engagement in order to support a key enabler of the Group’s 2015 strategy. The KPIs for this element are linked to the People Strategy and focus on employee engagement and wellbeing. During the year the Committee discussed and challenged the proposed targets and the focus of the work stream. It was agreed that the focus should be on (i) pride in working for the Group; (ii) telling others that the Group is a great place to work; and (iii) employee wellbeing.
Being recognised as part of our communities The Committee received reports about how the Group was strengthening the level of support provided to the network of Community and Social Committees operating at the main Group locations. The main targets which had been agreed related to volunteering, fund raising and matched payroll giving.
The ‘One Day’ volunteering initiative and Community Cashback scheme were considered to be the two areas with the greatest potential for impact.
Reduce, Reuse and Recycle This strand of the strategy considered energy use, waste management and resource use within our operations as well as environmental matters in the Group’s supply chain. Key objectives related to a reduction in greenhouse gas emissions and diverting waste from landfill.
The Investment Committee’s role The Committee is responsible for overseeing how the Group develops its investment strategy. It also oversees the management and performance of the Group’s investment portfolio.
• Consider and approve material changes to the risk framework that underpins investment activity, and any proposals to change the operating model. This typically relates to how outsource service providers are used
• Review global financial market developments and changes to the regulatory environment, and consider the ongoing appropriateness of investment activities in light of such developments
Meetings The Investment Committee held four scheduled meetings in 2015. This table shows attendance at the scheduled meetings: Scheduled meetings
Main activities during the year Investment strategy After considering and challenging, the Committee recommended to the Board the following material changes to the Group’s investment strategy. The Board approved the changes during 2015.
• The introduction of three new asset mandates. Two mandates will invest in global credit and subordinated financial credit respectively, and the third mandate will invest in Sterling commercial real estate loans, a new asset class for the Group’s investment portfolio
Monitoring investment activity and performance The Committee monitored the performance of investments every quarter. It also received reports from the Director of Investment Management and Treasury on various matters. These included: key market developments; financial results from investment activity; investment performance versus benchmark for internally and externally managed portfolios; operational performance by the custodian and other service providers; and compliance with risk limits and internal delegated authorities. The Committee also received presentations from Investment Managers on their performance against benchmark.
Solvency II The Committee examined progress on initiatives linked to preparing for Solvency II, notably: • Preparing a liquidity plan and contingent management actions
• Restructuring the securitised credit portfolio to meet Solvency II requirements
The Investment Committee’s effectiveness The Company Secretary facilitated the Committee’s review of its effectiveness during the year. The Company Secretary also prepared a report based on responses from Committee members and other stakeholders to a pre-agreed questionnaire. After reviewing and discussing the report, the Committee concluded that it was operating effectively, and has access to sufficient resources to perform its duties.
Responsibilities The Committee’s main responsibilities are: • Considering and recommending to the Board matters regarding appointment of Directors, membership and chairmanship of Board Committees
You can find the Nomination Committee’s terms of reference at www.directlinegroup.com .
Priscilla Vacassin was appointed as a Committee member on 13 May 2015, when Glyn Jones stepped down as a NED and Committee member.
Meetings The Nomination Committee held three scheduled meetings in 2015. It also held additional meetings to deal with membership of the Board’s Committees and the search for the new SID.
Mike Biggs (Chair) 3 of 3 100% Glyn Jones1 2 of 2 100% Andrew Palmer 3 of 3 100% Priscilla Vacassin1 1 of 1 100%
Board changes Glyn Jones stepped down from the Board following the AGM on 13 May 2015, due to his increasing responsibilities as Chairman of other listed companies. On 18 January 2016, the Group appointed Richard Ward as a NED of the Company and SID.
JCA Group prepared a long list of candidates of appropriate merit from diverse backgrounds. The Committee agreed a shortlist and interviewed candidates. It then approached the PRA and FCA for approval, and recommended appointing Richard Ward as a NED to the Board.
Diversity The Group celebrates the diversity of its workforce. It seeks to recruit the best candidates for all positions throughout the business, whatever their gender. At the date of this report, three of the Group’s nine Directors are women, which equates to 33% of the Board. This is the target set in Lord Davies’ Women on Boards Review Five Year Summary published in October 2015, to be achieved by 2020. The Board also acknowledges the benefit of diversity. The Nomination Committee has encapsulated in its terms of reference a requirement to consider candidates for appointment to the Board on merit, against objective criteria and with due regard to diversity, including gender diversity.
The Nomination Committee’s effectiveness The Company Secretary facilitated the Committee’s review of its effectiveness during the year. The Company Secretary also prepared a report based on responses from Committee members and other stakeholders to a pre-agreed questionnaire. After reviewing and discussing the report, the Committee concluded that it was operating effectively, and has access to sufficient resources to perform its duties.
• Recommending and monitoring the level and structure of remuneration for senior executives
Meetings The Remuneration Committee held five scheduled meetings in 2015. One was a joint meeting with the Board Risk Committee to discuss matters relating to overlapping remits between the two Committees. This table shows attendance at the scheduled meetings: Scheduled meetings
The Chief Executive Officer, Human Resources Director and senior representatives of the Human Resources function are invited to attend Remuneration Committee meetings. FIT Remuneration Consultants LLP, who act as independent advisers to the Committee, are also invited to attend Remuneration Committee meetings. The Chair reports on matters dealt with at each Committee meeting to the subsequent scheduled Board meeting.
Long-Term Incentives In 2015, the first awards, made in November 2012 under the Direct Line Insurance Group 2012 Long-Term Incentive Plan (“LTIP”), vested. These awards were made shortly after the IPO, and had two performance metrics based on RoTE and TSR. After assessing performance against these metrics, the awards vested at a level of 89.2%. Before vesting, the Committee considered the LTIP’s financial and risk underpins. The Committee considered whether to operate the malus provisions. You can find out more about this in the Directors’ remuneration report on pages 70 to 95.
The Committee also determined the quantum of awards in 2015 under the LTIP in view of business and individual performance.
The Committee advised and supported RBS Group when it was assessing the Group’s performance for the purpose of LTIP awards it had made. The awards were made under an RBS Group LTIP scheme to Direct Line Group employees over Direct Line Group shares prior to the IPO.
The Committee also considered how the 11-for-12 share consolidation would affect existing awards under the Company’s Share Incentive Plan.
Remuneration strategy In addition to the scheduled Committee meetings, the Committee held an additional meeting to review the remuneration framework and ensure that it was aligned to the Group strategy, and to set future priorities.
Dear shareholder As Chair of the Remuneration Committee (the “Committee”) I am pleased to introduce our report on Directors’ remuneration for the 2015 financial year. We have set out this report in the following sections: Section Pages
Executive remuneration snapshot – summarising the remuneration arrangements for Executive Directors 72 to 73 Annual report on remuneration – covering how the Group will implement its remuneration policy in 2016, and detailing pay outcomes for 2015 74 to 85 Approved policy report 86 to 95
Linking remuneration to performance – pay outcomes for 2015 As highlighted in the Board Chairman’s letter on pages 10 to 11, 2015 has marked another good performance year for the Group with operating profit from ongoing operations ahead of target, despite higher than normal claims costs from major weather events. The incentive outcomes for our Executive Directors as set out in the annual report on remuneration reflect this level of performance.
We base bonuses under the AIP on performance against key financial, strategic and personal measures. We awarded bonuses of 83% of the maximum to the Chief Executive Officer and 86% of the maximum to the Chief Financial Officer for 2015. This reflects achievement of operating profit from ongoing operations ahead of the target set under the AIP, strong progress made on customer experience metrics, as evidenced by improved Net Promoter Scores in Personal Lines and highlighted in the Group highlights section of the Annual Report on page 2, and achievement against personal objectives. We have provided enhanced disclosure this year relating to the AIP outcome for 2015. You can find this on page 78.
Overall, 89.2% of the total award vested in November 2015, which is a good level of achievement and is reflective of the business performance and returns to shareholders over the same period.
Awards under the LTIP granted in March and August 2013 are due to vest during 2016. The RoTE performance period for these awards ended on 31 December 2015 and, subject to the Committee’s satisfaction that the financial and risk underpins have been met at the end of the vesting period, awards under the RoTE element are due to vest at 94% of the maximum potential, again reflecting the returns delivered to shareholders.
Here are the highlights of our approach to pay for the Executive Directors in 2016: • The salaries of both Executive Directors will increase by 2.5% in April 2016, a lower increase compared to the average increase to employees across the Group generally
• Our overall approach to measuring performance under the AIP in 2016 will be broadly similar to our approach in 2014 and 2015. We will continue measuring performance using financial, strategic and personal targets and the Committee will also use its broader judgement to carefully assess payouts. From 2016, to better align AIP outcomes with shareholders’ experience, we will assess financial performance using profit before tax, as opposed to ongoing operating profit. Consequently, we will remove the specific allocation of other financial measures not included in the definition of ongoing operating profit
Separately to the executive share plans, we believe it is important for all our employees to have the opportunity to become shareholders in the Company. We run a Buy-As-YouEarn Share Incentive Plan (the “SIP”) which allows employees to receive one matching share for every two shares they purchase. In addition, to recognise the continued contribution of our employees to the success of our business, we will be granting a further free share award of around £250 to each eligible employee during March 2016. This award will be the third offer of free shares to employees since the IPO.
I hope you find this report informative and I welcome any comments you may have.
Finally, on a personal note, this will be my last report as Chair of the Committee as I step down from the Board on 1 March. I hope that you will agree that the work of the Committee, which I have chaired since IPO, has struck an appropriate balance and served well the interests of shareholders. I know that my successor, Clare Thompson, will continue to do so.
Executive remuneration snapshot The information in this section relates to the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”).
(For more information, see the policy report on pages 86 to 95) Implementation in 2016
AIP • Maximum opportunity level is 175% of salary for the CEO and 150% for the CFO
• Nil-cost options to be granted in March and August 2016 at a total annual grant level of 200% of salary
• Performance conditions as per 2015 awards 2015 pay decisions reflect performance achieved during the year Aligning performance and reward The Committee has considered the performance over 2015, as demonstrated by the achievement of key performance indicators on pages 24 to 25, which marks the third year of good performance for the Group. As a result of this performance, the Remuneration Committee has approved the following incentive outcomes for the Executive Directors.
Achievement under the AIP The actual payouts from the AIP this year reflect performance in 2015, with operating profit from ongoing operations ahead of the target set under the AIP, the progress made towards achieving our strategic objectives and the Executives’ achievement of personal and shared goals. Further details of the assessment of performance against the targets are provided on page 78.
Release of value under the LTIP The first award under the 2012 LTIP vested in November 2015. The value of the award on vesting, as illustrated below, reflects the significant value generated for shareholders through share price growth and dividends over the three-year period. The value of these awards has been captured across both 2014 and 2015 single figures for the RoTE and TSR elements respectively on page 77 of the implementation report. The total value of the award vesting at the end of the three-year performance period in November 2015, inclusive of shares vesting under both the RoTE and TSR elements, was £1,706,857 to Paul Geddes and £1,033,095 to John Reizenstein. This compares with an increase in the value of the Company of over £2.5 billion plus £1.3 billion returned to shareholders by way of dividends over the same time period.
Note: 1. Shares held as at 31 December 2015 reflect the impact of the share consolidation on 30 June 2015 in which every 12 existing Ordinary Shares were replaced by 11 new Ordinary Shares, meaning the aggregate number of Ordinary Shares in issue was reduced. For the purposes of this chart, holdings include all vested but unexercised awards, valued on a basis that is net of applicable personal taxes.
Committee Chair Priscilla Vacassin Non-Executive Directors Mike Biggs Sebastian James Andrew Palmer
Advisers to the Committee The Committee consults with the Chief Executive Officer, the Human Resources Director, and senior representatives of the HR, Risk and Finance functions on matters relating to the appropriateness of all remuneration elements for Executive Directors and Executive Committee members. The Chairman, Chief Executive Officer and the Human Resources Director are not present when their remuneration is discussed. The Committee works closely with the Chairs of the Board Risk Committee and the Audit Committee, including receiving reports from those Chairs regarding the setting of targets and payouts under incentive plans and whether it is appropriate to operate malus and clawback. The Chair of the Audit Committee is a member of the Remuneration Committee; and the Chair of the Board Risk Committee attended Remuneration Committee meetings on three occasions.
The Committee retains FIT Remuneration Consultants LLP (“FIT”) as its independent adviser. FIT is a signatory to the Remuneration Consultants Group’s Code of Conduct. The Committee appointed FIT when preparing for the IPO and after considering the firm’s experience in this sector.
During the year, FIT advised on market practice, corporate governance, incentive plan design and target setting, regulations, and other matters that the Committee was considering. FIT does not provide the Company with any other services. The Committee is satisfied that the advice FIT provides is objective and independent.
FIT’s total fees for remuneration related advice in 2015 were £117,406 exclusive of VAT. FIT charged its fees based on its standard terms of business for providing advice.
Annual Incentive Plan 2016 The maximum annual incentive awards which may be paid to Executive Directors have not changed since the IPO.
Paul Geddes Chief Executive Officer 175% 40% John Reizenstein Chief Financial Officer 150% 40%
Financial Profit before tax (2015: ongoing operating profit) 55% 50% Other financial measures not reflected in the definition of ongoing operating profit, primarily the performance of the Run-off segment and restructuring costs 0% 10%
Strategic Based on a basket of customer measures, including Net Promoter Score and complaints 25% 20%
Gateway criteria for the Annual Incentive Plan for 2016 – outcomes for Executive Directors • Year-on-year changes in profit before tax
• 40% based on relative TSR performance against the constituents of the FTSE 350 (excluding investment trusts) over a three-year performance period, starting on the date of grant. The starting and closing TSR will be averaged over a three-month period www.directlinegroup.com 75
For these purposes, we use the Group’s standard definition for RoTE, subject to such other adjustments as the Committee may consider appropriate. To find out more about how we calculate RoTE, see page 175.
Relative TSR 20% of this element of the award Median Upper quintile
The LTIP awards will also vest only to the extent that the Committee is satisfied that the outcome of the TSR and RoTE performance conditions reflects the Group’s underlying financial performance from the date of grant until vesting. When considering these matters, the Committee will also deliberate on whether there have been any material risk failings.
Non-Executive Directors’ fees The current fees for the Chairman and Non-Executive Directors were set in 2012 and have not changed since.
Board Chairman fee 400 Basic Non-Executive Director fee 70 Additional fees Senior Independent Director fee 30 Chair of Audit, Board Risk and Remuneration Committees 30 Chair of CSR Committee 10 Member of Board Committee (Audit, Board Risk or Remuneration) 10 Member of Board Committee (CSR or Nomination) 5
John Reizenstein is a trustee and Director of Farm Africa, for which he receives no fees. Otherwise, the Executive Directors do not currently hold any external directorships.
Implementing policy and pay outcomes relating to 2015 performance Single figure table (audited)
4. The expected vesting outcome figures for the RBS Group LTIP awards granted in 2012 and reported in 2014 have been updated. These updates are based on the actual vesting share price of £3.39806 on 9 March 2015, compared to the three-month average share price of £2.828 used in reporting this figure in the 2014 remuneration report. This results in an adjusted reportable increase of approximately £408,958 for Paul Geddes and £92,016 for John Reizenstein, with a corresponding increase to the single figure for 2014 reflected in the table above.
5. The expected vesting outcome figures for the RoTE portion of the awards granted under the Direct Line Group LTIP in 2012 and reported in 2014 have also been updated. These updates are based on the actual vesting of the RoTE portion of the awards and a share price of £3.944 on 9 November 2015, compared to the three-month average share price of £2.828 used in reporting this figure in the 2014 remuneration report. The revised figures reflect the impact of the share consolidation on 30 June 2015 and actual number of dividends accrued on this portion of the award at vesting. This results in an adjusted reportable increase of approximately £323,814 for Paul Geddes and £195,998 for John Reizenstein, with a corresponding increase of the single figure for 2014 reflected in the table above.
6. The long-term incentive figures for 2015 include the estimated vesting outcome for the RoTE portion of the awards made under the Direct Line Group LTIP in March and August 2013 as the performance period under this element is now complete. In line with the criteria set at the time of grant, this has been assessed by referring to RoTE performance during 2013, 2014 and 2015 in respect of 56.4% of the shares under award (being a 94% vesting outcome of shares relating to the RoTE element). For these purposes, an RoTE figure of 17.6% has been used, including the impact of the International division during 2015 until the completion of its sale in May 2015. Had the RoTE figure of 18.5% from ongoing operations been used for the purposes of determining LTIP vesting, then full vesting under the RoTE element would have been achieved. The corresponding values under long-term incentives, including the value of dividends accrued to 31 December 2015, are £1,947,016 for Paul Geddes and £1,178,450 for John Reizenstein based on a three-month average Company share price to 31 December 2015 of £3.97283. Any shares vesting under the Direct Line Group LTIP granted in 2013 will not be delivered until the end of the applicable vesting periods in March and August 2016.
7. The long-term incentive figures for 2015 reflect the actual vesting under the TSR element of awards made under the Direct Line Group LTIP in November 2012. In line with the criteria set at the time of grant, this has been assessed by referring to TSR performance to the end of the performance period of 15 October 2015. A total of 40% of the shares under award (being the maximum number of shares relating to the TSR element) vested. The corresponding values under long-term incentives, including the value of dividends on vesting, are £765,407 for Paul Geddes and £463,271 for John Reizenstein using the share price on 9 November 2015 of £3.944.
Each Executive Director has confirmed that they have not received any other items in the nature of remuneration, other than those already disclosed in the single figure table.
Annual Incentive Plan outcomes for 2015 The Committee established target performance levels at the start of the year. However, like last year, the Committee did not set a formal threshold to maximum range for performance measures. Instead, the Committee believed it more appropriate to carefully consider performance relative to AIP targets and to assess over or underperformance by judging overall corporate performance at the year-end.
To be transparent with our shareholders, we are disclosing more information this year about bonus payout levels. As such, in the table below, we have included the remuneration targets set at the beginning of the year and performance achieved under the financial measures. We have also explained the performance achieved against the non-financial measures which remain commercially sensitive to disclose.
Note: 1. Profit and loss items excluded from ongoing operating profit, primarily the performance of the Run-off segment and restructuring costs and other one-off costs.
Other financial measures not reflected in the definition of ongoing operating profit1
Strategic A basket of key customer measures 20% See narrative Above target
Financial element (60% weighting) While there is no pre-set scale around target, the Committee used a range of 90-110% of target as an initial reference point to consider vesting levels for the financial measures. The Committee will consider the appropriate range each year and as such this scale may not be used in subsequent years. Having considered the actual results against these reference points, the Committee agreed that the level of performance warranted the level of payouts shown in the chart above.
Director 2015 Fees1 £’000 2015 Benefits2 £‘000 Total 2015 £’000 2014 Fees £‘000 £‘000 Total 2014 £’000
Notes: 1. Non-Executive Directors are not eligible to participate in any of the Group's bonus or share incentive schemes, or to join any Group pension scheme.
3. Glyn Jones stepped down from the Board on 13 May 2015.
Chief Executive Officer 2% 5% 12% All UK employees 3.6% 11% 8%
Notes: 1. Based on the change in average pay for UK employees employed in the year ended 31 December 2015 and the year ended 31 December 2014. Salaries are not adjusted for number of working hours and the increase therefore partly reflects the increase in working hours for some employees during the year.
Historical performance of Total Shareholder Return This graph shows the Company’s TSR since the Company’s shares began trading on the London Stock Exchange in October 2012 against the FTSE 350 Index (excluding investment trusts) over the same period. This peer group is the same used for measuring relative TSR under the LTIP.
Approval of Directors’ remuneration report (2015) 1,108,103,256 96.2% 44,283,445 3.8% 9,502,728 0.8% Approval of Directors’ remuneration policy (2014) 1,064,002,114 97.5% 26,743,783 2.5% 1,945,618 0.2%
The Committee is grateful for the strong vote in favour of the Directors’ annual remuneration report in 2015. The Committee continues to communicate with investors on developments in the remuneration aspects of corporate governance generally and changes to the Company’s executive pay arrangements in particular.
2. For these purposes, holding Ordinary Shares will be treated as including all vested but unexercised awards, valued on a basis that is net of applicable personal taxes.
2. This includes awards under the Direct Line Group LTIP. As described in the notes to the single figure table, 94% of awards made under the Direct Line Group LTIP in March and August 2013 that are subject to the RoTE performance condition measured to 31 December 2015 are expected to vest. This has been calculated with reference to an adjusted 2015 RoTE of 17.6% as opposed to 18.5% in order to reflect the impact of the International division during 2015. The corresponding values under long-term incentives, including the value of dividends accrued to 31 December 2015, are £1,947,016 for Paul Geddes and £1,178,450 for John Reizenstein based on a three-month average Company share price to 31 December 2015. These shares will be delivered to Executive Directors in March and August 2016.
4. 20% of the shares awarded to Paul Geddes under the Direct Line Group DAIP in March 2013 vested during the financial year. This is consistent with the policy at RBS Group. These vesting shares and related dividend accrual shares were exercised by Paul Geddes on 30 March 2015 (51,060 shares at £3.233949). Additionally, under the RBS Group LTIP 2012, 717,300 shares vested to Paul Geddes and 161,392 shares vested to John Reizenstein on 9 March 2015 (share price £3.39806).
5. Paul Geddes exercised an award granted on 7 November 2012 under the Direct Line Group LTIP on 9 November 2015 as shown on page 84 (432,773 shares). The Direct Line Group DAIP and LTIP plan rules provide that all dividends accruing in the vesting period (or until exercise for awards made in 2012 and 2013) will be added on vesting. The figure of exercised shares accordingly includes all dividends that were accrued in respect of the 2012 LTIP awards.
The table shows the Non-Executive Directors' beneficial interests in the Company’s shares.
2. Includes holdings of connected persons, as defined in section 96B(2) of the Financial Services and Markets Act 2000.
4. Shares held as at 31 December 2015 reflect the impact of the share consolidation on 30 June 2015 in which every 12 existing Ordinary Shares were replaced by 11 new Ordinary Shares, meaning the aggregate number of Ordinary Shares in issue was reduced.
Direct Line Group share awards Direct Line Group Deferred Annual Incentive Plan awards made in 2015 This table details the awards made to Paul Geddes and John Reizenstein under the Direct Line Group DAIP relating to the bonus in respect of 2014.
3. Awards adjusted on 30 June 2015 as a result of the share consolidation in which every 12 existing Ordinary Shares were replaced by 11 new Ordinary Shares.
4. Exercised on 30 March 2015 at £3.233949, resulting in an aggregate gain of £165,125.
Direct Line Group Long-Term Incentive Plan awards made in 2015 This table details the Directors’ interests in the Company’s LTIP. For all LTIP awards, 20% of the awards granted would vest if the minimum performance was achieved
4. Awards under the LTIP vested at 89.2% of the maximum potential on 9 November 2015.
The Company’s policy is to issue awards twice a year, after the Group announces its full and half-year results. The value of each grant of awards is set at 50% of the normal annual policy level. This means the total combined face value of awards to each Executive Director during the year equates to 200% of their base salary paid in the year.
Policy report A resolution in respect of the Directors’ remuneration policy was approved at the Company’s AGM on 15 May 2014 by a significant majority (97.5% in favour). No changes to the policy are proposed. For ease of reference, a copy of the policy approved by shareholders is repeated below (subject only to minor referencing updates to assist with the reading of the policy).
Base salary • This is the core element of pay that reflects the individual's role and position within the Group and is payable for doing the expected day-to-day job
• Ensuring we are competitive in the market allows us to attract, retain and motivate high calibre executives with the skill sets to achieve our key aims while managing costs
• Base salaries are reviewed annually and set in April of each year, although the Committee may undertake an out-of-cycle review if it determines that this is appropriate
• Salaries are typically reviewed against: − level of skill, experience and scope of responsibilities, individual and business performance, economic climate and market conditions; − the median market pay in the context of insurance peers and companies of a similar size, particularly FTSE 31-100 companies being companies which are considered to be reflective of the size and complexity of the Group; and
• To motivate Executives and incentivise delivery of performance over a one-year operating cycle, focusing on the short to medium-term elements of our strategic aims
• To motivate and incentivise delivery of sustained business performance over the long term, aligning Executives’ interests with those of shareholders
While the Committee reserves the right to do otherwise, practice has been to make awards twice in each financial year following the announcement of the Group's annual and half-year results
• Where salary increases are awarded, the Committee will have regard to the increase being awarded to employees within the Group more generally, as well as the other factors outlined in this table under ‘Operation’
• Maximum and target bonus levels for Executive Directors are set by reference to practice at other insurance and general market comparators
• The AIP remains a discretionary arrangement and the Committee reserves discretion to adjust the out-turn (from zero to the cap) should it consider that to be appropriate. In particular, the Committee will operate this discretion as a gateway in respect of any risk concerns
• The Plan allows for awards over shares with an absolute maximum value of 200% of base salary per financial year (although awards of up to 300% of base salary are permitted in exceptional circumstances in relation to the recruitment or retention of an employee, as determined by the Committee)
• The Committee will determine the performance conditions for each award made under the LTIP, with performance measured over a single period of at least three years with no provision to retest
• Awards vest based on performance against financial and/or share return measures, as set by the Committee, to be aligned with the long-term strategic objectives of the Group
• For awards to be granted in 2016, vesting will continue to be determined based on two measures: RoTE and relative Total Shareholder Return (“TSR”) performance against the FTSE 350 (excluding investment trusts). The Committee may apply different performance measures and targets in future years
• Awards will be subject to a payment gateway such that the Committee must be satisfied that there are no material risk failings, reputational concerns or regulatory issues
• Fuller details of the performance conditions and targets for 2016 and prior-year awards are set out in the annual remuneration report
• The Committee reserves the right to lengthen (but not reduce) any performance period and/ or to introduce a separate holding period www.directlinegroup.com 87
• This is in line with the approach taken for all Group employees
• The Committee may periodically amend the benefits available to employees. The Executive Directors are eligible to receive such additional benefits on similar terms to other senior executives
• Executive Directors are also eligible to participate in any of the employee share plans operated by the Company, in line with HMRC guidelines (where relevant), on the same basis as for other eligible employees. Currently this includes the Share Incentive Plan, which was also used to provide an award of free shares to all employees (including Executive Directors) at the time of the IPO
Malus and clawback Malus (being the forfeiture of unvested awards) and clawback (being the ability of the Company to claim repayment of paid amounts) provisions apply to the AIP (cash and deferred element) and LTIP if, in the opinion of the Committee, any of the following has occurred: • There has been a material misstatement of the Company’s financial results which has led to an overpayment
• Pension contributions for both Executive Directors are set at 25% of base salary per annum
• The costs of benefits provided may fluctuate from year to year even if the level of provision has remained unchanged
• The Executive Directors may be entitled to retain fees received for any directorships held outside the Group
Exercise of discretion In line with market practice, the Committee retains discretion in relation to the operation and administration of the AIP, DAIP and LTIP. This discretion includes, but is not limited to: • The timing of awards and payments
Remuneration payments agreed prior to appointment to the Board The Committee reserves the right to make any remuneration payments and payments for loss of office (including, where relevant, exercising any discretions available to it in connection with such payments) notwithstanding that they are not in line with the policy set out above where the terms of the payment were agreed (i) before the policy came into effect or (ii) at a time when the relevant individual was not a Director of Direct Line Insurance Group plc and, in the opinion of the Committee, the payment was not in consideration for the individual becoming a Director of the Company. For these purposes ‘payments’ include pension arrangements, the Committee satisfying awards of variable remuneration and, in relation to an award over shares, the terms of the payment are ‘agreed’ at the time the award is granted.
Selection of performance measures Annual Incentive Plan The AIP performance measures have been selected by the Committee to incentivise Executive Directors to achieve financial targets for the year as well as specific strategic and personal objectives. These measures are aligned with the key performance indicators that we use as a business to monitor performance against our strategic priorities, as shown on pages 24 and 25 of the Annual Report & Accounts.
To enable the Company to recruit and retain NonExecutive Directors of the highest calibre, at the appropriate cost
• Non-Executive Directors are paid a basic annual fee plus reasonable travel expenses. Additional fees may be paid to Non-Executive Directors who chair a Board Committee, sit on a Board Committee and for the Senior Independent Director. The level of fees for 2016 is shown in the annual remuneration section
• The Non-Executive Directors are not entitled to receive any compensation for loss of office, other than fees for their notice period. They do not participate in the Group’s bonus, employee share plans or pension arrangements and do not receive any benefits
Recruitment remuneration policy The recruitment remuneration policy aims to give the Committee sufficient flexibility to secure the appointment and promotion of high-calibre executives to strengthen the management team and secure the skill sets to deliver the Group’s strategic aims.
Buy-out awards • Where it is necessary to make a recruitment-related pay award to an external candidate, the Company will not pay more than is necessary, in the view of the Committee, and will in all cases seek, in the first instance, to deliver any such awards under the terms of the existing incentive pay structure
• All such awards for external appointments, whether under the AIP, LTIP or otherwise, to compensate for awards forfeited on leaving their previous employer will be capped at the commercial value of the amount forfeited and will take account of the nature, time horizons and performance requirements of those awards. In particular, the Committee’s starting point will be to ensure that any awards being forfeited which remain subject to outstanding performance requirements (other than where substantially complete) are bought out with replacement requirements and any awards with service requirements are bought out with similar terms. However, exceptionally the Committee may relax those obligations where it considers it to be in the interests of shareholders and those factors are, in the view of the Committee, equally reflected in some other way, for example through a significant discount to the face value of the awards forfeited. It will only include guaranteed or non-prorated amounts under the AIP where the Committee considers that it is necessary to secure the recruitment www.directlinegroup.com 91
In exceptional circumstances, the initial notice period may be longer than the Company’s 12 month policy up to a maximum of 24 months. However, this will reduce by one month for every month served, until it has reduced to 12 months in line with the Company’s policy position.
Termination policy summary It is appropriate for the Committee to retain discretion to consider the termination terms of any Executive Director, having regard to all the relevant facts and circumstances available to them at the time. A Director is deemed a ’good leaver‘ if the following circumstances are met: • Annual Incentive Plan and Long-Term Incentive Plan – death, injury, ill-health, redundancy, retirement, the sale of the individual’s employing company or business out of the Group, or in such other circumstances as the Committee determines
All awards will lapse Deferred shares typically vest on the normal vesting date, although the Committee reserves discretion to accelerate vesting. In the case of the participant’s death or other exceptional circumstances, awards may vest immediately.
Long-Term Incentive Plan All awards will lapse Awards will vest on the normal vesting date subject to performance and, unless the Committee determines otherwise, time pro rating. In exceptional circumstances, as determined by the Committee, for example in the case of the participant’s death, awards may vest on cessation.
Service agreements for Executive Directors provide that Paul Geddes and John Reizenstein are not eligible to receive any enhanced redundancy terms which may be offered by the Group from time to time. Their rights to a statutory redundancy payment are not affected.
The Directors may appoint additional members to join the Board during the year. Directors appointed in this way will be subject to election by shareholders at the first AGM after their appointment. In subsequent years, the Directors are required to submit themselves for re-election at each AGM.
External directorships The Company encourages Executive Directors to accept, subject to the approval of the Chairman, an invitation to join the board of another company outside the Group in a non-executive capacity, recognising the value of such wider experience. In these circumstances, they are permitted to retain any remuneration from the non-executive appointment. Executive Directors are generally limited to accepting one external directorship.
Consideration of employment conditions elsewhere in the Group As explained elsewhere in the Directors’ remuneration report, the Committee reviews the overall pay and bonus decisions in aggregate for the wider Group and therefore takes account of pay and conditions in the wider Group in determining the Directors’ remuneration policy and the remuneration payable to Directors. Through the Chief Executive Officer, Paul Geddes, and other senior management the Committee may receive input provided by employee groups within the Group, such as the Employee Representative Body, as required.
The Committee will also seek to build an active and productive dialogue with investors on developments in the remuneration aspects of corporate governance generally and any changes to the Company’s executive pay arrangements in particular.
The following charts show the potential remuneration that may be earned by Executive Directors under three assumed performance scenarios as follows: Total fixed pay AIP LTIP
• LTIP – consists of the threshold level of vesting (20% vesting)
Maximum Based on the maximum remuneration receivable (excluding share price appreciation and dividends): • Fixed remuneration as above
• LTIP – consists of the face value of awards (200% of base salary)
The Directors present their report for the financial year ended 31 December 2015.
Strategic report The Company’s Strategic report is on pages 1 to 45. It includes the following information that would otherwise need to be disclosed in this Directors’ report: Subject Pages
Dividends The Group aims to generate long-term sustainable value for shareholders, while balancing operational, regulatory, rating agency and policyholder requirements. The Board has a progressive dividend policy for the Company. This aims to increase the dividend annually in real terms to reflect the Company’s cash flow generation and long-term earnings potential.
Additionally, if the Board believes the Group has capital surplus to its view of its requirements, it is intended that such excess capital will be returned to shareholders. The Company may consider a special dividend and/or a repurchase of its own shares to distribute surplus capital to shareholders.
The Board recommends a final dividend of 9.2 pence per share to shareholders. Subject to shareholder approval at the Company’s 2016 AGM, this will become payable on 19 May 2016 to all holders of Ordinary Shares on the Register of members at close of business on 11 March 2016. A second special interim dividend has also been declared of 8.8 pence per share and will have the same record and payment dates as the final dividend for 2015.
Due to uncertainty about the timing of completion of the International division sale (and related distribution), the Board declared a second interim dividend (in lieu of a final dividend) for 2014 of 8.8 pence per share. It also declared a second special interim dividend of 4.0 pence per share for the 2014 financial year, which was paid in April 2015, at the same time as the second interim dividend.
The special interim dividends are consistent with the Group’s policy to distribute excess capital.
Directors You can find the current Directors’ biographies on pages 48 to 49. All Directors will retire and be submitted for election or re-election at the 2016 AGM except for Priscilla Vacassin, who steps down from the Board on 1 March 2016. This is in accordance with the UK Corporate Governance Code and the Articles of Association of the Company, which govern the appointing and replacing of Directors.
The Company’s Articles of Association set out the Directors’ powers. You can obtain a copy of these on the Company’s website at www.directlinegroup.com . The Directors’ powers are also subject to relevant legislation and, in certain circumstances, authority from the Company’s shareholders.
Directors’ indemnities The Articles of Association of the Company permit it to indemnify the Company’s officers – and officers of any associated company – against liabilities arising from conducting Company business, to the extent permitted by law. As such, the Company has executed deeds of indemnity for each Director’s benefit, regarding liabilities that may attach to them in their capacity as Directors of the Company or associated companies. These indemnities are qualifying thirdparty indemnities as defined by section 234 of the Companies Act 2006. No amount was paid under any of these indemnities during the year.
Shareholders approved certain authorities at the Company’s 2015 AGM related to the Company’s share capital. As part of the share consolidation approved at the General Meeting on 29 June 2015, these authorities were refreshed and adjusted to account for the share consolidation. Therefore, the Directors now have authority to:  allot shares in the Company or grant rights to subscribe for, or convert, any security into shares up to an aggregate nominal amount of £50,000,000;  allot shares up to an aggregate nominal amount of £100,000,000, for the purpose of a rights issue; and
To date, the Directors have not used these authorities. Shareholders will be asked to renew them at the 2016 AGM in line with the most recent institutional investors’ guidelines.
The Company has not held any shares in treasury during the period under review.
You can find out more about the Company’s share capital and shares under option at 31 December 2015 in notes 28 and 34 to the consolidated financial statements.
Rights attaching to shares All of the Company’s issued Ordinary Shares rank equally in all respects. The Company’s Articles of Association set out the rights and obligations attaching to the Company’s Ordinary Shares. You can obtain a copy of this on the Company’s website at www.directlinegroup.com .
All of the Company’s employee share incentive plans contain provisions relating to a change of control. Outstanding awards would typically vest and become exercisable. This is subject to satisfying any performance conditions, and normally with an additional time-based pro-rata reduction where performance conditions apply, and approval from the Remuneration Committee.
Employees with disabilities The Group is committed to promoting diversity across every area of the business. At recruitment, we adjust and enhance our application and selection process and also guide and provide additional training for interviewers, where necessary.
Scope 2 – indirect emissions resulting from generating electricity purchased for office buildings and accident repair centres
Total GHG emissions for continuing operations for 2015 were 22,611 tonnes (2014: 27,308 tonnes), as set out in the table below. This primarily comprised emissions from purchased electricity and natural gas, diesel fuel and refrigerant gas used.
Ecometrica has externally verified the GHG emissions data. Verification statements can be found on the Group’s website at www.directlinegroup.com .
You can find further information on the Group’s approach to energy and the environment in the CSR section on page 32.
Longer term viability and going concern basis The statements required to be included in the Annual Report following the UK Corporate Governance Code provisions C.1.3 and C.2.2 can be found on pages 56 and 57, and are incorporated here by reference.
Disclosing information to the Auditor Each Director at the date of approving this Annual Report & Accounts confirms that:  as far as they are aware, there is no relevant audit information of which Deloitte LLP, the Company’s external auditor, is unaware; and
In preparing these financial statements, IAS 1 requires that Directors:  Properly select and apply accounting policies
 Provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance
 Assess the Company’s ability to continue as a going concern
 the Strategic report (on pages 1 to 45) and Directors’ report (on pages 96 to 99) include a fair review of the development and performance of the business, and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties they face.
Notes to the Parent Company financial statements 1. Accounting policies 167 2. Investment in subsidiary undertakings 167 3. Assets held for sale 168 4. Other receivables 169 5. Current tax 169 6. Derivative financial instruments 169 7. Financial investments 169 8. Cash and cash equivalents 169 9. Share capital 169 10. Subordinated liabilities 170 11. Trade and other payables 170 13. Cash generated from operations 170 14. Related parties 171 15. Share-based payments 171 16. Risk management 171 17. Directors and key management remuneration 171
Opinion on the financial statements of Direct Line Insurance Group plc In our opinion: • the financial statements give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2015 and of the Group’s profit for the year then ended; • the financial statements have been properly prepared in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the European Union; and
The financial statements comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated and Parent Company balance sheets, the consolidated and Parent Company cash flow statements, the consolidated and Parent Company statements of changes in equity and the related notes 1 to 40 on the consolidated financial statements, and the related notes 1 to 17 on the Parent Company financial statements. The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union.
Going concern and the Directors’ assessment of the principal risks that would threaten the solvency or liquidity of the Group As required by the Listing Rules we have reviewed the Directors’ statement on page 56 regarding the appropriateness of the going concern basis of accounting to the financial statements and the Directors’ statement on the longer-term viability of the Group. We have nothing material to add or draw attention to in relation to: • the Directors’ confirmation on page 56 that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity; • the disclosures on pages 28 to 29 that describe those risks and explain how they are being managed or mitigated.
• the Directors’ statement on page 56 about whether they considered it appropriate to adopt the going concern basis of accounting in preparing the financial statements and their identification of any material uncertainties to the Group’s ability to continue to do so over a period of at least 12 months from the date of approval of the financial statements; • the Director’s explanation on pages 56 to 57 as to how they have assessed the prospects of the Group, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.
There were a number of weather events at the end of 2015 which caused severe flooding across the UK. Management has exercised judgement in the determination of the full extent of the claims. Therefore the scope of this risk was extended to include the valuation of the additional provision for these events.
We have tested the design and implementation and operating effectiveness of the key controls over the end-to-end reserving process, including the controls over the inputs and outputs for the actuarial best estimate (“ABE”) and the controls for setting of the margin above ABE.
We also tested the completeness and accuracy of the underlying data used in the actuarial calculations through performing reconciliations on the data back to the financial ledger and the actuarial data used by our Deloitte actuarial specialists in performing their audit.
• challenge management’s identification of items to be included in the margin above ABE, to perform sensitivity analysis on the range of potential scenarios and assess the consistency of the point within the range that the margin is set.
IT control environment In May 2015, the Group essentially finished their planned programme of transitioning IT infrastructure from RBS Group to an independently hosted data centre. In addition, management have a number of ongoing projects to assess and improve the IT control environment. Due to the significant change in the IT environment, there is an increased risk that the underlying IT infrastructure controls supporting key financial reporting processes might not adequately mitigate the risk of material financial misstatement.
We have tested the design, implementation and operating effectiveness of general IT controls around key IT processes on the applications and the migrated infrastructure, with a focus on access security, change management and operational controls, and have understood the governance process over the infrastructure migration itself. Our audit procedures also included testing additional business controls and site visits to the hosted UK data centre to test the physical access controls and the operational offices in India. We have also reviewed the scope of management’s ongoing project to improve the IT environment and tailored our audit approach to take into account the findings and changes implemented as at the time of our audit.
Transformation projects There is a risk that the transformation programme, which includes outsourcing and offshoring, could impact the financial reporting control environment, in particular where processes and controls have changed operation and location. There is also a risk that the change will cause management stretch which could impact on the effectiveness of existing internal controls. There is a risk that there may no longer be an appropriate level of review or adequate segregation of duties.
We have tested the design and implementation and operating effectiveness of the key controls over the reinsurance asset measurement and valuation process. We reviewed a sample of reinsurance contracts and assessed whether their terms are correctly applied.
Revenue recognition Due to the large number of policies underwritten by the Group there is a risk that the revenue recorded in the financial statements and the flow of premium information from the underwriting systems to the financial reporting ledger is not complete and accurate.
We have determined that the critical benchmark for the Group was average profit before tax from ongoing operations. This measure uses a three-year average of profit before tax, excluding the impact of discontinued activities and transformation costs to exclude the effect of year-on-year volatility. We calculated materiality for the Group to be £28 million (2014: £28 million), which is below 5.2% (2014: 6.5%) of average profit before tax from ongoing operations. We also considered this measure to be suitable having compared to other benchmarks: our materiality is 5.7% of statutory profit before tax, 0.8% of gross earned premium and below 1.4% of equity. Group materiality is used for setting audit scope and the assessment of uncorrected misstatements. Materialities are set for each significant component in line with the components proportion of the chosen benchmark. This is capped at the lower of 90% of Group materiality and the component materiality calculated for a standalone audit. The main UK insurance trading entity, which makes up 94% of Group revenue and 66% of Group statutory profit before tax, is scoped to a component materiality of £24.8 million (2014: £25.1million). We determine performance materiality at a level lower than materiality to reduce the probability that, in aggregate, uncorrected and undetected misstatements exceed materiality for the financial statements as a whole. The audit testing for U K Insurance Limited is carried out to a performance materiality of £17.4 million (2014: £17.6 million).
An overview of the scope of our audit The scope of our Group audit was determined by obtaining an understanding of the Group and its environment, including Group-wide controls, and assessing the risks of material misstatement at the Group level.
At the parent entity level we also tested the consolidation process and carried out analytical procedures to confirm our conclusion that there were no significant risks of material misstatement of the aggregated financial information of the remaining components not subject to audit or audit of specified account balances. The Group audit team also performs the audit of the UK entities, which account for 100% of the Group’s net assets and 95% of the Group’s profit before tax.
The Group audit team was responsible for both the UK location and Group audit.
Directors’ remuneration Under the Companies Act 2006 we are also required to report if, in our opinion, certain disclosures of Directors’ remuneration have not been made or the part of the Directors’ remuneration report to be audited is not in agreement with the accounting records and returns. We have nothing to report arising from these matters.
Respective responsibilities of the Directors and the Auditor As explained more fully in the Directors’ responsibilities statement, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). We also comply with International Standard on Quality Control 1 (UK and Ireland). Our audit methodology and tools aim to ensure that our quality control procedures are effective, understood and applied. Our quality controls and systems include our dedicated professional standards review team and independent partner reviews.
David Rush FCA (Senior Statutory Auditor) for and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 29 February 2016 www.directlinegroup.com 105
Direct Line Group Annual Report & Accounts 2015 106 £m 2014 £m
Items that may be reclassified subsequently to the income statement: Exchange differences on translation of foreign operations 14.4 (14.5) Cash flow hedges (1.4) 1.3 Fair value (loss) / gain on AFS investments 29 (100.5) 97.2 Less: realised net gains on AFS investments included in income statement 29 (44.3) (22.8) Tax relating to items that may be reclassified 29 34.6 (17.6)
Other comprehensive (loss) / income for the year net of tax (92.1) 45.8 Total comprehensive income for the year attributable to owners of the Company 488.3 418.4
Assets Goodwill and other intangible assets 18 524.8 517.5 Property, plant and equipment 19 186.3 181.3
Derivative financial instruments 25 46.4 29.4 Trade and other payables including insurance payables 35 656.5 660.6 Deferred tax liabilities 14 29.9 20.6 Current tax liabilities 14 10.3 35.7 Liabilities held for sale 5C – 964.4 Total liabilities 7,326.6 8,415.1 Total equity and liabilities 9,956.6 11,225.6
The attached notes on pages 111 to 163 form an integral part of these consolidated financial statements.
Profit for the year – – – – – – 580.4 580.4
Transfer to non-distributable reserve 29 – – – – 28.0 – (28.0) – Shares acquired by employee trusts – (17.8) – – – – – (17.8) Credit to equity for equity-settled share-based payments 34 – – – – – – 12.1 12.1 Shares distributed by employee trusts – 11.0 – – – – (11.0) – Tax on share-based payments – – – – – – 2.9 2.9
Net cash generated from / (used by) operating activities before investment of insurance assets 36 42.1 (410.6) Cash generated from investment of insurance assets 36 503.1 1,121.1 Net cash generated from operating activities 545.2 710.5 Cash flows from investing activities Purchases of property, plant and equipment (67.9) (86.7) Purchases of intangible assets (75.5) (92.8) Purchases of assets held for sale – (12.6) Proceeds on disposals of assets held for sale 7.1 0.8 Net cash flows from disposal / (acquisition) of subsidiaries 327.1 (24.7) Net cash generated from / (used by) investing activities 190.8 (216.0) Cash flows from financing activities Dividends paid 15 (666.0) (401.1) Finance costs (38.2) (37.9) Purchase of employee trust shares (17.8) (4.4) Net cash used by financing activities (722.0) (443.4) Net increase in cash and cash equivalents 14.0 51.1 Cash and cash equivalents at the beginning of the year 898.2 853.2 Effect of foreign exchange rate changes (9.8) (6.1) Cash and cash equivalents at the end of the year 27 902.4 898.2
The Company’s financial statements and the Group’s consolidated financial statements are presented in Sterling, which is the functional currency of the Company.
The International segment was classified as a discontinued operation and International assets and liabilities have been presented as a disposal group.
Adoption of new and revised standards The following amendments have been adopted in the year and have not had a material impact on the Group’s financial statements: IFRS 2 (amended), ‘Share-Based Payment’ – The amendment defines “performance condition” and “service condition”.
IFRS 8 (amended), ‘Operating Segments’ – The first amendment clarifies that an entity must disclose the judgements made by management in applying the aggregation criteria and the second amendment clarifies when a reconciliation of segment assets to total assets is required to be disclosed.
IAS 24 (amended), ‘Related Party Disclosures’ – The amendment provides additional clarification as to when an entity which provides managerial services is a related party.
1.1 Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and the entities that are controlled by the Group at 31 December 2015 and 31 December 2014. Control exists when the Group is exposed, or has rights, to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. In assessing if the Group controls another entity, the existence and effect of the potential voting rights that are currently exercisable or convertible are considered.
1.2 Foreign currencies The Group’s consolidated financial statements are presented in Sterling which is the presentational currency of the Group. Group entities record transactions in the currency of the primary economic environment in which they operate (their functional currency), translated at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date. Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in the income statement.
Premiums collected by intermediaries or other parties, but not yet received, are assessed based on estimates from underwriting or past experience, and are included in insurance premiums. Insurance premiums exclude insurance premium tax or equivalent local taxes and are shown gross of any commission payable to intermediaries or other parties.
Cash back payments to policyholders under motor telematics policies represent a reduction in earned premiums.
Rental income from investment property is recognised in the income statement on a straight-line basis over the period of the contract. Any gains or losses arising from a change in fair value are recognised in the income statement.
1.5 Insurance claims Insurance claims are recognised in the accounting period in which the loss occurs. Provision is made for the full cost of settling outstanding claims at the balance sheet date, including claims incurred but not yet reported at that date, net of salvage and subrogation recoveries. Outstanding claims provisions are not discounted for the time value of money except for claims to be settled by PPOs established under the Courts Act 2003. A court can award damages for future pecuniary loss in respect of personal injury or for other damages in respect of personal injury and may order that the damages are wholly or partly to take the form of PPOs. These are covered in more detail in note 2.1. Costs for both direct and indirect claims handling expenses are also included.
Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the incidence, timing and amount of claims and any specific factors such as adverse weather conditions. When calculating the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable probability parameters, the value of outstanding claims (gross and net) at the balance sheet date. Also included in the estimation of outstanding claims are factors such as the potential for judicial or legislative inflation. In addition, an allowance is made for reinsurance assets deemed not recoverable.
Reinsurance assets include balances due from reinsurance companies for ceded insurance liabilities. Amounts recoverable from reinsurers are estimated in a consistent manner with the outstanding claims provisions or settled claims associated with the reinsured policies and in accordance with the relevant reinsurance contract. Recoveries in respect of PPOs are discounted for the time value of money.
A reinsurance bad debt provision is assessed in respect of reinsurance debtors, to allow for the risk that the reinsurance asset may not be collected or where the reinsurer’s credit rating has been downgraded significantly. This also includes an assessment in respect of the ceded part of claims provisions to reflect the counterparty risk exposure to long-term reinsurance assets particularly in relation to periodical payments. Increases in this provision affect the Group by reducing the carrying value of the asset and the impairment loss is recognised in the income statement.
The principal acquisition costs deferred are direct advertising expenditure, administration costs, commission paid and costs associated with telesales and underwriting staff.
Direct Line Group Annual Report & Accounts 2015 114 1. Accounting policies continued Depreciation is charged to the income statement on a straight-line basis so as to write off the depreciable amount of property, plant and equipment over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and leasehold buildings 50 years or the period of the lease if shorter
1.10 Impairment of intangible assets, goodwill and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets, goodwill or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss, if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent of those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit (“CGU”) to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. Value in use is the present value of future cash flows from the asset or CGU, discounted at a rate that reflects market interest rates, adjusted for risks specific to the asset or CGU that have not been reflected in the estimation of future cash flows.
Impairment of financial assets At each balance sheet date the Group assesses whether there is any objective evidence that a financial asset or group of financial assets classified as AFS, HTM or loans and receivables is impaired. A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.
Impairment losses are assessed individually where significant or collectively for assets that are not individually significant.
Gains and losses arising from changes in the fair value of a derivative are recognised as they arise in the income statement unless the derivative is the hedging instrument in a qualifying hedge. The Group enters into a number of hedge relationships for cash flow and fair value hedges.
Direct Line Group Annual Report & Accounts 2015 116 1. Accounting policies continued 1.14 Financial liabilities Financial liabilities are initially recognised at fair value net of transaction costs incurred. Other than derivatives which are recognised and measured at fair value, all other financial liabilities are subsequently measured at amortised cost using the effective interest rate method.
The Group’s defined benefit pension scheme, as described in note 33, was closed in 2003. Scheme liabilities are measured on an actuarial basis, using the projected unit credit method, and discounted at a rate that reflects the current rate of return on a high-quality corporate bond of equivalent term and currency to the scheme liabilities.
The standard introduces a new expected loss model that is a departure from the current incurred loss model. The model requires a 12 month expected loss to be recognised for all financial instruments when they first originate or are acquired. In subsequent periods, if there is a significant increase in credit risk of a financial instrument since it was originated or acquired, the full lifetime expected credit loss would then be recognised.
In May 2014 the IASB issued IFRS 15 ‘Revenue from Contracts with Customers’ to establish a single comprehensive model to use in accounting for revenue recognition and measurement (insurance contracts are excluded from the scope of IFRS 15). The standard provides guidance on when and how combined contracts should be unbundled and when a transaction price includes a variable consideration element. The standard will require the Group to consider contracts with customers to determine if changes are required to existing accounting practices, but is not expected to have a material impact on the Group’s financial statements.
The effective date of this new standard has been revised to annual periods beginning on or after 1 January 2018, although early adoption is permitted.
In January 2016 the IASB issued IFRS 16 ‘Leases’. There are some changes to the guidance with the definition of a lease, in particular, more detail is provided on determining whether a contract conveys the right to use a particular asset; however, in most areas companies will find that their arrangements under the new guidance will not change. The standard provides a single lessee accounting model, requiring lessees to recognise assets and liabilities for all leases unless the lease term is 12 months or less or the underlying asset has a low value. Lessors will continue to classify leases as operating or finance, with the approach to lessor accounting substantially unchanged. The standard will require the Group to consider how some of the lease arrangements are currently treated to determine if changes are required to existing accounting practices.
Direct Line Group Annual Report & Accounts 2015 118 2. Critical accounting estimates and judgements The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial information. The Group’s principal accounting policies are set out on pages 111 to 117. Company law and IFRSs require the Directors, in preparing the Group’s financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent.
2.1 General insurance: outstanding claims provisions and related reinsurance recoveries The Group makes provision for the full cost of outstanding claims from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling. Outstanding claims provisions net of related reinsurance recoveries at 31 December 2015 amounted to £3,602.6 million (2014: £3,898.6 million with an additional £393.6 million included in liabilities held for sale).
The corresponding reinsurance recoveries and impairment provision are calculated on an equivalent basis, using significant judgement, as discussed in note 1.6. The reinsurance bad debt provision is mainly for expected recoveries against future PPO payments. The methodology to calculate the impairment provision was refined in the year to more closely align to Solvency II and to more accurately reflect potential future exposure to credit risk and the expected timeframe of cash flows associated with recoveries against these claims.
The Group holds provisions for a reduction in the Ogden discount rate at 31 December 2015 to 1.5% (2014: 1.5%). Details of sensitivity analysis to the assumed Ogden discount rate are shown in note 3.3.1.
The Group settles some large bodily injury claims as PPOs rather than lump sum payments.
The table below analyses the outstanding PPO claims provisions on a discounted and an undiscounted basis at 31 December 2015 and 31 December 2014. These represent the total cost of PPOs rather than any costs in excess of purely Ogden-based settlement.
In the majority of cases, the inflation agreed in the settlement is the Annual Survey of Hours and Earnings SOC 6115 inflation published by the Office for National Statistics, for which the long-term rate is assumed to be 4.0% (2014: 4.0%). The rate of interest used for the calculation of present values is 4.0% (2014: 4.0%), which results in a real discount rate of 0.0% (2014: 0.0%). Since lump sum payments are calculated using a real discount rate of 2.5% (2014: 2.5%) the PPOs reserved cost is greater than that of lump sum settlements.
Details of sensitivity analysis to the discount rate applied to PPO claims are shown in note 3.3.1.
2.2 Impairment provisions – financial assets The Group determines that AFS financial assets are impaired when there is objective evidence that an event or events since initial recognition of the assets have adversely affected the amount or timing of future cash flows from the asset. The determination of which events could have adversely affected the amount or timing of future cash flows from the asset requires judgement. In making this judgement, the Group evaluates, among other factors, the normal price volatility of the financial asset, the financial health of the investee, industry and sector performance, changes in technology and operational and financing cash flow or whether there has been a significant or prolonged decline in the fair value of the asset below its cost. Impairment may be appropriate when there is evidence of deterioration in these factors.
There was no impairment provision on AFS debt securities in the year ended 31 December 2015 (2014: £1.3 million release).
HTM and loans and receivables On a quarterly basis, the Group reviews whether there is any objective evidence that the financial instruments classified as HTM or loans and receivables are impaired based on the following criteria: • adverse movements in the credit rating of the borrower; • actual, or imminent, default on interest or nominal; or
Direct Line Group Annual Report & Accounts 2015 120 2. Critical accounting estimates and judgements continued Estimation of the fair value of assets and liabilities In estimating the fair value of financial assets and investment properties, the methods and assumptions used by the Group incorporate: Financial assets and liabilities For fixed maturity securities, fair values are generally based upon quoted market prices. Where market prices are not readily available, fair values are estimated using values obtained from quoted market prices of comparable securities.
Investment property Investment property is recorded at fair value, measured by independent valuers who hold recognised and relevant professional qualifications. The valuation model is driven predominantly by unobservable inputs, as although in part the valuations are compared with recent market transactions for similar properties, they are adjusted for the specific characteristics of each property.
Level 3 fair value measurements used for investment properties are those derived from a valuation technique that includes inputs for the asset that are unobservable.
2.5 Goodwill The Group capitalises goodwill arising on the acquisition of businesses as discussed in note 1.8. The carrying value of goodwill at 31 December 2015 was £211.0 million (2014: £211.0 million).
Goodwill is the excess of the cost of an acquired business over the fair value of its net assets. The determination of the fair value of assets and liabilities of businesses acquired requires the exercise of management judgement; for example, those financial assets and liabilities for which there are no quoted prices and those non-financial assets where valuations reflect estimates of market conditions, such as property. Different fair values would result in changes to the goodwill arising and to the postacquisition performance. Goodwill is not amortised but is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.
Impairment testing inherently involves a number of judgemental areas: the preparation of the five-year strategic plan and the extrapolation of cash flow forecasts beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the business; estimation of the fair value of CGUs; and the valuation of the separable assets of each business whose goodwill is being reviewed. Details of a sensitivity analysis on the recoverable amount in excess of carrying value are shown in note 18.
Understatement of reserves may result in not being able to pay claims when they fall due. Alternatively, overstatement of reserves can lead to a surplus of funds being retained resulting in opportunity cost.
Reserve risk is controlled through a range of processes: • regular reviews of the claims, premiums and an assessment of the requirement for a liability adequacy provision for the main classes of business by the internal actuarial team; • the use of external actuaries to review periodically the actuarial best estimate reserves produced internally, either through peer review or through provision of independent reserve estimates; • accompanying all reserve reviews with actuarial assessment of the uncertainties through a variety of techniques including bootstrapping and scenario analysis; • oversight of the reserving process by relevant senior management and the Board; • regular reconciliation of the data used in the actuarial reviews against general ledger data and reconciliation of the claims data history against the equivalent data from prior reviews; and
• regular assessment of the volatility in the reserves to help the Board set management best estimate reserves.
PPOs1 Impact of an increase in the discount rate used in the calculation of present values of 100 basis points 76.0 87.3 76.0 87.3 Impact of a decrease in the discount rate used in the calculation of present values of 100 basis points (109.4) (121.8) (109.4) (121.8) Ogden2 Impact of an increase in the Ogden discount rate by 100 basis points 131.9 159.6 131.9 159.6 Impact of a decrease in the Ogden discount rate by 100 basis points (190.0) (224.0) (190.0) (224.0)
Notes: 1. The sensitivities relating to an increase or decrease in the discount rate used for PPOs illustrate a movement in the time value of money from the assumed level of 4.0%. An increase in the discount rate reflects a decrease in the time value of money and therefore the present value of future liabilities, which increases total equity and would be reflected in the income statement.
2. The sensitivities relating to an increase or decrease in the Ogden discount rate illustrate a movement in the value from the current prescribed level of 2.5%.
• Each member of staff has a specified handling authority, with controls preventing them handling or paying claims outside their authority, as well as controls to mitigate the risk of paying invalid claims. In addition, there are various outsourced claims handling arrangements, all of which are monitored closely by management, with similar principles applying in terms of the controls and procedures.
• Loss adjustors are used in certain circumstances to handle claims to conclusion. This involves liaison with the policyholder, third parties, suppliers and the claims function.
• Specialist bodily injury claims teams are responsible for handling these types of losses with the nature of handling dependent on the level and type of claim. Claims exceeding a certain threshold are referred to the technical and large loss teams who also deal with all other claim types above defined limits or within specific criteria.
• A process is in place to deal with major weather and other catastrophic events, known as the ‘Surge Demand Plan’. A surge is the collective name given to an incident which significantly increases the volume of claims reported to the Group’s claims functions. The plan covers surge demand triggers, stages of incident, operational impact, communication and management information monitoring of the plan.
• Sector concentration risk – the concentration of the Group to any given industry sector is monitored and analysed in respect of commercial customers.
• Changes in the external legal, regulatory, social or economic environment altering the definition and application of reinsurance policy wordings or the effectiveness or value for money of reinsurance.
Direct Line Group Annual Report & Accounts 2015 124 3. Risk management continued Using reinsurance, the Group cedes insurance risk to reinsurers but, in return, assumes back counterparty risk against which a reinsurance bad debt provision is assessed. The financial security of the Group’s panel of reinsurers is therefore important and both the quality and amount of the assumed counterparty risk are subject to an approval process whereby reinsurance is only purchased from reinsurers that hold a credit rating of at least A- at the time cover is purchased. The Group’s leading counterparty exposures represent the accumulated counterparty risk for all Group underwriting entities and are reviewed on a monthly basis. The Group aims to contract with a diverse range of reinsurers on its contracts to mitigate the credit and / or non-payment risks associated with its reinsurance exposures.
The Group is mainly exposed to the following market risk factors: • Spread risk; • Interest rate risk; • Property risk; and
The Group has policies and limits approved by the Board for managing the market risk exposure. These set out the principles that the business should adhere to for managing market risk and establishing the maximum limits the Group is willing to accept having considered strategy, risk appetite and capital resources.
• Maximise the portfolio’s total return within the constraints of the other objectives and the limits defined by the investment guidelines and capital allocation.
The Group uses its internal economic capital model to determine its capital requirements and market risk limits, and monitors its market risk exposure based on a 99.5% value-at-risk measure. The Group also applies market risk stressed scenarios testing for the economic impact of specific severe market conditions. The results of this analysis are used to enhance the understanding of market risk. The asset liability matching and investment management minimum standard explicitly prohibits the use of derivatives for speculative or gearing purposes. However, the Group is able to and does use derivatives for hedging its currency risk and interest rate risk exposures.
Spread risk This is the risk of loss from the sensitivity of the value of assets and investments to changes in the level or in the volatility of credit spreads over the risk-free interest rate term structure. The level of spread is the difference between the risk-free rate and actual rate paid on the asset, with larger spreads being associated with higher risk assets. The Group is exposed to spread risk through its investments in bonds and securitised credit.
Interest rate risk This is the risk of loss from all assets and liabilities for which the net asset value is sensitive to changes in the term structure of interest rates or interest rate volatility. The Group’s interest rate risk arises mainly from its debt, floating interest rate investments and assets and liabilities exposed to fixed interest rates.
Foreign currency risk The exposure to currency risk is generated by the Group’s investments in US Dollar corporate bonds and US Dollar securitised credit.
The Group was also exposed to currency risk through its investments in subsidiaries in Italy and Germany (that is, investments in equity) until the disposal of the International business on 29 May 2015.
2. The increase or decrease in total equity reflects a fair value movement in infrastructure debt and HTM debt securities that would not be recorded in the financial statements under IFRSs as they are classified as loans and receivables and HTM respectively, which are carried at amortised cost. This result has been included in the table above to provide a comprehensive analysis of the fair value impact of this sensitivity.
4. The subordinated liabilities and associated interest rate swap are excluded from the sensitivity analysis.
5. The sensitivities calculated above exclude the impact of assets in the disposal group at 31 December 2014.
The main sources of counterparty risk for the Group are: • Investments – this arises from the investment of funds in a range of investment vehicles permitted by the investment policy; and
• Reinsurance recoveries – counterparty exposure to reinsurance counterparties arises in respect of reinsurance claims against which a reinsurance bad debt provision is assessed. PPOs have the potential to increase the ultimate value of a claim and, by their very nature, to significantly increase the length of time to reach final payment. This has increased reinsurance counterparty risk in terms of both amount and longevity.
Reinsurance assets 1,011.4 – – – 1,011.4 Insurance and other receivables 917.3 32.4 6.1 – 955.8 Derivative assets 19.6 – – – 19.6 Debt securities 5,240.1 – – – 5,240.1 Deposits with credit institutions with maturities > three months 44.9 – – – 44.9 Infrastructure debt 329.6 – – – 329.6 Cash and cash equivalents 963.7 – – – 963.7
Concentration risk This is the risk of exposure to increased losses associated with inadequately diversified portfolios of assets and / or obligations, in particular: • Large exposures to individual credits (either bond issuers or deposit-taking institutions); • Large exposures to different credits where movements in values and ratings are closely correlated.
The table below analyses the distribution of debt securities and infrastructure debt by geographical area.
Deposits with credit institutions with maturities > three months – 5.0 34.9 5.0 – – 44.9
Deposits with credit institutions with maturities > three months – 54.7 – – – – 54.7 Infrastructure debt – – – 76.2 – – 76.2 Cash and cash equivalents 729.1 – 81.4 69.9 – – 880.4
IT continuity risk This is the risk of loss of technology services due to data, systems or data centre failure and / or failure of a third party to restore services.
Outsourcing risk This is the risk of failing to implement a robust framework for the sourcing, appointment and ongoing contract management of external suppliers, outsourced service providers and intragroup relationships.
The measurement and management of liquidity risk within the Group is undertaken within the limits and other policy parameters of the Group’s liquidity risk appetite and is detailed within the liquidity risk minimum standard. Compliance is monitored in respect of both the minimum standard and the regulatory requirements of local regulators.
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 1,876.3 42.2 – – 42.2
Designated as hedging instruments: Foreign exchange contracts (forwards) 0.7 0.1 – – 0.1
Interest rate futures1 540.5 – – – – Designated as hedging instruments: Foreign exchange contracts (forwards) 5.0 0.1 – – 0.1
Direct Line Group Annual Report & Accounts 2015 132 3. Risk management continued The tables below analyse financial investments, cash and cash equivalents, insurance and financial liabilities by remaining duration, in proportion to the cash flows expected to arise during that period, for each category.
Trade and other payables including insurance payables 660.6 659.4 1.2 – – –
From 1 January 2016, the Group’s regulatory capital position will be assessed against the Solvency II framework. Initially, the Group (including its regulated insurance entities) will assess its SCR using the standard formula. Its principal underwriter UKI has applied for its internal economic capital model to be approved as its internal model and approval is expected during 2016. From that point, UKI will calculate its capital requirement using the internal model which, will form part of a Group-wide partial internal model.
In 2015, the Group monitored its financial resources with reference to the requirements of the Insurance Group Directive and on this basis at 31 December 2015 had a surplus of approximately £1.7 billion (2014: £1.9 billion). The Group’s capital requirements and solvency position are produced and presented to the Board on a regular basis.
Restructuring and other one-off costs Restructuring costs are costs incurred in respect of the business activities which have a material effect on the nature and focus of the Group’s operations. One-off costs are costs that are non-recurring in nature.
No inter-segment transactions occurred in the year ended 31 December 2015 (2014: £nil). If any transaction were to occur, transfer prices between operating segments would be set on an arm’s length basis in a manner similar to transactions with third parties. Segment income, expenses and results will include those transfers between business segments which will then be eliminated on consolidation.
Direct Line Group Annual Report & Accounts 2015 134 4. Segmental analysis continued The table below analyses the Group’s revenue and results for continuing operations by reportable segment for the year ended 31 December 2015.
Restructuring and other one-off costs (48.7) Operating profit 545.1 Finance costs (37.6) Profit before tax 507.5
The table below analyses the Group’s assets and liabilities by reportable segment at 31 December 2015.
The table below analyses the Group’s revenue and results for continuing operations by reportable segment for the year ended 31 December 2014.
Insurance claims recoverable from reinsurers 63.4 0.8 – 6.4 70.6 (19.4) 51.2
Note: 1. The Group’s revenue and results for the year ended 31 December 2014 relating to the Tracker business, which was disposed of on 5 February 2014, were recorded in the Motor segment (other operating income: £1.4 million and operating loss: £0.4 million).
The table below analyses the Group’s assets and liabilities by reportable segment at 31 December 2014.
Disposal group – assets held for sale1 – – – – – 1,205.4 1,205.4
The Group completed the disposal of its Italian and German subsidiaries on 29 May 2015, generating a gain on disposal of £167.1 million.
The following table analyses the other comprehensive loss relating to discontinued operations, included in the consolidated statement of comprehensive income for the period from 1 January to disposal on 29 May 2015 and year ended 31 December 2014.
Items that may be reclassified subsequently to income statement: Exchange differences on the translation of foreign operations 14.4 (15.5) Cash flow hedge (1.2) – Fair value gain on AFS investments 0.6 26.1 Less: realised net gains on AFS investments included in income statement (31.8) (6.6) Tax relating to items that may be reclassified 10.1 (6.9) Other comprehensive loss for the year net of tax (7.9) (2.9)
The following table analyses the cash flows relating to the discontinued operations included in the consolidated cash flow statement for the period 1 January to disposal on 29 May 2015 and the year ended 31 December 2014.
Note: 1. The Group entered into a foreign currency hedge converting Euro into Sterling in September 2014 for the disposal proceeds. The foreign currency hedge gain of £34.0 million and other sale-related consideration are included in cash consideration received.
Direct Line Group Annual Report & Accounts 2015 138 5. Discontinued operations and disposal group continued C) Assets and liabilities held for sale The following table analyses the assets and liabilities held for sale at 31 December 2015.
Liabilities held for sale: Disposal group (note 5B) – 964.4 Total – 964.4
Reinsurance premium: Premium payable (191.7) (182.5) Movement in reinsurance unearned premium reserve 2.5 25.0 7. Investment return
Claims handling expenses for the year ended 31 December 2015 of £200.4 million (2014: £226.3 million) have been included in the claims figures above. Claims handling expenses can be further analysed for the year ended 31 December 2015 between ongoing operations of £195.6 million (2014: £222.3 million) and run-off of £4.8 million (2014: £4.0 million).
Direct Line Group Annual Report & Accounts 2015 140 11. Operating expenses continued The table below analyses restructuring and other one-off costs included in operating expenses.
The Group’s discontinued operations employed no employees at 31 December 2015 (2014: 1,267) and an average monthly number of 1,279 people for the period until disposal on 29 May 2015 (2014: 1,275).
The aggregate remuneration of those employed by the Group’s operations comprised: Continuing operations 2015 £m 2014 £m
Wages and salaries 335.4 344.0 Social security costs 37.8 37.7 Pension costs 23.4 23.9 Share-based payments 12.1 6.6
The aggregate remuneration of those employed by the Group’s discontinued operations (note 5A) was £12.6 million in 2015 (2014: £32.9 million).
The audit fees in respect of the Group’s discontinued operations (note 5A) were £nil in 2015 (2014: £0.4 million).
Aggregate Directors’ emoluments The table below analyses the total amount of Directors’ remuneration, all of which is in relation to continuing operations, in accordance with Schedule 5 to the Accounting Regulations.
Salaries, fees, bonuses and benefits in kind 3.5 3.4 Gains on exercise of share options 4.9 1.2 Defined contribution pension scheme contributions 0.1 0.1
Profit before tax 507.5 456.8 Expected tax charge 102.8 98.2 Effects of: Realised gains on disposal of subsidiaries – (0.5) Disallowable expenses 7.8 3.4 Effect of change in corporation taxation rate (0.7) 0.1 Over provision in respect of prior year (1.6) (3.7)
Direct Line Group Annual Report & Accounts 2015 142 14. Current and deferred tax Current tax £m 2014 £m
Credit / (charge) to the income statement on continuing operations 2.6 (0.5) 0.5 (6.5) (3.3) 0.8 (6.4) Credit to the income statement on discontinued operations 2.1 – – – – – 2.1 Charge to other comprehensive income (7.4) (0.6) – – – – (8.0) Credit direct to equity – – – – – 1.0 1.0
Amounts recognised as distributions to equity holders in the period: 2014 final dividend1 of 8.8 pence per share paid on 17 April 2015 131.6 – 2013 final dividend of 8.4 pence per share paid on 20 May 2014 – 125.7 2015 first interim dividend of 4.6 pence per share paid on 11 September 2015 63.0 – 2014 first interim dividend of 4.4 pence per share paid on 12 September 2014 – 65.8 2015 first special interim dividend of 27.5 pence per share paid on 24 July 2015 411.5 – 2014 first special interim dividend of 10.0 pence per share paid on 12 September 2014 – 149.7 2014 second special interim dividend of 4.0 pence per share paid on 17 April 2015 59.9 – 2013 second special interim dividend of 4.0 pence per share paid on 20 May 2014 – 59.9
The proposed final dividend for 2015 has not been included as a liability in these financial statements.
16. Earnings per share Earnings per share is calculated by dividing earnings attributable to the owners of the Company by the weighted average number of Ordinary Shares during the period.
On 30 June 2015, the Group completed an 11 for 12 share consolidation which had the effect of reducing the number of shares in issue from 1,500 million Ordinary Shares of 10 pence each to 1,375 million Ordinary Shares of 10 10/11 pence each. The weighted average number of Ordinary Shares used in calculating basic and diluted earnings per share reflects this share consolidation.
Earnings attributable to owners of the Company arising from: Continuing operations 399.2 359.3 Discontinued operations 181.2 13.3 Continuing and discontinued operations 580.4 372.6 Weighted average number of Ordinary Shares (millions) 1,431.2 1,495.0 Basic earnings per share (pence): Continuing operations 27.9 24.0 Discontinued operations 12.7 0.9 Continuing and discontinued operations 40.6 24.9
Earnings attributable to owners of the Company arising from: Continuing operations 399.2 359.3 Discontinued operations 181.2 13.3 Continuing and discontinued operations 580.4 372.6 Weighted average number of Ordinary Shares (millions) 1,431.2 1,495.0 Effect of dilutive potential of share options and contingently issuable shares (millions) 17.8 12.9 Weighted average number of Ordinary Shares for the purpose of diluted earnings per share (millions) 1,449.0 1,507.9 Diluted earnings per share (pence): Continuing operations 27.6 23.8 Discontinued operations 12.5 0.9 Continuing and discontinued operations 40.1 24.7 17. Net assets per share and return on equity Net asset value per share is calculated as total shareholders’ equity divided by the number of Ordinary Shares at the end of the period excluding shares held by employee share trusts.
Return on equity The table below details the calculation of return on equity.
overnance Financial statem ents www.directlinegroup.com 145 18. Goodwill and other intangible assets
Direct Line Group Annual Report & Accounts 2015 146 18. Goodwill and other intangible assets continued The table below analyses the goodwill of the Group by CGU.
overnance Financial statem ents www.directlinegroup.com 147 19. Property, plant and equipment Freehold land and buildings £m
Transfer to assets held for sale (note 5C) (22.6) – (22.6)
Impairment losses – 0.1 0.1 Disposal of subsidiary – (2.9) (2.9) Effect of foreign currency exchange adjustment – (1.4) (1.4) Transfer to assets held for sale (note 5C) – (21.3) (21.3)
Impairment losses – 4.8 4.8 Transfer to assets held for sale (note 5C) (0.5) – (0.5)
Additions at cost 16.0 76.2 Increase in fair value during the year 24.2 28.7 Disposals – (21.1)
Direct Line Group Annual Report & Accounts 2015 148 21. Subsidiaries The principal subsidiary undertakings of the Group, over which it exercises 100% voting power, are shown below. Their capital consists of Ordinary Shares which are unlisted. All subsidiaries (a full list of which is included in note 2 of the Parent Company financial statements) are included in the Group’s consolidated financial information.
Reinsurers’ share of general insurance liabilities 975.8 841.9 Impairment provision (53.9) (66.4)
Derivative assets At fair value through the income statement 19.3 24.9 Designated as hedging instruments 0.3 2.4
Derivative liabilities At fair value through the income statement 46.3 29.3 Designated as hedging instruments 0.1 0.1
HTM debt securities Corporate 13.5 – Total debt securities 5,240.1 5,830.3 Total debt securities Fixed interest rate 4,801.6 5,147.3 Floating interest rate 438.5 683.0
Cash at bank and in hand 131.8 151.3 Short-term deposits with credit institutions with maturities less than 3 months 831.9 729.1 Cash and cash equivalents 963.7 880.4 Bank overdrafts1 (61.3) (69.8) Cash and cash equivalents in assets held for sale (note 5B) – 87.6 Cash and cash equivalents including bank overdrafts 902.4 898.2
Note: 1. Bank overdrafts represent short-term timing differences between transactions posted in the records of the Group and transactions flowing through the accounts at the bank.
The effective interest rate on short-term deposits with credit institutions for the year ended 31 December 2015 was 0.56% (2014: 0.61%) and average maturity was 10 days (2014: 10 days).
The non-distributable reserve is a statutory claims equalisation reserve that is calculated in accordance with the rules of the PRA. With the introduction of Solvency II on 1 January 2016 the requirement to maintain the reserve ceases and the non-distributable reserve transfers into retained earnings.
The subordinated guaranteed dated notes were issued on 27 April 2012 at a fixed rate of 9.25%. On the same date, the Group also entered into a 10-year hedge to exchange the fixed rate of interest for a floating rate of three-month LIBOR plus a spread of 706 basis points which was credit value adjusted to 707 basis points with effect from 29 July 2013.
The nominal £500 million notes have a redemption date of 27 April 2042. The Group has the option to repay the notes on specific dates from 27 April 2022. If the notes are not repaid on that date, the rate of interest will be reset at a rate of the six-month LIBOR plus 7.91%.
Accident year 2006 £m 2009 £m £m £m £m £m 2015 £m Total £m
Current estimate of cumulative claims1 3,434.5 3,967.5 3,311.4 3,672.8 3,512.0 2,354.0 2,041.2 1,913.4 2,115.2 2,118.1
Gross liability recognised in balance sheet 143.5 206.0 140.6 230.9 266.0 271.1 289.9 437.9 765.1 1,205.7 3,956.7 2005 and prior 473.4 Claims handling provision 94.4 Total 4,524.5
Note: 1. The claims development and cumulative payments to date by accident year in the above table have been re-presented to exclude the claims and payments in respect of the International business sold on 29 May 2015.
Direct Line Group Annual Report & Accounts 2015 154 31. Insurance liabilities continued Movements in gross and net insurance liabilities
Incurred but not reported 1,992.7 (449.8) 1,542.9 Claims handling provision 128.3 – 128.3
Incurred but not reported 1,778.2 (460.2) 1,318.0 Claims handling provision 104.8 – 104.8
Movement in prior-year net claims liabilities by operating segment £m 2014 £m
overnance Financial statem ents www.directlinegroup.com 155 33. Retirement benefit obligations Defined contribution scheme The pension charge for continuing operations in respect of the defined contribution scheme for the year ended 31 December 2015 was £23.5 million (2014: £23.9 million). The charge for discontinued operations was £0.9 million (2014: £1.8 million).
The weighted average duration of the defined benefit obligations at 31 December 2015 is 20 years (2014: 20 years) using accounting assumptions.
Rate of increase in pension payment 2.1 2.1 Rate of increase of deferred pensions 2.1 2.1 Discount rate 3.8 3.4 Inflation rate 3.2 3.1
The table below analyses the fair value of the scheme assets by type of asset.
Impact on present value of defined benefit scheme obligations £m £m 2014 £m
Discount rate 0.25% increase in discount rate (0.2) (0.2) (3.7) (4.1)
Inflation rate 0.25% increase in inflation rate – – 1.7 2.1 0.25% decrease in inflation rate – – (1.7) (2.1) Life expectancy 1 year increase in life expectancy 0.1 0.1 2.0 1.8 1 year decrease in life expectancy (0.1) (0.1) (2.0) (1.8)
overnance Financial statem ents www.directlinegroup.com 157 34. Share-based payments The Group operates equity-settled, share-based compensation plans in the form of an LTIP, a Restricted Shares Plan, a DAIP and Direct Line Group Share Incentive Plans, including both the Free Share awards and a Buy-As-You-Earn Plan, details of which are set out below. All awards are to be satisfied using market purchased shares.
Weighted average assumptions during the year: Share price (pence) 339 270 Exercise price (pence) 0 0 Volatility of share price 20% 26% Average comparator volatility 27% 30% Expected life 3 years 3 years Risk-free rate 0.8% 1.1%
Expected volatility was determined by considering the actual volatility of the Group’s share price since IPO and that of a group of listed UK insurance companies.
Plan participants are entitled to receive additional shares in respect of dividends paid to shareholders over the vesting period. Therefore no deduction has been made from the fair value of awards in respect of dividends.
The awards outstanding at 31 December 2015 have no performance criteria attached, other than the requirement that the employee remains in employment with the Group for three years from the date of grant.
Granted during the year1 6.8 6.1 Impact of share consolidation (see note 28) (1.6) – Forfeited during the year (1.5) (0.8) Exercised during the year (2.9) (0.3)
The weighted average share price for awards exercised during the year ended 31 December 2015 was £3.95 (2014: £2.56).
Due to agents, brokers and intermediaries 22.5 19.3 Due to reinsurers 78.9 57.0 Due to insurance companies 4.7 5.3 Trade creditors and accruals 295.5 342.8 Other creditors 98.8 96.5 Other taxes 78.9 55.0
Operating cash flows before movements in working capital 363.5 294.4 Movements in working capital: Net decrease in net insurance liabilities including reinsurance assets, unearned premium reserves and deferred acquisition costs (194.5) (589.0) Net increase in prepayments and accrued income and other assets (2.8) (19.1) Net decrease in insurance and other receivables (66.4) 59.2 Net increase / (decrease) in trade and other payables including insurance payables 52.3 (57.9) Contribution to retirement benefit obligations (2.8) (2.8)
overnance Financial statem ents www.directlinegroup.com 161 38. Commitments Operating lease commitments The Group has entered into non-cancellable operating lease agreements for properties, vehicles and other assets.
The minimum lease payments under operating leases recognised as an expense for discontinued operations during the year ended 31 December 2015 were £0.8 million (2014: £2.5 million).
The following table analyses the outstanding commitments for future minimum lease payments under non-cancellable operating leases by the period in which they fall due.
There were no outstanding commitments in relation to the Group’s discontinued operations at 31 December 2015 (2014: £11.5 million).
Within one year 15.7 14.6 In the second to fifth years inclusive 53.6 51.7 After five years 89.3 99.6
Direct Line Group Annual Report & Accounts 2015 162 39. Fair value The methodology adopted by the Group for fair value measurement of investment properties, financial assets and liabilities and the basis for determining the fair value hierarchy are explained in note 2.3.
HTM debt securities (note 26) 12.7 13.5 – – Deposits with credit institutions > three months (note 26) 44.9 44.9 54.7 54.7
Investment property (note 20) – – 307.2 307.2 Derivative assets (note 25) – 27.3 – 27.3 AFS debt securities (note 26) 985.6 4,844.7 – 5,830.3
Derivative liabilities (note 25) – 29.4 – 29.4 Total liabilities – 29.4 – 29.4
Sale and purchase of products and services were conducted on an arm’s length basis.
Year end balances arising from sales and purchases of products and services to and from related parties Amounts owed by related parties Amounts owed to related parties £m £m 2014 £m
Movement in amounts owed by and to related parties Amounts owed by related parties Amounts owed to related parties £m £m 2014 £m
Transactions in the year – 0.1 – 19.1 Settled in the year – (0.8) (25.4) (52.4)
Short-term employee benefits 9.5 10.2 Post-employment benefits 0.2 0.3 Termination benefits – 0.4 Share-based payments 4.5 3.4
Current tax assets 5 – 1.2 Derivative financial instruments 6 0.4 2.4
For the year ended 31 December 2015 www.directlinegroup.com 165 £m 2014 £m
Total comprehensive income for the year – – – 1.2 436.7 437.9 Dividends paid – – – – (401.1) (401.1) Credit to equity for equity-settled share-based payments – – 6.6 – – 6.6 Shares distributed by employee trusts – – (1.0) – – (1.0)
Direct Line Group Annual Report & Accounts 2015 166 £m 2014 £m