Direct Line Group (the “Group”) is Britain’s leading personal lines motor and home insurer1, with motor insurance operations in Italy and Germany. We operate a multi-brand, multi-product and multi-distribution channel business that covers the majority of customer segments in the UK for personal lines general insurance and small- and medium-sized enterprise commercial insurance. Our brands offer the following products: motor, home, rescue, pet, travel and commercial.
Direct Line has maintained the heritage of its brand in the UK by selling products directly to its customers through the phone and internet only. We target customers who have a high brand affinity, with a focus on a quick and straightforward customer experience.
Direct Line for Business, an extension of the Direct Line brand, is our direct commercial insurance brand for micro and small-sized businesses in the UK that have straightforward commercial insurance requirements.
Brand Partners is the business-to-business arm of the Group, specialising in providing personal lines insurance and roadside rescue and recovery products to some of the UK’s biggest brands.
Governance 50 Chairman’s introduction 52 Board of Directors 54 Executive Committee 56 Corporate governance report 65 Committee reports 76 Directors’ remuneration report 100 Directors’ report
Other information 175 Additional information 177 Glossary 179 Forward-looking statements disclaimer 180 Contact information
• Combined operating ratio for ongoing operations1 in 2013 included higher than expected contribution from prior-year reserve releases of 12.4 percentage points (£435.1 million) compared to 8.7 percentage points in 2012 (£322.0 million)
• Strong capital position maintained with risk-based capital coverage of 148.7% post final and second special interim dividends, towards the upper end of the target range of 125% to 150%
It excludes the Run-off segment, restructuring and other one-off costs and gain on disposal of subsidiary. 2. Operating expenses and claims handling expenses from ongoing operations. It excludes the Run-off segment and restructuring and other one-off costs. 3. Return on tangible equity (“RoTE”) is adjusted profit after tax from ongoing operations divided by the Group’s average tangible shareholders’ equity.
Profit after tax is adjusted to exclude the Run-off segment, restructuring and other one-off costs and gain on disposal of subsidiary and is stated after charging tax (using the UK standard tax rate of 23.25%; 2012: 24.5%).
4. Pro forma RoTE is based on the return on tangible equity, but assumes that the capital actions taken by the Group prior to the initial public offering (£1 billion dividend payment and £500 million long-term subordinated debt issue) occurred on 1 January 2012.
For information on performance rewards see our remuneration report on p.76
We have operations in Italy and Germany, two of the three largest motor insurance markets in Europe6, providing private motor insurance for customers through our Direct Line brand, and have around 1.6 million in-force policies.
Notes: 1. See note 1 on page 2 2. Ranked by total in-force policies in the motor and home markets, including partner brands: RBS, NatWest, Nationwide, Prudential and Egg © GfK NOP Financial Research Survey (FRS) 6 months ending October 2013, 15,260 adults interviewed for motor insurance and 15,922 for home insurance.
3. Mintel Vehicle Recovery – UK, September 2013 report 4. Mintel estimate, based on 2012 data. Mintel Pet Insurance – UK, September 2013 report 5. Mintel estimate, based on 2012 data. Mintel Travel Insurance – UK, February 2013 report 6. insurance Europe, European Insurance in Figures February 2014 report, Motor gross written premiums 2012
Rescue and other personal lines 46.5 l Commercial 9.5 l International 16.6
Multi-brand Millions of consumers recognise many of our brands. For almost 30 years, we have sought to make it easier for our customers to obtain good value insurance cover.
Motor We are Britain’s leading personal motor insurer, with a 14% share of in-force policies2. Mainly represented through our highly recognised brands, Direct Line, Churchill and Privilege, we insure one in seven cars on the road, representing 3.8 million in-force policies. We also provide motor insurance for customers through partners such as Sainsbury’s Bank.
Rescue and other personal lines We are one of the leading providers of rescue and other personal lines insurance in the UK, with 8.8 million in-force policies. This includes providing roadside assistance and recovery for customers through Green Flag, the UK’s third largest roadside recovery provider3. We also offer customers protection for their pets and holidays with 11%4 and 14%5 shares of gross written premium respectively.
We use a multi-brand, multiproduct and multi-distribution channel business model, aiming for each of our brands to offer a specific proposition to a distinct customer segment. We believe that this approach, when combined effectively with our significant scale, should help us achieve high performance in distribution, pricing, claims and cost. In turn, this enables us to aim to generate value for customers and sustainable returns for our shareholders.
Our customers Our business model starts with our customers, whom we aim to keep at the core of what we do. We aspire to give them the products that best suit their needs and encourage them to expect a high quality of service throughout their relationship with us. We also strive to be a business that can adapt to their changing needs. We treat each phase of the customer journey as an opportunity to provide an excellent service and outcome from the moment customers select our products, through to the time they make a claim or need to resolve an unexpected event.
Our people Everyone – from front-line staff, who interact directly with our customers, to our people in support and central functions, who run the processes that support our products and services – plays a part in ensuring we are meeting customers’ needs. Without our people, we could not generate value for our customers and sustainable returns for our shareholders.
Settling claims If the time comes to make a claim, it is at that point that customers see the value of their policy. Through active engagement with our customers, we aim to settle their claim as quickly and as easily as possible. Doing this the right way helps us to demonstrate the value of the products and services we provide and manage our claims costs.
Managing finances We seek to ensure that our business is well governed and controlled. We aim to manage our finances carefully by spending money on items that add the most value to our customers, balancing this with the need to generate a suitable and sustainable return to our shareholders.
Benefits to young drivers Young drivers as a high-risk, high-premium group are expected to gain the greatest benefit from telematics.
Have our black box fitted to your car or download the smartphone app
Settling claims – Motor Our claims transformation programme is improving the way we deal with customers, making it smoother and faster.
Our ongoing roll-out of ClaimCenter has passed the milestone of registering 1 million customer claims, as well as bringing Commercial and Italian motor claims onto the platform. All new customer motor and home claims for our Direct Line, Churchill and Privilege brands, as well as some of our partnership brands, are now handled through the system.
Therefore, to resolve this in our Motor business, our customers are now able to receive regular updates on when their car will be ready.
This transparency should give them peace of mind and, once active across our entire accident repair centre network, is expected to reduce call volumes and avoidable frustrations.
Settling claims – Home Over the last year the UK experienced some of the worst wind and rain storms in a quarter of a century, leaving many homes damaged and without power.
Before each storm hit, we put our severe weather plans into action, making sure there were extra staff on the phones and on the ground to help our customers. On the day of greatest impact, we received more than double our normal customer call volumes. We also deployed our emergency response vehicle, CHARLIE, to the worst affected areas to help customers on the ground get on with the claims process.
2013 represented another significant year for Direct Line Group. In the first full year of being listed on the London Stock Exchange, the Group achieved the 2013 combined operating ratio1 (“COR”) and cost targets set at the time of the initial public offering (“IPO”) in October 2012. This resulted in a 16.0% RoTE from ongoing operations2, ahead of its long-term target. This has been achieved despite competitive market conditions and demonstrates the improved levels of performance the Group’s transformation plan is delivering.
Our shareholders have also seen a 15.3% increase in the share price to 249.6 pence per share in the year to 31 December 2013. In addition, we paid shareholders dividends totalling 16.2 pence per share during 2013. As at the date of this report (25 February 2014) the share price is 261.0 pence.
Strategy update During 2013, the Group has continued to focus on delivering the strategic plan established in 2010 to transform Direct Line Group into ‘Britain’s best retail general insurer’. We have made good progress in 2013 across each of our strategic priorities and have plans for further transformation in the future.
Looking to 2014, we will continue to focus on delivering for our customers, in particular by using technology to enhance customer experience. More details of this and other strategic priorities can be found in the Chief Executive Officer’s review.
We continue to target a RoTE from ongoing operations2 of 15%. In addition, we have set specific targets for 2014, being a total cost base3 of approximately £1,000 million and a COR in Commercial of less than 100%. Overall, we currently expect a COR for the Group of between 95% and 97% in 2014. These assume a normal level of claims from weather events and large losses.
Dividend and capital management Through our progressive dividend policy, we aim to increase the dividend annually in real terms. The Board is recommending a final dividend of 8.4 pence per share to shareholders. If approved, the full year regular dividend of 12.6 pence per share would represent a 5.0% growth on the pro forma full year dividend4 of 2012 (12.0 pence per share) and is in line with this policy.
In addition, we paid a special interim dividend of 4.0 pence per share in December and we are now declaring a second special interim dividend of 4.0 pence per share. Both these special interim dividends relate to items in 2013 that were not expected at the start of the year. First, the sale of our closed life insurance operation, Direct Line Life Insurance Company Limited (the “Life business”), and secondly, better than expected profit from the Run-off segment and the sale of Tracker. Due to the one-off nature of these items, the Board believes it is appropriate in this instance to return this capital to shareholders.
In determining this position, the Board has considered a number of factors that may positively and negatively affect the Group’s capital position over the next 12 months. The Board will continue to review this position as clarity improves on these factors and the Group makes further progress with its transformation plan. More details can be found on page 42.
Relationship with RBS Group Our ongoing relationship with RBS Group is principally set out in two key agreements, the Relationship and Transitional Services Agreements. The Relationship Agreement sets out that Direct Line Group is to carry on its business independently of RBS Group and entitles RBS Group to nominate a Director for appointment to the Board. The agreement will terminate once RBS Group holds less than 20% of Direct Line Insurance Group plc (the “Company”) shares. Under the Transitional Services Agreement, RBS Group will continue to provide IT and certain other services to Direct Line Group for a transitional period of up to 36 months following the IPO in October 2012.
Subsequent to the IPO, RBS Group undertook two further placings in 2013 of 551.6 million Ordinary Shares in the Company. These represented 36.8% of the total share capital and generated additional gross proceeds of £1,135.8 million for RBS Group. Following the placings, RBS Group’s shareholding in the Company was 28.5%.
Board changes and effectiveness Following RBS Group’s reduction in its shareholding in the Company to below 50%, and in accordance with the terms of the Relationship Agreement, Mark Catton stepped down from the Board on 26 April 2013. On 1 October 2013, Bruce Van Saun stepped down from the Board to focus on other projects for RBS Group and Mark Catton was reappointed. May I take this opportunity to thank Bruce for the insights and value he brought to the Board during his time as a Director. I would also like to extend this gratitude more generally to all of our Non-Executive Directors for their dedication to the Group.
“Our strategic progress and successful delivery of our targets is a direct result of the hard work demonstrated throughout the business. This has enabled us to deliver benefits to our customers and returns to our shareholders.”
We are on the cusp of a new era, when growing customer use of new technologies prompts them to seek a different experience from their insurer, and where nimble providers can harness technology to offer both competitive products and more personalised solutions. The strength of our data and brands, together with the operational and financial transformation of our platform, leaves us well placed to help draw the road map for this new age. For instance, we are piloting real-time online progress updates on car repairs, and we are offering telematics technology to give customers instant feedback on the quality of their driving, which can ultimately, if they drive well, improve road safety and save them money.
We recognise that, while we have made improvements in how we interact with our customers, we have not met all of our aspirations to develop and differentiate our customer propositions and brands. We have much to do to meet the evolving needs of our customers, but we are rising to the challenge with determination and energy.
Delivering for our people Our people continue to be the main driver behind delivering better outcomes for our customers. Although we have had to remove 3,200 roles since the start of our cost savings initiatives, to ensure our organisation can operate in the most cost-efficient manner, our consistent aim has been to treat colleagues with the utmost fairness and respect throughout redeployment or redundancy processes. As we continue to drive an agenda of operational and cultural change through the organisation, we remain committed to investing in our people, which in turn will help us to deliver the products and services that our customers value.
Developing stand-alone systems Ever since beginning our separation from RBS Group, we have made significant investments to design and started to build a stand-alone IT infrastructure capable of supporting a multi-brand, multi-product and multi-distribution channel business with 18 million in-force policies. Notwithstanding the complex operational risk associated with this task, we aim for the migration to have made substantial progress by the end of 2014. Alongside the construction of a stand-alone IT platform, we are continuing to develop our technological capabilities by investing in other systems designed to improve customer operations and business processes. The opening of our own, state-of-the-art data centres was a significant step forward in advancing our technology initiatives in 2013.
The Group continues to engage proactively in new or emerging regulatory priorities. Good conduct is integral to the success of our business, which is why we decided to switch the sale of our motor legal protection product to opt in prior to the publication of regulatory guidance, and why we chose to lay the foundations for DLG Legal Services as an alternative business structure, which should help shield our existing customers from potentially excessive third-party solicitor fees.
In December, the CC published the provisional findings of its ongoing investigation into the UK private motor insurance market. We continue to work with the CC, and have always said we welcome the investigation, if it results in a level playing field and the removal of market dysfunction, to the benefit of our customers and consumers more broadly.
We will also continue to enhance our products and update our infrastructure to ensure we sharpen our customer experience, delivering what the customer has grown to expect, and doing so sustainably for all of our stakeholders, be they our customers, our people or our shareholders.
For 2014, we aim to achieve a COR in the range of 95% to 97% for ongoing operations, assuming a normal level of claims from weather events. Assuming underlying claims trends continue, a significant contribution from prior-year reserve releases is currently expected, albeit at a lower level than in 2013.
I would like to thank our people for the continuous hard work and dedication that they have demonstrated throughout the year. This has enabled us to continue to deliver benefits to our customers, shareholders, and wider stakeholders.
We seek to understand customers’ needs and provide them with products that meet their needs, offer good value and are straightforward to purchase.
Priorities for 2014: • Complete the roll-out of our new smartphone and tablet optimised websites and leverage the new digital platform
• To continue to develop and differentiate the Direct Line customer proposition
• To evolve our telematics propositions based on customer feedback and performance
Pricing We aim to leverage our substantial data and the investments we have made to provide leading technical and market pricing.
2013 progress: • Launched updated technical pricing models in Motor with further granularity
Priorities for 2014: • 30 major programmes due to be delivered in 2014
• A number of specific pricing initiatives to enhance trading capability on PCWs
Financial targets 15% Return on tangible equity1 125% to 150% capital coverage consistent with credit rating in the ‘A’ range 2014 targets £1,000m Approximate total cost base2
Notes: 1. See note 3 on page 2 2. See note 2 on page 2 3. See note 2 on page 17 4. See note 1 on page 2 5. This assumes a normal level of claims from weather events.
We recognise the requirement to keep costs down, whatever the market conditions. We are also in the process of updating our IT infrastructure which should improve efficiency, offer us more flexibility and enable us to enhance our customers’ experience.
• Started roll-out of new voice and desktop tools to improve efficiency throughout the organisation
We continue to invest in our capabilities to provide customers with a service that is reliable and straightforward, with improved transparency at each step of a claim.
Motor and Home with ClaimCenter roll-out and new operating model, including the use of social networking techniques to combat fraud
• Making full use of our claims fulfilment network to offer improved customer propositions, for example car replacement service
experience by rolling out further claims initiatives, for example using smartphone technology
Commercial and International We focus our Commercial business on targeting the growing SME and micro segments, and are well positioned to benefit as these customers move towards direct and e-trading distribution channels.
We have 10 years of experience in Italy and Germany, two of Europe’s biggest motor insurance markets, and are now reaching scale.
• Delivered efficiencies through consolidation of underwriting centres and separating trading activities
Priorities for 2014: • Achieve target for COR of below 100% for Commercial division2
Measuring our performance We have defined eight key performance indicators that allow us to monitor our performance against our strategic priorities. In turn, these are supported by further performance indicators monitored by management.
Definition A measure of financial year underwriting profitability calculated by the sum of claims, commissions and expenses divided by net earned premium for ongoing operations. This excludes instalment and other operating income and investment return. A COR of less than 100% indicates profitable underwriting.
Definition The cost of doing business, including paying our people, marketing, infrastructure and IT. This includes the costs we incur in handling claims, but excludes any commissions we pay to brokers or partners and restructuring and other one-off costs.
Definition The return generated by investing the assets we hold. These investments are held to pay out future claims and to support our capital base. It is calculated by dividing investment income (excluding net realised gains) by average investment assets under management (“AUM”).
Definition The amount of cash paid to shareholders out of the profit of the Group. The comparative amount shown excludes dividends paid prior to the IPO.
Definition A measure to show the level of capital held compared to the level that is required, taking into account the risks faced by the business.
Aim We target risk-based capital coverage of 125% to 150% which is consistent with our aim to maintain a rating in the ‘A’ range from our credit rating agencies.
Notes: 1. The 1st line of defence is provided by line managers who are responsible for ownership and management of the risks to the achievement of business objectives on a day-to-day basis.
3. Group Audit delivers the 3rd line of defence through the provision of an independent view for the Board on the effectiveness of risk management.
“Our risk and compliance strategy is designed to support our goal to become Britain’s best retail general insurer.” José Vazquez, Chief Risk Officer
The Board has responsibility for setting and monitoring adherence to the risk strategy, risk appetite and risk framework. The Board has established a risk management model that separates the business’s risk management responsibilities into ‘three lines of defence’ as set out in the diagram below.
Delivering a strategic plan will, by its very nature, result in taking risk. Management of this risk is therefore a key aspect of the strategic planning process and it is important that the link between strategy and its impact on capital is clear. We place Enterprise-wide Risk Management (“ERM”) at the very heart of our approach.
We recognise that our long-term sustainability depends on having sufficient funds to meet our liabilities as they fall due. This protects our reputation and the integrity of our relationship with customers and other stakeholders. For information on our allocation of capital by risk type see page 42.
Risk strategy and appetite The risk appetite statements are expressions of the level of risk we are prepared to accept to achieve our business objectives. In order to monitor whether we are within risk appetite, we have aligned the statements to key business metrics, such as volumes of business or levels of exposure. These metrics form key risk indicators, which are both qualitative and quantitative and forward and backward looking, and our risk profile is monitored regularly using these indicators to ensure we remain within appetite.
Risk appetite should not be static and we are committed to performing, as a minimum, an annual review of the risk appetite to ensure it remains suitable to support the Group. Such a review was undertaken in the second quarter of 2013 and resulted in Board approval of the risk appetite statements outlined in the table. We would also review risk appetite if the Group’s strategy changed, ensuring risk management remains aligned to the Group strategy.
Over the last 12 months, to help achieve these strategic risk objectives, we have: • Strengthened financial risk oversight by developing the risk management function through tailored recruitment
• Enhanced the ERM framework to reflect our operation as a stand-alone Group
Our ERM framework has been made stronger during 2013 as a result of: • The linking of risk strategy and governance to our risk appetite and policy frameworks, documented in our High Level Controls and System of Governance document
The ERM framework: enhanced by an effective risk and control culture Risk culture is about how the principles, processes and tools of the risk framework are applied in day-to-day behaviour. A good risk culture is one where risk management is a significant part of the way we work. Our Group values align to the risk culture and seek to promote proactive risk management.
Solvency II Making use of Pillar I models, the PRA has developed the Individual Capital Adequacy Standards Plus (“ICAS+”) process to enable UK insurers to make use of capital models developed under Solvency II programmes.
The Group’s risk management system, including the automated risk management tool, is being embedded and the Solvency II data warehouse implementation is continuing to progress. The Group expects Solvency II to be in force on 1 January 2016 with the Internal Model Approval Process taking place in 2015. As a result, the risk management team is developing a revised timeline for progress towards internal model approval and engaging with the PRA about the Group’s self-assessment of its progress towards Solvency II.
Strategic risk The external environment could put at risk our ability to meet our strategic objectives through the five key strategic priorities of distribution, pricing, claims, costs and Commercial and International.
• Risk assessment of projects designed to enhance pricing and claims capability
• We invest in enhanced external data to mitigate exposures, for example flood and individual underwriting risk through Geospatial
• The Managing Directors of each division own and manage this risk
Insurance risk: reserving Due to the uncertain nature and timing of the risks to which we are exposed, we cannot precisely determine the amounts that we will ultimately pay to meet the liabilities covered by the insurance policies written.
Reserving generates both upside and downside risk, with the potential for outcomes to be in our favour, generating reserve releases.
For the Group this includes: interest rate risk, spread risk, currency risk and property risk.
• We manage and control our investment portfolio through: – Investment strategy and guidelines proposed to the Board by the Investment Committee and monitored by the Asset and Liability Committee
– Diversity in the types of assets held, including by geography, sector and credit rating
In particular we have IT systems risk, including that we are highly dependent on the use of RBS Group’s information technology, software, data and service providers.
Migrating IT systems away from RBS Group introduces different operational risks; there is increased likelihood of system failure at the point that functions are moved onto new infrastructure. Further, if the migration fails to stay on schedule, we will incur charges for remaining on RBS Group IT infrastructure.
IT migration also introduces people risk, as management may be distracted away from day-to-day activities.
Operational risk includes cyber risk, the risks relating to the use of computers, other IT and the storage of data.
Within this category, we also consider the risk of the Group not recruiting and retaining suitable talent. This risk is particularly important during the Group’s current period of change.
• We have strong operational processes and systems, including fraudulent claims detection systems. Our risk, business and capital strategies are integrated
• We have strong recruitment processes to help our aim of ensuring that the right people are recruited and placed into the right roles
In particular, Solvency II regulations are currently being introduced. Solvency II requirements are still uncertain and subject to the outcome of discussion between UK and European regulators. The outcome and impact of the ICAS+ process is also uncertain. These uncertainties increase our level of risk.
• Our organisational culture prioritises a consistent approach towards customers and the interests of customers are at the heart of how we operate
• Our brand and reputational risk is regularly reviewed through our governance framework
• We undertake substantial marketing activities to protect and build our brands, and regularly measure their effectiveness
• Specific members of the Executive own and manage this risk
• The results of the MoJ consultation into the discount rate used to value certain types of bodily injury claim awards
The Italian regulatory landscape is changing which could lead to greater regulatory intervention.
• Regular contact with the regulator to ensure the business is kept abreast of changes in expectations
There is a strategic risk of the potential failure to execute the plan, or that the expected benefits of the plan may not be achieved on time or to the extent targeted.
There is also a large potential for upside risk should initiatives provide benefits that are greater than those planned, or if the expected benefits are felt by the business sooner than planned.
• Using ‘lessons learnt’ exercises to ensure later projects are improved by our experiences
Pro forma return on tangible equity – ongoing operations3 n/a 13.4%
Motor Highlights • Retained position as Britain’s leading personal motor insurer with a 14% share of in-force policies1
• Improvement in risk selection and claims capability contributing to reserve releases and reduced loss ratio
Market In the UK, an economic recovery appears to have been taking hold, and it is expected to gather pace2. Consistent with this, car registrations recorded their highest monthly total for many years in September3, while higher petrol prices are anticipated from oil price inflation.
The motor insurance market in the UK was again highly competitive, with another year of insurance premium deflation. PCW sales continue to rise and their media advertising remains high. Customers are shopping around more and there is a greater market focus towards retention and cross- selling products. There has also been a relatively benign claims experience during 2012 and 2013, alongside the positive effects of a series of government interventions to reduce the costs of bodily injury claims. In particular, a package of reforms, including the Legal Aid, Sentencing and Punishment of Offenders (“LASPO”) Act measures and the banning of legal referral fees, were introduced during 2013.
These reforms are intended to reduce the average cost of bodily injury claims, largely due to lower legal costs. However, it is too early to say whether they will also have a material benefit in terms of the frequency of bodily injury claims. Furthermore, improved fraud detection capabilities are expected to help reduce false declarations of driving experience and convictions. Also, the FCA continues to review all aspects of conduct risk through a series of thematic reviews, including motor legal expenses insurance, which we, and our distribution partners, continue to engage with proactively.
Following the implementation of the EU Gender Directive, some young drivers, particularly males, have seen reductions in premiums. The growth of telematics has supported this, as drivers of all ages and genders are able to receive discounts. This follows installation of a device to their car or the download of a smartphone app, and the display of safer driving behaviour.
Performance Given the highly competitive market, we continued to make choices to optimise value and prioritise underwriting margin over volume growth. Furthermore, the results reflected previous actions taken to reduce risk and manage claims costs, which together contributed to significant prior-year reserve releases. We have enhanced our pricing engines, delivered claims efficiencies and improved our customer propositions, including the roll-out of telematics propositions. These have helped to successfully manage the business through a period of regulatory change.
There was an improvement in underwriting result driven by the attritional loss ratio and reserve releases, as a result of actions taken on pricing and claims. These reserve releases, which were higher than expected, were driven by both small and large bodily injury claims. The expense ratio rose by 0.6 percentage points following reduced net earned premium, which more than offset the lower cost base. However, the significant improvement in the operating profit was partially offset by reduced other income, from the cessation of solicitors’ referral fee income, and a lower investment return. In February 2014, the Group sold its stolen vehicle recovery business, Tracker. Operating loss from this business was £1.4 million in 2013.
Outlook The UK motor market remained highly competitive in the first quarter of 2014 and gross written premium is expected to be approximately 10% lower than the same period in 2013. We continue to focus on protecting underwriting margins, rather than prioritise policy volumes. During 2014, we aim to develop initiatives to support our strategic priorities further including the rolling out of new customer websites, enhancing our trading capability, evolving our telematics-based propositions and continuing to evolve technical pricing sophistication.
2. Bank of England 3. Society for Motor Manufacturers and Traders
• Improvement in the COR by 2.8 percentage points to 93.8%, following fewer claims from major weather events
The Association of British Insurers (“ABI”) and the UK Government arrived at the Flood Re solution, which is intended to ensure the availability of affordable home insurance in the highest flood risk affected parts of Britain. As with the motor market, the FCA continues to review all aspects of conduct risk through a series of thematic reviews, which we continue to engage with proactively.
Performance The Home business experienced another strong result in 2013, which benefited from lower weather claims than 2012, despite the significant flooding and storm claims in December. Customer retention improved on last year as we optimised technical-pricing models. The product range was also rationalised from 30 products to three across the brand portfolio to simplify the customer proposition. The number of policies sold through the PCW channel increased by 8.0% on last year. Promising initial results have been experienced from the launch of the Home estimation tool, which allows more accurate assessment of claims to facilitate speedier claims adjustment and payment.
Notes: 1. Direct Line Group including partner brands: RBS, NatWest, Nationwide,
Prudential and Egg © GfK NOP Financial Research Survey (FRS) 6 months ending October 2013, 15,922 adults interviewed for home insurance.
2. Consumer Intelligence 3. Insurance policy giving customers access to vetted tradesmen for home emergencies and repairs.
• Gross written premium broadly stable at £383.4 million reflected rise in direct sales offset by reduced cross sales
• Completed sale of the Life business for £62 million enabling payment of a special interim dividend
Market The economic trends are the same as in the Motor and Home operating reviews.
The roadside assistance market is similarly showing signs of recovery, with the overall market size increasing. Three major providers, including Green Flag, account for the majority of the market and competition is increasing, with service and price being important aspects for customers. Products are bought direct from providers, as part of linked motor sales, as part of packaged bank accounts, and via PCWs.
The pet population and market penetration rates remain stable; however, average premiums have been rising. The premiums increase in recent years is due to higher claims severity, driven by treatment and drug advances, while price competition continues to increase. Insurance providers are focused on recommendations by, and distribution through, vets as an important channel to customers; however, PCW visits are gradually increasing. The travel insurance market has been stable, and characterised by high volumes and penetration rates, the latter being the uptake of insurance by travellers. Medical claims represent the largest component of claims severity and continue to grow, followed by cancellation claims. Distribution is moving away from travel agents and brokers, with travel insurance being offered through packaged bank accounts and PCWs.
Gross written premium of £383.4 million was broadly stable to last year. This reflected increased direct sales of Green Flag products offset by reduced linked sales. Pet gross written premium increased by 3.7% from rate increases and travel gross written premium decreased by 0.8% driven by volume decreases.
Underwriting profit reduced to £27.9 million from last year while the loss ratio increased 9.2 percentage points as 2012 benefited from positive one-offs relating to legacy creditor business. The expense ratio improved by 1.0 percentage point due to cost improvements across the Group, partially offset by increased Green Flag marketing costs. Overall, operating profit decreased to £46.5 million following the non-repeat of certain one-offs, primarily in the legacy creditor business, which benefited 2012. Of the total operating profit, £38.1 million was delivered by Rescue and £6.4 million by the closed Life business. The Rescue contribution was £9 million lower than in 2012, due to the increased marketing spend and the non-repeat of certain one-off items.
Outlook Rescue and other personal lines continues to represent an opportunity to create value for the Group, and meet customers’ broader insurance needs. Investment in distribution and propositions will support further contribution, offset by the disposal of the Life business, and lower Creditor premiums as the business runs off.
“With a continued focus on the SME sector, we have improved our COR for the third year running. We are on track to achieve a sub-100% COR in 2014, helped by driving our efficiencies and delivering improvements in our underwriting.” Jon Greenwood, Managing Director of Commercial
• Continued roll-out of NIG’s broker eTrading platform ‘The Hub’ to new products
• Improvement in operating profit of £7.3 million, despite adverse weather in the fourth quarter and a high level of large losses
The COR improved by 1.4% to 106.8%; however, when normalised for weather this would have been 103.7%, showing good progress towards the 2014 target. The loss ratio improved modestly by 0.8 percentage points to 62.3% despite higher than normal claims relating to weather events, the majority of which were in the fourth quarter, and a high level of large losses. We continued to experience reserve releases, similar to the level of 2012, but remain prudently reserved. An improvement in current-year loss ratio was led by an improvement in the underwriting profit of £3.5 million. A marginal improvement in the expense ratio of 0.3 percentage points reflected cost improvements across the Group. The regional restructure undertaken in Commercial was implemented in the second half of the year and is expected to deliver cost savings in 2014. Overall, operating profit increased by £7.3 million to £9.5 million for the year.
• Loss ratio improved marginally by 0.8 percentage points despite £8 million of higher than normal hailstorm claims in Germany
Market Italy’s economy continued to decline in 2013. In 2014, it is expected gradually to return to growth1. Household consumption is stagnant1 and the number of new car registrations is declining2. The number of road accidents, injuries and deaths has contributed to a reduction of claims frequency, which has led to a decrease in average price of around 5%3.
The economic conditions in Germany are different, with the recovery continuing4 and growth expected to rise slightly faster4. Household consumption continues to strengthen4 and the number of registered vehicles is rising, while petrol costs decline4. Motor average premiums, which have risen over the previous two years, are expected to remain stable, taking account of claims inflation5. The severe hailstorms in June and July 2013 may result in increased average premiums.
In-force policies grew by 10.1% and gross written premium increased by 4.9% in local currency terms. These were driven by Germany where we expanded our share of business renewing on 1 January 2013. PCWs, while still small in both markets, continued to grow their share of new business. Direct Line is present on PCWs in both countries.
Against a backdrop of competitive markets, the Group made progress on its financial targets, achieving a COR for ongoing operations1 of 96.1% and a 16.0% RoTE2. We maintained a strong capital position, with a conservative approach to reserving and a high-quality investment portfolio.
(2012: £461.2 million) and total Group profit before tax of £423.9 million (2012: £249.1 million)
• Combined operating ratio1 of 96.1% for 2013, an improvement of 3.1 percentage points against last year (2012: 99.2%). This arises from improved underwriting and lower costs
• Prior-year reserve releases for ongoing operations1 amounted to £435.1 million (2012: £322.0 million)
• Net asset value per share of 186.6 pence and tangible net asset value per share of 153.2 pence
Overall operating profit from ongoing operations1 of £526.5 million represented a 14.2% increase on 2012 (2012: £461.2 million). There was a significant improvement in the underwriting result, driven by higher than expected reserve releases of £435.1 million (2012: £322.0 million), in part due to management actions to improve the risk profile of the book and initiatives relating to claims, and despite poor weather in the last quarter, fewer claims from major weather events in Home in 2013. This more than offset a lower investment return, lower instalment and other operating income and higher than normal weather-related claims in Commercial and International.
In-force policies for ongoing operations1 decreased by 6.0% during 2013 to 18.5 million. The fall related primarily to Rescue and other personal lines and Home. The Rescue and other personal lines reduction arose mainly from travel policies from packaged bank accounts. Home in-force policies fell mainly as a result of the removal of Home Response7 policies (around 420,000) from certain packaged bank accounts no longer sold through partners. Excluding this effect, which had little impact on gross written premium, Home in-force policies have decreased by 2.6% during 2013.
International growth arose from Germany where the Group has benefited from improved market conditions. Commercial continued to grow in-force policies, particularly in Direct Line for Business and also benefited from the reclassification of van business from Motor.
Gross written premium of £3,826.6 million fell 4.1% compared with the prior year (2012: £3,990.6 million). This reflects the impact of a competitive market, particularly in UK motor, together with the Group’s continued focus on maintaining its underwriting discipline.
International gross written premium of £604.5 million was 9.4% higher than the previous year (2012: £552.7 million) as a result of strong growth in Germany more than offsetting subdued trading in Italy. Gross written premium in local currency terms increased by 4.9%, broadly in line with the growth of in-force policies.
5. See note 6 on page 3 6. See note 5 on page 3 7. Insurance policy giving customers access to vetted tradesmen for home emergencies and repairs.
The commission ratio increased by 2.1 percentage points to 11.2% (2012: 9.1%), partly due to profit-share payments, reflecting the higher profitability of partnership business in the Home division. This is mainly attributable to fewer claims from major weather events.
The expense ratio improved 0.7 percentage points to 22.3% (2012: 23.0%), reflecting the benefits of cost reduction initiatives and reduced parallel running costs, but these benefits were partially offset by the effect of lower net earned premium.
The improvement was primarily the result of a 4.5 percentage points reduction in the loss ratio. This arose from two main factors: significant reserve releases partly due to management actions to improve the risk profile of the book and initiatives relating to claims; and despite poor weather in the last quarter, fewer claims from major weather events in Home across the year. In 2013, the Home division incurred approximately £69 million of claims from major weather events (2012: approximately £105 million). This was partially offset by higher than normal weather-related claims in International (German hailstorms in June and July 2013) and in Commercial (storms and floods in the fourth quarter of 2013).
The Group views the trend in the current-year attritional loss ratio as a good indicator of underlying performance as it excludes prior-year reserve movements and claims from major weather events in the Home division.
Overall, the current-year attritional loss ratio remained unchanged at 73.0% in 2013, despite competitive market conditions and higher than expected weather-related claims in International and Commercial.
Notes: 1. Home claims from major weather events, including inland and coastal flooding and storms. 2. This excludes Run-off segment reserve releases of £52.1 million
The Home COR improved to 93.8% in 2013 from 96.6% in 2012. The improvement was almost entirely driven by reduction in claims from major weather events. In 2013, claims from major weather events totalled approximately £69 million compared with approximately £105 million in 2012. The current-year attritional loss ratio was in line with the prior period, reflecting stable underwriting margins, albeit in a more competitive operating environment. Reserve releases were broadly in line with 2012.
The Commercial division improved its COR to 106.8% from 108.2% principally as a result of better underlying underwriting performance and a lower expense ratio. The current-year attritional loss ratio improved despite higher weather-related claims demonstrating the positive effect of recent management actions. The division continues to experience significant reserve releases. Excluding the impact of weather-related claims above normal levels, the COR would have been approximately 104%.
International COR in 2013 increased to 103.9% from 103.3% in 2012. The increase was due to claims relating to hailstorms in Germany in June and July. For 2013 as a whole, weather-related net claims were approximately £8 million more than expected. Reserve releases increased to £39.3 million (2012: £30.2 million) although are not expected to continue at these levels.
Instalment and other operating income from ongoing operations reduced by 9.1% from 2012. This was primarily as a result of the cessation of solicitors’ referral fee income from 1 April 2013 and lower instalment income.
Investment income was £188.6 million, a 5.4% decrease on 2012, as a result of a lower average investment asset base, which was partially offset by an increase in investment income yields.
Gain on disposal of subsidiary On 8 October 2013, the Group announced an agreement with Chesnara plc for the sale of the Life business. Total sale proceeds of £62.3 million, which include a pre-closing dividend of £23.0 million, represent 85% of the embedded value of the business at 30 June 2013. The sale completed on 28 November 2013 and the profit on disposal was £12.0 million.
The effective tax rate for 2013 was 26.2% (2012: 26.0%) compared with the standard UK corporation tax rate of 23.25% (2012: 24.5%). This is driven primarily by earnings from the International operations which are subject to higher corporation tax rates, re-measurement of deferred tax asset, disallowable expenses, non-taxable disposal of subsidiary, and adjustments to provisions in respect of prior-year tax.
Profit for the year and return on tangible equity Profit for the year amounted to £312.8 million (2012: £184.3 million), an increase of 69.7% on 2012.
Cash generated from investment of insurance assets reduced to £433.0 million in 2013 (2012: £2,004.8 million). Proceeds on the disposal and maturity of available-for-sale financial assets reduced to £3,147.8 million (2012: £4,021.6 million) and investment balances held with credit institutions decreased by £209.3 million (2012: £844.6 million). For 2012, amounts primarily reflected the funding of dividend payments to RBS Group of £1,000.0 million prior to the IPO, and investment portfolio restructuring.
Dividends paid amounted to £242.7 million (2012: £1,000.0 million) with the 2012 balance representing payment of dividends to RBS Group prior to the IPO. The Group repaid borrowings during the year representing the Tesco loan note of £258.5 million with the 2012 repayment (£246.4 million) representing loans with RBS Group. Following these, net cash used by financing activities totalled £544.7 million (2012: £774.5 million).
Overall, cash and cash equivalents decreased by £564.0 million (2012: £110.1 million increase) across the year to £853.2 million (31 December 2012: £1,417.5 million) representing the rebalancing of the investment portfolio including the reduction of cash holdings.
Significant accounting policies Except as disclosed in note 1 to the consolidated financial statements, the same accounting policies and basis of recognition and measurement have been followed in the consolidated financial statements as applied in the Group’s previous annual audited financial statements for the year ended 31 December 2012.
Where new or revised standards have been adopted in the year, these have not had a material impact on the Group’s financial statements.
Financial management The Group’s long-term sustainability depends on having sufficient funds to meet its liabilities as they fall due. This protects the reputation of its brands and the integrity of the Group’s relationship with customers and other stakeholders. The principal financial risks that are present in the Group are reserving, market risk connected to the investment portfolio and counterparty risk.
Reserving Estimation of claims reserves is a central aspect of financial management. Insurance is inherently uncertain, requiring the use of judgement in estimating the ultimate claims liability. The factors that must be considered when assessing the level of outstanding liabilities include class of business, timeliness of notification of claims, validity of claims made against a policy and validity of the amount of the claim. At any time there is a range of possible outcomes at which the claims reserves could ultimately settle and, as time passes, the uncertainty surrounding likely claims settlement reduces. The uncertainty is greater for bodily injury claims due to the time it takes for these claims to settle. This is particularly true for PPOs awarded to settle some bodily injury claims, in which annually indexed payments could be awarded over the lifetime of the injured party.Note: 1. See note 5 on page 3
Actuarial reviews are carried out quarterly, with over 95% of all claims reserves being reviewed at least annually. Actuarial best estimates are produced internally, and are subject to independent external review at least annually. Reserves are based on management’s best estimate set by the Group, which will be at least equal to the actuarial best estimate at a legal entity level. The Group will set reserves informed by a range of actuarial outputs including percentiles and scenarios. It will consider the level of historical variability inherent in the claims data and other short- and long-term risks not reflected in the actuarial data.
Investment portfolio The Group’s investment portfolio comprises primarily of investments in sovereign debt securities, investment grade fixed income securities and cash. The strategy ensures adequate liquidity is always available to meet customers’ claims, particularly in periods of stress (for example, natural disasters). It is also designed to ensure that asset and liability durations match closely where possible; and that risk is diversified and return maximised relative to the Group’s risk appetite and capital allocated to investment risk.
• Transferring the management of ‘AAA’ fixed-income credit in-house to improve the overall cost effectiveness of the operating model
• Increasing the benchmark allocation to investment grade credit and the sub-allocation to ‘BBB’ rated assets
• The continuing selective purchase of assets for the UK commercial property portfolio. The asset brings portfolio return diversification and long-term returns to support inflation-linked liabilities
Derivatives are permitted for risk management purposes within the investment portfolio. These include interest rate swaps to change the liability to a floating basis on the debt issuance and US Dollar credit mandates and forward currency contracts to manage currency risk.
The internally managed gilt and ‘AAA’ credit portfolios have intentionally been held at a shorter duration than benchmark given the expectation of improvements in the interest rate environment. In addition, to minimise further interest rate risk the Group has increased its investment allocation to floating rate instruments, for example securitised credit. The US credit portfolios have been swapped to a floating basis since inception in 2012.
Capital management Capital management policy The Group seeks to manage its capital efficiently, maintaining an appropriate level of capitalisation and solvency, while aiming to grow its dividend annually in real terms.
Where the Board believes the Group has capital which is surplus to requirements, for example if it had an expectation that the risk-based capital coverage would be significantly above the 125% to 150% target range for a prolonged period, it would look to return capital to shareholders.
Risk-based capital For its principal UK general insurance underwriter, U K Insurance Limited (“UKI”), the Group uses its own risk-based capital model to determine the level of capital required to operate within its risk appetite. The internal model is calibrated to a 99.5% confidence interval and considers both earned business and future business written over a one-year period. Furthermore, the model allows for uncertainty on this business until ultimate settlement. This approach is consistent with the ICA methodology set by the PRA.
For UKI, the major part of its required capital is held against reserve risk (approximately 46%) followed by underwriting risk (approximately 27%) and operational risk (approximately 13%). The high level of reserve risk reflects the size of the claims reserves still held against business written when the Group’s premium base was larger, including the Run-off segment, and the Group’s exposure to PPOs which carry a high capital requirement.
The Group’s International entities, in Italy and Germany, hold capital in excess of that required by their local regulators.
Taken together the Board believes that it is appropriate to maintain capital at the upper end of its risk-based capital coverage range. The Board will continue to review this position as clarity improves on the factors mentioned above and the Group makes further progress on its transformation plan.
The above regulatory numbers are estimated, based on preliminary regulatory returns for 31 December 2013.
At 31 December 2013, the Group had an estimated risk-based capital coverage ratio of 158.7% (31 December 2012: 151.4%) which reduces to 148.7% after deducting the recommended final and second special interim dividends (31 December 2012: 145.4%). On an IGD basis, the coverage is 291.6% (31 December 2012: 279.4%).
Notes: 1. Repaid in January 2013. Following the repayment of the undated subordinated loan, the financial leverage ratio on a pro-forma basis, excluding the undated subordinated loan, as at 31 December 2012 would have been 15.7%.
Working with Government The Department for Environment, Food and Rural Affairs has cited flooding as one of the key risks facing Britain. As one of Britain’s largest home insurers, we want to help address this risk. In June 2013, the UK Government and the ABI published a Memorandum of Understanding on flood insurance, which Direct Line Group played a key role in negotiating, as well as preparing for the creation of Flood Re. This is a vital step in seeking to make insurance affordable and accessible to high risk customers. We are pleased the UK Government has made significant commitments to help prevent and mitigate the effects of flooding, most notably not to reduce spending on flood defences.
In June 2013, we hosted a debate in Westminster to discuss the topical issue of insurance for young drivers. Young drivers aged between 17 and 24 represent 12% of licence holders, but account for 25% of all UK motor accidents where someone is killed or seriously injured. As a result, this demographic group of motorists face higher insurance premiums. The debate brought together Members of Parliament, national and trade press, road safety practitioners, academics and trade bodies to discuss how to improve road safety among young drivers. Ideas included a graduated driver’s licence, a minimum learning period, a lower tolerance limit to alcohol, and restrictions on passenger numbers and night-time driving. We encourage the Government to release its Young Driver consultation paper.
A number of our Executives are actively involved in various industry bodies, including the ABI, FCA Practitioner Panel and Financial Ombudsman Service (“FOS”) Insurance Industry Steering Group; and Tom Woolgrove was elected President of the Chartered Insurance Institute. This involvement informs our policy insights.
We recognise that there is a general concern that lobbying can have an inappropriate influence on government policy and therefore we engage only in public policy debates that have an impact on our business or our stakeholders. We do not support party political interests or make political donations.
We have developed an Optimum Repair Process (“ORP”). ORP is a new, environmentally sustainable approach to modern vehicle crash repair, which cuts waste and emissions by encouraging the practice of ‘repair, not replace’. This dramatically reduces the volume of new parts used. ORP has been supported by our research partner, Thatcham, which provides technical training courses for vehicle damage assessors.
On average, it used to take 10 days and 16 hours’ labour to complete a repair. In working time, a vehicle could be in a body shop for 64 hours awaiting repair, preventing other cars from being serviced. Much of that time was wasted waiting for parts. The repair industry had become accustomed to replacement rather than repair, creating an over-reliance on expensive new parts and the accompanying deskilling of many technicians. This, in turn, increased both repair times and costs, which affected customer satisfaction.
As a result of ORP, we are using around 200,000 fewer new car parts per annum.
Other initiatives Other initiatives to make things better and easier for our customers include piloting the capability to use smartphones to send us live footage of their home claims so we can settle their claim far quicker. Smartphones can also be used to give claimants a live view of progress on their car repair as it moves through the accident repair centre process.
Supply chain Last year, we began a significant piece of work to ensure we were properly managing the risks and improving the sustainability of our supply chain. We reviewed and republished our Ethical Code for Suppliers and reworked the selection criteria and contract terms for new suppliers. Our focus in 2014 is on developing our supplier management programme. We were also proud to sign up to the Prompt Payment Code advocated by the Department for Business, Innovation and Skills, which is aimed specifically at alleviating the pressure of delayed customer payments on smaller businesses that tend to be more vulnerable to experiencing cash flow problems. Signatories to the code commit to pay suppliers on time (the default period being within 30 days), give clear guidelines on payment procedures, and encourage lead suppliers to adopt the code in their own supply chains.
Employee experience Our focus continues to be on our people strategy, to build the future capability required to achieve our strategic objectives and fulfil our people. We are committed to strong employee engagement, which we believe underpins the quality of service we offer our customers.
Engagement We continue to transform our business. Since the start of our cost saving initiatives there has been a reduction of 3,200 roles. While necessary in order to sustain our business in a highly competitive market, such initiatives inevitably impact on the engagement of our employees. In line with our values, we have worked hard to ensure that as much information as possible was communicated, confirmed that our redundancy terms would remain unchanged during this initiative, and fully consulted our employee representatives.
Anyone at risk of redundancy had access to our redeployment support and where redundancy resulted, individuals had access to both redeployment and outplacement support.
Diversity As a Group, we actively celebrate the diversity of our employees. Our Diversity Network Alliance aims to represent the full range of populations within our business and seeks to ensure we have a workforce reflective of society and our customer base. The network is still in its infancy, but we remain hopeful of encouraging 10% of our workforce to become members by the end of 2014.
Human rights Our diversity and inclusion practices are in line with the Universal Declaration of Human Rights and we continue to work towards an environment that is based on meritocracy and inclusion, where all employees can develop their full potential, irrespective of their age, belief, disability, ethnic or national origin, gender, gender identity, marital or civil partnership status, political opinion, race, religion or sexual orientation.
Through our Ethical Code for Suppliers we adhere to the core International Labour Organization standards.
Volunteering Aligned to our core business, our focus is on Making Communities Safer through improving road safety and reducing crime and anti-social behaviour. In 2013, we worked with four charities focused on these themes: Brake, RoadSafe, Catch22, and The Prince’s Trust. Activities undertaken included: Community Space Challenges, which brought together our employee volunteers with young people to improve neglected community spaces; Speedwatch programmes, where we worked with local police and councils; and ‘Walking Buses’, which encourage children to walk to their school in an organised and safe environment. We also sponsor Brake’s Giant Walking Bus initiative, which this year saw 70,000 children from 350 schools march for safer streets while they walk to school.
Best CSR Initiative Our initiative, ‘Get into Car Repairs’, won ‘Best CSR Initiative’ at the British Insurance Awards 2013. Record levels of youth unemployment mean the young miss out on vital work experience, which may hold them back throughout their careers. It also creates the risk of a rise in anti-social behaviour and crime, which has a direct impact on our business and wider society. ‘Get into Car Repairs’ had a positive impact on the lives of a group of disaffected unemployed young people in Wakefield, Yorkshire, where one in three 16 to 24 year olds are unemployed. It gave 15 young people first-hand experience of repairing cars in a body shop at our local accident repair centre. They also received training on CV writing and interview techniques, as well as soft skills such as communication and team building.
For Comic Relief and Children in Need, 675 employees were proud to offer their time to take calls from the public wanting to pledge donations. At a local level, our Community and Social Committees also arranged and coordinated a significant amount of charity activity.
Strategic partnerships Now that our volunteering programme is established, our focus is on supporting our network of Community and Social Committees to develop their relationships with local charities and authorities. Centrally, we will focus on two strategic partnerships. The first is a continuation of our well-established partnership with Brake, with whom we plan a series of campaigns on road safety issues, for example on the introduction of 20 mph speed limits in certain urban environments. The second is with Groundwork, who deliver local community projects, improving community spaces and getting people back into work. We will look to work with them on programmes to help 16 to 24 year olds, not in employment, education or training, onto schemes which give skills and work experience, principally through social enterprises.
Our emission data has been externally verified by Ecometrica. The verification statements can be found on the Group’s website (www.directlinegroup.com ).
During 2013, 94.9% of the Group’s purchased electricity was from renewable sources on green tariffs purchased from GDF Energy and SSE in the UK, and LichtBlick and Naturstrom in Germany.
British Independent Utilities (“BIU”) was appointed as our Energy Partner to advise us on procuring the energy supply for our offices and accident repair centres from 2014. Part of the agreement is for BIU to work with us to reduce our power and gas consumption over the next three years, through environmental surveys and improvement plans for our buildings. We have set a target of a 10% reduction in our gas and electricity usage by the end of 2016, against our 2013 annual consumption figures.
litres of water per annum saved at our head office in Bromley
Business travel We continue to seek ways to reduce business travel, including better use of technology for video and conference calls, as well as enabling colleagues to work more smartly. We appointed a new travel management company, Capita Travel and Events, in October 2013 and will work with them to establish a baseline for reporting future travel-related emissions.
Our Code of Business Conduct governs our interactions with our various stakeholders and ultimately helps with our goal of becoming Britain’s best retail general insurer. This is set out alongside.
Our Code of Business Conduct The Board requires that all employees adhere to the highest possible standards of professional and ethical conduct – and this applies equally to the Board itself. Each function within the Group operates with policies and minimum standards and the following principles: • Business practices We shall engage in honest, professional and ethical conduct and maintain effective procedures to prevent confidential information being misused
• Dealing with competitors We shall compete with competitors honestly and in accordance with competition law
• Dealing with regulators We shall maintain a constructive and open relationship with our regulators to foster mutual trust, respect and understanding and shall not offer anything to officials in return for favourable treatment
“Direct Line Group believes that the combination of a good governance structure, a strong values-based culture and the highest standards of corporate behaviour stimulates value creation.”
As a result of the review, we have re-engineered the High Level Controls and System of Governance Document, Enterprise-wide Risk Management Framework, Group Policies and Minimum Standards to remove unnecessary content, close gaps, reduce duplication and give greater focus and accountability to each element. Further details are provided in this report on page 60.
Consequently, individual components of the governance framework are now more clearly articulated and aligned to the expectations of the Board. The framework as a whole is considered fit for purpose to support our strategic priorities as a dynamic retail general insurance business, rather than as a division within a large bank.
Diversity We are strongly committed to the merits of diversity at Board level and throughout the Group. 33% of the Board are women and we are keen to maintain this representation at around the current level. During the year, the proportion of women on the Executive Committee increased from 10% to 20% – that is, two women on a Committee of 10, namely Sara Gomez, Group Human Resources Director, and Angela Morrison, Chief Information Officer.
Board effectiveness review Our intended practice is to conduct a thorough review of the effectiveness of the performance of the Directors, the Board as a whole and its committees on an annual basis, with the input of an external facilitator at least once every three years.
Given that the Board was largely new to the Company last year in the run up to the IPO, I felt it was appropriate to assess its performance at the same time as reviewing the main elements of the Company’s governance architecture. Accordingly, the Company appointed Edis-Bates Associates to assist us as independent external facilitators. A description of the process and the findings of the evaluation are set out on page 63.
Take ownership Treat it like it’s OUR business; take the initiative, if you can see a better way, go make a difference; take decisions, be accountable for your actions in whatever role you carry out; take responsibility for your own personal development and performance.
Experience and qualifications 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 businesses between 2003 and 2007, and subsequently Managing Director, Corporate and Markets. Prior to that, John spent more than 20 years in investment banking with UBS and Goldman Sachs. John is an Economics graduate of the University of Cambridge. John is 57. External appointments None Key strengths and contribution John is an experienced Chief Financial Officer and former banker with extensive City and financial services experience. He is accordingly well placed to provide strong support to Paul Geddes in leading the Group.
Experience and qualifications Mark rejoined the RBS Group in August 2007 as a Managing Director in corporate banking, having previously worked for NatWest. Prior to joining the RBS Group, Mark was a Senior Executive at Barclays from 2001 to 2007, responsible for a number of its clients and product businesses, and in the latter period as Managing Director in European investment banking and debt capital markets at Barclays. Mark is an Associate of the Chartered Institute of Bankers and Association of Corporate Treasurers. Mark is 47. External appointments Mark sits on the RBS Group management committee and is Chief Executive Officer of UK Corporate and Institutional Banking at RBS, a position he has held since 2008. Key strengths and contribution Mark is a Non-Executive Director nominated by RBS Group. He has over 20 years’ experience in corporate banking and financial markets to add to the perspectives around the boardroom table.
Non-Executive Director Appointment Andrew joined the Board in March 2011 and is Chair of the Audit Committee.
Experience and qualifications Andrew retired from Legal & General Group plc, where he was the Group Finance Director, in 2009. He is a Fellow of the Institute of Chartered Accountants in England and Wales. Andrew is 60. External appointments Andrew resigned from his position as Senior Independent Director of Segro plc, the British and European Industrial Real Estate Investment Trust Company in April 2013. Andrew continues to hold a number of external positions. He is a Trustee of the Royal School of Needlework, a Trustee and Treasurer of Cancer Research UK, a Non-Executive Director of Royal London Mutual Insurance Society Limited and a member of the Financial Reporting Review Panel of the Financial Reporting Council (“FRC”). Key strengths and contribution Andrew has undertaken a number of senior roles within the financial services and insurance industries. In addition, he has insight into corporate governance developments and best practice in financial reporting through his membership of the Financial Reporting Review Panel of the FRC. Accordingly, he is able to advise the Group on its governance framework and financial reporting policies and can draw on his experience in the insurance sector.
Experience and qualifications Clare was a partner at PricewaterhouseCoopers (“PwC”) from 1988 to 2011. During her 23 years as a partner of PwC, she held several senior and high profile roles, particularly within the insurance sector. She is a graduate of the University of York with a degree in Mathematics and is a Fellow of the Institute of Chartered Accountants in England and Wales. Clare is 59. External appointments Clare is currently a Non-Executive member of the Partnership Board of Miller Insurance Services LLP and is Treasurer of the Disasters Emergency Committee.
Key: (A) Audit Committee (B) Board Risk Committee (C) Corporate Social Responsibility Committee (I) Investment Committee (N) Nomination Committee (R) Remuneration Committee (+) Independent
Experience and qualifications Rob has 20 years’ experience in international capital markets as a communications specialist and financial journalist. Rob was previously a Managing Director and Head of Group Press Office at HSBC Holdings. Prior to this he was Managing Director, Financial Services and a Partner of Financial Dynamics, a subsidiary of FTI Consulting Inc. Rob began his career in business media where he held senior journalist roles in the UK and Asia. Rob is a graduate of the University of Nottingham where he gained a Bachelor of Arts (Honours) in Politics and the University of London where he gained a Master of Arts in South Asia Studies. He holds a Certificate in Investor Relations awarded by The Investor Relations Society.
2 Jamie Brown Managing Director of International “ Targeting the delivery of core corporate growth and profit as well as aiming to deliver a sustained increase in shareholder value” Appointment Jamie joined the Group in 1997.
Experience and qualifications Before his current role, Darrell was Managing Director, Sales, Services and Partnerships. Prior to this, he was Director of Products at RBS Group before assuming responsibility for mortgage brands and the retail telephony centres at the retail bank at RBS Group. Darrell began his career with RBS Group when he joined NatWest in 1986 where he undertook a variety of strategy, finance, marketing and product management roles. Darrell holds an MBA from Aston Business School.
4 Sara Gomez Group Human Resources Director “ Ensuring that we have capable and engaged people to deliver the business strategy, both now and in the future” Appointment Sara joined the Group in March 2007 and became Group Human Resources Director in May 2013.
5 Jonathan Greenwood Managing Director of Commercial “ Focusing on the micro and SME sector, where we have a long history, allows us to leverage Group assets such as geospatial risk mapping and the claims systems and processes” Appointment Jonathan joined the Group in 2001.
Experience and qualifications Previously, Jonathan held various senior Group positions in Personal Lines and Partnership divisions including Managing Director Home and Product and Pricing Director Partnerships. Immediately prior to joining the Group, Jonathan was Vice President of Insurance for MBNA Europe and prior to that General Manager for a joint venture between Commercial Union and BNP Paribas. Jonathan started his career at Halifax Building Society, later HBOS, where he held a variety of senior product and operational roles in the general insurance division.
6 Steve Maddock Managing Director of Claims and Business Services “ Aiming to achieve upper quartile claims cost performance and maximise value for our shareholders, while providing exceptional service to our customers” Appointment Steve joined as Managing Director of Claims in February 2010.
Experience and qualifications Previously, Steve held the position of Director of Strategic and Technical Claims at RSA, a role he assumed in 2004. He has over 20 years’ insurance industry experience, including roles as Director of Claims and Customer Service at Capita and Director of Operations at AMP. Steve holds an MBA from the University of Reading and is a Non-Executive Director of the Motor Insurers’ Bureau and the Insurance Fraud Bureau.
9 José Vazquez Chief Risk Officer “ Continuing to provide risk management leadership to support strong commercial performance and good customer outcomes” Appointment José joined as Chief Risk Officer in March 2012.
10 Thomas Woolgrove Managing Director of Personal Lines “ Continuing to drive improved value from our UK personal lines’ franchise, meeting the needs of, and deepening relationships with, our customers” Appointment Tom joined as Managing Director, Personal Lines in April 2010.
Experience and qualifications Tom previously held various Managing Director roles with HBOS and Lloyds Banking Group, including UK Private Banking, General Insurance and Motor Finance. Before that, he was a strategy consultant with Gemini Consulting, part of the Capgemini Group, and a graduate engineer with Rolls-Royce Aerospace. He was elected President of the Chartered Insurance Institute in July 2013 and is a member of the ABI General Insurance Committee. Tom holds a Masters Degree in Engineering and Management from the University of Oxford, and an MBA from the University of Chicago, Booth School of Business, where he was a Fulbright Scholar.
The UK Corporate Governance Code The following report details how the Board has applied the principles and provisions in the FRC’s UK Corporate Governance Code 2012 (the “Code”) as required by the UK Listing Rules. See also the statement on page 100 of the Directors’ report.
The specific duties of the Board are clearly set out in the Schedule of Matters Reserved to the Board (the “Schedule”) within the Board’s terms of reference. The Schedule lists those items that are specifically reserved for consideration and decision by the Board. These include: • the establishment of the Group’s strategy and oversight of the business and affairs of the Group; • the raising and allocation of capital; • setting the Group’s risk appetite; • ensuring the maintenance of a sound system of internal control and risk management; • approval and oversight over execution and delivery of major capital projects, contracts which are material strategically and major investments; • communication and meetings with shareholders; • changes to the structure, size and composition of the Board and Board Committees, following recommendations from the Nomination Committee; • determining the remuneration policy for Directors and Senior Executives and the introduction of new share incentive plans or major changes to existing plans; • delegation of authority; • corporate governance matters; and
Division of responsibilities The roles and responsibilities of the Chairman and the Chief Executive Officer are clearly differentiated. The division of responsibilities at the top of a company is required by the Code to ensure that no one person may exert absolute control. The role statements of both the Chairman and the Chief Executive Officer were approved by the Board on 21 September 2012.
The Chairman’s responsibility is to provide leadership of the Board and ensure its effectiveness, whilst the Chief Executive Officer develops and delivers the Group’s strategy within the policies and values established by the Board.
The Non-Executive Directors provide constructive challenge and help to develop proposals on strategy.
What has the Board overseen, challenged and supported? What will the Board focus on?
• Support the vision of becoming Britain’s best retail general insurer
• Continued oversight of the development of claims capability, including the roll-out of initiatives to Home and approved the establishment of DLG Legal Services
• Approved the Group’s commercial strategy and received regular progress reports from each of the principal businesses
• Continue to pursue improvements in our claims and pricing capabilities
• Consider the strategic development of Commercial and International in the context of the Group’s RoTE target
• Review the appropriateness of the Group’s capital basis in the context of the current environment
• Oversaw the £100 million cost transformation plan delivered by management
• Supported decisions enabling COR and RoTE targets to be met
• Set the tone and culture of the Group, focusing on behaviours to help achieve the strategic objectives
• Oversee programmes to invest in the Group’s people and culture
• Approved the next phase of the Group’s transformation plan, in particular, focusing on customer facing systems
• Conduct a full Board evaluation, since the Board will have been in place for sufficient time to make such a review appropriate
Executive Committee The Executive Committee is the principal management committee that assists the Chief Executive Officer in the day-to-day management of the Group as a whole. It supports him in setting performance targets and in implementing the Group’s strategy and direction as determined by the Board. The Committee assists him to monitor key objectives and commercial plans to meet the Group’s targets. It also helps him to evaluate new business initiatives and opportunities, and receives and considers reports on operational matters, where these are material to the Group or have cross-company implications.
Board Risk Committee Enterprise-wide risk management framework approved by the Board Risk Committee, following review by the Risk Management Committee. Policies are drafted by Executive policy owners.
Risk Management Committee Developed by Executives with the framework approved by the Board. Minimum standards are drafted by the Group’s minimum standard owners. Review by the policy and minimum standard owners review forum. Approved by Executives via the Risk Management Committee.
Board effectiveness Structure of the Board As part of the process of helping to ensure a Code-compliant Board, the Company focused on obtaining the elements considered necessary to maximise the Board’s effectiveness. Consequently, the Board and its Committees have been constructed with a view to ensuring that an appropriate balance of skills, experience, independence, knowledge of the sector and diversity exists to enable the Directors to discharge their duties and responsibilities effectively.
The individuals’ attributes were established as part of the selection procedure. Please see the section “Appointment of Directors” for the desired attributes of our Directors and a description of the selection process.
Appointment of Directors The Company did not appoint any new members to the Board in 2013 as all Non-Executive Directors were appointed very recently. Mark Catton, who had been a Non-Executive Director until April, re-joined the Board as the nominated Director of RBS Group upon the resignation of RBS Group’s nominated Director Bruce Van Saun. The Group’s key competencies for Board members are as follows: Experience • Significant Board experience in major listed businesses
• Extensive knowledge and operational experience in insurance at a senior level (perceived as advantageous)
• Well organised and committed, an individual who takes his or her Non-Executive role seriously
• Robust, straight talking, open and approachable with a non-emotional and calm demeanour
• A team player and a good listener with the style and ability to be a highly constructive member of the Board
Our Directors have had a considerable workload during 2013 and showed great commitment to meeting the requirements of the business in a year of transformation. In all, 11 Board meetings were held during the year, all of which were scheduled meetings.
Board induction On appointment, each Director takes part in a tailored induction programme, which is designed to give him or her an understanding of the Company’s business, governance and shareholders. Mark Catton resigned as Non-Executive Director in April 2013 and was subsequently re-appointed in October 2013. As there was only a short time between his resignation and re-appointment, it was not considered necessary for Mark Catton to undergo an additional induction programme on his re-appointment.
Resources and training provided to the Board The Chairman, with the aid of the Company Secretary, ensures that the Board is kept abreast of any changes in the legal and regulatory environment in which the business operates. The Company believes it is crucial to provide Directors with adequate resources and training, and devoted considerable time during the year to ensure that all Directors received training and education to help them understand their duties, responsibilities and develop knowledge of the business as quickly as possible. These sessions were developed to supplement the comprehensive technical acclimatisation programme conducted in 2012 and specifically to meet the needs of the Directors, with individual Directors provided with bespoke training, as indicated in the following diagram.
Duration of appointment The Directors may appoint additional members to the Board during the year. Subsequently, in accordance with a provision of the Code and the Company’s Articles of Association, the Group submits Directors for re-election on an annual basis, subject to the Group’s independence criteria where appropriate, ongoing commitment to Group activities and satisfactory performance.
In line with these arrangements, all Directors will be subject to re-election by shareholders at our Annual General Meeting (“AGM”) on 15 May 2014.
• Bristol – customer relations, telephony trading operations, business support, commercial
• Italy and Germany – International market overview, international operations, international strategy, international risk, legal and compliance
• Home and motor insurance markets – overview including regulatory reforms 30 During the year in excess of 30 training sessions, including site visits and Internal sessions on the Group’s divisions and functions, were held. In addition, the Non-Executive Directors had a number of meetings with members of the Executive committee throughout the year.
Each of the Company’s Executive and Non-Executive Directors, together with the General Counsel and Company Secretary, participated in the effectiveness review process, which involved questionnaires, one-to-one interviews and a review of Board processes.
Following the conclusion of the evaluation process, the responses and comments were analysed and summarised in a report. The report was discussed initially with the Chairman and then circulated to the full Board. The report concluded that the Board is operating effectively.
Direct Line Group’s approach to diversity The Board carefully considered the diversity of its members from a variety of perspectives and sought to ensure that Directors had the relevant range of knowledge, skills, experience and, where necessary, independence to help the Group deliver its strategy.
Also, the Corporate Social Responsibility Committee considers the issue in the context of ensuring the diversity of the Group talent pipeline for future requirements, with mentoring schemes for high-potential candidates and associated training and development programmes. Numerical data relating to the gender diversity of the Board, senior managers and the employees may be found on page 47.
Accountability Financial and business reporting The Board is responsible for providing shareholders with a fair, balanced and understandable assessment of the Company’s position and prospects.
An explanation from the Directors of their responsibility for preparing the financial statements is set out in the statement of Directors’ responsibilities on page 103. The statement by our auditors explaining their responsibilities is on page 107.
We meet specific responsibilities placed on the Board under the provisions of the Code as follows: • an explanation of how the Company generates value over the long term is included within the business model on page 6 and the strategy for delivering Company objectives on page 18; • how the Board has concluded that the business remains a going concern is discussed on page 102; • the arrangements established by the Board for the application of risk management and internal control principles are detailed below; and
The Group’s risk assessment process includes output from a system for reporting on all the significant risks that stand in the way of achieving Group objectives. The system also reports on the nature and effectiveness of the controls and other management processes that manage these risks. The system also sets risk appetites for key categories of quantifiable risk. It additionally encompasses self-assessment of controls by risk owners throughout the Group, whose assertions are independently challenged by the 2nd line of defence and 3rd line of defence.
Internal systems of control The Board has put in place a management structure with defined lines of responsibility and clear delegation of authority. This control framework cascades down through the divisions and central functions, showing clear responsibilities for ensuring that appropriate controls are in place at an operational level, including those that relate to the financial reporting process.
The Group Audit function supports the Board by providing an independent and objective assurance of the adequacy and effectiveness of the Group’s operations. It brings a systematic and disciplined approach to evaluating and improving the effectiveness of its risk management, control and governance frameworks and processes.
Remuneration The Board has delegated responsibility to the Remuneration Committee for the remuneration arrangements of the Executive Directors and senior executives of the Group. Please refer to the Directors’ remuneration report on page 76.
Minimum number of meetings per annum The Committee meets at least four times a year at appropriate times in the financial and regulatory reporting and audit cycle and otherwise as required.
What did the Committee say it would do in 2013? • Provide oversight of the actuarial reporting process; a review of the Group’s control environment and processes
What have we achieved? • Reviewed the interim report for the half year ended 30 June 2013 issued in August and the interim management statements issued in May and November
• Reviewed a number of specific items including: – an update on flood insurance; – the planned migration of the Group’s IT systems from RBS Group; – a consultation with the Chartered Institute of Internal Auditors on the role of Internal Audit functions; – reserving policy; – updates on the tender process relating to the appointment of external actuaries; and
• Agreed the scope of the audit work to be undertaken by the external auditor and Group Audit
• Reviewed regular reports of the work conducted by the external auditors and Group Audit and noted mitigating actions proposed by management where required
• Providing oversight to ensure that the control environment for financial reporting is not impacted by the migration of our underlying systems
• Ensuring Group Audit adopts industry best practice in line with recently published guidance
• Overseeing the enhancement in the process for setting reserve margins
Financial reporting control framework RBS Group’s shareholding in the Company fell to below 50% in March 2013. Prior to this, the Group had been operating a formal financial control framework including identification, cataloguing and testing of controls in line with requirements set out by SOX legislation. Following divestment, this no longer applied to the Group. However, as good governance practice, the Group has continued to adopt the embedded features of the existing SOX framework, albeit tailored to respond to the changes in the business control environment.
In formulating the approach for the new framework, the principles from the Committee of Sponsoring Organizations of the Treadway Commission framework have been followed. The approach aligns with our existing operational risk framework with assurance work undertaken across the business focusing on our key financial reporting controls. Reports are presented to the Committee every six months highlighting any deficiencies and mitigating action required.
The Group Head of Audit reports to the Chair of the Audit Committee and has functional reporting to the Chief Financial Officer.
Group Audit provides the Committee with independent and objective reports on the appropriateness, effectiveness and sustainability of the Group’s risk management, systems of internal control, governance frameworks and processes. The Group’s statement of internal controls can be found on page 64.
Reserves The Committee approves annual plans for reviews of reserves, informed by internal and external emerging issues. It also considers an appropriate balance between internal and external actuarial review. Consultants appointed to provide validation of actuarial reviews are subject to approval by the Committee. During the year, an open tender process was conducted and the Committee approved the appointment of a professional services company to carry out the external actuarial review for the year ended 31 December 2013.
Simultaneously with this review, the Committee also considers and challenges the appropriateness of proposals made by the Chief Financial Officer for management best estimate reserves for booking, informed both by actuarial analysis, wider commercial and risk management insights and principles of consistency from period to period.
Financial reporting The review process undertaken by the Committee prior to the publication of the Group’s financial statements focuses on the Group’s critical accounting policies and practices, and on any changes and decisions that require a major element of judgement, unusual transactions, clarity of disclosures and significant audit adjustments. In addition, the Committee reviews the going concern assumption, compliance with accounting standards and obligations under applicable laws, regulations and governance codes and makes appropriate recommendations to the Board.
• the carrying value of the investments held by the Group and the need for any impairment provisions.
External audit The Committee plays a key role in managing the relationship with the Group’s external auditor, Deloitte LLP. The external auditor provides some non-audit services, primarily in the provision of audit-related assurance services. The Group’s Audit / Non-Audit Services Minimum Standard ensures that the independence and objectivity of the external auditor are not impaired.
Both audit and non-audit services provided by the Group’s external auditor are closely monitored: • the Committee formally approves a list of audit and non-audit services in advance of each financial year in line with the Auditing Practices Board’s Ethical Standard 5; • all permitted services must be approved before any work commences and applications for approval must be submitted on a prescribed form, signed by the relevant member of the Executive Committee; • the Chair of the Committee approves non-audit services costing less than £100,000, while the Committee approves services costing £100,000 or more; and
Fees payable to the auditor During the year ended 31 December 2013, Deloitte LLP’s fees for audit services and other services supplied were £2.2 million.
In accordance with the Group’s Audit / Non-Audit Services Minimum Standard, all services were approved prior to work commencing and each of the non-audit services was confirmed to be permissible for the external auditor to undertake. The Committee approved fees of £0.1 million payable to Deloitte LLP for services not related to audit work, which accounted for 4.5% of total fees paid to the external auditor in the year.
The non-audit fees of £0.1 million related to audit-related assurance services.
The Committee and Board remain satisfied that the provision of non-audit services by Deloitte LLP has not compromised Deloitte’s independence as the Company’s external auditor.
Auditor performance and independence The performance of the external auditor is assessed every year, including its independence and objectivity and the effectiveness of the external audit process. The effectiveness review includes regular questioning of the external auditor during Committee meetings.
The Committee reviews the external audit plan and receives reports from Deloitte LLP on its own policies and procedures regarding independence and quality control, including an annual confirmation of independence in line with industry standards. The Committee concluded that the performance of the external auditor and the effectiveness of the audit process were satisfactory.
Role and focus The Board Risk Committee provides oversight and advice to the Board in relation to current and potential future risk exposures of the Group and future risk strategy. It recommends risk appetite and tolerance to the Board and promotes a risk awareness culture within the Group.
Minimum number of meetings per annum The Committee meets at least four times a year at appropriate times in the risk and regulatory reporting cycle.
Notes: 1. Attendance is expressed as the number of meetings attended out of the number of meetings possible or applicable for the Director to attend. 2. The Committee met jointly with the Remuneration Committee on
• Challenging our level of preparedness for external changes and driving business improvement of processes and frameworks
• Continuing the pro-active governance, oversight and challenge of risk and control across the Group
• In readiness for greater capability in a digital world, overseeing and monitoring processes currently being embedded in the business
• Reviewing and overseeing operational risk management in the context of significant change programmes
Evaluation of the Committee The annual evaluation of the Committee’s effectiveness was initiated by the Chairman of the Board and undertaken by Edis-Bates Associates, as external facilitators. The evaluation concluded that the Committee continued to operate effectively, and the Committee will consider the results and recommended actions resulting from the evaluation in 2014. Further details of the effectiveness review can be found on page 63.
What did the Committee say it would do in 2013? • Foster a culture which is aligned to appropriate outcomes for the customer
• Consider and recommend for approval by the Board: – the Group’s risk appetite, framework and tolerance levels for current and future strategy; and
• Reviewed, challenged and recommended to the Board the high-level risk appetite and the supporting statements
• Considered the results of the stress tests and scenario analysis completed in 2013 and the material risk assessment undertaken by the Risk function
• Reviewed and challenged the new Conduct Risk Policy, agreed our Conduct Risk appetite statements and monitored Key Risk Indicators (“KRIs”)
• Reviewed the governance framework of the Group and in particular the High Level Controls and System of Governance document, which was recommended to the Board and approved
• Reviewed and approved the Enterprise-wide Risk Management (“ERM”) strategy and framework document
Other attendees include • Human Resources Director • General Counsel and Company Secretary • Director of Communications • Head of Public Affairs and Sustainability
Minimum number of meetings per annum The Committee meets at least four times a year.
What have we achieved? • Scrutinised and challenged standing reports relating to key focus areas of the Committee as follows: – priorities and targets on key CSR matters; – health and safety, including consideration of updates on the 2013 plan, health & safety ‘dashboards’ detailing performance against plan and compliance with policies and procedures; – workplace policies and engagement; and – community engagement activities.
• Monitored progress by Human Resources and the employee network, Diversity Network Alliance, in achieving the key objectives of raising diversity awareness through training, and collecting management information
• Performed the annual review of relevant Direct Line Group policies and procedures and oversaw compliance with them
• Engaging with external stakeholders, to shape our future CSR strategy and identifying emerging issues
• Reviewing the effectiveness of the Group’s CSR communications • Encouraging employee engagement in CSR and community programmes
• Review the merits of derivative and asset strategies proposed to mitigate risks associated with long-term liabilities
• Recommended to the Board the inclusion of a new asset class in the U K Insurance Limited investment portfolio and oversaw the subsequent implementation of the asset class into the portfolio
• Agreed changes to the risk management framework underpinning investment activity, in line with risk appetite set by the Board on the recommendation of the Board Risk Committee
Notes: 1. Attendance is expressed as the number of meetings attended out of the number of meetings possible or applicable for the Director to attend. 2. Andrew Palmer stepped down as Chair of the Committee on 28 March 2013 and remained a member of the Committee. 3. Glyn Jones was appointed a member and Chair of the Committee on 28 March 2013.
• Monitoring the pace of economic recovery and the tapering of quantitative easing and the resulting impact on interest rates, credit spreads and asset values and then reviewing the implications for the positioning of the Group’s investment portfolio
Evaluation of the Committee The annual evaluation of the Committee’s effectiveness was initiated by the Chairman of the Board and undertaken by Edis-Bates Associates, as external facilitators. The evaluation concluded that the Committee continued to operate effectively and the Committee will consider the results and recommended actions resulting from the evaluation in 2014. Further details of the effectiveness review can be found on page 63.
The Nomination Committee’s terms of reference are available on our website at: www.directlinegroup.com .
Minimum number of meetings per annum As required, but not less than once a year.
Frequency of meetings The Committee meets at least once a year to consider the Board composition and membership of the principal Committees and to consider the suitability of all Directors standing for re-election at the AGM. The Committee will also meet as required to consider candidates for appointment to the Board.
Board Appointment and Reappointment Process No new Directors were appointed during 2013. The Committee does, however, have a pre-established Board appointment process. It includes the use of independent external search consultants, an evaluation of the balance of skills, diversity, independence and knowledge on the Board and establishment of target criteria for the appointment of new Directors. Details of the latter are shown on page 61 of this Report.
In advance of the proposed re-election of Directors at the 2013 AGM, the Committee reviewed the independent status of Non-Executive Directors. It was concluded that Ms Hanson, Mr Jones, Mr Palmer, Ms Thompson and Ms Vacassin were independent within the meaning of the UK Corporate Governance Code. Mr Biggs was independent on his appointment as Chairman. Mr Van Saun and Mr Catton, being RBS Group nominated Directors, did not meet the independence criteria of the Code though both had demonstrated a sufficient level of Board challenge to be considered independent in character and by judgement. Accordingly, it was recommended to the Board and Shareholders that all serving Directors be reappointed at the 2013 AGM.
Diversity The Group seeks to hire the best candidates for all positions at all levels throughout the business, irrespective of gender, including candidates at Board level. With three female independent Non-Executive Directors, 33% of the current Board is female, which is a greater percentage than that recommended by the Davies’ Report on Boardroom Diversity. However, both the Nomination Committee and Board recognise the benefits of gender diversity and will ensure that this is taken into account when considering any particular appointment. Accordingly, this is embedded in the Nomination Committee’s terms of reference. Work on encouraging the promotion of women to senior and executive management roles within the business will continue.
Evaluation of the Committee The annual evaluation of the Committee’s effectiveness was initiated by me as Chairman, and undertaken by Edis-Bates Associates as external facilitators. The evaluation concluded that the Committee has not since the IPO had to deal with the usual workload of such a committee, given the short period since the IPO. In addition, the only changes to the Board in 2013 were changes to the RBS Group-nominated Directors, which RBS Group was entitled to do pursuant to the Relationship Agreement between RBS Group and the Company. One of the actions arising from the Nomination Committee performance evaluation was the need for greater focus on succession planning, which has been incorporated in the Committee’s forward agenda for 2014.
Role and focus The Committee is responsible for setting and oversight of the Group’s remuneration policy. It also makes recommendations to the Board regarding the remuneration arrangements of the Company’s Executive Directors and senior executives.
The Remuneration Committee’s terms of reference are available on our website at: www.directlinegroup.com .
Meeting frequency The Committee meets at least four times a year.
What did the Committee say it would do in 2013? • Consider the 2013 remuneration and incentive plan arrangements within the context of the pay review budget for 2013 and the outcomes from the annual performance review
• Review the possible outcomes of the 2013 Annual Incentive Plan (“AIP”) and the structure of the 2014 AIP in light of the experience in 2013
What have we achieved? • After consultation with the Chief Risk Officer and the
• Developed extensive payment gateways for the AIP which requires the Committee to be satisfied that it is appropriate to permit payment of a bonus or at a given level
• Agreed the high level principles and key terms of the incentive plan arrangements for 2013 and rolled out the BAYE scheme in the United Kingdom and Italy
• Obtained advice from the Board Risk Committee on risk weightings and implemented adjustments to be applied to performance objectives and remuneration arrangements
• Oversaw the review of incentive arrangements in the customer facing areas of the business following the publication of FCA guidance in conjunction with the Board Risk Committee
• Reviewed the proposed approach to salary benchmarking for Executive Directors, the Executive Committee and other strategic leaders
• Considered the effectiveness of the performance of FIT Remuneration Consultants LLP during 2013 and agreed to re-appoint them as independent external advisers to the Committee for 2014
What will we be focusing on in 2014? In addition to its regular monitoring, challenge and oversight responsibilities, the focus for the Committee in 2014 is expected to include the following: • Greater alignment between reward and shareholder value creation
• Ensuring that reward is predicated upon satisfied and well served customers
• Ensuring that there is an appropriate level of oversight and balancing risk and reward in all of our schemes
Evaluation of the Committee The annual evaluation of the Committee’s effectiveness was commissioned by the Chairman of the Board and undertaken by Edis-Bates Associates, as external facilitators. The evaluation concluded that the Committee continued to operate effectively, and the Committee will consider the results and recommended actions resulting from the evaluation in 2014. Further details of the effectiveness review can be found on page 63.
What did we do in 2013? Roadshows 4 trips to the US targeting investors in New York, Boston, San Francisco and Chicago 1 trip to Canada 1 trip to Copenhagen 1 trip to Dublin 3 roadshows in London 2 visits to Edinburgh
• Briefings with investors and stockbrokers to convey key messages and performance and strategy
We anticipate that all Directors will attend the AGM and that the Chairs of the Audit, Board Risk, Corporate Social Responsibility, Investment, Nomination and Remuneration Committees will be available to answer questions.
2013 & 2014 AGMs – key highlights 2013 AGM Held on 6 June 2013 at The Auditorium, Allen & Overy LLP, One Bishops Square, London E1 6AD.
• Full Director attendance • 1,250 million to 1,258 million votes cast for each resolution
(83% of issued share capital) • All Directors were elected or re-elected to the Board, receiving at least 99% of the votes cast in favour • Remuneration report resolution passed, with 98.84% in favour • Highest votes in favour – 99.75% to authorise political donations and expenditure • Lowest votes in favour – 98.84% to approve the
Remuneration report 2014 AGM To be held on 15 May 2014 at The Auditorium, Allen & Overy LLP, One Bishops Square, London E1 6AD.
Dear shareholder I welcome you to our second remuneration report. In an important year for Direct Line Insurance Group plc, our first full year as a listed company, the Remuneration Committee (“Committee”) has sought to ensure that we continue to provide a reward proposition that supports the Group’s business strategy and is fair to our employees and our shareholders alike in the context of our overall performance.
As a Group, we continue to make good progress against both our strategic priorities and financial targets and have delivered on our COR target in 2013, which has resulted in a RoTE in excess of our long-term target, and have delivered a Total Shareholder Return of 24% over the financial year. At the same time, we are conscious of the need to exercise restraint in executive pay given the current economic environment and our cost savings initiatives. These factors have been reflected in our remuneration decisions as set out in full in this remuneration report and highlighted below.
To that extent, we have carefully considered the 2013 bonus outcome under the Annual Incentive Plan (“AIP”) to ensure that payouts are appropriate and reflect a rounded assessment of performance. The initial AIP outcome is based on a balanced scorecard in line with our approach last year. In addition, recognising both the complexity of the business and that assessment of success, particularly in an insurance group, requires the application of broader judgement than a simple application of the audited results, the Committee considers it appropriate to look at the wider factors of Group performance and exercise its judgement to better reflect the overall position. For 2013, it exercised such judgement by applying a quality of earnings assessment of the financial elements and a gateway assessment for all AIP elements, as described in more detail in the annual remuneration section of this report. In addition, overriding judgement based on each executive’s performance was taken into account. The Committee will continue to use such judgement in future years. In respect of 2013, this resulted in a lower payout than would have been the case under a more formulaic approach.
The first awards under our 2012 Long-Term Incentive Plan (“LTIP”) were made only following the IPO in October 2012 and are not due to vest until 2015. Awards vesting under legacy RBS plans are described in the annual remuneration section of the report.
Looking forward to 2014 – what we have decided In the context of the new requirements for executive pay reporting in the UK, the Committee took the opportunity to review our approach to remuneration and the associated policies put in place at the time of the IPO to ensure that, after their first full year of operation, they continue to support our strategic objectives.
As part of this review, we have not proposed any major changes to the policy for 2014; however, we have reached specific decisions as to how this policy will apply in the future in order to enhance its effectiveness, fairness between executives and other stakeholders and transparency for our shareholders. The section of this remuneration report describing how we intend to implement our remuneration policy following approval at the 2014 AGM explains this further.
I would like to highlight the following areas: • as in 2013, and in line with our commitment to exercise restraint in executive pay, there will be no increase to Executive Directors’ salaries in 2014
Our shareholder register has changed significantly in the year since IPO, following a further disposal of shares by RBS Group. As a consequence I, as the Chair of the Remuneration Committee, jointly with the Chairman of the Board contacted our major institutional shareholders, as well as the ABI and Institutional Shareholder Services, and we made ourselves available to discuss our remuneration policy.
Accordingly, over the following pages we have set out: • our forward-looking Directors’ remuneration policy which is subject to a binding shareholder vote at our 2014 AGM; and
• our annual remuneration report setting out the details of the implementation of our reward policy in 2013 and how the proposed remuneration policy will be implemented in 2014. This section of the report is subject to an advisory vote at our 2014 AGM.
In preparing the disclosures on our forward-looking policy, we have sought to balance the need to give our shareholders sufficient information to be able to evaluate it with the need to maintain sufficient operational flexibility over pay to allow us to respond to changing circumstances.
Q Why do Executive Directors (and other senior executives) need to be paid bonuses on top of their salary and other benefits? When we listed in October 2012, we set out our commitment to offer remuneration at the right cost, while ensuring that we provide Executive Directors with market-competitive rewards compared with relevant peer companies. Variable pay in the form of short and long-term incentives forms a significant proportion of total remuneration in the market in which we compete for executive talent and including this as part of our remuneration offering gives us the ability to attract the right calibre of executives without the need to increase fixed remuneration.
At the same time, in line with our value to ‘aim higher’ and strive to be the best in everything we do, we actively want to motivate Executive Directors and other senior executives, incentivise the delivery of strong performance and recognise and reward success at the individual and Group level. Our AIP is just one of many tools used throughout the business (and not just at senior executive level) to achieve these objectives.
Finally, having a high proportion of our total remuneration dependent on the achievement of stretching performance targets (through both the AIP and the LTIP) enables us to manage our costs appropriately by ensuring that the total expenditure on executive pay appropriately reflects performance at both the individual and Group level. The context of the external market environment is also taken into account. This would not be possible if our executive remuneration package comprised only fixed elements of pay.
The gateway criteria used by the Committee included factors such as affordability, the Group’s overall performance against the agreed risk profile, performance relative to peers, the occurrence of any regulatory breaches or reputational damage, whether the payment of any bonus may give rise to reputational damage and the wider economic environment. The Committee also considered whether there were any exceptional events or other factors that should be taken into account in assessing the bonus outcome.
In this context, the Committee aims to ensure that employees, including Executive Directors, are continuously engaged to deliver against our plan and are provided with fair pay for the job, which takes into account the context of pay in the wider market as well as their individual performance. It is also vital to ensure that we continue to pay competitively, at all levels.
Q Why are you paying bonuses to Executive Directors when gross written premium has reduced in 2013? As explained elsewhere in the annual report, the reduction in gross written premiums reflects the impact of a competitive market, particularly in UK motor, and our decision to maintain a cautious underwriting approach by emphasising underwriting margins over volume.
Gross written premium is just one of the set of metrics that we consider when assessing our business performance. Overall, we believe that good progress has been made across a range of financial and non-financial metrics and these determined the final bonus for Executive Directors.
These awards were granted to the Executive Directors in respect of their work as executives of RBS Insurance, as the Group was previously known when it was wholly owned by RBS Group. The extent to which awards under the RBS Group LTIP vest is determined by the Remuneration Committee of RBS Group based on an assessment against the performance conditions shown on page 99 of this remuneration report. RBS Group deferred awards are not subject to any performance conditions, as they represent the deferral element of annual bonuses that have already been earned.
Q Do you comply with the provisions of the FCA’s Remuneration Code? As an insurance business, we are not subject to the provisions of the FCA’s Remuneration Code. However, we seek to comply with the core requirements of the Code that we should establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote sound and effective risk management. Accordingly, for all of our strategic leaders including Executive Directors, significant elements of incentive-related pay are subject to deferral and potential malus and clawback as explained further within the remuneration report. In addition, the independence of our control functions is maintained by assessing their annual bonuses independently of the Group financial results.
Directors’ remuneration policy The following section contains the material required to be set out as the Directors’ remuneration policy for the purposes of Schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended). This policy will be put forward for shareholder approval at the 2014 AGM in accordance with section 439A of the
Context of policy The Group’s remuneration policy is to provide, in the context of the Group’s business strategy, a compelling reward proposition at the right cost to attract, retain, motivate and reward high-calibre employees so that they are engaged to deliver superior long-term business performance within acceptable risk parameters.
Within this overall policy, the individual elements of remuneration for Executive Directors are shown below: All employee share plans
Performance related • Reward reflects individual and business performance • Outstanding individual performance is recognised and rewarded • Group and individual performance will be reflected through variable pay • Poor performance is identified with effective management remedies in place
Pe rfo rm ance Transparent r ela ted and fair o w n ership our people a nd r ob us t
Transparent and fair • We aim to have a competitive total reward proposition • We aim to be open about our salary and variable pay arrangements and how they work • We aim to manage pay consistently for people doing the same role with equal opportunity for all
Simple and robust • The reward proposition is straightforward and simple for everyone to understand • Reward structures are easy to administer • The mix between fixed and variable pay is right for our business
• 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
• Performance over the financial year is assessed against performance measures which the Committee considers to be appropriate
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
• The Committee has determined that its policy will be to only set base salaries by reference to the factors set out in the previous column for the duration of this policy. In any event no increase will be made if it would take an Executive Director’s salary above the median level of salaries for relevant roles in the FTSE 100 as determined using data available to the Committee at or shortly prior to when any increase is considered
• Malus and clawback provisions apply to both the cash and deferred elements and are explained in more detail in the notes to the policy table
• Vested options will remain exercisable for a period of seven years • Malus and clawback provisions apply to the LTIP and are explained in more detail in the notes to the policy table • Awards under the LTIP may be made at various times during the financial year. 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
• The Committee will determine the performance condition 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
• In addition, there is an underpin relating to the Committee’s view of the underlying financial performance of the Group
• In line with our approach to all employees, certain Group products are offered to Executive Directors at a discount
• Executive Directors are expected to retain all of the ordinary shares vesting under any of the Company’s share incentive plans, after any disposals for the payment of applicable taxes, until they have achieved the required level of shareholding
Malus and clawback Malus (being the forfeiture of unvested awards) and clawback (being the ability of the Company to claim repayment of paid amounts as a debt) 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
Amounts in respect of awards under both plans may be subject to clawback for up to three years post payment or vesting as appropriate.
• Adjustments needed in certain circumstances, (for example, a rights issue, corporate restructuring or special interim dividend)
• Executive Directors receive a benefits package generally set by reference to market practice in companies of a similar size and complexity, particularly FTSE 31-100 companies. Benefits currently provided include a company car or car allowance, private medical insurance, life insurance, health screening and income protection
• 200% of salary for the Chief Executive Officer and 150% for the Chief Financial Officer
In addition, both Executive Directors continue to hold awards originally awarded under the RBS Group Deferral Plan and these will continue to be delivered in RBS Group shares. These awards are not subject to any performance conditions on vesting.
The relevant targets are set at or following the start of each year to ensure that Executive Directors are appropriately focused on the key objectives for the next 12 months.
To enable the Company to recruit and retain Non-Executive Directors of the highest calibre, at the appropriate cost
• Fee levels for Non-Executive Directors are reviewed and may be increased at appropriate intervals by the Board, with affected individual Directors absenting themselves from deliberations
• The fees paid to the Chairman are inclusive of all Board and Committee membership fees and are determined by the Remuneration Committee
• In terms of the principles for setting a package for a new Executive Director, the starting point for the Committee will be to look to the policy for Executive Directors as set out in the policy table and structure a package in accordance with that policy. Consistent with the Regulations, the caps contained within the policy table for fixed pay do not apply to new recruits, although the Committee would not envisage exceeding these caps in practice
• For external and internal appointments (including a major change in role), the Committee may agree that the Company will meet certain relocation expenses, legal and other fees involved in negotiating any recruitment or pay expatriate benefits in line with the Group’s international assignment policy, as appropriate
• 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 pro-rated amounts under the AIP where the Committee considers that it is necessary to secure the recruitment
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.
• Deferred Annual Incentive Plan – for any reason other than summary dismissal or resignation unless, in the case of resignation only, the Committee determines otherwise
If a leaver is a ‘bad leaver’, for example leaving through resignation or summary dismissal If a leaver is deemed to be a ‘good leaver’
Other events, for example, change in control or winding up of Company
Following RBS Group’s shareholding in the Company reducing to less than 50% of the Ordinary Shares in the Company, the Company can in its discretion terminate each Executive Director’s service agreement with immediate effect by making a payment in lieu of notice. 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.
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 (“ERB”), 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. During the year, the Chair of the Committee and the Chairman of the Board jointly wrote to major shareholders and made themselves available to discuss remuneration policy.
Minimum Consists of fixed remuneration only (that is, base salary, benefits and pension): • Base salary is the salary to be paid in 2014
• LTIP – consists of the face value of awards (200% of salary)
Remuneration Committee governance The members of the Remuneration Committee during 2013 (which remained unchanged during the year) are shown below. Each member’s attendance at meetings is set out in the Corporate Governance section on page 73.
In addition, the Committee has appointed FIT Remuneration Consultants LLP (“FIT”), signatories to the Remuneration Consultants Group’s Code of Conduct, as its independent adviser. This appointment was made by the Committee in preparation for the IPO and following consideration of the firm’s experience in this sector. FIT was reappointed by the Committee during the year following a review of its performance.
Allen & Overy LLP, one of the Group’s legal advisers, has also provided legal advice in relation to the Group’s executive remuneration arrangements, and has provided the Group with other legal services.
The following table shows historical levels of the Chief Executive Officer’s pay for 2012 and 2013 and vesting of annual and long-term incentive pay awards as a percentage of the maximum available opportunity.
Percentage change in pay of Chief Executive Officer 2012 to 2013 The table below shows the percentage change in the total annual remuneration of the Chief Executive Officer against all UK employees. The remuneration elements included in the calculation are salary, taxable benefits, and annual bonus outcomes. The Committee considers that it is appropriate to compare against all UK employees but to exclude those based outside the UK to ensure that the comparison against the Chief Executive Officer’s total annual remuneration can be made on a consistent basis.
Paul Geddes’ salary and benefits for 2012 reflect a period as an employee of RBS Group, prior to his appointment as a Director of the Company on 1 September 2012, when his salary and benefits were set at current levels in advance of the Company’s IPO. Paul Geddes’ salary and benefits package remain unchanged since then and will not be increased in 2014.
Voting outcomes from AGM 2013 The table below shows the percentage of shareholders voting for, voting against and the percentage of votes withheld in relation to the resolution to approve the 2012 Directors’ remuneration report put to the 2013 AGM.
Note: The percentages of votes for and against are expressed as a percentage of votes cast, excluding abstentions. The percentage of votes withheld is expressed as a percentage of total votes cast, including abstentions.
During 2013, the Committee considered the relative importance of the performance measures and whether the Board’s strategic priorities going forward were fully reflected in the AIP. This assessment resulted in the introduction of lead strategic indicators for 2014, which will include both financial and non-financial measures which indicate the overall strategic progress of the business. Furthermore, to further emphasise the gateway factors, the Committee concluded that while it would set a target for each measure (which is commercially confidential at the outset but which may be disclosed on a retrospective basis), it would not set threshold and stretch targets, leaving such assessment to judgement.
Through 2013, the Committee worked alongside the Board Risk Committee to ensure that risk management is central to all pay decisions and, for 2014, will more explicitly use risk as a gateway to moderate all aspects of the AIP. The Committee therefore decided to remove the specific risk measure, as it felt that attributing 10% to such aspect devalued the criticality of this metric. It also took the opportunity to improve the alignment to strategic objectives and removed the COR element which was felt to be largely duplicative with profit.
A mix of financial and non-financial lead indicators including market share, retention, quote to conversion ratio, scored loss ratio, progress with technology and strategic projects and others 10% n/a
Given the competitive nature of the insurance sector, while the performance measures for annual bonus are disclosed, the detailed targets are considered commercially sensitive and likely to remain so and are accordingly not disclosed. The level of achievement against each measure in respect of the financial year ended 31 December 2013 is shown in the audited section of the annual remuneration report. The Committee will aim to provide a consistent level of disclosure in future years.
All AIP outcomes will be determined following the Committee’s determination of a payment gateway, which requires the Committee to be satisfied that it is appropriate to permit the award of a bonus, at all or at a given level. The gateway necessarily involves an element of subjective judgement of performance and may result in moderation, either positive or negative, of each AIP performance measure. The gateway criteria for AIP for 2014 are set out overleaf.
• The relative performance of the Group to that of its peers
• The occurrence of any regulatory breaches and / or reputational damage to the Group
• Such other factors as the Committee may consider to be relevant
In addition to the gateway criteria, the Committee may use its discretion to take into account additional factors such as customer conduct and experience, the quality of financial results, the view of the “direction of travel” in all metrics and a wider consideration of reputation, risk and audit.
• 40% to be 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 TSR and closing TSR will both be averaged over a three-month period.
For these purposes, the Group’s standard definition for RoTE is used (see definition on page 178) subject to such other adjustments as the Committee considers appropriate.
The performance targets are as follows: Performance measure Threshold vesting Maximum vesting
RoTE 20% of portion of award vests for average annual RoTE performance of 14%
Pension and benefits A pension contribution of 25% of base salary will continue to be paid to both Executive Directors in 2014 as shown in the table below: Director Position Pension contribution (% base salary)
Non-Executive Director fees The current fees for the Chairman and Non-Executive Directors were set in 2012 and have not been changed to date.
No additional fees are paid for membership or chairmanship of the Investment Committee.
7. Paul Geddes was a participant in an RBS Group defined benefits scheme until 1 September 2012, when he became a member of Direct Line Group’s defined contribution scheme. He has kept his accrued pension in the RBS Group defined benefits scheme but received no benefit in the year as he is a deferred member only and no additional accruals were made to the scheme in respect of his participation.
Confirmation has been received by each Executive Director that they have not received any other items in the nature of remuneration, other than those already disclosed in the single figure table.
Measure Profit Combined operating ratio Cost reduction target Risk management within risk appetite Customer experience Paul Geddes John Reizenstein
Where the icons above represent performance broadly as follows: = below threshold, = threshold to 90% of on-target, = 90% to 110% of on-target, = above 110% of on-target, = maximum
Deferred Annual Incentive Plan The table below details the deferred share awards to be granted to Paul Geddes and John Reizenstein in respect of the 2013 financial year. These awards are not subject to any conditions other than continuous employment.
The extent to which Executive Directors have achieved the guideline requirements by 31 December 2013 can be summarised as follows: Position Share ownership guideline
Notes: 1. Includes legacy RBS LTIPs granted in 2011 and 2012. As described in the notes to the single figure table, 54.75% and 58% of Direct Line Group shares in respect of 2011 awards granted to Paul Geddes and John Reizenstein respectively are expected to vest in March 2014 following an assessment of performance by the RBS Group Remuneration Committee.
The beneficial interests of the Non-Executive Directors in the Company’s shares as at 31 December 2012 and 31 December 2013 are shown in the table below: Director Shares held at
Notes: 1. As at the date of this report, the number of shares held by Directors was as follows: Glyn Jones – 61,353; Clare Thompson – 30,676; and Priscilla Vacassin
– 30,676. There were no other changes between the year end and the date of this report. 2. Includes holdings of connected persons, as defined in sections 252-255 of the Companies Act. 3. Bruce Van Saun resigned as a Director on 1 October 2013. His shareholding for 2013 is shown as of that date.
Direct Line Group share awards Direct Line Group Deferred Annual Incentive Plan The table below details the first awards made to Paul Geddes and John Reizenstein under the Direct Line Group Deferred Annual Incentive Plan relating to the bonus in respect of 2012, the monetary value of which was disclosed in full in last year’s Remuneration Report.
Notes: 1. The awards in respect of the financial year ending 31 December 2012 were granted on 28 March 2013 as nil-cost options. 2. The terms on which Paul Geddes’ 2012 bonus outcome was deferred meant that 60% of the outcome was deferred, with deferral split broadly evenly between deferral into deferred cash and deferred shares, with phased vestings of the deferred amounts over the three year deferral period. As shown on page 96, 75,409 of the awards granted on 28 March 2013 vested during the year.
Percentage of scheme interests that would be receivable if the minimum performance was achieved
Direct Line Group 2012 Share Incentive Plan From 18 February 2013, all employees including Executive Directors can invest from £10 up to £125 per month from their pre-tax pay into the BAYE Share Incentive Plan (the “SIP”) and receive one matching share for every two shares purchased. The limit of £125 per month may be reviewed as legislation evolves to take account of any changes, where appropriate.
In addition, at the time of the IPO, and under the same terms as other employees, Executive Directors were offered the opportunity to subscribe for 143 free Company shares which will vest in November 2015, three years from grant. Both Executive Directors subscribed for this offer and the value of £289 for each Director is included in the single figure table.
Dilution The Company complies with both of the dilution levels recommended by the ABI guidelines (of 10% in 10 years for all share plans and 5% in 10 years for discretionary plans) consistent with the rules of the Company’s share plans. Legacy RBS Group awards to be satisfied in Company shares will be satisfied by RBS Group rather than the Company and RBS Group has placed shares in trust to facilitate this.
RBS Group LTIP 2011 102,953 102,953 7 March 2011 4.45 7 March 2014
RBS Group LTIP 2012 179,324 179,324 7 March 2012 2.80 7 March 2015
Notes: 1. The Direct Line Group share price at 31 December 2013 was £2.496 and the range of prices in the year was £1.982 to £2.496. 2. It was agreed with RBS Group that participants now employed by Direct Line Group holding awards granted in 2011 and 2012 under the RBS Group LTIP
would be given the opportunity to have those awards satisfied by the transfer of Company shares from RBS Group on vesting. The conversion rate applied to these awards was the average price of RBS Group shares over the five business day period prior to 11 October 2012 divided by the Direct Line Group share offer price (£1.75). This conversion equated to 1.487 Company shares for every RBS Group share under grant. Both Executive Directors took up this offer.
These awards are subject to performance conditions to be assessed by the RBS Group Remuneration Committee. The conditions relate to financial and operational performance against the strategic plan for Direct Line Group and effective risk management with, in the case of Paul Geddes only, 25% of vesting also dependent upon RBS Group performance. The 2012 awards also applied measures based on employee and customer satisfaction.
RBS Group LTIP 2010 229,779 69,509 160,270 – 14 May 2010 24 April 2013
Awards held as at 31 December 2013 (RBS Group shares) Grant date Vesting dates
Note: 1. Vested on 7 March 2013 when the RBS Group share price was £3.036.
This report was reviewed and approved by the Board on 25 February 2014.
Strategic report The Company has chosen, in accordance with section 414c(ll) of the Companies Act 2006, and as noted in this Directors’ report, to include certain additional matters in its Strategic report that would otherwise be required to be disclosed in this Directors’ report.
Disclosure and Transparency Rule 4.1.5(2) requires this Annual Report & Accounts to include a management report. The information that fulfils this requirement can be found in the Strategic report on pages 2 to 49.
Corporate governance statement The information that fulfils the requirements of the corporate governance statement for the purposes of Disclosure and Transparency Rule 7.2 can be found in this Directors’ report and in the corporate governance report on pages 56 to 75, which is incorporated into this Directors’ report by reference.
Directors’ indemnities The Articles of the Company permit it to indemnify the officers of the Company (and the officers of any associated company) against liabilities arising from the conduct of Company business to the extent permitted by law. Accordingly, the Company executed deeds of indemnity for the benefit of each Director in respect of liabilities that may attach to them in their capacity as Directors of the Company or of associated companies. These indemnities are qualifying third-party indemnities as defined by section 234 of the Companies Act 2006. No amount was paid under any of these indemnities during the year.
At no time during the year did any Director hold a material interest in any contract of significance with the Company or the Group other than the Relationship Agreement with RBS Group, the indemnity provision described above and service contracts between each Executive Director and the Company.
Details of Directors’ remuneration, service contracts, employment contracts and interests in the shares of the Company are set out in the Directors’ remuneration report on pages 76 to 99.
In addition, there are restrictions on the transfer of the Ordinary Shares under the Company’s employee share incentive plans while the shares are subject to the plan rules. Where, under an employee share incentive plan operated by the Company, participants are the beneficial owners of shares but not the registered owners, the voting rights are normally exercised at the discretion of the participants.
Significant agreements A number of agreements may take effect, alter or terminate upon a change of control of the Company including following a takeover bid, for example commercial contracts and distribution agreements. None is considered to be significant in terms of its impact on the business of the Group as a whole.
• The Relationship Agreement between the Company and RBS Group remains in force until such time as the RBS Group’s shareholding reduces below 20% of the issued share capital of the Company. There are also provisions which provide the RBS Group with the right automatically to terminate the Relationship Agreement if the Company ceases to be listed, or if it passes a resolution to wind up, or if an administration order is made or it makes an arrangement with creditors. There are no provisions in the Relationship Agreement which allow RBS Group to terminate the agreement in the event of a change of control of Direct Line Group
Notes: 1. The interests of RBS Group indicated above are held directly. 2. Information provided to the Company pursuant to the Disclosure and
Transparency Rules is publicly available via the regulatory information services and on the Company’s website.
We have well-established Employee Representative Bodies (“ERBs”) that comprise elected representatives of employees across our business. ERBs help shape initiatives by helping us share and discuss proposals and initiatives which affect our future and advise the Executive Committee regarding employee matters.
On 26 June 2013, the Company announced proposals to improve its operational efficiency as part of its business transformation plan.
These proposals resulted in approximately 3,200 roles being put at risk. The Group ensured meaningful consultation took place with elected representatives regarding ways to avoid, reduce or mitigate the impact of proposed reductions in the number of roles.
Employees can also raise issues and ideas through “BEST Quest” – an intranet based communication tool which facilitates on-line information sharing. We will be phasing this out and replacing it with Yammer; a business social networking tool which will help reinforce some of our core values such as ‘working together’ ‘say it like it is’ and ‘bring all of yourself to work’ and reduce the impact of geographic and organisational barriers to communication.
Numerical data relating to the gender diversity of the Board, senior executives and the employees may be found on page 47.
Employees with disabilities As an organisation we are committed to ensuring that diversity is promoted across all areas of our business. At recruitment we make adjustments to facilitate applications and the selection process and provide guidance and where necessary additional training for interviewers.
Our Diversity Network Alliance has a ‘strand’ which focuses on matters important to our employees with a disability and to identify areas that we can improve upon. To facilitate continued employment we make reasonable adjustments to the working environment/equipment, the role or role requirements and ensure that the same opportunities are available to all.
• Scope 1 – direct emissions including fuels used in office buildings, accident repair centres and owned vehicles
In addition to total emissions, the Group also monitors emissions per £ million of net earned premium. In 2013, this was 8.7 tonnes per £ million of net earned premium. This is a measure of how efficiently insurance products are provided and allows comparison between insurance companies.
The GHG emissions data has been externally verified by Ecometrica. The verification statements can be found on the Group’s website (www.directlinegroup.com ).
The finance review on pages 34 to 43 describes the Group’s capital management strategy, which covers how it measures its regulatory and economic capital needs and how capital
is deployed. The financial position of the Group is also covered in that section, including a commentary on cash and investment levels, reserves, currency management, insurance liability management, liquidity and borrowings. In addition, note 3.2 to the consolidated financial statements describes capital management needs and policies and note 3 covers underwriting, market, liquidity and credit risks which may affect the Group’s financial position.
Auditor Deloitte LLP has expressed its willingness to continue in office as external auditor. A resolution to reappoint the firm will be proposed at the forthcoming AGM.
Paul Geddes, John Reizenstein, Chief Executive Officer Chief Financial Officer 25 February 2014 25 February 2014
Notes to the consolidated financial statements 1. Accounting policies 113 2. Critical accounting estimates and judgements 120 3. Risk management 123 4. Segmental analysis 135 5. Net earned premium 138 6. Investment return 138 7. Other operating income 139 8. Net insurance claims 139 9. Commission expenses 139 10. Operating expenses 140 11. Finance costs 141 12. Tax charge 142 13. Deferred tax 143 15. Earnings and net assets per share, return on equity 144 16. Goodwill and other intangible assets 145 17. Property, plant and equipment 147 18. Investment property 147 20. Reinsurance assets 148 21. Deferred acquisition costs 148 22. Insurance and other receivables 149 23. Derivative financial instruments 149 24. Financial investments 149 25. Cash and cash equivalents 150 26. Assets held for sale 150 27. Share capital 150 28. Other reserves 151 29. Subordinated liabilities 151 30. Insurance liabilities, unearned premium reserve and reinsurance assets 152 31. Life insurance liabilities and reinsurance assets 156 32. Retirement benefits obligations 157 33. Share-based payments 159 34. Trade and other payables including insurance payables 161 35. Notes to the consolidated cash flow statement 162 36. Contingent liabilities 162 38. Classification of financial instruments 164 39. Related parties 166 40. Post balance sheet events 167
Notes to the Parent Company financial statements 1. Accounting policies 171 2. Investment in subsidiary undertakings 171 3. Other receivables 171 4. Current tax assets 172 5. Cash and cash equivalents 172 6. Share capital 172 7. Subordinated liabilities 172 8. Derivative financial instruments 172 10. Trade and other payables 173 12. Cash generated from operations 173 13. Related parties 174 14. Share-based payments 174 15. Risk management 174 16. Directors and key management remuneration 174
Separate opinion in relation to IFRSs as issued by the IASB As explained in note 1 to the consolidated financial statements, in addition to complying with its legal obligation to apply IFRSs as adopted by the European Union, the Group has also applied IFRSs as issued by the International Accounting Standards Board (“IASB”).
Going concern As required by the Listing Rules we have reviewed the Directors’ statement on page 102 that the Group is a going concern. We confirm that: • we have concluded that the Directors’ use of the going concern basis of accounting in the preparation of the financial statements is appropriate; and
• we have not identified any material uncertainties that may cast significant doubt on the Group’s ability to continue as a going concern.
However, because not all future events or conditions can be predicted, this statement is not a guarantee as to the Group’s ability to continue as a going concern.
The methodology and assumptions used in setting insurance reserves The determination of the value of the insurance reserves requires significant judgment in the selection of key assumptions and methodology. Management makes significant judgement in respect of the trends in bodily injury claims frequency and severity, the propensity for large claims to settle as PPOs, the Ogden discount rate consultation and other regulatory developments.
We have tested the design and implementation and operating effectiveness of the key controls over the end to end reserving process engaging our internal actuarial specialists where appropriate.
In addition we have: • tested the completeness and accuracy of the underlying data used; • considered the suitability of the methodology used in setting insurance reserves; and
Our work included assessing whether the reserving methodology has been applied consistently across periods. We have also performed work to understand the sensitivity of insurance reserves to changes in key assumptions and methodology.
The valuation of investments including complex financial instruments and their accounting treatment in accordance with IAS 39 and IFRS 13 The valuation of financial investments held at fair value utilises a range of inputs. Many of the inputs required can be obtained from readily available, liquid market prices and rates. Where observable market data is not available, for example, when determining the valuation of investment property, estimates must be developed based on the most appropriate source data and are subject to significant judgement.
We have performed audit procedures over the valuation and accounting of investments held by the Group. We have tested the design and implementation and operating effectiveness of the key controls over the investment valuation process.
On a sample basis we have tested their valuation at the year end. We also performed a review of sources and systems used by the Group for valuation and compared valuations to those obtained from more than one independent source or recalculated them. We also engaged our valuation specialists where appropriate and checked that the disclosure requirements of IAS 39 and IFRS 13 were appropriately addressed. We have also tested the Group’s compliance with the accounting rules for complex financial instruments.
At the Parent Company 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.
Reinsurance asset valuation The valuation of the reinsurance asset in respect of the ceded part of the insurance reserves requires significant judgement to reflect the counterparty risk exposure to long-term assets arising from PPOs.
Revenue recognition International Standard on Auditing 240 (UK and Ireland) state this risk must always be treated as significant. We focus on the completeness of the revenue recorded in the financial statements and the flow of premium information from the underwriting systems to the financial reporting ledger.
We have tested the design and implementation and operating effectiveness of the key controls over revenue recognition, focusing on the flow of information from the underwriting systems to the financial reporting ledger. In addition, we performed substantive analytical testing procedures on the gross and unearned premium balances.
• the information given in the Strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements.
Respective responsibilities of Directors and 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). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. 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, strategically focused second partner reviews and independent partner reviews.
Direct Line Group Annual Report & Accounts 2013 108 £m 2012 £m
Gross earned premium 5 3,896.3 4,048.5 Reinsurance premium ceded 5 (373.0) (326.5) Net earned premium 5 3,523.3 3,722.0 Investment return 6 221.1 281.8 Instalment income 117.8 125.4 Other operating income 7 62.4 73.3 Total income 3,924.6 4,202.5 Insurance claims 8 (2,334.8) (2,875.3) Insurance claims recoverable from reinsurers 8 180.5 451.0 Net insurance claims 8 (2,154.3) (2,424.3)
Earnings per share: Basic (pence) 15 20.9 12.3 Diluted (pence) 15 20.8 12.3
Direct Line Group Annual Report & Accounts 2013 109 £m 2012 £m
Unearned premium reserve 30 1,818.7 1,872.9 Retirement benefit obligations 32 2.0 –
Derivative financial instruments 23 19.3 6.5 Trade and other payables including insurance payables 34 818.3 654.6 Deferred tax liabilities 13 19.3 20.9 Current tax liabilities 12 21.1 34.5 Total liabilities 8,997.8 9,866.3 Total equity and liabilities 11,787.8 12,697.9
The attached notes on pages 113 to 167 form an integral part of these consolidated financial statements.
Profit for the year – – – – – – 312.8 312.8
Transfer to non-distributable reserve – – – – 29.6 – (29.6) – Shares acquired by employee trusts – (5.7) – – – – – (5.7) Credit to equity for equity-settled share-based payments – – – – – – 4.1 4.1 Shares distributed by employee trusts – 0.5 – – – – (0.5) – Deferred tax on share-based payments – – – – – – 0.2 0.2
2. The movements in net assets of Direct Line Versicherung AG ceased on 2 April 2012, see note 1.
Balance at 1 January 2012 258.5 Transfer to subordinated liabilities (258.5) Balance at 31 December 2012 and 31 December 2013 –
Corporate information Direct Line Insurance Group plc is a public limited company incorporated in the United Kingdom. The address of the registered office is Churchill Court, Westmoreland Road, Bromley, BR1 1DP, England.
The consolidated financial statements are prepared on the historical cost basis except for available-for-sale (“AFS”) financial assets, investment property and derivative financial instruments, which are measured at fair value.
The Company’s financial statements and the Group’s consolidated financial statements are presented in Pounds Sterling, which is the functional currency of the Company.
The Group in its current structure was formed on 2 April 2012 when the Company acquired Direct Line Versicherung AG from a former fellow subsidiary of The Royal Bank of Scotland Group plc. Therefore the basis of preparation represents a reorganisation of entities under common control, which is outside the scope of IFRS 3 ‘Business Combinations’. Accordingly, as permitted by IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, it has been accounted for as a group reconstruction as described in Financial Reporting Standard 6, ‘Acquisitions and Mergers’. The consolidated financial statements have been prepared as if the transaction that gave rise to the formation of the Group had taken place at the beginning of 2011. Under these principles, the consolidated financial statements have been prepared as if the Company were the holding company of Direct Line Versicherung AG from 1 January 2011.
Adoption of new and revised standards The following new or revised standards have been adopted in the year and have not had a material impact on the Group’s financial statements: IFRS 10 ‘Consolidated Financial Statements’ replaced SIC 12 ‘Consolidation – Special Purpose Entities’ and the consolidation elements of IAS 27 ‘Consolidated and Separate Financial Statements’. The new standard adopts a single definition of control: a reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity to generate returns for the reporting entity; IAS 27 ‘Separate Financial Statements’ was amended to delete all other aspects of the previous standard other than those dealing with separate financial statements; IFRS 12 ‘Disclosure of Interests in Other Entities’ covers disclosures for entities reporting under IFRS 10 and IFRS 11, replacing the requirements in IAS 28 and IAS 27. Entities are required to disclose information that helps users of financial statements evaluate the nature, risks and financial effects associated with an entity’s interests in subsidiaries, associates and joint arrangements and unconsolidated structured entities; IFRS 13 ‘Fair Value Measurement’ sets out a single IFRS framework for defining and measuring fair value and requiring disclosures about fair value measurements; IAS 1 ‘Presentation of Items of Other Comprehensive Income’ requires items that will never be recognised in the income statement to be presented in other comprehensive income separately from those that are subject to subsequent reclassification; IFRS 7 ‘Financial Instruments: Disclosure – Offsetting Financial Assets and Financial Liabilities’ was amended to allow users to consider the impact of netting arrangements as permitted by IAS 32 (paragraph 42) on the financial statements; and
Where necessary, adjustments have been made to the financial statements of subsidiaries to bring the accounting policies used into line with those used by the Group. The policies set out below have been applied consistently throughout the years ended 31 December 2013 and 31 December 2012 to items considered material to the consolidated financial statements.
The long-term assurance contracts that the Group wrote included whole-life and term assurance contracts that were expected to remain in force for an extended period of time. The contracts insured events associated with human life (for example, death or the occurrence of a critical illness). These were recognised as revenue when they became payable by the contract holder. Premiums were shown before the deduction of commission.
Vehicle replacement referral income Vehicle replacement referral income comprises fees in respect of referral income received when a customer or a non-fault policyholder (claimant) of another insurer has been provided with a hire vehicle from a preferred supplier.
The calculation is particularly sensitive to the estimation of the ultimate cost of claims for the particular classes of business at gross and net levels and the estimation of future claims handling costs. Actual claims experience may differ from the historical pattern on which the actuarial best estimate is based and the cost of settling individual claims may exceed that assumed. As a result, the Group sets provisions at a margin above the actuarial best estimate. This amount is recorded as claims provisions.
1.9 Property, plant and equipment Items of property, plant and equipment (except investment property – see accounting policy 1.11) are stated at cost less accumulated depreciation and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately.
1.11 Investment property Investment property comprises freehold and long-leasehold properties that are held to earn rentals or for capital appreciation or both. Investment property is not depreciated, but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties adjusted for the specific characteristics of each property. Any gain or loss arising from a change in fair value is recognised in the income statement.
Investment property is derecognised either when it has been disposed of, or permanently withdrawn from use and no future economic benefit is expected from disposal. Any gains or losses on the retirement or disposal of investment property are recognised in the income statement in the year of retirement or disposal.
AFS Financial assets that are not classified as loans and receivables are classified as AFS. Financial assets can be designated as AFS on initial recognition. AFS financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Impairment losses and exchange differences resulting from retranslating the amortised cost of foreign currency monetary AFS financial assets are recognised in the income statement, together with interest calculated using the effective interest rate method. Other changes in the fair value of AFS financial assets are reported in a separate component of shareholders’ equity until disposal, when the cumulative gain or loss is recognised in the income statement.
(if available), reference to the current fair value of another instrument that is substantially the same, discounted cash flow analysis and option pricing models. If there is a valuation technique commonly used by market participants to price the instrument and that technique has been demonstrated to provide reliable estimates of prices obtained in actual market transactions, the Group uses that technique.
The fair value of other investments that do not have a quoted market price in an active market and derivatives that are linked to and must be settled by delivery of such an unquoted equity instrument are reliably measurable if: (a) the variability in the range of reasonable fair value estimates is not significant for that instrument; or
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 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.
AFS When a decline in the fair value of a financial asset classified as AFS has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in the income statement. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on AFS equity instruments are not reversed through profit or loss, but those on AFS debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event. Subsequent increases in the fair value of AFS other investment funds were recognised in equity.
Loans and receivables If there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as loans and receivables has been incurred, the Group measures the amount of the loss as the difference between the carrying amount of the asset or group of assets and the present value of estimated future cash flows from the asset or group of assets, discounted at the effective interest rate of the instrument at initial recognition.
Direct Line Group Annual Report & Accounts 2013 118 1. Accounting policies continued Impairment losses are assessed individually where significant or collectively for assets that are not individually significant.
In the hedge of a net investment in a foreign operation, the portion of foreign exchange differences arising on the hedging instrument determined to be an effective hedge were recognised directly in equity, where they remain until disposal or partial disposal of the associated subsidiaries. Any ineffective portion was recognised in the income statement. Non-derivative financial liabilities as well as derivatives may have been the hedging instrument in a net investment hedge.
When the Group has an onerous contract, it recognises the present obligation under the contract as a provision. A contract is onerous when the unavoidable costs of meeting the contractual obligations exceed the expected future economic benefit. In respect of leasehold properties, a provision is recognised when the Group has a detailed formal plan to vacate the leasehold property, or significantly reduce its level of occupancy, the plan has been communicated to those affected and the future property costs under the lease exceed future economic benefits.
The Group’s defined benefit pension scheme, as described in note 32, 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.
1.19 Taxation The tax charge or credit represents the sum of the tax currently payable or receivable and deferred tax.
Vesting conditions include service conditions (requiring the employee to complete a specified period of service) and performance conditions (requiring the employee to meet specified performance targets).
The cost of employee services received in exchange for an award of shares or share options granted is measured by reference to the fair value of the shares or share options on the date the award is granted and takes into account non-vesting conditions and market performance conditions (conditions related to the market price of the Company’s shares).
The cancellation of an award through failure to meet non-vesting conditions triggers an immediate expense for any unrecognised element of the cost of an award.
Direct Line Group Annual Report & Accounts 2013 120 1. Accounting policies continued 1.23 Accounting developments In December 2011, the IASB amended IAS 32 ‘Financial Instruments: Presentation’ for the section dealing with offsetting a financial asset and a financial liability. Effective for annual periods beginning on or after 1 January 2014, to be applied retrospectively, this amendment is not expected to have any effect on the Group.
IFRS 9 ’Financial Instruments’ is a new standard that is intended to replace IAS 39 ‘Financial instruments: Recognition and Measurement’ in its entirety. The replacement project consists of three planned phases and will impact the measurement and disclosures of financial instruments.
The first phase will change the basis and treatment of the classification and measurement of financial assets and financial liabilities.
The second phase is the impairment methodology and a revised exposure draft in March 2013 has proposed a more forward-thinking impairment model that reflects expected credit losses as opposed to the incurred loss model in IAS 39.
The final phase will cover hedge accounting for both general hedge accounting and macro hedge accounting.
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 113 to 120. UK company law and IFRSs require the Directors, in preparing the Group’s financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. In the absence of an applicable standard or interpretation, IAS 8 requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB’s Framework for the Preparation and Presentation of Financial Statements. The judgements and assumptions involved in the
Group’s accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.
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 provision. Outstanding claims provisions net of related reinsurance recoveries and liability adequacy provision at 31 December 2013 amounted to £4,840.1 million (2012: £5,377.6 million).
Claims reserves are assessed separately for large and attritional claims typically using normal actuarial methods of projection. Key judgements in this assessment include the selection of specific methods as well as assumptions for claims frequency and severity through the review of historical claims and emerging trends. The corresponding reinsurance recoveries are also calculated on an equivalent basis as discussed in note 1.6.
The most common method of settling bodily injury claims is by a lump sum paid to the claimant and, in the cases where this includes an element of indemnity for recurring costs such as loss of earnings or ongoing medical care, settlement normally occurs using a standardised Ogden annuity factor at a discount rate of 2.5%. This is normally referred to as the Ogden discount rate. Other estimates are also required for case management expenses, loss of pension, court protection fees, alterations to accommodation and transportation fees.
The Group holds provisions for a reduction in the Ogden discount rate at 31 December 2013 to 1.5% (2012: 1.5%). Details of sensitivity analysis to the assumed Ogden discount rate are shown in 3.3.1.
PPOs give rise to additional claims costs which are in excess of those calculated based on the Ogden tables and discounting is applied to the total cost of the PPO and not just the additional cost. The table below analyses the outstanding PPO claims provisions on a discounted and an undiscounted basis at 31 December 2013 and 31 December 2012. These represent the total cost of PPOs rather than any costs in excess of purely Ogden-based settlement.
AFS 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 where 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.
Impairment provision charges on AFS financial assets at 31 December 2013 amounted to £nil (2012: £nil).
Freehold and long leasehold properties that are classified as investment properties are recognised in the financial statements at fair value. The fair value at 31 December 2013 amounted to £223.4 million (2012: £128.9 million) was determined using a valuation model that includes inputs that are unobservable.
Level 2 financial assets are measured using a valuation technique based on assumptions that are supported by prices from observable current market transactions. These are assets for which pricing is obtained via pricing services, but where prices have not been determined in an active market, or financial assets with fair values based on broker quotes, investments in private equity funds with fair values obtained via fund managers or assets that are valued using the Group’s own models whereby the majority of assumptions are market-observable.
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 2013 was £211.0 million (2012: £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 post-acquisition 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.
For the purpose of impairment testing, goodwill acquired in a business combination is allocated to each of the Group’s CGUs or groups of CGUs expected to benefit from the combination. Goodwill impairment testing involves the comparison of the carrying value of a CGU or group of CGUs with its recoverable amount. The recoverable amount is the higher of the CGU’s fair value and its value in use. Value in use is the present value of expected future cash flows from the CGU or group of CGUs. Fair value is the amount obtainable from the sale of the CGU in an arm’s length transaction between knowledgeable, willing parties.
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
3. Risk management 3.1 Enterprise-Wide Risk Management framework The ERM framework within the Group is designed to ensure that risk management is a forward-looking discipline, focused on facilitating appropriate and fair outcomes on a consistent and reliable basis for all stakeholders. The ERM process provides the Group with a consistent and holistic view of risk management. Further information can be found in the Risk management section of the Strategic report on page 22.
The Group predominantly underwrites personal lines insurance including motor, residential property, roadside assistance, creditor, travel and pet business. The Group also underwrites commercial risks primarily for low-to-medium risk trades within the SME market. Contracts are typically issued on an annual basis, which means that the Group’s liability usually extends for a 12-month period, after which the Group is entitled to decline to renew or can impose renewal terms by amending the premium or other policy terms and conditions such as the excess as appropriate.
For creditor insurance, contracts are issued either on a monthly renewable basis (regular premium), which can be amended or cancelled by the customer at any point during the contract, or cover period of a loan (single premium). In the former case, the Group can cancel or amend the policy following a 90-day written notice period. In the latter case (these policies were withdrawn from sale in April 2009), the customer has the option to cancel the contract at any point but generally the Group is obligated for the full term up to a maximum of 10 years, but typically three to five years.
Direct Line Group Annual Report & Accounts 2013 124 3. Risk management continued Reserving risk is controlled through a range of processes: • regular periodic reviews of the claims, premium and liability adequacy reserves 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
PPOs1 Impact of an increase in the discount rate used in the calculation of present values of 100 basis points (“bps”) 81.7 104.7 80.5 104.7 Impact of a decrease in the discount rate used in the calculation of present values of 100bps (118.5) (150.4) (116.8) (150.4) Ogden Impact of an increase in the Ogden discount rate by 100bps 169.7 156.6 169.7 156.6 Impact of a decrease in the Ogden discount rate by 100bps (238.2) (219.8) (238.2) (219.8)
3. The sensitivities set out above include the impact of reinsurance, but exclude the impact of taxation.
Claims are managed utilising a range of IT system driven controls coupled with manual processes outlined in detailed policies and procedures to ensure claims are handled in an appropriate, timely and accurate manner.
3.3.2 Financial risk The Group is exposed to financial risk through its financial assets and financial liabilities. The Group’s financial risk is concentrated within its investment portfolio and reinsurance.
3.3.2.1 Market risk Market risk is the risk associated with the adverse impact of the market risk factors’ movement on the Group’s balance sheet due to changes in the fair value or cash flows of its assets or liabilities.
The Group is mainly exposed to the following market risk factors: • interest rate risk; • spread risk; • foreign currency risk; and
The Group uses its internal capital model to determine its capital requirements and market risk limits, and monitors its market risk exposure based on a 99.5% one-year value at risk measure. The Group also applies market risk stressed scenarios testing for analysing the economic impact of specific severe market conditions. The results of this analysis are used to enhance the understanding of market risk. The market risk policy 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.
The Group also invests in floating rate notes, whose investment income is influenced by the movement of the short-term interest rate. A movement of the short-term interest rate will affect the expected return on the investments.
The market value of the Group’s investments in fixed coupon securities is affected by the movement of the interest rates. For the investments in US Dollar corporate bonds, the Group hedges the exposure of this portfolio to the US Dollar interest rate risk using swaps. The derivatives reduce the duration of the portfolio to close to zero, eliminating its sensitivity to the US Dollar interest rate fluctuation.
Notes: 1. The income statement impact on AFS debt securities is limited to floating rate bonds and interest rate derivatives used to hedge a portion of the portfolio. The income statement is not impacted in relation to fixed rate bonds, where the coupon return is not impacted by a change in prevailing market rates, as the accounting treatment for AFS debt securities means that only the coupon received is processed through the income statement with fair value movements being recognised through total equity.
5. The sensitivities set out above have not considered the impact of the general market changes on the value of the Group’s insurance contract liabilities or retirement benefit obligations.
Interest rate futures 561.3 7.3 – – 7.3 Designated as hedging instruments: Foreign exchange contracts (forwards) – – – – –
At 31 December 2013 Notional amounts Maturity and fair value £m
At 31 December 2012 Notional amounts Maturity and fair value £m
Designated as hedging instruments: Foreign exchange contracts (forwards) 1.2 – – – –
Interest rate futures 375.7 – 0.1 – 0.1 Designated as hedging instruments: Foreign exchange contracts (forwards) 228.2 2.4 – – 2.4
The terms and conditions of collateral pledged for both assets and liabilities are market standard. When securities are pledged they are required to be readily convertible to cash, and as such there has been no policy established for the disposal of assets not readily convertible into cash.
Counterparty risk is primarily managed through the Credit Risk and Investment Forum. The main responsibility of this forum is to ensure that all material aspects of counterparty risk within the Group are identified, monitored and measured.
The main sources of counterparty risk for the Group are: • investment counterparty – this arises from the investment of monies in the range of investment vehicles permitted by the investment policy; and
AFS debt securities 7,147.9 – – 8.6 7,156.5 Deposits with credit institutions 1,951.7 – – – 1,951.7 Reinsurance assets 1,102.0 – – – 1,102.0 Derivative assets 37.5 – – – 37.5 Cash at bank and in hand 201.7 – – – 201.7 Insurance and other receivables 1,109.8 50.3 3.9 – 1,164.0
Direct Line Group Annual Report & Accounts 2013 130 3. Risk management continued The tables below analyse the credit quality of AFS debt securities that are neither past due nor impaired.
£m AA+ to AA- £m A+ to A- £m BBB+ to BBB- £m BB+ and below £m Total £m
The tables below analyse the credit quality of financial and insurance assets that are neither past due nor impaired (excluding AFS debt securities analysed above). The table includes reinsurance exposure, after provision. Note 3.3.1 details the Group’s approach to reinsurance counterparty risk management.
£m BBB+ to BBB- £m BB+ and below £m Not rated £m Total £m
Cash at bank and in hand – 0.2 255.4 51.7 – 0.2 307.5
Deposits with credit institutions 1,256.7 145.0 550.0 – – – 1,951.7
Note: 1. Other loans and receivables due from policyholders, agents, brokers and intermediaries generally do not have a credit rating.
Trade and other payables including insurance payables 818.3 794.3 6.4 1.9 6.4 9.3
South Africa – – – 1.4 – 1.4 South Korea 7.1 – – – – 7.1
Cayman Islands 7.5 – – – – 7.5 Czech Republic 6.4 – – – – 6.4
Mortgage and other asset backed securities 227.7 3% 45.2 0% Sovereign, supranational and local government 1,899.7 27% 2,635.7 37%
3.4 Capital adequacy The Group defines its capital requirement in accordance with the regulations prescribed by the PRA, other regulatory bodies and the credit rating agencies. Capital is managed in accordance with the Group’s capital management minimum standard, the objectives of which are to manage capital efficiently and maintain an appropriate level of capitalisation and solvency.
The UK regulated insurance entities of the Group carry out an assessment of the adequacy of their overall financial resources in accordance with the PRA’s ICA methodology. The Group also monitors its financial resources with reference to the requirements of the IGD. The UK capital requirement is calculated based on an internal risk based capital model which is calibrated, as required by the PRA, to a 99.5% confidence interval over a one-year time horizon. The risk-based capital model also supports decision making in the business.
The Group’s capital requirements and solvency position are produced and presented to the Board on a regular basis.
The Group sells rescue and recovery insurance as a stand-alone product through the Green Flag brand or as an insurance add-on to all Group own brand and certain partner motor policies, or as part of packaged bank accounts sold through our bank partnership channel. Rescue insurance policies range from basic roadside rescue to a full Europe-wide breakdown recovery service.
Commercial This segment consists of the underwriting of commercial insurance for micro businesses and SMEs in the UK. The Group sells commercial products through its own brands – NIG and Direct Line for Business – and through its partnership with RBS and NatWest.
International This segment consists primarily of personal motor car insurance cover sold in Italy and Germany using a multi-channel strategy through the Direct Line brand and through partnerships and PCWs.
No inter-segment transactions occurred in the year ended 31 December 2013 (2012: £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.
Restructuring and other one-off costs2 (140.5) Operating profit 449.6 Finance costs (37.7) Gain on disposal of subsidiary 12.0 Profit before tax 423.9
2. Restructuring costs are costs which have been incurred in respect of business activities which have a material effect on the nature and focus of the Group’s operations. One off costs are costs which are non-recurring in nature.
The table below is an analysis of the Group’s revenue and results by reportable segment in the year ended 31 December 2012: Motor £m Home £m
Direct Line Group Annual Report & Accounts 2013 138 5. Net earned premium £m 2012 £m
Gross earned premium: Gross written premium 3,834.5 4,001.4 Movement in unearned premium reserve 61.8 47.1
Investment income: Interest income on AFS debt securities 169.9 172.5 Other investment funds income – 3.1 Cash and cash equivalent interest income 7.3 19.3 Rental income from investment property 11.4 4.4
Derivative gains / (losses) Foreign exchange forward contracts 21.2 12.0 24.3 11.7 Associated foreign exchange risk 2.0 (33.3) (2.9) (32.6)
Solicitors’ referral fee income1 6.9 21.2 Vehicle replacement referral income 15.7 17.5 Revenue from vehicle recovery and repair services 31.8 25.9 Fee income from insurance intermediary services 1.7 1.9 Other income 6.3 6.8
Current accident year claims paid 1,306.2 (90.5) 1,215.7 Prior accident years claims paid 1,566.6 (75.8) 1,490.8 Movement in insurance liabilities (538.0) (14.2) (552.2)
Claims handling expenses for the year ended 31 December 2013 of £246.8 million (2012: £290.3 million) have been included in the claims figures above.
Commission expenses 333.3 316.5 Expenses incurred under profit participations 59.1 136.4
Note: 1. Includes commission expenses for the Run-off segment for the year ended 31 December 2013 of £0.8 million (2012: £115.4 million).
Direct Line Group Annual Report & Accounts 2013 140 10. Operating expenses £m 2012 £m
Amortisation and impairment of other intangible assets 37.2 40.7 Other operating expenses 290.6 228.4
Management fees were in respect of expenses recharged from RBS Group up until 30 June 2012. Management fees were charged on an arm’s length basis. From 1 July 2012 the equivalent costs have been incurred directly by the Group and included in staff costs and other operating expenses.
Staff costs1 57.9 103.9 Management fees – 16.3 Other operating expenses 82.6 69.3
Note: 1. Staff costs include redundancy costs for the year ended 31 December 2013 of £40.9 million (2012: £34.6 million).
The table below analyses the average monthly number of persons employed by the Group.
Wages and salaries 421.3 444.5 Social security costs 49.8 50.0 Pension costs1 25.8 62.3 Share-based payments 4.1 0.3
Fees payable for the audit of: The Company’s annual accounts – Deloitte LLP 0.4 0.2 The Company’s subsidiaries – Deloitte LLP 1.6 1.3 The Company’s subsidiaries – Mazars S.p.A 0.1 0.1
Note: 1. Fees incurred for corporate finance services in the year ended 31 December 2012 relate to the divestment of the Group from RBS Group.
Salaries, fees, bonuses and benefits in kind 3.2 2.5 Gains on exercise of share options 0.5 0.2 Defined contribution pension scheme contributions 0.1 –
During the year ended 31 December 2013, two Directors exercised share options (2012: one Director exercised share options) in relation to RBS Group LTIP and incentive deferral plans.
Note: 1. As described in note 29, on 27 April 2012 the Group issued subordinated dated notes with a nominal value of £500 million at a fixed rate of 9.25%. On the same date, the Group also entered into a 10-year hedge to exchange the fixed rate of interest on the subordinated dated notes for a floating rate of three-month LIBOR plus a spread of 706 bps which increased to 707 bps with effect from 29 July 2013.
Current taxation: Charge for the year 102.5 61.7 Under / (over) provision in respect of prior year 1.8 (1.0)
Deferred taxation (note 13): Charge for the year 1.6 13.9 Under / (over) provision in respect of prior year 5.2 (9.8)
Current taxation 104.3 60.7 Deferred taxation (note 13) 6.8 4.1 Tax charge for the year 111.1 64.8
Credit / (charge) to income statement 5.2 (0.6) (0.5) (7.4) – (0.8) (4.1) (Charge) / credit to other comprehensive income (6.1) 0.6 – – – – (5.5) Other movements (3.6) – – – – – (3.6)
(Charge) / credit to income statement (4.5) (0.5) 0.7 (3.5) (1.5) 2.5 (6.8) Credit to other comprehensive income 2.4 1.5 – – – – 3.9 Credit direct to equity – – – – – 0.2 0.2
Notes: 1. A deferred tax asset of £1.2 million at 31 December 2012 was not recognised in respect of capital losses arising on the revaluation of investment property.
2. A deferred tax asset of £3.7 million at 31 December 2013 has not been recognised in respect of provisions and other timing differences in Italy.
Per balance sheet: Deferred tax assets 19.3 22.5 Deferred tax liabilities (19.3) (20.9) – 1.6 £m 2012 £m
The proposed final dividend is subject to approval by shareholders at the Annual General Meeting on 15 May 2014 and has not been included as a liability in these financial statements.
The trustees of the employee share trusts, waived their entitlement to dividends on shares, which are not held for the benefit of employees’ (except for free share awards) which reduced the total dividend paid by £0.3 million (2012: £nil).
Direct Line Group Annual Report & Accounts 2013 144 15. Earnings and net assets per share, return on equity Earnings per share is calculated by dividing earnings attributable to the owners of the Company by the weighted average of Ordinary Shares in issue during the period.
Weighted average number of Ordinary Shares in issue (millions) 1,495.4 1,499.4
Diluted Diluted earnings per share is calculated by dividing the earnings attributable to the owners of the Company by the weighted average of Ordinary Shares in issue during the period adjusted for the dilutive potential Ordinary Shares. The Company has share options and contingently issuable shares as categories of dilutive potential Ordinary Shares.
Weighted average number of Ordinary Shares in issue (millions) 1,495.4 1,499.4 Effect of dilutive potential of share options and contingently issuable shares (millions) 5.8 0.6 Weighted average number of Ordinary Shares for diluted earnings per share (millions) 1,501.2 1,500.0
Net asset value and tangible net asset value per share Net asset value per share is calculated as total shareholders’ equity divided by the number of Ordinary Shares in issue at the end of the period. Ordinary Shares in issue exclude shares held by employee share trusts at 31 December 2013 of 5,204,771 (2012: 2,848,991).
Tangible net asset value per share is calculated as total shareholders’ equity less goodwill and other intangible assets divided by the number of Ordinary Shares in issue at the end of the period.
Number of Ordinary Shares in issue (millions) 1,500.0 1,500.0 Shares held by employee share trusts (millions) (5.2) (2.8) Closing number of Ordinary Shares in issue (millions) 1,494.8 1,497.2
Accumulated amortisation and impairment At 1 January 2012 134.2 382.2 516.4 Charge for the year – 30.0 30.0 Effect of foreign currency exchange adjustment (0.6) (0.7) (1.3) Fully utilised – (282.1) (282.1) Impairment losses – (10.5) (10.5)
The Group’s goodwill is reviewed annually at 30 September for impairment by comparing the recoverable amount of each CGU to which goodwill has been allocated with its carrying value and updated at each reporting date in the event of indicators of impairment.
The recoverable amount is the higher of the CGU fair value less the costs to sell and its value in use. Value in use is the present value of expected future cash flows from the CGU. Fair value is the amount obtainable for the sale of the CGU in an arm’s length transaction between knowledgeable and willing parties.
The table below details the recoverable amounts in excess of carrying value for the CGUs where goodwill is held.
Note: 1. Reflects a 1% decrease to the profit for each year of the five-year forecast.
Accumulated depreciation and impairment At 1 January 2012 0.8 41.4 42.2 Depreciation charge for the year 0.1 13.0 13.1
The valuation conforms to international valuation standards. The fair value was determined using a methodology based on recent market transactions for similar properties, which have been adjusted for the specific characteristics of each property within the portfolio. This approach to valuation is consistent with the methodology used in the year ended 31 December 2012. There has been no change to the valuation technique during the year. All investment properties are classified as level 3 under the fair value reporting hierarchy as described in note 2.3. Fair value equates to carrying value.
The lease agreements are drawn up in line with local practice and the Group has no exposure to leases that include contingent rents.
Disposals in the year ended 31 December 2012 comprised freehold property occupied by RBS Group under operating leases.
Direct Line Versicherung AG, DL Insurance Services Limited and U K Insurance Limited are owned directly by Direct Line Insurance Group plc. Direct Line Insurance S.p.A is owned indirectly through intermediary holding companies. All subsidiaries are included in the Group’s consolidated financial information and have an accounting reference date of 31 December.
The Group acquired 100% of the share capital of Direct Line Versicherung AG on 2 April 2012. The fair value of identifiable assets acquired was £368.7 million (including cash and cash equivalents of £39.7 million) and the fair value of identifiable liabilities assumed was £263.5 million. The total cash consideration paid was £105.2 million.
Reinsurers’ share of general insurance liabilities (including unearned premium reserve) 1,064.2 1,068.0 Impairment provision (53.2) (60.7)
Receivables arising from insurance and reinsurance contracts: Due from policyholders 927.9 965.3 Impairment of policyholder receivables (7.6) (9.7) Due from agents, brokers and intermediaries 53.4 106.6 Impairment of agent, broker and intermediary receivables (0.5) (0.3) Due from reinsurers 19.3 34.8
Other loans and receivables: Accrued interest 1.2 2.0 Receivables from related parties 0.9 5.1 Other debtors1 127.4 60.2
Note: 1. Includes £42.1 million in respect of a deposit for the purchase of owner occupied property (2012: £nil).
AFS debt securities Fixed interest rate 6,468.4 6,854.2 Floating interest rate 537.1 302.3
Loans and receivables Deposits with credit institutions with maturities in excess of three months 435.7 645.0
2. The Group held no level 3 securities at 31 December 2013 (2012: £nil).
Cash at bank and in hand 307.5 201.7 Short-term deposits with credit institutions1 600.8 1,306.7
Note: 1. Short-term deposits included £nil (2012: £492.5 million) held by the Group in Global Treasury Funds PLC (an open ended umbrella investment company with variable capital incorporated with limited liability in Ireland). RBS Asset Management (Dublin) Limited is the appointed manager to the fund.