Information on our environmental, social and governance (“ESG”) related activities is structured according to the five pillars of our approach to responsibility. These pillars, activities in the year relating to responsibility, and where to find ESG related information are set out in the Responsibility section. This also contains information on how we satisfy the requirements of the Non-Financial Reporting Directive.
Governance 60 Chairman’s introduction 62 Board of Directors 65 Executive Committee 66 Corporate Governance report 76 Committee reports 88 Directors’ remuneration report 118 Directors’ report
Our performance reflects our focus on satisfying customers with the aim of delivering sustainable, profitable growth
2. Results for the year ended 31 December 2018 are based on total Group operations including restructuring costs and the Run-off segment. Comparative data has been re-presented accordingly to include restructuring costs and Run-off profits within the Motor segment. The adjusted profit after tax reported in 2017 was £462.9 million and the return on tangible equity was 21.7%.
4. Estimates based on the Group’s solvency II partial internal model. The 2017 comparative has been updated to reflect the amounts in the Group Solvency and Financial Condition Report for the year ended 31 December 2017.
Whether that be driving their car, enjoying their home and possessions, exploring the world, caring for their pets or building their businesses.
Churchill customers are looking for a dependable partner which is reliable, trustworthy, and will spend time making sure they are happy.
Green Flag is our roadside rescue and recovery service. It is a standalone and optional product offered alongside motor insurance across all of our brands.
DLG Partnerships is the Group’s partnerships arm. It specialises in providing personal insurance, and roadside rescue and recovery products to some well-known brands.
We protect commercial businesses through our brands, NIG, Direct Line for Business and Churchill. NIG sells its products exclusively through brokers operating across the UK.
Notes: 1. Includes Direct Line, Churchill, Privilege and partner brands: RBS, NatWest, Prudential and Sainsbury’s © GfK Financial Research Survey six months ending
January 2018, 14,063 adults interviewed for motor insurance and 12,214 for home insurance. 2. Mintel Vehicle Recovery – UK, September 2018. 3. Mintel Pet Insurance – UK, August 2018 and Mintel Travel Insurance – UK, February 2019.
We are one of the leading providers of rescue and other personal lines insurance in the UK2,3, with 7.5 million in-force policies. This includes providing roadside assistance and recovery for customers through Green Flag, the UK’s third largest roadside recovery provider2. We offer customers protection for their holidays and pets and are the third largest travel and the third largest pet insurer3. We also offer insurance packages tailored for mid-to high-net worth customers.
Every customer is unique and we want our products to reach customers wherever they shop. But we don’t stop there. We also want to give them choices about their insurance and we offer our products through the three main routes to market: We give our customers a reason to come direct with our strong brands and great propositions, because we want to deliver excellent value for our customers and shareholders.
Partnerships Strong brands and propositions are important but so are great prices. We are investing in the latest generation IT to improve our speed to market and pricing capabilities.
Our successful customer focused strategy, built around our ‘rocket’ (see page 19), also enables us to invest in future capabilities with the aim of sustaining our strong performance.
Maintain solvency capital around the middle of the 140% – 180% solvency II target range
Remuneration Your Remuneration Committee ensures a close correlation between creating value for shareholders, and remunerating Executive Directors and senior executives appropriately.
Relations with shareholders and stakeholders Your Board maintains strong relationships and regular interaction with shareholders. Their continued support for the strategic aims is important. Your Board also has regard to the interests of other stakeholders.
See pages 66 and 75 12 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
The Group aims to grow the dividend in line with business growth. Accordingly, the Board has recommended a final dividend of 14.0 pence per share (2017: 13.6 pence), an increase of 0.4 pence per share. If approved, the total regular dividend of 21.0 pence per share will represent 2.9% growth on 2017’s regular dividend (20.4 pence per share). This reflects the Board’s continued confidence in the Group’s earnings and the progress the business continued to make.
The Board has taken into account the high level of political and economic uncertainty, including in relation to the UK’s exit from the EU (“Brexit”) and considers it appropriate for the time being to maintain a prudent solvency capital ratio towards the upper end of the solvency capital ratio risk appetite range of 140% to 180%. The Board will keep this position under review as it monitors developments in the political and economic environment. In normal circumstances, the Board expects the Group to operate around the middle of its solvency capital ratio risk appetite range.
ESG practices The Board subscribes to the principle that a business model that is sustainable in the long term will be better able to drive value for its shareholders and other stakeholders, contributing to the development of a sustainable economy. The Group has strong values and is customer focused to ensure it is continuing to meet customer needs. The Board is proud of the high level engagement of its people, whose wellbeing is one of the pillars in our approach to ESG, reflected in our support for Mind and the Scottish Association for Mental Health as well as numerous wellbeing initiatives across the Group. Our investment portfolio has started to be weighted towards ‘green bonds’ and investments which attract higher ESG ratings. Each of our UK offices seeks to act constructively with the local community and we encourage our people to allocate at least a day each year out of their working lives to support charitable or community initiatives. Our people donated nearly 4,800 hours of company time to volunteer within their communities during 2018.
Strategy The Group aims to make insurance much easier and better value for our customers. The Board supports and challenges the Group’s management to develop and execute a strategy which is aligned to this aim. Our strategy looks to position us as a multi-brand, multi-product and multi-channel business, to enable us to meet our customers’ needs now and in the future, regardless of their channel preference.
Supporting this strategy is a substantial and ongoing change and investment agenda. We look to continue to invest in our direct offering, as we believe it enables us to deliver the best value for our customers and our shareholders, through our differentiated brands and propositions and simple customer journeys. Our investments in technology and digitisation are intended to improve competitiveness, agility and efficiency. This also supports our ambition to grow our profitable share of the price comparison websites market, particularly by moving us towards best-in-class pricing. By leveraging our manufacturing strengths and investments in digital capabilities, we are continuing to support our aim of winning new partnerships.
The Group achieved a return on tangible equity (“RoTE”) of 21.5% for 2018. A decrease of 16.5% (2017: an increase of 3.3%) in the share price over the year to 318.7 pence (2017: 381.7 pence) at 31 December 2018, together with dividend payments, provided a total shareholder return (“TSR”) of minus 7.7% for the year (2017: 8.1%). This compares favourably to the FTSE 350 which had an overall return of minus 9.5% at 31 December 2018 as financial markets reacted to global trade tensions and Brexit. Over the past five years, shareholders have received a TSR of 87% compared to the FTSE 350 (excluding investment trusts) of 22%. The Group has continued to deliver good results each year, which has enabled the Board to declare cumulative dividends, including special dividends, equivalent to approximately 106% of the Initial Public Offering (“IPO”) share price. More information on the Group’s remuneration policy and share awards are disclosed in the Directors’ remuneration report on pages 88 – 117.
Three Non-Executive Directors (“NEDs”) joined the Board in 2018: Mark Gregory and Gregor Stewart were appointed on 1 March; and Fiona McBain joined us on 1 September. The Board is already benefiting from their skills and experiences.
Employees The Group’s employees are fundamental to the Group’s success and sustainability and to ensuring a high level of service to our customers. I would like to thank each of them for their hard work, initiative and commitment to our mission. Their positive energy, embodiment of the Group’s values and unwavering dedication to our customers have helped our businesses progress over the successful years since the IPO, and have put us in a strong position for the future.
I am pleased to announce a strong set of results driven by our resilient business model which performed well in a highly competitive market.
I am pleased to report another strong set of results in a highly competitive market driven by the Group’s resilient and customer-centric business model. We continued to make significant operational progress in 2018 and we head into a pivotal year of delivery in 2019, with the aim of delivering a springboard from which to grow the contribution from current-year profitability. We maintained good cost discipline in 2018 and are determined to leverage our investment in the business to step change our efficiency. The new technology and greater efficiency are, in turn, designed to support our ambition to innovate more rapidly and find new ways to serve our customers as their demands evolve. Financially, we continued to see the benefits of improving the efficiency of our balance sheet, which has contributed to another attractive dividend, while continuing to invest in the business and maintaining a prudent solvency margin.
Direct Line for Business achieved its 11th consecutive year of premium growth. This time last year, we launched a more personalised approach for our business customers, from start-ups to growing businesses. Starting with Hair and Beauty and followed by Bed & Breakfast in 2017, this year we ramped up our delivery by releasing cover for over 500 new trades, taking us to 75% of our target trades on the new platform. A national marketing campaign was launched in the year and the early campaign metrics have been positive. This has driven higher volumes to the website and there has been a 100% increase in brand searches. Work is underway to re-launch two of our biggest products on our new system, Van and Tradesman in 2019. This continues to demonstrate our increased ability to work in an agile way and to launch new, innovative products quickly to meet the ever-changing needs of our customers.
And finally Green Flag, our challenger brand in the Rescue market, continued to display great growth potential and demonstrated this again by achieving another period of double digit percentage growth in policy count and premiums. Our Rescue network dealt with over 640,000 breakdowns in 2018, which is one every 49 seconds. There has been great progress in Rescue in 2018, launching a five-year transformational plan and the team have relocated to a Centre of Excellence, bringing together multi-skilled teams to recognise efficiencies and offer greater flexibility. The Rescue Me app, which is rated 4.8 in the Apple App store, was rebuilt using in-house digital capabilities and was used in over 35,000 claims.
The actions we’ve taken supported the reduction in the operating expense ratio and we aim to continue to transform our business and improve our efficiency and long-term competitiveness.
In Motor, our new partnership with Volkswagen Insurance Service (Great Britain) Limited is going well. We provide both annual insurance cover and complimentary ‘5 day driveaway’ cover for customers buying new and used cars from Volkswagen, Volkswagen Commercial Vehicles, SEAT, Audi and ŠKODA dealers.
increased again in 2018 and I’m proud that this year we came third in the Sunday Times list of the 25 Best Big Companies to Work For in 20191. This is a huge achievement and is testament to the value we place in our people.
Business performance We ended 2018 having delivered a sixth successive year of strong financial performance and a return on tangible equity of 21.5% (2017: 23.0%), well ahead of our target of at least a 15% return on tangible equity.
Our direct own brands gross written premium increased by 1.8% whereas total gross written premium was lower as expected due to the exits from Nationwide and Sainsbury’s Home partnerships. We achieved an operating profit of £601.7 million (2017: £642.8 million). The reduction in operating profit was primarily due to lower prior-year reserve releases and investment return. Both years benefited from reserve releases relating to the Ogden discount rate. In respect of 2018, we have now assumed a higher Ogden discount rate of 0%, following Royal Assent of the Civil Liability Act 2018 which contributed £55 million to operating profit (2017: £49 million) of which £51 million related to the prior years.
The targeted improvement in current-year underwriting profitability is supported by the significant investment the Group is making in building future capability. This aims to improve the current-year loss ratio by delivering additional pricing sophistication and supporting multiple initiatives to combat fraud. In addition, the Group is targeting to improve efficiency through self-service and digitalisation. These improvements are targeted to emerge over a number of years. In 2019, the Group expects to make further progress in reducing operating costs and is targeting operating expenses below £700 million. We reiterate our ongoing target of achieving at least a 15% return on tangible equity.
Customers Customers are increasingly looking for unique insurance products, tailored to their needs.
Partnerships Partnerships enable us to leverage unique distribution and/or access data to streamline the customer experience and create competitive advantage in our pricing and underwriting.
We also signed a five-year deal with Volkswagen Insurance Service (Great Britain) Limited, providing motor insurance using five Volkswagen Group brands.
Data Insurers are gaining greater data insight as devices become ever-more connected.
We are exploring the use of new approaches across our value chain, including the use of machine learning techniques in pricing and the use of robotics across our business, which is currently delivering 500,000 transactions a quarter.
Sophisticated technology is changing vehicles, including the advent of electric and autonomous cars.
We remain partners in leading in-car technology projects StreetWise and MOVE_UK, helping us to gain insight into the development of autonomous vehicles and the impact on liability and claims.
The Act will introduce new measures to reform the soft-tissue whiplash injury compensation system and introduce a new framework for setting the Ogden discount rate.
We are working with the Government to help design the new online portal for whiplash claims that will come into force in 2020.
Our strategy looks to position us as a multi-brand, multi-product and multi-channel business to enable us to meet our customers’ needs now and in the future, regardless of how and where they buy our products. Supporting this strategy is a substantial and ongoing change and investment agenda.
Culture and capability We invest in our people to help them realise their potential because it leads to better customer experience and more sustainable business performance.
Direct The growth in Direct Line and Green Flag demonstrates that if you give customers a reason to come direct then they will, as we strive to deliver excellent value for our customers and our shareholders.
Price comparison websites Strong brands and propositions are important but so are great prices. We are improving our effectiveness on price comparison websites through our work on pricing and in dealing with fraud, supported by our investment in latest generation IT systems.
Latest generation IT systems We continue to build our latest generation IT capabilities designed to enable much more customer self-service and straight-through processing and to give our customers easier and quicker service at a lower cost whilst improving the efficiency and flexibility of the business.
As a forward-looking and proactive business, we are constantly evolving our offer to meet our customers’ needs and taking advantage of significant advances in technology. In 2018 we continued to improve our competitiveness, agility and efficiency across the business.
It is also why we introduced a training programme called CONNECT, which has been accredited by the Institute of Customer Service, for our people in a customer facing role. This training helps to ensure that our customers receive a personalised service which matches their expectations and needs. The programme enables our people to learn about the different approaches customers may take and gives them the skills to respond with empathy, whilst also taking responsibility and accountability. This is important for our customers who are dealing with difficult situations such as illness or bereavement and vulnerable customers who need additional help to ensure that their cover is the right cover for them. Based on the CONNECT training, our people who successfully demonstrate high levels of customer service receive a certificate of accreditation from the Institute of Customer Service. The impact is clear from customer benchmarking studies which measure the willingness of customers to recommend products or services, adding to our ability to maintain strong customer retention rates.
Bristol Our new Bristol office, The Core, has created a new and dynamic environment for our people to serve our customers. It has given our people a variety of new workspaces to support collaboration and flexible working, all in a fully refurbished building half the size of our previous site.
Environmental considerations were central to the design. LED lighting, new chillers, heating, ventilation and an air conditioning system have made the site more energy efficient. Run costs are now 55% lower than they were in 2016. The Core is the latest example of how we are looking to shape our technology and workspaces for the future, while meeting our environmental objectives. We are proud it has reduced our carbon emissions in our Bristol office by 62%.
Price comparison websites This year a working group has focused on establishing a price comparison website hub aiming to drive capability across the Group by assessing customer needs throughout the entire price comparison website sales journey. A dedicated team, using digital resource and data analytics, is seeking to build greater expertise and agility in real time, enabling better insight on pricing and the opportunity for swifter decision-making. This is important for a sales platform that operates on very different market dynamics compared to selling direct. By working across product lines the working group has instilled a price comparison website- focused philosophy to safeguard against functional thinking that can otherwise restrict effectiveness.
In-car technology The automotive industry is undergoing dramatic change with improvements in in-car technology and the advent of electric, connected and autonomous vehicles. We are embracing these changes and the opportunities they may present for us to evolve our products. We are maintaining our industry-leading position through our partnerships with MOVE_UK in Greenwich and our participation in StreetWise, which aims to put driverless cars on the streets of Croydon in 2019. We also continue to work with motor manufacturers such as Volkswagen, Peugeot, Citroën and Tesla, evolving our products to match their customers’ needs.
Our high operating efficiency has also allowed us to deliver excellent cost control while meeting our environmental targets through lowering emissions and increased recycling of parts.
We know that service matters a lot in this market – customers won’t sacrifice it for price. We’ve brought in new leadership and brought the business together – not only in reporting lines but also physically to create rescue ‘centres of excellence’ to deliver this great service. We will be using many of the same agile techniques that have proved successful in delivering fast and affordable change for Direct Line for Business.
We reach diverse customers by offering a range of products through many routes to market.
Customer focus Customers are at the heart of everything we do. Our brands, products and distribution channels aim to make insurance much easier and better value for our customers.
Talented people We invest in our people, encouraging everyone to aim higher. Our talented people constantly strive to improve and innovate to exceed the current and future expectations of our customers.
Brand power Our well-known and trusted brands offer customers decades of experience, knowledge and service. The scale of being Britain’s leading motor insurer and one of its leading home insurers1 gives us a platform for product development.
Data and technology Continuing our history of disrupting the insurance market, we are harnessing the power of technology and data to make life easier for both our customers and our people.
Capital and financial strength Our cash-generative business model underpinned by proven underwriting discipline, claims excellence and cost control helps us to meet our customers’ needs whilst targeting sustainable returns for our shareholders.
Claims Our new propositions, such as Fast Response (see page 41) and our expanded network of accident repair centres delivering our seven day repair proposition (see page 21), not only get customers’ lives back on track quickly but also aim to deliver high operating efficiency resulting in excellent claims cost control.
Investments As we gather premiums and provide for future claims payments we use these assets to invest in a diversified investment portfolio.
Risk framework The Board has an established risk management model that separates responsibility into ’Three Lines of Defence’ (see page 44 for more details).
Percentage of staff who fundraised or volunteered on the Group’s time
Notes: 1. See glossary on pages 191 to 192 and alternative performance measures in Appendix A on pages 193 to 194. 2. Results for the year ended 31 December 2018 are based on total Group operations including restructuring costs and the Run-off segment. Comparative data for 2017 has been re-presented accordingly to include restructuring costs and Run-off segment profits within the Motor segment. 3. Estimates based on the Group’s solvency II partial internal model for 2016 to 2018. Solvency capital coverage based on the standard formula for
– Employee engagement has been added in recognition of the importance of our people in meeting our strategic objectives
– A five-year view, where possible, was chosen to demonstrate our track record of performance
Key for dividend per share Ordinary Special 4. On an aggregated 12-month rolling basis, with 2013 rebased to 100. 5. FCA complaints reporting requirements have changed for periods after 29 June 2016. Before 29 June 2016, only complaints resolved after two business days were classed as FCA reportable. From July 2016 all complaints resolved are classed as FCA reportable. 6. For the Group’s principal underwriter, U K Insurance Limited.
The amount of cash paid to shareholders from the Group’s retained profits. (See page 26 for dividend breakdown).
We aim to grow the regular dividend in line with business growth. Additionally, we look to return any capital to shareholders which is expected to be surplus to our requirements for a prolonged period.
This is a broad measure of earnings and reflects the results of the Group after tax. We base part of the AIP awards on profit before tax and earnings per share is closely linked to this.
The AIP awards include a weighting to a balance of customer metrics, including NPS.
The AIP awards include a weighting to a balance of customer metrics, including complaints.
Financial highlights – Direct own brands premium up 1.8% compared to 2017, driven by growth across all segments. Total Group premium reduced by 5.3% year on year, as a result of the exit from Nationwide and Sainsbury’s1 Home partnerships.
In-force policies (thousands) 15,032 15,714 Of which: direct own brands (thousands) 7,132 6,909
Of which: direct own brands 2,223.0 2,184.1 Net earned premium 3,089.5 3,135.0
Net asset value per share (pence) 188.6 198.9 Tangible net asset value per share (pence) 147.0 164.4 Solvency capital ratio6 post-
4. See glossary on pages 191 and 192 for definitions and Appendix A – Alternative performance measures on pages 193 and 194 for reconciliation to financial statement line items.
6. Estimates based on the Group’s solvency II partial internal model.
Underwriting profit 255.1 288.1 Instalment and other operating income 192.0 179.3 Investment return 154.6 175.4 Total operating profit 601.7 642.8
Operating profit decreased by £41.1 million to £601.7 million (2017: £642.8 million) mainly due to a reduction in the underwriting profit and investment return, partly offset by an increase in instalment and other operating income. Overall, current-year operating profit was lower, with a stable current-year combined operating ratio offset by a lower investment return.
The current-year attritional loss ratio increased by 3.1 percentage points to 72.5% (2017: 69.4%) as the Group experienced a reversal of the benign motor conditions in 2017 and a reduction in partnership business in Home. This was offset by a 2.6 percentage point reduction in the commission ratio as a result of both lower commission and profit share payments to Home partners, as a result of the exit of the Nationwide and Sainsbury’s partnerships and changes to other partnership commissions arrangements. The current-year combined operating ratio was stable.
Investment return decreased to £154.6 million (2017: £175.4 million) primarily due to a £7.9 million reduction year on year in investment income as a result of lower assets under management and a £12.9 million reduction year on year in realised and unrealised gains.
Own brands 1,789 1,794 Partnerships (excluding Nationwide and Sainsbury’s) 803 823 Partnerships (Nationwide and Sainsbury’s) 59 631
Other personal lines 126 133 Rescue and other personal lines 7,532 7,739
The expense ratio improved by 2.3 percentage points to 23.4% (2017: 25.7%), as the Group continued to reduce its operating expenses (0.5 percentage points excluding the impact of impairments in 2017). The reduction in the commission ratio of 2.6 percentage points primarily reflected both lower commissions and profit share payments to Home partners, as a result of the exit of the Nationwide and Sainsbury’s partnerships, and changes to other partnership commissions arrangements. The remaining premium from these partnerships was substantially earned in 2018 and consequently the commission ratio is expected to reduce again in 2019 albeit at a significantly slower rate. In subsequent years the direction of the commission ratio will be dependent on the Group’s partnership activities.
For the year ended 31 December 2018 Net earned premium 4 1,541.8 667.8 414.7 465.2 3,089.5
Loss ratio – current-year attritional 81.5% 57.0% 70.7% 66.8% 72.5% Loss ratio – prior-year reserve releases (17.9%) (4.9%) (3.9%) (17.1%) (13.1%) Loss ratio – major weather events1 n/a 9.7% n/a 2.1% 2.4%
Current-year COR 106.8% 98.5% 99.1% 112.6% 104.8% For the year ended 31 December 20172 Net earned premium 4 1,470.6 790.5 417.6 456.3 3,135.0
Notes: 1. Home and Commercial claims for major weather events, including inland and coastal flooding and storms. 2. Results for the year ended 31 December 2018 are based on total Group operations including restructuring costs and the Run-off segment. Comparative data has been re-presented accordingly to include restructuring costs and Run-off segment profits within the Motor segment.
The movement in the current-year attritional loss ratio is an indicator of underlying accident year performance as it excludes prior-year reserve releases and claims costs from major weather events. The Group’s current-year attritional loss ratio of 72.5% increased by 3.1 percentage points compared to 2017 primarily due to a change in business mix and a reversal of benign conditions experienced in 2017 in Motor.
Notes: 1. Staff costs and other operating expenses attributable to claims handling activities are allocated to the cost of insurance claims.
2. Other operating expenses include IT costs, insurance levies, professional fees and property costs.
In 2019, the Group expects to make further progress in reducing operating costs and is targeting operating expenses below £700 million.
Other operating income 7 72.1 62.9 Total instalment and other operating income 192.0 179.3
Investment income 159.2 167.1 Hedging to a sterling floating rate basis (30.8) (27.0) Net investment income 128.4 140.1 Net realised and unrealised gains excluding hedging 26.2 35.3 Total investment return 6 154.6 175.4
Total investment return decreased by £20.8 million to £154.6 million (2017: £175.4 million). This was due to a reduction in investment income primarily as a result of lower assets under management, and a reduction in realised and unrealised gains excluding hedging which was predominantly driven by a reduction in investment property valuations (2018: £12.7 million, 2017: £21.6 million) and debt security disposals.
The investment income yield for 2018 remained stable at 2.5% (2017: 2.5%). The net investment income yield was lower at 2.0% (2017: 2.1%) as a result of increased hedging costs.
Finance costs Finance costs reduced to £19.1 million (2017: £103.8 million), with 2017 including costs and interest associated with the repurchase of £250 million nominal value of the subordinated debt in December 2017.
Profit for the year was £473.7 million (2017: £434.0 million) as the decrease in operating profit was more than offset by the non-repeat of finance costs in relation to the debt repurchase in 2017.
Investing activities generated a cash outflow of £141.8 million (2017: outflow of £95.3 million) primarily due to an increase in the purchase of intangible assets, which was partially offset by lower tangible asset purchases and proceeds from the asset held for sale.
Financing activities generated a cash outflow of £542.6 million (2017: outflow of £256.9 million). The increased outflow primarily reflected an increase in dividends and appropriations paid in the year.
Goodwill and other intangible assets 16 (566.8) (471.1) Tangible net assets 16 2,006.3 2,244.0 Closing number of Ordinary Shares (millions) 16 1,364.6 1,365.1 Net asset value per share (pence) 16 188.6 198.9 Tangible net asset value per share (pence) 16 147.0 164.4
The net assets at 31 December 2018 decreased to £2,573.1 million (31 December 2017: £2,715.1 million) and tangible net assets decreased to £2,006.3 million (31 December 2017: £2,244.0 million). These decreases mainly reflected the payment of the 2017 final and special dividends, a reduction in the available-for-sale reserves due to rising market yields and an increase in expenditure on intangible assets as the Group continued to invest in the business, partially offset by the 2018 retained profit.
Note: 1. See glossary on pages 191 and 192 for definitions and Appendix A –
Alternative performance measures on pages 193 and 194 for reconciliation to financial statement line items.
In the normal course of events the Board will consider whether or not it is appropriate to distribute any surplus capital to shareholders once a year, alongside the full year results.
The Board has also declared a special dividend of 8.3 pence per share. After both dividends the solvency capital ratio will be 170% as at 31 December 2018.
The final dividend and special dividend will be paid on 16 May 2019 to shareholders on the register on 5 April 2019. The ex-dividend date will be 4 April 2019.
Notes: 1. The 2017 comparative period has been updated to reflect the amounts in the
Solvency and Financial Condition Report for the year ended 31 December 2017, published on 2 May 2018.
Notes: 1. The PPO real discount rate used is an actuarial judgement which is reviewed annually based on the economic outlook for wage inflation relative to the European Insurance and Occupational Pensions Authority discount rate curve.
2. These sensitivities only include the assessed impact of the above scenarios in relation to AFS investments.
Own funds The following table splits the Group’s own funds by tier on a solvency II basis.
Tier 1 capital after foreseeable dividends represents 84% of own funds and 143% of the estimated SCR. Tier 2 capital relates solely to the Group’s £0.26 billion subordinated debt. The amount of Tier 2 and Tier 3 capital permitted under the solvency II regulations is 50% of the Group’s SCR and of Tier 3 alone it is less than 15%. Therefore, the Group currently has no ineligible capital. The requirement that Tier 1 restricted capital should not exceed 20% of total Tier 1 capital, when satisfying the requirement that eligible Tier 1 items should be at least 50% of SCR, is not applicable to the Group.
Tier 2 capital – subordinated debt 0.26 0.26 Tier 3 capital – deferred tax 0.09 0.04 Total own funds 2.15 2.30
Financial debt – subordinated debt 259.5 264.7 Total capital employed 3,179.1 3,326.3 Financial-leverage ratio1 19.1% 18.4%
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 calculations have reference to a standardised annuity factor at a discount rate normally referred to as the Ogden discount rate. The Ogden discount rate was 2.5% from 2001 until 2017, when it was changed to minus 0.75% based on a 3-year average of yields on index-linked government securities, in line with case law that claimants were entitled to invest their lump sum in a way which was very low or even zero risk. The Civil Liability Act 2018 changes this approach and instead requires the Government to reset the Ogden discount rate by reference to low risk rather than very low or zero risk investments. The process is due to conclude in 2019, but there is considerable uncertainty about its outcome and the date from which a new rate will apply.
The Group’s prior-year reserve releases were £404.4 million (2017: £435.4 million) with good experience in large bodily injury claims being a key contributor.
Looking forward, the Group expects to continue setting its initial management best estimate conservatively. Assuming current claims trends continue, the contribution from prior-year reserve releases will reduce over time, although it is expected to remain significant.
Sensitivity analysis – the discount rate used in relation to PPOs and changes in the assumed Ogden discount rate The table below provides a sensitivity analysis of the potential net impact of a change in a single factor (the discount rate used for periodic payment orders (“PPOs”) and separately the Ogden discount rate) with all other assumptions left unchanged. Other potential risks beyond the ones described could have an additional financial impact on the Group.
Notes: 1. These sensitivities are net of reinsurance and exclude the impact of taxation.
The Group will consider the statutory discount rate when setting its reserves but not necessarily provide on this basis, as is the case at the year ended 31 December 2018. This is intended to ensure that reserves are appropriate for current and potential future developments.
The sensitivity above is calculated on the basis of a permanent change in the rate used for the actuarial best estimate reserves as at 31 December 2018. It does not take into account a change in the Ogden discount rate setting regime, nor any second order impacts such as those on the Group’s PPO assumptions or reinsurance bad debt assumptions.
The reduction in sensitivity to a change in the Ogden discount rate since 31 December 2017 primarily reflects the overall reduction in bodily injury exposures. The reduction in exposure is due to continued positive prior-year development of claims reserves for large bodily injury claims, and a higher proportion of reserves benefiting from a lower reinsurance retention.
Reinsurance The objectives of the Group’s reinsurance strategy are to reduce the volatility of earnings, facilitate effective capital management, and transfer risk outside the Group’s risk appetite. This is achieved by transferring risk exposure through various reinsurance programmes: – Catastrophe reinsurance to protect against an accumulation of claims arising from a natural perils event. The retained deductible is 14.88% of gross earned premium (£126.5 million at 31 December 2018) and cover is placed annually on 1 July up to a modelled 1-in-200 year loss event of 128.88% of gross earned premium (£1,095.5 million at 31 December 2018). At the last renewal, 1 July 2018, approximately 60% of the reinsurance programme was placed on a fixed price basis (reinsurers’ rate on line) as the second year of a three-year contract.
– Motor reinsurance to protect against a single claim or an accumulation of large claims which renews on 1 January. The retained deductible is at an indexed level of £1 million per claim, providing a substantial level of protection against large motor bodily injury claims. This programme was renewed on 1 January 2019.
– to match PPO and non-PPO liabilities in an optimal manner – to deliver a suitable risk-adjusted investment return commensurate with the Group’s risk appetite
Asset and liability management The following table summarises the Group’s high-level approach to asset and liability management. Liabilities Assets Characteristics
More than 10 years, for example PPOs Property and infrastructure debt Inflation linked or floating
Short and medium term − all other claims Investment-grade credit, short-term high yield and subordinated financial debt
Commercial real estate loans 4.0% 3.3% 3.0% 2.5% Cash and cash equivalents 7.0% 17.7% 9.0% 19.4%
2. Net of bank overdrafts: includes cash at bank and in hand and money market funds with no notice period for withdrawal.
At 31 December 2018, total investment holdings of £6,164.1 million were 8.1% lower than at the start of the year reflecting primarily the cash paid in 2018 for dividends and a decline in fair value of debt securities. Total debt securities were £4,258.4 million (31 December 2017: £4,610.1 million), of which 4.6% were rated as ‘AAA’ and a further 59.3% were rated as ‘AA’ or ‘A’. The average duration at 31 December 2018 of total debt securities was 2.5 years (31 December 2017: 2.3 years).
Tax management The Board recognises that the Group has an important responsibility to manage its tax position effectively. The Board has delegated day-to-day management of taxes to the Chief Financial Officer and oversight is provided by the Audit Committee.
For more information please see our published Group Tax policy on the Group’s website at www.directlinegroup.co.uk/ en/who-we-are/governance/other-policies.html
During 2018 the sum of taxes either paid or collected across the Group was £961.7 million. The composition of this between the various taxes borne and collected by the Group is shown below.
Current-year corporation tax charge 114.4 Irrecoverable VAT incurred on overheads 90.2 Irrecoverable VAT embedded within claims spend 197.2 Employer’s national insurance contribution 39.2 Other taxes 8.7 Total 449.7
Total taxes borne by tax type (£m) Total taxes collected by tax type (£m)
In-force policies (thousands) 4,094 4,019 Of which own brands 3,950 3,845
Gross written premium £1,671.2m £1,670.4m Loss ratio 63.6% 58.0% Commission ratio 2.0% 2.5% Expense ratio 23.3% 29.3% Combined operating ratio 88.9% 89.8% Operating profit £415.2m £396.4m
– Own brand in-force policies increased by 2.7% with overall growth in in-force policies of 1.9%, up to 4.1 million – Own brand growth in gross written premium of £17.9 million, overall gross written premium broadly stable – Operating profit of £415.2 million was £18.8 million higher than prior year primarily due to a non-repeat of 2017’s intangible asset impairment of £56.9 million
The Group continued its progress with its customer-focused initiatives launched in the year. The Group’s Direct Line brand remained attractive as it continued to enhance the propositions and services customers value. The brand launched a new proposition in the first quarter: a ‘No Blame’ proposition which protects customers from losing their no claim discount for a range of common non-fault claims. A new Motor partnership was signed in 2018 with Volkswagen Insurance Service (Great Britain) Limited.
Performance The Motor division grew in-force policies by 1.9% to 4.1 million and gross written premium was broadly stable at £1,671.2 million. The growth in in-force policies was across both direct and price comparison website channels, driven by growth in Direct Line and Churchill which showed the value of our multi-brand strategy. While new business volumes fell slightly, retention remained strong year on year across all channels.
Motor average premium2 fell by 1.0% in 2018. Motor risk-adjusted prices increased by 0.6% in 2018 while risk mix reduced average premiums by 1.5%. The change in risk mix primarily reflected the attractiveness of the Group’s free Motor legal protection cover to lower average premium Churchill aggregator customers.
The current-year attritional loss ratio in Motor increased by 1.8 percentage points to 81.5% (2017: 79.7%) following a reversal of benign conditions experienced in 2017. The Group observed higher claims frequency in 2018 following an unusually low frequency year in 2017. The Group’s long-term view of claims inflation remains within the range of 3% to 5%.
Overview In 2018, the Group maintained underwriting discipline in a competitive market. The Group maintained strong retention rates, demonstrating the appeal of our brands and propositions. The shift in distribution of Home’s business from partners to price comparison websites continued in 2018. Against this backdrop, the Group remained competitive across all channels.
Focusing on propositions that differentiate Home’s products, 2018 saw the launch of Direct Line’s ‘Fast Response’. This proposition sees the Group agreeing an action plan with customers within 24 hours of major water damage.
– Total in-force policies and gross written premium 18.4% and 24.1% lower, respectively, in 2018 following exit of Nationwide and Sainsbury’s1 partnerships – Own brands in-force policies were broadly stable year-on-year and gross written premium on own brands increased by 0.7% – Total operating profit was £45.7 million lower than in 2017, reflecting Q1 2018’s freeze event
In-force policies (thousands) 2,651 3,248 Of which own brands 1,789 1,794
Note: 1. The exit from Sainsbury’s is in respect of new business. 2. By original channel. 3. Average incepted written premium excluding insurance premium tax for
The current-year attritional loss ratio, excluding major weather event claims, increased by 5.0 percentage points to 57.0%, reflecting changes in business mix, and was more than offset by lower commissions from partnerships. Claims inflation, excluding the impact of major weather events, remained within the Group’s long-term expectation of 3% to 5%. Subsidence claims, including those associated with the dry summer weather in the UK, were not materially above normal annual expectations.
Fast Response was designed to enable our home insurance customers to get their home back on track, following damage caused by a severe water leak, with minimal disruption to their daily lives.
Our proposition provides for us to be there within 24 hours of the incident to make the important decisions on the repair that will get our customers’ homes back to normal. Once a claim has been reported, our suppliers arrange an appointment with customers within 24 hours, including over weekends.
Providing an action plan within 24 hours for our customers 24 hour response, including weekends
– Total gross written premium remained broadly stable as growth in Green Flag Rescue and some premium inflation in Travel were offset by lower partnership and packaged account volumes – The Group’s direct Rescue brand, Green Flag, grew in-force policies by 11.5% and gross written premium by 14.3% in the year – During 2018 the Group successfully renewed two major Travel partnerships with RBS Group and Nationwide for a further five years
In-force policies (thousands) 7,532 7,739 Of which: own brands 894 802
Loss ratio 66.8% 65.4% Commission ratio 4.6% 5.5% Expense ratio 23.8% 23.4% Combined operating ratio 95.2% 94.3% Operating profit £43.4m £43.6m
Insurance Card scheme potentially leading to customers’ greater reliance on travel insurance.
In-force policies for the Group’s linked rescue channel reduced to 1.9 million, driven by the end of the Churchill ‘Free Rescue’ campaign in July, where Churchill Motor customers received a year’s Rescue cover when they purchased their policy. Rescue partnerships in-force policies and gross written premiums, where margins tend to be lower than for direct, reduced, driven by a partnership exit and a reduction in packaged bank account volumes.
Other personal lines in-force policies reduced by 2.6% to 4.0 million primarily due to lower packaged bank account volumes. The rate of reduction of Pet in-force policies slowed considerably in 2018 and insurance packages tailored for mid-to high-net worth Home and Motor customers saw strong growth. Gross written premium remained broadly stable as a slight growth in Travel offset a reduction in Pet.
The combined operating ratio for Rescue and other personal lines increased by 0.9 percentage points to 95.2% (2017: 94.3%) primarily due to an increase in the loss ratio partially offset by a lower commission ratio. During the year, Rescue experienced a higher average claims cost due to a mix of recoveries, weather conditions and a restructuring of the Group’s third-party recovery network. As a result, Rescue’s combined operating ratio increased to 85.0% (2017: 82.8%). Other personal lines combined operating ratio was stable as improved performance in Pet and Travel was offset by weather-related and large claims in Home products for mid-to high-net worth customers.
– Track their technician so they know when they will be arriving
With data driving every customer experience we are implementing technology to deliver the high level of service that customers expect from their breakdown provider. Our challenger status is reaffirmed in our most recent pledge to provide customers with 50% off their RAC or AA renewal quote.
In 2016 Direct Line for Business launched a new end-to-end business transformation programme to create a proposition that enables small business owners to buy insurance direct and with confidence. The proposition targets a number of trades, ranging from hairdressers and dog walkers to IT consultants and cake makers, and allows them to create a flexible policy that is unique to their business.
– No mid-term amendment admin fees means that customers have the flexibility to make changes to their policy, whether they are increasing their workforce, moving to new premises or working from multiple locations, giving them peace of mind that they have an insurance policy flexible enough to keep up with their world.
Overview The Commercial broker market continued to consolidate in 2018. Customers continued to seek cover that was flexibly tailored to their individual needs and demonstrated knowledge about their trade in the direct market. Against this backdrop, Commercial maintained underwriting discipline and grew its policy count.
In-force policies (thousands) 755 708 Of which: own brands 499 468
Direct Line for Business grew in-force policies by 6.6% as it grew in its traditionally strong areas of van and landlord, supplemented by growth in the small and micro business products on its new platform. Gross written premium increased by 7.7% to £132.0 million with increases across all product lines.
NIG and other in-force policies grew by 6.7%. Gross written premium remained steady at £379.0 million as the business continued to focus on improving margins and delivering on its strategy.
The current-year attritional loss ratio in Commercial improved by 2.0 percentage points to 66.8% as risk selection over volume remained the priority. Prior-year reserve releases were £6.9 million lower at £79.4 million.
Commission and expense ratios remained broadly stable compared to 2017 despite increased pressure on commissions due to broker consolidation.
Our risk governance framework The Board sets and monitors adherence to the risk strategy, risk appetite and risk framework, and has established a risk management model that separates responsibilities into ‘Three Lines of Defence’.
and implementation of the Enterprise Risk Management Strategy and Framework (“risk management framework”), and for providing proportionate oversight of, and challenge to, the business’s handling of risks, events and management actions. Group Audit is the Third Line of Defence, providing an independent and objective view of the adequacy and effectiveness of the Group’s risk management, governance and internal control framework.
We derive the key risk indicators from the risk appetite statements which are used to drive and monitor risk-aware decision-making.
Overarching risk objective The Group recognises that its long-term sustainability is dependent on having sufficient economic capital to meet its liabilities as they fall due, thus protecting its reputation and the integrity of its relationship with policyholders and other stakeholders. As part of this, its appetite is for general insurance risk, focusing on personal lines retail and small and medium-sized enterprise insurance in the UK. The Group has appetite for non-insurance risks, as appropriate, to enable and assist it to undertake its primary activity of insurance.
Maintain capital adequacy The Group seeks to hold capital resources in the range of 140% to 180% of the internal model solvency capital requirement. The Group also seeks to maintain sufficient economic capital consistent with its strategic aim of maintaining a credit rating in the ‘A’ range.
The Group has no appetite for material risks resulting in reputational damage, regulatory or legal censure, poor customer outcomes, fines or prosecutions, and other types of non-budgeted operational risk losses associated with Group conduct and activities. The Group will maintain a robust and proportionate internal control environment.
Our Enterprise Risk Management Strategy and Framework This section sets out, at a high level, our approach to setting risk strategy and the risk management framework for managing risks. It documents the high-level principles and practices to achieve appropriate risk management standards and demonstrates the inter-relationships between components of the risk management framework – see diagram.
Our risk culture Our risk culture underpins our business and decision-making, and helps us embed a robust approach to managing risk. Our risk culture is demonstrated in the understanding and businesswide use of the risk management systems and processes and through risk-aware decision-making. The Board is committed to promoting a culture of high standards of corporate governance, business integrity, ethics and professionalism in all our activities. An annual assessment of risk behaviours and attitudes is undertaken jointly by the Risk function and Group Audit and considers a range of factors influencing risk culture. This process is overseen by the Board Risk Committee on behalf of the Board.
Key drivers of the outlook for insurance risk across our business plan include reserve, underwriting, distribution, pricing and reinsurance risks.
– Third-party experts review the majority of our reserves – Underwriting guidelines are set for all transacted business, and pricing refined by analysing comprehensive data
– We invest in enhanced external data to analyse and mitigate exposures
Key drivers of market risk are the sensitivity of the values of our assets and investments to changes in credit spreads, and our exposure losses as a result of changes in interest rate term structure or volatility.
– We carry out an annual matching exercise on our assets and liabilities, which reduces the net impact of interest rate risk as shown in interest rate sensitivities
– We use risk-reduction techniques, such as hedging foreign currency exposures with forward contracts, and hedging exposure to US interest rates with swap contracts
– We only purchase reinsurance from reinsurers with at least an A– rating. For liabilities with a relatively long period of time to settlement, this rating will be at least A+
– We have well-defined criteria to determine which customers are offered and granted credit 46 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
The risk of loss due to inadequate or failed internal processes or systems, human error or from external events.
– We have appropriate operational processes and systems, including detection systems for fraudulent claims and appropriate processes which seek to enable operational resilience
– We are continuing to work to improve performance and stability of our IT systems while focusing on developing future systems capability. With significant change underway, we are continuing to monitor risks associated with our IT systems’ stability, and resilience, cyber security, and the internal control environment
– Our risk management framework is designed to enable us to capture risk information in a robust and consistent way
– We monitor how risks are managed in the performance of outsourced and off-shored activities
– We have a strong culture of delivering on our commitments to our customers
– We carry out planned risk-based monitoring of customer processes as well as more targeted thematic reviews which consider strategic or regulatory projects
– We agree, monitor and manage performance against the Board-approved plan and targets
– The Board leads an annual strategy and planning process which considers our performance, competitor positioning and strategic opportunities
– We identify and manage emerging risks using established governance processes and forums
Procurement and supply chain: In particular as part of the Group’s ability to deal with claims made under insurance policies, the Group needs to acquire a wide range of goods and services. A significant amount and spread of goods, for example such as car parts, are sourced from within the EU. The Group has been in discussion with principal suppliers who have taken some steps to increase stocks within the UK in the event of a ‘hard’ Brexit leading to disruption at borders. However, the Group’s ability to deal with claims in its normal ordinary course of business manner could be adversely impacted and there could be delays and extra costs.
The Group has a small amount of business in the Republic of Ireland, servicing a small Irish part of a UK partner’s wider business. The Group is well advanced in establishing a formal third-country branch in the Republic of Ireland in order to be able to continue with this business post a ‘hard’ Brexit, and expects the branch to be authorised for business by the Central Bank of Ireland by the current deadline of 29 March 2019, should that become necessary.
The Group has also been focusing on Brexit from a potential crisis management perspective, with the objective of maintaining operational resilience in the event of a disruptive Brexit and with a view to being able to react better to events as they unfold.
Emerging risks Our definition of emerging risks is new or developing risks which are often difficult to quantify; they are also usually highly uncertain and external to the Group. Emerging risks are identified by management and the latest information is maintained within an Emerging Risk Register. Each emerging risk is owned by a business subject matter expert and members of the Second Line of Defence provide challenge and oversight of activity taking place. We report emerging risks to the Board Risk Committee for review and challenge. Our emerging risks processes aim to: – identify emerging risks on a timely basis; – manage emerging risks proactively; – mitigate the impact of emerging risks which could affect the delivery of the strategic plan; and
We consider our main emerging risks to be: Climate change Climate change poses a range of financial risks to the Group. These can be divided into three categories: – Physical risks include many weather-related risks arising directly from climate change. These include changes in the frequency and severity of events, floods, storms, freeze, subsidence or wildfire. The Group’s use of catastrophe reinsurance mitigates against many of the worst potential impacts and the Group regularly reassesses its use of
– Transitional risks arise from efforts to mitigate or adapt to climate change. These include the strategic and operational risks from the transition towards electric-powered vehicles. Whilst insuring electric vehicles does not fundamentally change the business model, the business seeks to develop the new processes, skills and technical knowledge required to keep pace with these changes in technology.
Furthermore, the Group’s strategic pillars of being a great retailer, smart and efficient manufacturer and leading disrupter, as well as our aim of multi-channel success, help position us to take advantage of changes in technology and customer behaviours, through the development of new capabilities, new partnership capabilities, and by enabling us to have the flexibility to adapt/react to these changes.
The Group remains up-to-date with developments from the FCA and the Competition and Markets Authority work on pricing practices and will keep the review in focus throughout 2019 as well as seeking to ensure that the Group continues to maintain fair pricing principles.
Based on the results of these reviews, the Board has a reasonable expectation that the Company and the Group can continue in operation, and provide the appropriate degree of protection to those who are, or may become, policyholders or claimants in the period to 31 December 2022.
Our planet Reducing, reusing and recycling to build a sustainable future
Our society Playing an active role in issues that affect our society 50 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Further information on our ESG pillars, strategy and full disclosure can be found online at www.directlinegroup.co.uk/en/investors/esg.html
Our governance Creating a long-term business that serves all of our stakeholders 1. The Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016, SI 2016 No 1245.
The Corporate Social Responsibility Committee focuses on the Group’s responsibility for the environment, the community and the wellbeing and engagement of its people.
The Board Risk Committee oversees all aspects of financial, regulatory and operational risk, including the long-term risk to the Group of climate change.
Our customers Customers are at the heart of everything we do, and as such our work in pursuit of making insurance much easier and better value for our customers is highlighted throughout this report. You can read about our brands, products and channels on the following pages. Our latest customer propositions can be found on pages 39 and pages 41 to 43 and our strategy in action on pages 20 and 21 outlines how we are delivering outcomes for our customers.
We’ve built a reputation for delivering for our customers by regularly developing new and different ways to make our products easier and better value for our customers. Propositions such as our Churchill Vandalism Promise, Direct Line’s Fair Claim Commitment or Fast Response are ways of making insurance easier and we’ve used training to help our people have far more empathetic and powerful conversations with our customers.
Steve Maddock, our Chief Operating Officer, and Judith Cummins MP, who was awarded Brake and Direct Line Group’s Parliamentarian of the Year Award and who campaigned for tougher sentences for dangerous drivers.
We remain a committed partner to the road safety charity Brake, campaigning throughout the year to make our streets safer.
Working with politicians, our partnership has raised the profile of local campaigns leading to meaningful change in constituencies throughout the UK. Highlights this year have included the introduction of 20 mph zones near schools, reducing the speed limit on major A roads and tackling speeding on rural roads through greater law enforcement.
Our people pulled together to get involved in this great cause and it was an engaging and rewarding group experience where each individual effort combined to fight cancer. This was a fun and collaborative way to really live our value of ‘Working Together’. The marathon was completed in under two hours and there’s not many people in the world who can say they achieved that!
Financial responsibility Responsible investing As the Group’s investment strategy evolves, it is constantly looking for ways to enhance its investment practices with regard to ESG issues.
To date, the Group’s investment strategy has reflected the following initiatives: – Approximately 95% of externally managed assets are run by managers who are currently signatories to the United Nations-supported Principles for Responsible Investment
– The commercial property portfolio invests only in assets with an energy efficiency level of D or higher (or with apportioned funds to achieve this level), exceeding the government minimum requirement of an E rating
– Investment guideline amendments now instruct the portfolio managers to prefer investment in green bonds where they offer a similar risk-reward profile to other issues
Tax As part of our contribution to society we believe that it is important to pay the appropriate amount of tax and manage our tax obligations responsibly. For the first time, this year we are publishing the Group’s total tax contribution of £961.7 million, which includes the Group’s direct and indirect tax contribution as well as amounts collected on behalf of the UK Exchequer. See the full tax contribution note and tax strategy on page 37.
Suppliers The Prompt Payment Code sets out standards for payment practices for the benefit of suppliers. The Group is committed to maintaining the highest possible standards of integrity with suppliers and partners and is a long-standing signatory of the Prompt Payment Code. During the financial year, the Group remained committed to prompt payment terms to ensure fair payment practices.
Our diversity and inclusion practices are in line with the Universal Declaration of Human Rights. Our Ethical Code for Suppliers requires that all our suppliers adhere to the core International Labour Organisation standards. We support the aims of the Modern Slavery Act 2015 and are committed to ensuring that modern slavery is not present in our supply chain.
The facts are stark: – The part of the brain that helps assess risk is not fully developed until we reach our mid 20s
– One in four 18 to 24 year olds crash within two years of passing their driving test
Shotgun’s real-time feedback after every journey has already led to driver improvement on important safety metrics such as speeding, braking and smoothness.
One Day We give every colleague the opportunity to do a full day each year out of the office either individually or as a team, to volunteer for a charity or a community group day.
Our One Day initiative is hugely popular, giving everyone the time to support causes they are personally dedicated to.
We communicate the details of a carbon management programme through the Carbon Disclosure Project and this year achieved a rating of ‘B’.
The Group has reviewed its investment strategy, deciding that a greater weighting should be given towards issuers with stronger ESG credentials (including climate change). More information can be found in the Investment Committee’s section of the Annual Report on page 87.
This year we have taken further steps to build a sustainable future.
We have an open culture of dialogue between management and staff at all levels. This is underpinned by an Employee Representative Body (“ERB”) which is made up of colleagues elected by their peers to represent their views at divisional and company-wide level. As of October 2018 our gross staff turnover rate was 16.5%.
I’m shaping the way we deliver our future recruitment programme. The fantastic technology we can use for video interviews will really move us into the digital era. CHRISTINE SWIFT RECRUITMENT TEAM MANAGER, LEEDS
I love how customer focused the business is. It is very open to feedback, encouraging everyone to put forward ideas to improve the customer journey.
The percentage of employees who are proud to work for the Group also increased from 91% in 2017 to 92%, while 87% tell others that the Group is a great place to work (85% in 2017).
My life We understand that work doesn’t always come first. We’re all human beings with our own families, people we care for, other responsibilities and dreams to follow. We launched a new set of policies, designed to be simple and flexible, to help our people focus on what matters to them.
– Employees with at least one year’s service receive full pay during the first 20 weeks of maternity and adoption leave
– Two weeks’ paid paternity leave for all employees – Up to four weeks’ unpaid parental leave each year is also available to all parents, carers and grandparents
– A period of paid compassionate leave can be agreed for anyone
– Paid time off and/or flexible working arrangements can be agreed during IVF investigations and treatment
We know that successful businesses are the ones that offer greater flexibility and take meaningful steps to help people achieve this. We are proud of being one of the first 10 companies to back a campaign calling for large firms to publish policies on their external websites.
Some of the highlights include: – Giving our drivers tool kits when returning vehicles to customers in case any further minor damage arises on the delivery which can be instantly fixed
This year we celebrated three years of success with over 5,900 ideas.
Employee share incentive scheme All colleagues are able to benefit from an attractive Buy As You Earn scheme. Our people are rewarded with a top up share for every two they purchase, incentivising people to benefit from the Group’s success.
To challenge ourselves, we took the step this year to sign an industry-wide pledge that sets out expected minimum standards of inclusive behaviour. It commits us to speak up and call out inappropriate or discriminatory behaviour, even when it is uncomfortable to do so.
Diversity The Group is proud of its Diversity Network Alliance (“DNA”), the employee network which champions diversity and inclusion in our business.
As of April 2018, our median gender pay gap was 15.4% compared to the financial services industry average of 22%.
Mental health and wellbeing Stress, depression and mental health issues are unfortunately increasingly common in the UK. Mental health is central to the Group’s Wellbeing Strategy. We give our people immediate access to free and confidential support, with professional, independent and impartial information and counselling. Staff can also talk to our external provider about any issue including stress, work issues, finances, family or personal crises or anything else that is on their mind.
– Formed a partnership with the charity Mind in England and their partner charity the Scottish Association for Mental Health with the ambition of raising £100,000, which has the potential to fund 13,000 people in a time of need via Mind’s national helpline
– Became a gold partner of This Can Happen, a charity focused specifically on tackling mental health issues in the workplace
– Backed the ‘Where’s Your Head At?’ campaign calling for mental health provision in the workplace to be put on an equal footing with physical first aid
We also have 285 apprentices gaining technical expertise across various functions including Pricing, Auto Services and Human Resources. Their development is supported by the opportunity to study for vocational qualifications, allowing our apprentices to become established in the business.
– Our #ThisIsMe campaign has encouraged open and honest discussion about challenges some of our people face daily
– Ran our first Mental Health First Aider’s conference allowing 650 colleagues to come together and collaborate with renowned mental health campaigners
Be the best you can be, the real and whole you; celebrate our diversity of skills, experiences and personalities; be a role model to others, demonstrate a ‘can do’ spirit, have fun and make this a great place to be; be excited about our Company and our future; believe in yourself, feel confident and empowered.
Executive remuneration The Group’s remuneration policy was approved at the 2017 AGM with 98.29% of votes cast and is expected to remain in place for three years. The resolution approving the Directors’ remuneration report at the 2018 AGM was passed with 76.58% of votes cast. Whilst the majority of our major institutional shareholders voted in favour of the resolution, we understand some of our shareholders objected to the CFO’s base salary compared to that of her predecessor. I have engaged with a number of our shareholders during the year to discuss executive remuneration (in addition to Board succession planning, diversity, data security, climate change and strategic continuity) and to reassure them that good governance is a matter of the highest priority for the Board. Further details on the work of the Remuneration Committee can be found in the Directors’ remuneration report on pages 88 to 91.
Effectiveness and evaluation As Chairman, my principal objective is to guide and develop an effective Board for the benefit of our shareholders, whilst having regard to the interests of our other stakeholders. This year, the Board and its Committees again carried out their effectiveness review in-house with the assistance of the Company Secretary. Suggestions for further improving effectiveness were raised during the review process and taken into consideration by the Board. Further details can be found on page 71.
Communication with our shareholders and other stakeholders is extremely important to us. By maintaining dialogue with you, we aim to ensure that your views are considered and our objectives are understood. I would like to thank you for your support and look forward to discussing the Group’s progress with you at our forthcoming AGM on 9 May 2019.
Our commitment to good corporate governance Your Board is committed to putting strong and robust corporate governance at the heart of everything we do. This report explains how your Board has dealt with ensuring that we have effective corporate governance in place to help support the creation of long-term value for our shareholders and stakeholders.
UK Corporate Governance Code 2018 The Board welcomes the new UK Corporate Governance Code and the Guidance on Board Effectiveness which were published by the Financial Reporting Council (“FRC”) in July 2018 and apply to our 2019 financial year. We seek to ensure that our governance framework remains aligned with best practice and we will report against the new Code in next year’s Annual Report.
The Board has arrangements in place to comply with the new Code. For example, in 2018, the Board gave detailed consideration to its workforce engagement mechanisms and agreed that attendance at the Group’s national Employee Representative Body (“ERB”) meetings by NEDs on a rotational basis would enable them to participate effectively in the workforce dialogue and would enable ERB members to benefit from exchanges of views with a variety of NEDs in person.
Succession planning and Board changes Following the announcement on 1 August 2018, that Paul Geddes will step down as CEO in the summer of 2019, the Board launched a search for his successor.
The Nomination Committee conducted a thorough interview and assessment programme, which is described in more detail on page 83, culminating in its recommendation to the Board that Penny James be appointed as the Group’s new CEO. The Board agreed to appoint Penny as CEO with effect from the conclusion of the AGM on 9 May 2019, at which point Paul Geddes will step down from the Board.
The Nomination Committee reviews succession plans both for the Board and at executive level each year. The Board recognises the benefit of recruiting leaders who live the Group’s culture and values and represent a diversity of gender, ethnicity, cognitive strengths and socio-economic, educational and professional backgrounds. The Board has female representation of 42% and the Board remains committed to the principle that diversity is a key enabler of its effectiveness.
Our Code of Business Conduct Your Board maintains strong relationships and regular interaction with our shareholders and other stakeholders. Their continued support for our strategic aims is important. Visit www.directlinegroup.co.uk for more information.
Biography Mike is Chairman of the Nomination Committee. He has over 40 years’ experience of the UK and international financial services sectors. Mike was previously Chairman of Resolution, then a FTSE 100 UK life assurance business, and has acted as Chief Executive Officer and Group Finance Director of Resolution plc. He was previously Group Finance Director of Aviva plc. He is an Associate of the Institute of Chartered Accountants in England and Wales.
Biography Danuta is Chair of the Remuneration Committee. She has extensive experience and knowledge of the telecommunications and financial services sectors. Danuta was Chairman of Telefónica O2 in Ireland until December 2012, having previously been its Chief Executive from 2001 to 2010. Prior to Telefónica O2, Danuta held various senior positions within BT Group from 1984 to 2001.
Biography Penny is the CFO and CEO-designate. She will succeed Paul Geddes as CEO from the conclusion of the AGM on 9 May 2019. She has extensive financial services experience, having been Group Chief Risk Officer and Executive Director at Prudential plc, where she was responsible for leading risk oversight globally. Before this Penny was Director of Group Finance at Prudential. She had previously been Group CFO at Omega Insurance Holdings Limited and CFO, UK General Insurance, at Zurich Financial Services. Penny was a NED of Admiral Group plc from January 2015 to September 2017. Penny is an Associate of the Institute of Chartered Accountants in England and Wales.
Biography Jane is Chair of the Board Risk Committee. She has extensive experience of risk management, corporate governance and internal control. She also has wide experience of developing and monitoring customer and conduct risk frameworks and overseeing IT and transformation programmes. Jane spent her early career with KPMG, working in the financial sector, becoming responsible for delivering corporate governance, internal audit and risk-management services in the north of England. She has also held a number of executive roles, including Director of Audit, and Risk and Governance Director at Aviva plc. She is a Fellow of the Institute of Chartered Accountants in England and Wales.
Current external appointments Jane is Chair of Reclaim Fund Ltd and an Independent Member of the Fairness Committee at ReAssure Ltd. She is the Honorary Treasurer and a Trustee of the Disasters Emergency Committee and has her own financial sector consulting business. Jane is also a magistrate.
Biography Fiona has over 30 years’ experience in retail financial services, in the industry and as an auditor, in the UK and the USA. She served as CEO of Scottish Friendly Group for 11 years, before which she was Scottish Friendly Group’s Finance Director. Fiona is also an Associate Member of the Institute of Chartered Accountants in England & Wales, qualifying as an accountant early on in her career at Arthur Young (currently known as EY).
Current external appointments Fiona is Chairman of Scottish Mortgage Investment Trust plc and Non-Executive Director of Dixons Carphone plc.
Biography Clare has extensive financial and audit experience in financial services. She was a partner at PwC from 1988 to 2011, during which time she held several senior positions, particularly in the insurance sector. Her roles included People Partner for Assurance, in which she oversaw talent management, career development and the design of remuneration structures for PwC UK. Clare is a Fellow of the Institute of Chartered Accountants in England and Wales.
Experience and qualifications Jonathan has over 30 years’ experience of the insurance industry. He is responsible for delivering the Commercial strategy, developing customer propositions, enhancing the Commercial brands and delivering efficiencies within the Commercial businesses. Jonathan was previously Managing Director of the Group’s household and life businesses. He joined the Group as Product and Pricing Director for UK Partnerships. Before joining the Group, Jonathan held roles at HBOS, MBNA and Pinnacle.
The UK Corporate Governance Code The UK Corporate Governance Code 2016 (the “Code”) applied to the financial year ended 31 December 2018. Direct Line Insurance Group plc (the “Company”) complied with all of the principles and, except as explained below, all provisions of the Code throughout the financial year up to the date of this report. The Company has applied the UK Corporate Governance Code 2018 since 1 January 2019, and will report against this new Code next year.
For more information about the Code, visit the FRC’s website at www.frc.org.uk.
Leadership The Board The Board understands the views of the Company’s shareholders and has regard to a range of other key stakeholders and their interests and other relevant matters in Board discussions and decision-making. The example below demonstrates how the Board recognises that stakeholders’ interests are integral to the promotion of the Company’s long-term success.
The Board’s specific duties are set out in the Schedule of Matters Reserved for the Board, which contains items reserved for the Board to consider and approve, relating to strategy and management, material contracts, financial reporting
Chairman Mike Biggs 9 of 9 – – – – 3 of 3 4 of 4 Senior Independent Director Richard Ward 9 of 9 – 5 of 5 – – 3 of 3 – Non-Executive Directors Danuta Gray 9 of 9 – – – – 3 of 3 4 of 4 Mark Gregory 7 of 7 3 of 3 – – 2 of 2 – – Jane Hanson 9 of 9 5 of 5 5 of 5 3 of 3 4 of 4 – – Sebastian James 9 of 9 – – 3 of 3 – – 4 of 4 Fiona McBain 3 of 3 – – – – – – Andrew Palmer2 4 of 4 2 of 2 2 of 2 – 2 of 2 2 of 2 1 of 2 Gregor Stewart2 6 of 7 3 of 3 3 of 3 – – – – Clare Thompson 9 of 9 5 of 5 – – – – 4 of 4 Executive Directors Paul Geddes 9 of 9 – – 3 of 3 – – – Penny James 9 of 9 – – – 2 of 2 – – Mike Holliday-Williams 9 of 9 – – – – – – John Reizenstein 4 of 4 – – – 2 of 2 – – Executive Committee Member Simon Linares – – – 3 of 3 – – –
Meetings attendance and controls, internal controls and risk management, Board membership and succession planning, corporate governance, structure and capital, and delegation of authority.
In addition to the Schedule of Matters Reserved to the Board, each Board Committee has written terms of reference defining its role and responsibilities. Further details regarding the role and activities of the Board and Board Committees can be found on pages 68 and 76 to 87.
Meetings The Board and Board Committees held a number of scheduled meetings in 2018 at which senior executives, external advisers and independent advisers were invited to attend and present on business developments and governance matters. The Company Secretary attended all Board meetings and he, or his nominated deputy, attended all Board Committee meetings. The table below sets out attendance at the scheduled meetings in 20181. Additional Board and Committee meetings were convened during the year to discuss ad hoc business development, governance and regulatory matters.
Leadership The Board has clear divisions of responsibility and seeks the long-term success of the Group.
Shareholder benefit The Board organises and directs the Group’s affairs in a way that it believes will help the Group succeed for the benefit of its members as a whole, whilst having regard to its stakeholders generally.
Financial performance The Board sets the financial plans, annual budgets and key performance indicators and monitors the Group’s results against them.
Strategy The Board oversees the development of the Group’s strategy, and monitors management’s performance and progress against the strategic aims and objectives.
Information & support The Board accesses assistance and advice from the Company Secretary. The Board may seek external independent professional advice at the Company’s expense, if required, to discharge its duties.
The Remuneration Committee: – Sets and oversees how the Group implements its remuneration policy
The Nomination Committee: – Reviews the Board’s structure, size, composition, and balance of skills, experience, independence, and knowledge of the Company
– Leads the process for Board appointments and makes recommendations to the Board
The Investment Committee: – Provides oversight of the Group’s investment strategy – Oversees the management and performance of the Group’s investment portfolio 68 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Board and executive management roles Each Director brings different skills, experience and knowledge to the Company, with the NEDs contributing additional independent thought and judgement. Depending on business needs, the NEDs and the Chairman commit at least three days a month and three days a week respectively to discharging their duties effectively in accordance with their letters of appointment.
Biographical details of the Executive Directors and Executive Committee members are shown on pages 62 to 65.
The CEO As authorised by the Board, the CEO manages the Group’s day-to-day operations and delivers its strategy. The CEO delegates certain elements of his authority to Executive Committee members to help ensure that senior executives are accountable and responsible for managing their businesses and functions.
Risk management, regulatory and other related governance, including: considering the impact of the Ogden discount rate; reviewing and agreeing the Group’s Policies; setting risk appetites; approving the ORSA; approving major changes to the Group’s partial internal model and seeking to ensure that the Group complies with its regulatory requirements; reviewing the Group’s solvency position and forecast; and agreeing the Group’s ESG approach.
Board & Board Committee governance, including: receiving reports from the Board’s Committees; updating terms of reference for the Committees; implementing an annual review of the Board’s and Board Committees’ effectiveness; and conducting an annual review of the Group’s governance framework.
The Company Secretary maintained the training agenda for the Board and its Committees during the year. Training topics during the year included anti-bribery and corruption, growth initiative strategy updates, cyber training, competition law, the forthcoming changes in accounting rules, the IT transformation programme, Green Flag and Capital Model training.
Effectiveness Board meetings & activity in 2018 70 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Board and Committee effectiveness review In accordance with the principles and provisions of the Code, the Board’s 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. In 2018, the Board chose to conduct its effectiveness review in-house as an independent Board effectiveness review had taken place in 2016.
The Company Secretary designed and co-ordinated the process. This involved agreeing a structured questionnaire with the Chairman, SID and the Chairs of the Board’s Committees, distributing it to and interviewing the Directors and relevant executives and advisers and preparing reports. The Board and each of its Committees reviewed and discussed the relevant reports.
Respondents were asked whether matters identified as particular strengths in previous years, including the Board’s leadership and culture, the openness of debate, the productiveness of proceedings, the quality of information flow to the Board and the relationship between the Board and management, remained positive. Interviews also covered the extent to which the Board’s 2018 strategy day had helped the Board to debate and establish the Group’s medium-term strategy, the quality of the information received by the Board to monitor the progress of the Group’s major technology transformation programmes and the Group’s culture.
The Committee questionnaire focused on the clarity of each Committee’s role and scope, its composition, the resources available to it, the balance between challenging and supporting management and the quality and timeliness of information supplied to each Committee.
Outcome of the effectiveness review The Chairman discussed the outcome of the effectiveness review with the NEDs and the CEO, providing them with feedback on their individual performance and contributions. The Board and each of its Committees received and debated their own reports resulting from this exercise. Feedback on the Chairman’s performance was provided by the SID, with input from his fellow NEDs.
Whilst the findings of the 2018 effectiveness review were positive, the Board and each of its Committees will focus during 2019 on opportunities for fine-tuning with the objective of further improving effectiveness.
Governance framework and structure The Board oversees the system of governance in operation throughout the Group. This includes a robust system of internal controls and a sound risk management framework. The Board has established a risk management model that separates the Group’s risk management responsibilities into three lines of defence. An explanation of these responsibilities can be found on page 44.
The core elements of the governance framework are the: – Matters Reserved to the Board and the Board Committees’ Terms of Reference; – High Level Control and System of Governance Framework document; – Risk appetite statements, which are described on page 44; – Enterprise Risk Management Strategy and Framework, which is described on page 45; – Group policies, which address specific risk areas and inform the business how it needs to conduct its activities to remain within risk appetite; and
– Minimum Standards, which interpret the Group policies into a set of operational requirements that can be implemented throughout the Group.
Overarching risk appetite statements 72 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Approach to diversity The Board and executive management are committed to ensuring that diversity is promoted across all areas of the Group and that everyone is treated fairly, irrespective of their racial or ethnic origin, gender, age, disability, belief or sexual orientation, religion, or educational or professional background. There is a Board approved diversity policy and progress has been made in embedding principles and practices to promote diversity across the Group and to champion the benefits of a diverse and inclusive workforce.
The principles and practices set by the Board and the progress made in broadening the diversity of the Board include: 1. Maintaining at least 30% female representation on the Board The Board aims to maintain female representation of at least 30% and remains committed to seeking to improve further its position on diversity when appropriate opportunities arise. The Board will continue to appoint the most appropriate candidates based on knowledge, skills, experience and, where necessary, independence. As at the date of this report, female representation on the Board was 42% which exceeds the target set in Lord Davies’ Women on Boards Review Five Year Summary to be achieved by 2020 and remains on target with the HamptonAlexander Review’s recommendations for a minimum of 33% of women’s representation on boards by 2020.
2. Only engaging executive search firms who have signed up to the Voluntary Code of Conduct for Executive Search Firms on gender diversity and best practice In its search for candidates, the Board aims to only engage with executive search firms who are signatories to the Voluntary Code of Conduct for Executive Search Firms as recommended by Lord Davies. During the year, the Nomination Committee worked closely with Egon Zehnder which culminated in the appointment of Fiona McBain, Mark Gregory and Gregor Stewart. Egon Zehnder is a signatory to the Voluntary Code and has no other connection to the Company.
Further information regarding the Group’s approach to diversity including the process for Board appointments and reappointments can be found on pages 83 and 84 of the Nomination Committee report.
The Board continues to support Group-wide diversity initiatives, including succession planning programmes, to broaden and strengthen female talent at middle management level. Other key 2018 gender diversity initiatives included: the promotion of flexible working; a partnership with the EveryWoman network which helps organisations enhance the potential of female talent; and mentoring schemes and associated development programmes for high-potential female candidates.
Nomination Committee On behalf of the Board, the Nomination Committee assesses the NEDs’ independence, skills, knowledge and experience annually. The Board concluded that every current NED was independent, continued to contribute effectively, and demonstrated they were committed to the role. The Board is also satisfied that the Chairman’s external appointment as Chairman of Close Brothers Group plc set out on page 62 does not restrict him from carrying out his duties effectively.
– how the Board has assessed the Group’s longer-term viability and the adoption of the going concern basis in the financial statements is on pages 49 and 121.
You can find an explanation from the Directors about their responsibility for preparing the financial statements in the Statement of Directors’ responsibilities on page 121. The Company’s External Auditor explains its responsibilities on page 129.
Risk management and internal control systems The Board oversees the Group’s risk management and internal control systems. It has complied with the Code by establishing a continuous process for identifying, evaluating and managing the principal risks the Group faces.
Remuneration The Board has delegated responsibility to the Remuneration Committee for the remuneration arrangements of the Group’s Executive Directors and Chairman. It recommends and monitors the remuneration level and structure for senior executives. You can find out more about this in the Directors’ remuneration report starting on page 88.
During 2018, the Board received regular updates from the Executive Directors, the Investor Relations team and the Company’s corporate brokers on the views of its shareholders and other investors.
It is open to all shareholders to raise any issues they wish with the Chair of the Remuneration Committee. As part of the development of the revised remuneration policy for Executive Directors which was approved by shareholders at the Group’s 2017 AGM, the Chair of the Remuneration Committee led a wide-ranging consultation through engagement with proxy advisers, regulators and shareholders on corporate governance matters including executive remuneration.
Annual General Meeting The Board sees the Company’s AGM as a good opportunity for private shareholders to talk directly with the Board. All shareholders can attend the AGM if they wish. All Directors attended the AGM in 2018.
The outcome of the resolutions put to the AGM, including poll results detailing votes for, against and withheld, are published on the London Stock Exchange’s and the Company’s websites once the AGM has concluded.
– The Group initiated a change programme to transition to IFRS 9 and IFRS 17. As part of the programme the Group’s ledger system will be upgraded. The change programme will review finance processes to deliver operational benefits alongside the transition to IFRS 17.
– The impact of the change in the methodology for setting the Ogden discount rate on reserves following the Civil Liability Act 2018 receiving Royal Assent and the related sensitivity analysis were considered by the Committee.
Main activities during the year At each scheduled Committee meeting, the Committee received reports on financial reporting, reserves, internal controls and Group Audit, except at the December 2018 meeting where the focus was on pre-year-end financial matters. You can find out more about this in the following sections.
The Committee followed a review process before recommending the reports to the Board which focused on the choice and application of significant accounting policies, emphasising those requiring a major element of estimation or judgement. The review also considered the going concern assumptions and viability statement in the Annual Report & Accounts, valuation of assets and impairment reviews, reserving provisions, non-recurring period-specific transactions and clarity of disclosures.
Reserves The Committee reviews and challenges the key assumptions and judgements, emerging trends, movements and analysis of uncertainties underlying the estimate of reserves. These assumptions and judgements are informed by actuarial analysis, wider commercial and risk management insights, and principles of consistency from period to period. After reviewing the reserves, the Committee recommends them to the Board.
The Committee also considered an appropriate balance between internal and external actuarial review. An external actuarial review of the reserves was carried out by PricewaterhouseCoopers LLP (“PwC”) for the Directors of the Company. The appointment of consultants to provide actuarial reviews of reserves is subject to approval by the Committee.
Internal control and Group Audit During the year, the Committee reviewed the adequacy and effectiveness of the Group’s internal control systems. The Group’s financial reporting control framework is part of the wider internal controls system. It addresses financial reporting risks. The Board delegates supervision of the framework to the Committee while the CFO is responsible for the framework’s operation on a day-to-day basis. During 2018, the Committee received regular reports on control deficiencies, compensating controls and the mitigating actions taken by management.
The Committee reviewed the level of reserves of the Group. As part of its review, the Committee considered the estimate of reserves, taking into account certain trends and risks as well as management judgement where higher confidence, knowledge and experience can be applied. The Committee also obtained insight from an independent actuarial review of the reserves. Further information on reserves is provided on pages 76 and 77.
The Committee considered the valuation of intangible assets. These mainly related to investment in the Group’s IT systems and capabilities in respect of projects which are aimed at improving the digital offering, customer experience and operational efficiency. Reports were presented to the Committee covering the assumptions and judgements made in arriving at a valuation of these assets.
In 2018, the Committee considered major accounting estimates and judgements in respect of the valuation of intangible assets and was satisfied that the assets did not warrant any further impairment.
External audit Deloitte LLP (“Deloitte”) has served as the Company’s Auditor since 2000. Before listing, the Group was audited by Deloitte as a division of RBS Group. The Committee is responsible for overseeing the External Auditor and agreeing the audit fee, as well as approving the scope of the External Auditor’s annual plan.
The current audit partner is Mr Colin Rawlings, FCA, who was first appointed for the 2016 audit. The Committee has reviewed the latest public report on Deloitte, issued by the FRC Audit Quality Review Team, and has discussed the findings with Mr Rawlings and made enquiries as to how those findings relevant to the Group have been addressed.
The Financial Reporting Council’s Audit Quality Review team reviewed the audit of the 2017 financial statements of the Group’s principal subsidiary as part of their 2018 annual inspection of audit firms. The inspection covered selected aspects of the audit and focused on identifying areas where improvements were required. The Committee received a full copy of the report and noted that there were no areas for improvement identified. In addition, the AQR team identified areas of good practice within the audit areas they reviewed. Having considered the report and discussed it with the audit partner, the Committee was satisfied that there was nothing noted which might have a bearing on the audit appointment.
The Committee oversees Group Audit’s work and seeks to ensure industry best practice is adopted appropriately. The Group Head of Audit’s primary reporting line is to the Chair of the Committee. The secondary reporting line, for day-to-day administration, is to the CFO. Group Audit provides the Committee with independent and objective reports on the adequacy and effectiveness of the Group’s governance, risk management and internal controls. The Committee approves Group Audit’s annual plan and receives quarterly reports detailing internal audit activity, key findings, management responses, and proposed action plans. Group Audit also monitors that the most significant actions are completed. The Committee approves the Group Audit Charter, which is reviewed annually.
Additional information The Committee has unrestricted access to management and external advisers to help discharge its duties. It is satisfied that in 2018 it received sufficient, reliable and timely information to perform its responsibilities effectively.
During the year the Committee reviewed the non-audit services that could be provided by the External Auditor. It was agreed that, in order to protect the independence of the External Auditor, generally on an on going basis non-audit services should not be provided unless there is a strong, clear and understandable business reason. The Committee is satisfied that the Group has adequate procedures to ensure that the External Auditors are independent and objective.
Audit fees1 1.9 70% Audit-related assurance services 0.1 4% Other assurance services 0.1 4% Non-audit fees 0.6 22% Total fees for audit and other services 2.7 100%
Note: 1. Further information is disclosed in note 10 to the consolidated financial statements.
The Committee recommended to the Board that the Group re-appoint Deloitte as External Auditor. The Group will put a resolution regarding this to shareholders at the 2019 AGM.
Areas of focus in the reporting period – As the Group continues with its IT transformation programme, the Committee reviewed progress against the plans at each meeting. In 2018, the Committee received and challenged reports from management on the programme plans and considered how these would achieve the planned benefits for customers. The Committee probed and challenged all aspects of the programme including the governance, key risks and assumptions and progress reporting. The Committee obtained objective views from the Risk and Group Audit functions on the programme’s progress at each meeting and commissioned a series of external specialist reviews to obtain assurance on the approach being taken.
– The Committee considered risks relating to the Group’s conduct towards its customers. During the year the Committee reviewed the key themes and topics from the Group’s Customer Conduct Committee, which were focused on complaints improvement, vulnerable customers, and improved oversight of offshore and supplier performance. The Committee undertook a deep dive into pricing rating factors including the pricing principles and policies currently in place. This area will be closely monitored giving consideration to appropriate regulatory expectations.
Risk management and controls The Committee monitored the Group’s risk management and internal control systems, and reviewed their effectiveness. This covered all material risks, including financial, operational and compliance. The Committee reviewed the residual risk position after the operation of controls and considered the effectiveness of any associated mitigating actions and compensating controls. The monitoring and review by the Committee involved examining an assessment of the control environment and material controls at Group level, based on divisional risk and control self-assessments. These assessments had been subject to challenge by the Risk and Group Audit functions.
Material Risk Register The Committee assessed the principal risks facing the Group, which are listed on pages 46 and 47. The Committee achieved this by reviewing and challenging the Group’s Material Risk Register in the context of the Group’s risk appetite and through consideration of the risk assessment contained in the Chief Risk Officer’s report that was discussed at each scheduled meeting.
The Committee undertook a deep dive which focused on rating factors, governance and pricing practices. The Committee challenged management in order to gain assurance that the pricing principles and policies in place were fit for purpose and remained fair to customers. The Committee will monitor closely any changes to regulators’ expectations.
The Committee continued to monitor and challenge the Group’s plans for compliance with the EU General Data Protection Regulation which came into force on 25 May 2018. Following its introduction, the Committee received assurance that the programme had successfully implemented the strategy for compliance and that activity to further enhance the programme would be built into the existing compliance strategy. The Committee reviewed and challenged the outputs from conduct and compliance assurance reviews, including in relation to solvency II compliance.
The Committee also considered operational risks and controls in respect of third-party suppliers, operational resilience and offshoring, with the aim of ensuring that these risks were being managed appropriately by management and actions taken where necessary.
Financial risk At each meeting, the Committee monitored the Group’s performance against its capital risk appetite through the Chief Risk Officer’s report. Committee members considered financial risks in the strategic plan against risk appetite. Committee members also reviewed and challenged the ORSA process and key content before the report was submitted for approval to the Board. Committee challenges on elements of the ORSA during the year included those in relation to stress testing of the strategic plan, pricing and underwriting risk, internal model validation activity and the appropriateness of contingent management actions.
The Committee reviewed and challenged the stress and scenario testing plan prioritising the importance of certain scenarios. The Committee also examined the outputs of the budget stress tests and the associated management actions, where necessary, required to keep the Group within capital risk appetite.
Anti-bribery and corruption Annually, the Committee considers an anti-bribery and corruption report, which includes an annual risk assessment of the level of anti-bribery and corruption risk to the Group. Following review and challenge, the Committee was satisfied that the Group’s policies and procedures on anti-bribery and corruption were fit for purpose and that anti-bribery and corruption risks were managed appropriately.
Board composition During the year, the Committee: considered the Board’s skills and experience; reviewed the structure, size and composition of the Board; reviewed the membership and chairmanship of the Board’s Committees; and reviewed NEDs’ letters of appointment, terms of appointment and time commitment.
The letters of appointment for the Chairman and NEDs set out the time the Group anticipates that they will commit to their roles. This is at least three days a week for the Chairman and an average of three days a month for the other NEDs depending on business needs.
The Committee guides management in executive succession planning. Further information on how the Group develops our talent pipeline can be found on page 73.
Following the conclusion of the 2018 AGM, it was agreed that Gregor Stewart be appointed as Chair of the Audit Committee and a member of the Risk Committee. Mark Gregory was appointed Chair of the Investment Committee and a member of the Audit Committee and Penny James was appointed as a member of the Investment Committee. Danuta Gray was appointed Chair of the Remuneration Committee in place of Clare Thompson. Clare remained a member of the Committee.
The Committee appointed MWM Consulting, which is a signatory to the Volutary Code of Conduct for Executive Search Firms, to lead the search and engaged Egon Zehnder and YSC Consulting to assist with the evaluation of the candidates. The appointed specialists have no other connection to the Company. The Committee considered a diverse long list prepared by MWM and, having agreed a shortlist, interviewed a number of internal and external candidates. Following a thorough interview and assessment programme and having obtained regulatory approval, the Committee recommended Penny James as its preferred candidate. The Board accepted the recommendation and agreed to appoint Penny as Chief Executive from the conclusion of the AGM on 9 May 2019. The decision was announced on 26 February 2019. The Company has launched the search for a new CFO.
The Board is satisfied that Jane and Mike remain independent in judgement and character, that they continue to make a significant contribution to the Board and its Committees, and that they provide valuable continuity to the Board. The Committee recommended to the Board and shareholders that all serving Directors be submitted for election or re-election at the Company’s 2018 AGM, with the exception of Andrew Palmer and John Reizenstein, who had decided to step down at the conclusion of the AGM.
In March 2018, the Board adopted a Diversity Policy which sets out the Board’s approach to diversity and is available on the Company’s website. This policy, which is annually reviewed and monitored by the Committee, is presented to any executive search firm during the selection and appointment process for Board positions. Further information on the Board Diversity Policy and the Group’s diversity initiatives can be found in the Corporate Governance report on page 73.
The Board also supports the recommendations set out in the Parker Review. It is the Board’s ambition to increase cultural and ethnic diversity on the Board by 2021.
Areas of focus in the reporting period – The Committee focused on Shotgun, the Group’s CSR initiative, aimed at reducing young driver accidents, and noted encouraging evidence that use of the Shotgun app was having a measurable positive influence on young drivers’ driving behaviours.
– During the year, management introduced a new initiative to realign Group charitable giving with a single cause: mental health. The Committee supported management in its collaboration with MIND and its partner charity, the Scottish Association for Mental Health.
– The Committee was delighted to see increases in employee engagement scores across the Group, as measured by the annual employee survey and the 2019 Sunday Times list of the 25 Best Big Companies to Work For, in which the Group achieved third place.
– The Group’s target for reducing energy usage is 30% by 2020 against a baseline established in 2013. The Committee noted that, in 2018, the Group’s energy usage had decreased by 2% compared to 2017, bringing the total reduction against the 2013 baseline to 20%.
Stop deaths now During the year, the Committee received regular progress updates on Shotgun. The Committee was pleased that, since its inception in 2015, there had been more than 27,000 downloads of the Shotgun app and 79% of users had experienced an improvement in their overall driving scores. You can find further details on Shotgun in the Responsibility Report on page 54.
Shape the future During 2018, the Committee monitored the ‘shape the future’ strategy, which aims to influence the future road safety framework through strategic partnerships. The Committee supports the Group’s three-year programme with the road safety charity, Brake, to produce a series of topical survey reports on driver behaviour and attitudes, and the Group’s work with the Parliamentary Advisory Council for Transport Safety to investigate whether the lack of seat belt use is leading to road casualties.
During the year, management updated the Committee on key statistics in relation to the Group’s gender pay gap, and on the work being undertaken to increase the number of women in senior roles. This included the introduction of a progression focused support programme for high-potential females, new recruitment methods for attracting and retaining female talent and the launch of the ‘Thrive’ initiative, a support community aimed at inspiring the Group’s female colleagues. Further details on diversity can be found in the Corporate Governance report on page 73.
Support our community The ‘One Day’ volunteering initiative, which gives employees paid leave to volunteer in their local community, continued to be an area with great impact. The Committee was pleased to hear that 28% of the Group’s employees engaged in some form of volunteering or fundraising activity in Company time during 2018.
Suitability of investment strategy An annual asset and liability management study and a stressed liquidity analysis were presented to the Committee, informing strategic benchmark allocations and providing part of the context for the addition of new asset classes or exiting a present holding. The Committee approved a small reduction in US credit exposure, a reduction in overall access to liquidity required over a three-month horizon and increases in exposure to commercial real estate loans and Euro credit.
Monitoring investment activity and performance The Committee received a comprehensive report at each scheduled meeting covering: the financial results from investment activity; aggregate portfolio positioning against strategic benchmarks; performance of each individual portfolio against benchmark; adherence to operational controls; performance of suppliers; and compliance with an agreed framework of risk limits. The Committee invited the managers responsible for the commercial real estate loans portfolio and the infrastructure debt portfolio to present updates on their respective portfolios. The Committee also examined a proposal by management to reduce investment fees through the appointment of a core external asset manager, under whom a number of investment mandates would be consolidated. The Committee met the recommended manager to determine the adequacy of their skills and resources to meet the expanded role towards the end of the year. The Committee was also updated on the change in categorisation of money market funds (used by the Group for cash investments) as the funds move to comply with EU money market reform regulation.
– The positioning and asset holdings in the investment portfolio and the need to balance risk and reward were considered in light of the potential Brexit outcomes.
Against this background, the Committee considered papers and reports which examined current portfolio diversification, portfolio positioning (duration, liquidity) and the possible range of changes in asset valuations that could be experienced under the orderly transition and ‘no deal’ exit scenarios. The Committee also debated the benefits of hedging strategies to mitigate changes in asset valuations in addition to the investment portfolio’s existing defensive orientation.
The Committee’s view was that the positioning and asset holdings within the investment portfolio were proportionate to the need to balance risk and reward. The Committee noted the likelihood of higher cash balances at the end of 2018, reflecting existing defensive positioning within the portfolio and a decision taken in November to not reinvest sterling bond maturities in the short term while monitoring market reactions to the development of a Brexit solution. The Committee’s conclusions were reported to the Board during its discussions on the wider implications of Brexit on the business operations and capital position of the Group.
Dear shareholders, I am pleased to introduce my first Directors’ Remuneration Report as Chair of the Remuneration Committee (“the Committee”), for the 2018 financial year. I would like to thank Clare Thompson for her stewardship of the Committee over the last few years.
At Direct Line Group we believe that Directors should be paid fairly for the job they do and the results that they generate. I see the Committee’s objectives as: – Rewarding Directors for results that are generated within the risk appetite set by the Board.
In this letter I introduce the items that I think are important or new in the Directors’ Remuneration Report. The report is set out in the following sections: Section Page
The Remuneration Policy which covers the 2018 report was approved, by a substantial vote in favour of the policy at the AGM in May 2017. Consistent with the regulations, the Directors’ Remuneration Policy is next due to be submitted to the Company’s AGM for approval in 2020.
Annual Incentive Plan The Group’s diversified product and channel portfolio, disciplined underwriting and our engaged employees have helped us to achieve a commendable profit before tax result of £583 million. For the purpose of the financial element of the Annual Incentive Plan, the profit before tax target excluded the budgeted reserve release related to the expected Ogden discount rate change. The actual profit before tax consequently differed from the statutory IFRS basis by excluding the actual Ogden discount rate related releases made in 2018. The out-turn was slightly ahead of the target leading to a pay-out of 64% of maximum for this element.
Review of the impact of the Ogden discount rate change on the 2016 AIP out-turn You may recall that, at the time of the approval of the 2016 AIP out-turn, the Government had just announced a change in the Ogden discount rate which materially impacted the financial results for 2016. To align the 2016 AIP out-turn with shareholders, the Committee significantly reduced the AIP out-turn from an anticipated maximum pay-out for the financial element (based on the indicative range used by the Committee for its assessment) to 10% out of the 55% of total bonus opportunity attributable, an approach more conservative than many of the Group’s competitors. The government, at the same time, announced that a review of the rate setting mechanism would be undertaken. Given these exceptional circumstances, the Committee agreed to keep its assessment of the 2016 AIP outcome under review to enable the Committee to recalculate the out-turn for the 2016 financial year if the Ogden discount rate was raised or the mechanism for setting it was changed.
The application of this new discount rate led to a reserve release of £55 million which, together with an earlier associated release in 2017 of £49 million, totalled £104 million of the £217 million originally charged in 2016 as a result of the Ogden rate change.
Long Term Incentive Plan The LTIP has two performance measures: RoTE (60% of the total award) and relative TSR (40% of the total award). Awards under the LTIP granted in March and August 2015 vested during 2018.
The Group achieved an average RoTE of 18.1% over 2015, 2016 and 2017 resulting in 100% of the maximum potential vesting of the RoTE element for both awards (60% of the total awards).
The TSR performance periods run from the date of award to the third anniversary of award (as opposed to across the three financial years commencing with the year in which the award was granted as for the RoTE measure). For the March 2015 award the TSR performance was positioned between the median and the upper quintile against its comparator group which resulted in 62% of the maximum potential vesting for this element (24.8% of the total award). Accordingly, this gave a total vesting outcome of 84.8%. For the August 2015 award, the TSR performance was below the threshold requirement of median and therefore no shares vested under this measure. Subsequently the overall vesting outcome for this award was 60%.
Awards under the LTIP granted in March and August 2016 are due to vest during 2019, subject to the Committee’s satisfaction that the financial and risk underpins have been met at the end of the vesting period. The RoTE performance period for these awards ended on 31 December 2018. The three-year average RoTE performance for 2016, 2017 and 2018 was 18.5% against a maximum target of 17.5%. Awards under the RoTE element are, therefore, due to vest at 100% of the maximum potential.
The MD Personal Lines will be awarded a salary increase of 2.25% from 1 April 2019 in line with the average rate for staff generally. The Committee is satisfied that the increase is warranted based on his performance and the role he performs.
Advisers to the Committee During the year, the Committee appointed PwC as its independent adviser from 1 January 2019. FIT Remuneration Consultants LLP have been advisers to the Remuneration Committee since the time of the IPO in 2012 and therefore the Committee felt it was appropriate to seek a change of adviser at this time. On behalf of myself and the Committee I wish to extend our thanks to FIT, and John Lee in particular, for their support and counsel over the past years.
Executive Directors’ total pay This chart illustrates the total remuneration components received in 2018.
Release of value This chart illustrates the total value of the 2015 LTIP awards that vested in 2018.
Remuneration outcomes for 2018 92 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
– No salary increase for the CEO-designate at 1 April – New CFO to be appointed – 2.25% salary increase for the MD Personal Lines to £575,242
– CEO and CFO contribution rate of 25% of salary – MD Personal Lines contribution rate of 15% of salary
– Maximum opportunity of 175% of salary for the CEO and the CFO, and 150% for the MD Personal Lines; 40% of the award is deferred into shares, typically vesting after three years and subject to continued employment
– Performance is measured over three years and determined by RoTE and relative TSR measures
– Malus and clawback conditions apply – Awards are subject to an additional two-year holding period following the end of the threeyear performance period
– No change to the maximum annual award levels – Nil-cost options will continue to be used for the grants – The current 60% RoTE and 40% TSR mix will continue to apply – A RoTE target range of 17.5% to 20.5% is required for the 2019 awards to vest
Statutory remuneration report Introduction We have prepared this remuneration report in accordance with the requirements of the Companies Act 2006 and the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended) (the “Regulations”). The report also meets the relevant requirements of the Listing Rules of the Financial Conduct Authority, and describes how the Board has complied with the principles and provisions of the UK Corporate Governance Code relating to remuneration matters. Remuneration tables subject to audit in accordance with the relevant statutory requirements are contained in the annual Remuneration Report and stated to be audited. Unless otherwise stated, the information within this Directors’ Remuneration Report is unaudited.
Annual remuneration report Remuneration Committee members and governance The following list details members of the Remuneration Committee during 2018. You can find information about each member’s attendance at meetings on page 67. You can find their biographies on pages 62 to 64.
Advisers to the Committee The Committee consults with the Chief Executive Officer, the Group Human Resources Director, and senior representatives of the HR, Risk and Finance functions on matters relating to the appropriateness of all remuneration elements for Executive Directors and Executive Committee members. The Chairman, Chief Executive Officer and the Group Human Resources Director are not present when their remuneration is discussed. The Committee works closely with the Chairs of the Board Risk Committee and the Audit Committee, including receiving input from those Chairs regarding target-setting and pay-outs under incentive plans, and whether it is appropriate to operate malus and clawback. The Chair of the Board Risk Committee attended Remuneration Committee meetings on two occasions. The Remuneration and Board Risk Committees can also hold joint meetings to consider matters of common interest.
Allen & Overy LLP, one of the Group’s legal advisers, also provided legal advice relating to the Group’s executive remuneration arrangements. It also provided the Group with other legal services.
Paul Geddes 826 807 19 18 983 1,242 1,204 1,770 − − 206 202 3,238 4,039 Penny James9 675 113 14 2 803 1,014 2,259 532 − − 169 28 3,920 1,689 Mike Holliday-
Notes: 1. Salary – the Company operates a flexible benefits policy, and salary is reported before any personal elections are made. 2. Benefits – includes a company car or allowance, private medical insurance, life assurance, income protection, health screening and discounted insurance. The value of benefits in the table above includes all taxable benefits received.
8. The 2018 long-term incentive figure for Penny James relates to an estimated amount in respect of the second and final tranche of her buy-out awards, disclosed on page 109, which vests in April 2019. The award is subject to the achievement of performance targets, ending in the 2018 performance year, that relate partly to the performance of the Company and partly to the performance of her previous employer. The value of this award is based on an expected level of vesting of 97.335% and a three-month average share price to 31 December 2018 of £3.20042. The actual vesting outcome will be confirmed in next year’s report once actual performance and the vesting date share price are known. Further details are set out on page 101.
2016 single figure table restated (Audited) As set out in the Chair’s letter, the Committee concluded that an adjustment to the 2016 profit out-turn as a result of the impact of reserve releases that are due to the Ogden rate changes is appropriate. This led to additional payments in March 2019, in relation to the 2016 AIP, representing 20% of maximum opportunity of the original awards. The 2016 single figure table is therefore restated below to reflect this. All additional payments in relation to the 2016 AIP have been made in accordance with the normal policy with 40% deferred into the Group’s shares which will vest on the third anniversary of award (March 2022).
Mike HollidayWilliams3 – – – – 546 – – – – – – – – –
Notes: 1. The revised 2016 annual bonus figure for Paul Geddes relates to an adjustment of 20% of maximum opportunity of the original award of £594,287, resulting in an increase of £276,413.
3. Although Mike Holliday-Williams was not an Executive Director during 2016, his restated annual bonus has been included above for completeness. This represents an adjustment of 20% of maximum opportunity of the original award of £385,074, resulting in an increase of £160,448. 4. The original out-turn and explanation of the 2016 AIP can be found on page 88 of the 2016 Annual Report and Accounts. 5. The 2016 figures are as disclosed on page 79 of the 2017 Annual Report other than in relation to the restated bonus.
Annual Incentive Plan outcomes for 2018 (Audited) The chart illustrates the final assessment of the level of achievement under the AIP and total outcome approved by the Remuneration Committee.
The approach taken to assessing financial performance against this measure was based on a straight-line outcome between 10% for threshold performance and 60% for on target performance, and a straight-line outcome between on target performance and 100% for achievement of maximum performance.
Note: The annual incentive award made to John Reizenstein represents a pro rated amount for the period to the AGM on 10 May 2018.
– Direct Line NPS was ahead of the target and continued to show strong year on year performance. Market leading propositions were successfully launched during the year and are performing well with consumers.
– Over 1.5 million responses from customers across the Group have provided feedback on the experience delivered by our people and 84% rated our people as 9 or 10 out of 10. A new platform was launched in Q4 to further improve insight capabilities.
– In Personal Lines MyCustomer consultant performance was significantly ahead of target. – MyCustomer for Claims stabilised in H2 after a challenging start to the year due to the high volumes of claims, however ended the year short of the ambitious target set.
For the People element of the AIP, the Board set a range of people measures specifically around succession strength, diversity and employee engagement, reflecting the importance of this agenda to the success of the Group. The Committee considered that performance across these measures was very strong and had exceeded expectations against a background of high employee engagement. The Committee therefore agreed an out-turn of 100% for the People measures, giving a total of 10% out of 10% attributable to this element. A detailed assessment of the People measures is set out below.
– After a comprehensive programme in 2017 to map our talent, with a particular focus on gender balance, we developed an emerging leader programme which has been attended by 20 high potential managers in 2018.
– We have successfully recruited for our new graduate and apprenticeship schemes with a further 26 graduates and 114 apprentices joining us during 2018.
Diversity – Since becoming a signatory to the Women in Finance Charter, we have actively recruited and promoted more women into senior roles; women now account for 28% of our senior management (2017: 22%) and we are on track to meet our 2019 target.
– All senior leaders have Diversity and Inclusion action plans in place. – We launched Wellbeing, CSR and My Life family policies to respond to the variety of life needs our people may have.
– Mental health was a particular focus this year and we trained over 135 Mental Health First Aiders with at least one available on every floor across all our locations, and all people managers attended mental health awareness training. It is our aspiration to enable conversations and support to be at the same level as they are for physical health.
Engagement – We achieved record participation levels (90%) in our employee survey, DiaLoGue, and increased our already high overall engagement levels from 78% in 2017 to 81%, which places us in the upper quintile of high performing companies.
– In 2018 our focus on fair pay for all employees resulted in ‘Fair Deal’ being one of the most positively valued aspects by our people in the ‘Best Companies to Work For’ survey.
– Through Idea Lab, our employee suggestions scheme established in 2015, we have adopted c.90 ideas to improve customer service, the way we work or save cost. Cost saving ideas have delivered over £3.2 million in savings so far and employees have received over £130 thousand in recognition rewards.
– We have remained focused on improving our digital offering, customer experience and operational efficiency, recognising the challenges experienced in previous years. The Committee is pleased to report that strong progress has been made in the development and delivery of the Group’s ambitious technology transformation programme to build capability for the future. The implementation of the new core Personal Lines systems is on track to start to roll out for Motor and Travel during 2019, and within the budget as agreed with the Board. The programme includes a new pricing engine and a digital Travel platform, both of which went into testing in 2018.
LTIP outcomes for 2018 (Audited) LTIP awards are granted in March and August of each year. Each grant is subject to the following performance conditions: – RoTE (60% weighting) – performance is measured over three financial years starting from the 1 January preceding the March grant; and
Consistent with the regulations, the expected RoTE vesting outcomes for the year ended 31 December 2017 (together with the TSR elements from the 2014 awards), were included in the 2017 single remuneration figure in the 2017 report. The 2017 single remuneration figure has been updated in the 2018 report to reflect the known share price at the actual vesting date for the RoTE portion of the awards. You can find details of this on page 95. The performance outcomes of these elements are included in the table below.
(2018 single figure) 40% Median Upper quintile Below median 0% 0%
Relative TSR performance over the period was just below the upper quartile of the comparator group. As such, 94.7% of this element will vest. The prior employer does not disclose the IFRS profit targets in advance of vesting. The outcome for this element is estimated to be 100% based on the prior employer’s previous year’s LTIP out-turn and the 2018 mid-year results. The overall estimated vesting outcome is therefore 97% of maximum. The final vesting outcome will be disclosed in the 2019 Directors’ Remuneration Report once the prior employer’s targets and actual performance have been published. The number of shares expected to vest is 705,871, calculated as 97% of 725,199. The estimated value is £2,259,087 based on a three-month average share price to 31 December 2018 of £3.20042.
Using shares (Audited) In receiving an award under the LTIP or DAIP, Executive Directors commit not to hedge their exposure to outstanding awards under these plans or in respect of shares they are reporting to the Company within their ownership for the purposes of any share ownership guidelines. They also agree not to pledge as collateral their participation under any of the plans or any shares which they are required to hold in the Company for any purposes, including for share ownership guidelines.
Paul Geddes 1,081,288 320,239 1,154 759,844 Penny James 1,413,501 106,242 – 213,075 Mike Holliday-Williams 829,306 193,524 – 372,026
Note: There have been no changes to the above share interests since 31 December 2018.
Share plan interests exercised during the year to end of employment 7 September 2018
Michael Biggs -- -Danuta Gray 10,000 10,000 Mark Gregory3 -- n/a Jane Hanson 11,083 26,190 Sebastian James 5,000 5,000 Fiona McBain4 -- n/a Andrew Palmer5 10,475 10,475 Gregor Stewart6 -- n/a Clare Thompson 44,065 40,128 Richard Ward -- –
Notes: 1. There were no changes to the number of shares held by Non-Executive Directors between the year end and the date of this report. 2. Includes holdings of connected person, as defined in section 96B(2) of the Financial Services and Markets Act 2000. 3. Mark Gregory was appointed to the Board with effect from 1 March 2018.
Non-Executive Directors (Audited) Fees were the only remuneration paid to Non-Executive Directors in 2017 and 2018. Non-Executive Directors may also claim for reasonable travel and subsistence expenses, in accordance with the Group’s travel and expenses policy, and, where these are classified as taxable by HMRC, they are shown under ‘Taxable Benefits’ below. The Non-Executive Directors receive no other benefits.
Audit Committee with effect from the AGM on 10 May 2018. 5. Fiona McBain was appointed to the Board with effect from 1 September 2018. 6. Andrew Palmer stepped down from the Board at the AGM on 10 May 2018. 7. Gregor Stewart was appointed to the Board with effect from 1 March 2018. He was appointed as Chair of the Audit Committee and as a member of the Board
Risk Committee with effect from the AGM on 10 May 2018.
The table below compares the 2018 single total figure of remuneration for the CEO with that of the Group employees who are paid at the 25th percentile (lower quartile), 50th percentile (median) and 75th percentile (upper quartile) of its employee population. Year Method 25th percentile pay ratio Median pay ratio 75th percentile pay ratio 2018 Option B 127:1 116:1 81:1
Each employee’s pay and benefits were calculated using each element of employee remuneration, consistent with the CEO, on a full-time equivalent basis. No adjustments (other than to achieve full-time equivalent rates) were made and no components of pay have been omitted.
The Group’s employees are fundamental to the Group’s strategy and to ensuring a high level of service to our customers. We are proud that the high number of consultants in our customer service centres are employed by the Group (rather than being outsourced), and note that the impact of these lower paid roles is reflected in the ratios above. Further details on our approach to fairly paying and motivating our employees are set out on page 58.
Chief Executive Officer 2.5% 7.1% (20.9%) All employees (average) 4.46% 16.9% (12.1%)
Chief Executive Officer’s pay between 2012 and 2018 and historical performance of TSR The table below shows historical levels of the Chief Executive Officer’s pay between 2012 and 2018. It also shows vesting of annual and long-term incentive pay awards as a percentage of the maximum available opportunity. This is presented against the Company’s TSR since its shares began trading on the London Stock Exchange in October 2012, against the FTSE 350 Index (excluding investment trusts) over the same period. This peer group is the same used for measuring relative TSR under the LTIP.
CEO single figure of remuneration (£’000s) 1,908 2,536 5,356 4,795 4,348 4,039 3,238 Annual bonus payment (% of maximum) 65% 63% 75% 83% 63% 88% 68%
Notes: 1. Based on actual vesting under the 2010, 2011 and 2012 RBS Group LTIP. The value included in the single figures in respect of these awards is £205,000 in 2. The 2016 single figure and annual bonus payment have been updated to reflect an adjustment to the original award of 20% of maximum opportunity related to the Ogden discount rate change.
3. The 2017 single figure has been revised to reflect the actual vesting of the 2015 awards under the LTIP, an increase of £292,700. 4. The 2018 single figure reflects the estimated vesting of the RoTE portion of the LTIP granted in March and August 2016. Any shares under the LTIP granted in 2015 will not be delivered until the end of the applicable vesting periods in March and August 2019. However, they have been included in the single figure, as the performance period in respect of the RoTE portion has now been completed.
The resolution approving the Directors’ Remuneration Report was passed by 76.58% of the votes cast in favour of the resolution. The reasons for this outcome and subsequent actions taken are discussed by the Chair in her letter on page 90.
Notes: 1. During 2018 the Company paid special dividends of £205m in addition to the regular dividends. Under the dividend policy the Board considers whether to make additional distributions each year alongside the full-year results. During 2017, no special dividend was paid for the 2016 financial year as following the implementation of the new Ogden discount rate the Board did not consider the Group had surplus capital.
Distribution statement This chart shows the overall pay expenditure across all Group employees compared with the total dividend value paid to shareholders in 2017 and 2018.
No. of share options held at 31 December 20186 Vesting date
interests across the entire year are disclosed above. Further information on what happened to his share scheme interests on leaving employment (on 7 September 2018) can be found on page 108.
7. The dates of the three-day averaging period used to determine the number of shares granted on 26 March 2018 were 21, 22 and 23 March, being the three days preceding the grant.
Direct Line Group Long-Term Incentive Plan awards (Audited) This table details the Directors’ interests in the Company’s LTIP. For all LTIP awards, 20% of the awards granted would vest if the minimum performance was achieved.
2. The RoTE targets for awards granted in 2018, applying to 60% of the award, were 17.5% for 20% vesting,18.5% for 40% vesting and 20.5% for full vesting. A straight-line interpolation occurs from threshold to target, and then from target to maximum performance. The remaining 40% of each award is based on TSR performance conditions, which are the same as noted on page 111.
3. The closing market price on the dates of the vesting of the awards was £3.728 on 26 March 2018 and £3.371 on 28 August 2018. 4. Awards under the LTIP vested at 84.8% of the maximum potential on 26 March 2018 and 60.0% of the maximum potential on 28 August 2018. 5. Dividends added post-vesting are shown to 31 December 2018, although these are not realised until exercise. 6. Paul Geddes exercised 225,506 options on 26 March 2018 when the share price was £3.728 resulting in a notional gain of £840,686, and on 29 August 2018 167,025 options when the share price was £3.32 resulting in a notional gain of £554,523.
2. The RoTE targets for awards granted in 2018, applying to 60% of the award, were 17.5% for 20% vesting, 18.5% for 40% vesting and 20.5% for full vesting. A straight-line interpolation occurs from threshold to target, and then from target to maximum performance. The remaining 40% of each award is based on TSR performance conditions, which are the same as noted on page 111.
8. John Reizenstein stepped down from the Board at the AGM on 10 May 2018 and his share interests are as at that date. However, the movements in his LTIP interests across the entire year are disclosed above. Further information on what happened to his share scheme interests on leaving employment (on 7 September 2018) can be found on page 106.
9. The dates of the three-day averaging period used to determine the number of shares granted on 26 March 2018 were 21, 22 and 23 March, being the three days preceding the grant. The dates of the three-day averaging period used to determine the number of shares granted on 28 August were 22, 23 and 24 August.
10. The performance period for the awards granted on 26 March 2018 will end on 31 December 2020 for the RoTE element and 25 March 2021 for the TSR element. The performance period for the awards granted on 28 August 2018 will end on 31 December 2020 for the RoTE element and 27 August 2021 for the TSR element.
All awards made from August 2017 include an additional two-year holding period before awards may be released. The Company’s normal policy is to grant awards twice a year, after the Group announces its full and half-year results. The value of each grant of awards is set at 50% of the annual policy level. This means the total combined face value of awards to each of the Executive Directors equates to 200% of base salary.
Buy-out awards (Audited) The table below details buy-out awards made to Penny James. These awards were made to the CFO in November 2017 as compensation for the forfeiture of legacy awards granted by her previous employer. The awards were made in the form of restricted stock options (pursuant to Listing Rule 9.4.2) and subject to performance conditions that, as far as possible, mirrored those of the original awards.
Notes: 1. Penny James exercised 145,500 options on 2 August 2018 when the share price was £3.352 resulting in a notional gain of £487,716. 2. The first tranche of the above buy-out awards vested on 2 May 2018, deferred from the original vesting date of 3 April 2018 due to the Company being in a closed period from 29 March to 1 May 2018.
Direct Line Group 2012 Share Incentive Plan (Audited) During 2018, all employees, including Executive Directors, were eligible to invest from £10 to £150 a month from their pre-tax pay into the scheme, and receive one matching share for every two shares they purchased. This table details the number of shares held by John Reizenstein under the SIP. Paul Geddes, Mike Holliday-Williams and Penny James do not participate in the plan.
Notes: 1. The accumulated market value of matching shares at the time of each award. Purchase of the matching shares takes place within 30 days of the contributions being deducted from salary.
2. John Reizenstein stepped down from the Board on 10 May 2018 and his interests are shown as at that date. On leaving employment on 7 September 2018, his SIP shares were transferred to him in accordance with the rules of the scheme.
Executive Directors’ salaries in 2019 The salary increase awarded to the Executive Directors, effective 1 April 2019, reflects the average increase awarded to staff generally.
Gateway criteria for the AIP for 2019 – outcomes for Executive Directors – Year on year changes in profit before tax – Quality and sustainability of earnings, referring to reserving, gross written premium, costs and loss ratio, and relevant lead indicators
The Committee may also use its discretion to account for additional factors. These include the quality of financial results, the ’direction of travel’ of all measures, and, more widely, reputation, risk and audit.
For these purposes, we use the Group’s standard definition for RoTE, subject to such other adjustments as the Committee may consider appropriate. To find out more about how we calculate RoTE, see page 192.
Awards in 2019 Awards in 2018 Awards in 2017 Awards in 2019 Awards in 2018 Awards in 2017
For the TSR element, there is a straight-line interpolation between threshold and maximum performance on a ranked basis.
For the RoTE element, 20% of the award will vest for threshold RoTE and 40% for a RoTE of 18.5% for awards to be made in 2019. Otherwise, vesting is similar to TSR: a straight-line interpolation occurs from threshold to target, then from target to maximum performance.
At the same time, Penny’s pension contribution will be reduced from her current contribution rate of 25% of salary to 9% of salary, in line with that of the wider workforce. There will be no change to her participation in the Company’s AIP up to a maximum of 175% of salary and the LTIP up to 200% of salary.
Payments since cessation as a Director of the Company 160 40 3 203
Board Chairman fee 400 Basic Non-Executive Director fee 75 Additional fees Senior Independent Director fee 30 Chair of Audit, Board Risk and Remuneration Committees 30 Chair of CSR and Investment Committees 10 Member of Board Committee (Audit, Board Risk or Remuneration) 10 Member of Board Committee (CSR or Nomination) 5
External directorships Paul Geddes is a Non-Executive Director for Channel 4 for which he receives and retains an annual fee of £22,177. Otherwise, the Executive Directors do not currently hold any further external directorships.
Service contracts Subject to the discretion set out in the recruitment remuneration policy, it is the Company’s policy to set notice periods for Executive Directors of no more than 12 months (both by the Director or Company). The Executive Directors’ service agreements summary is as follows: Director Effective date of contract Notice period (by Director or Company) Exit payment policy
There are no further obligations which could give rise to a remuneration or loss of office payment other than those set out in the remuneration policy and the termination policy.
– Pension contributions are paid only in respect of base salary – Executive Directors are eligible to participate in the defined contribution pension arrangement or alternatively they may choose to receive a cash allowance in lieu of pension
– Executive Directors are eligible to participate in any of the employee share plans operated by the Company, in line with HMRC guidelines (where relevant) and on the same basis as other eligible employees. Currently, this includes the Share Incentive Plan (“SIP”), which has been used to provide an award of free shares to all employees (including Executive Directors), and permit employees to purchase shares with a corresponding matching award
– Where an Executive Director is required to relocate to perform their role, they may be offered appropriate relocation benefits. The level of such benefits would be determined based on the circumstances of the individual and typical market practice
– When determining salary increases, the Committee will consider the factors outlined in this table under ‘Operation’. In any event, no increase will be made if it would take an Executive Director’s salary above £850,000 (the current median level of salaries for CEOs in the FTSE 100), as further increased by UK RPI from the date of approving this policy
AIP – 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
– Awards under the LTIP may be made at various times during the financial year. While the Committee reserves the right to do otherwise, the Committee’s practice has been to make awards twice in each financial year, following the announcement of the Group’s annual and half-year results
– Awards vest based on performance against financial and/or such other (including share return) measures, as set by the Committee, to be aligned with the Group’s long-term strategic objectives
– Awards will be subject to a payment gateway, such that the Committee must be satisfied that there are no material risk failings, reputational concerns or regulatory issues
– Executive Directors are expected to retain all the Ordinary Shares vesting under any of the Company’s share incentive plans, after any disposals for paying applicable taxes, until they have achieved the required shareholding level unless such earlier sale, in exceptional circumstances, is permitted by the Chairman
– 200% of salary for all Executive Directors – The Committee reserves the discretion to amend these levels in future years
– Malus and clawback provisions apply to the cash and deferred elements. These are explained in the notes to the policy table
– Maximum and target bonus levels for Executive Directors are set by taking into account annual bonus practice throughout the organisation and referring to practice at other insurance and general market comparators
– The maximum bonus opportunity under the AIP is 175% of base salary per annum. The current maximum bonus opportunity applying for each individual Executive Director is shown in the statement of implementation of policy
– Performance over the financial year is assessed against performance measures which the Committee considers to be appropriate
– These may be financial, non-financial (Group, divisional or business line) and individual. Each year, at least 50% of the bonus is based on financial measures. The remainder of the bonus may be based on a combination of strategic, shared and individual performance measures
– The Committee sets targets at the beginning of each financial year – No more than 10% of the bonus is paid for threshold performance (30% of the bonus for the individual performance element). No more than 60% of the maximum opportunity pays out for target performance. However, the Committee retains flexibility to amend the pay-out level at different levels of performance for future bonus cycles. This is based on its assessment of the level of stretch inherent in the set targets, and the Committee will disclose any such determinations appropriately
– Vested options will remain exercisable up to the 10th anniversary of grant – Malus and clawback provisions apply to the LTIP. These are explained in the notes to the policy table
Corporate governance statement The FCA’s Disclosure Guidance and Transparency Rules require a corporate governance statement in the Directors’ report to include certain information. You can find information that fulfils the corporate governance statement’s requirements in this Directors’ report; the Corporate Governance report; the Committee reports; and the Directors’ remuneration report, on pages 60 to 117. This information is incorporated in the Directors’ report by reference.
The final dividend resolution provides that the Board may cancel the dividend and, therefore, payment of the dividend at any time before payment, if it considers it necessary to do so for regulatory capital purposes. You can find detailed explanations about this in the Notice of AGM 2019. Likewise, the special interim dividend can also be cancelled if necessary.
You can find further details regarding dividends paid during 2017 and 2018 in the Finance review on page 26 and in note 14 to the consolidated financial statements on page 164. You can also find information on dividend and capital management in the Finance review on page 32.
Directors You can find the current Directors’ biographies on pages 62 to 64. All Directors will retire and, excepting Paul Geddes and Clare Thompson, will be submitted for election or re-election at the 2019 AGM. This is in accordance with the UK Corporate Governance Code and the Articles of Association of the Company, which govern appointing and replacing Directors.
The Directors listed on pages 62 and 64 were the Directors of the Company throughout the year apart from Mark Gregory and Gregor Stewart, who were each appointed as Directors on 1 March 2018, and Fiona McBain, who was appointed as a Director on 1 September 2018; Andrew Palmer and John Reizenstein also served during the year, retiring from the Board on 10 May 2018.
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. The Company maintains directors’ and officers’ liability insurance. This provides appropriate cover for legal actions brought against its Directors. The Company has also provided the directors of DLG Pension Trustee Limited with qualifying pension scheme indemnities. This is in accordance with section 235 of the Companies Act 2006. DLG Pension Trustee Limited acts as trustee for two of the Company’s occupational pension schemes.
At the Company’s 2018 AGM, the Directors were authorised to: – allot shares in the Company or grant rights to subscribe for, or convert any security into shares, up to an aggregate nominal amount of £50,000,000 and to allot further shares up to an aggregate nominal amount of £50,000,000, for the purpose of a rights issue; – allot shares having a nominal amount not exceeding in aggregate £7,500,000 for cash, without offering the shares first to existing shareholders in proportion to their holdings; – allot additional shares having a nominal amount not exceeding in aggregate £7,500,000 for the purposes of financing a transaction which the Board of the Company determines to be an acquisition or other capital investment, without offering the shares first to existing shareholders in proportion to their holdings; – make market purchases of up to 137,500,000 shares in the Company, representing 10% of the Company’s issued share capital at the time; and
– allot shares (with the disapplication of pre-emption rights) up to an aggregate nominal amount of £23,250,000 in relation to the issue of solvency II RT1 Instruments.
To date, the Directors have not used these authorities. At the 2019 AGM, shareholders will be asked to renew these authorities. The Company has not held any shares in treasury during the period under review. You can find out more about the Company’s share capital and shares under option at as 31 December 2018 in notes 29 and 35 to the consolidated financial statements.
Where the Company has issued a notice under section 793 of the Companies Act 2006, which is in default for at least 14 days, the person(s) interested in those shares shall not be entitled to attend or vote at any general meeting until the default has been corrected or the shares sold.
Substantial shareholdings In accordance with the provisions of chapter 5 of the FCA’s Disclosure Guidance and Transparency Rules, the Company has been notified of the following direct and indirect interests in the Company’s voting rights. Information provided by the Company pursuant to the FCA’s Disclosure Guidance and Transparency Rules is publicly available via the regulatory information services and on the Company’s website.
Employees with disabilities The Group is committed to promoting diversity and inclusion across every area of the business through initiatives such as the DNA. At recruitment, we adjust and enhance our application and selection process, and guide and provide additional training for interviewers, where necessary.
Total GHG emissions (Scope 1 and Scope 2) in 2018 were 16,219 tonnes (2017: 17399 tonnes), as set out in the table below. This primarily comprised emissions from purchased electricity and natural gas, diesel fuel, and refrigerant gas used. In addition to total emissions, the Group also monitors emissions per £ million of net earned premium. In 2018, this was 5.2 tonnes CO2e per £ million of net earned premium (2017: 5.5 tonnes). This is a measure of how efficiently insurance products are provided. It allows us to compare our year-on-year performance and performance against other insurance companies. You can find verification statements on the Group’s website at www.directlinegroup.co.uk. You can find further information on the Group’s approach to energy and the environment in the Responsibility report on page 55.
Global GHG emissions data for reporting year 1 January 2018 – 31 December 2018
Combustion of fuel & operation of facilities (Scope 1) 8,304 8,304 Electricity, heat, steam and cooling purchased for own use (Scope 2) 7,915 10,290 Total (Scope 1 & 2) 16,219 18,594 Intensity metric: tonnes CO2e/ Million GBP net earned premium (£m) 5.2 6.0 Transmission and Distribution (“T&D”) losses from electricity (Scope 3) 675 675 Total (Scope 1, 2 & 3 – T&D Losses) 16,894 19,269 Intensity metric: tonnes CO2e/ Million GBP net earned premium (£m) 5.5 6.2 T&D losses from electricity, commuting, paper and business travel (Scope 3) 17,809 17,809 Total (Scope 1, 2 & 3) 34,028 36,403 Intensity metric: tonnes CO2e/ Million GBP net earned premium (£m) 11.0 11.8
Disclosing information to the Auditor Each Director at the date of approving these Annual Report & Accounts confirms that: as far as they are aware, there is no relevant audit information of which Deloitte, the Company’s External Auditor, is unaware; and they have taken all the steps that they ought to have taken as a Director to make themselves aware of any relevant audit information, and to establish that Deloitte is aware of that information.
Notes to the consolidated financial statements 1. Accounting policies 136 2. Critical accounting judgements and key sources of estimation uncertainty 3. Risk management 146 4. Segmental analysis 157 5. Net earned premium 160 6. Investment return 160 7. Other operating income 161 8. Net insurance claims 161 9. Commission expenses 161 10. Operating expenses 161 11. Finance costs 162 12. Tax charge 163 13. Current and deferred tax 163 14. Dividends and appropriations 164 15. Earnings per share 165 16. Net assets per share and return on equity 165 17. Goodwill and other intangible assets 166 18. Property, plant and equipment 167 19. Investment property 168 21. Reinsurance assets 168 22. Deferred acquisition costs 168 23. Insurance and other receivables 169 24. Derivative financial instruments 169 25. Retirement benefit obligations 169 26. Financial investments 171 27. Cash and cash equivalents and borrowings 172 28. Assets held for sale 172 29. Share capital 172 30. Other reserves 172 32. Subordinated liabilities 173 33. Insurance liabilities 174 34. Unearned premium reserve 175 35. Share-based payments 176 36. Trade and other payables including insurance payables 37. Notes to the consolidated cash flow statement 178 38. Contingent liabilities 179 40. Fair value 180 41. Related parties 181
Report on the audit of the financial statements Opinion In our opinion: – the financial statements of Direct Line Insurance Group plc (the “Parent Company”) and its subsidiaries (together the “Group”) give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2018 and of the Group’s profit for the year then ended; – the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the European Union and IFRSs as issued by the International Accounting Standards Board (“IASB”); – the Parent Company financial statements have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice including Financial Reporting Standard 101 “Reduced Disclosure Framework” applied in accordance with the provisions of the Companies Act 2006; and
Key audit matters The key audit matters that we identified in the current year were: – valuation of insurance reserves: 1) The frequency and severity of bodily injury claims; and 2) The inflation and discount rate assumptions for valuing periodic payment orders (“PPOs”).
– valuation of intangible assets; and – valuation of investments not held at fair value. These key audit matters are consistent with those identified in the prior period audit.
Conclusions relating to going concern, principal risk and viability statements Going concern We have reviewed the Directors’ statement on page 121 to the financial statements about whether they considered it appropriate to adopt the going concern basis of accounting in preparing them and their identification of any material uncertainties to the Group’s and Parent Company’s ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements.
We confirm that we have nothing material to report, add or draw attention to in respect of these matters.
Based solely on reading the Directors’ statements and considering whether they were consistent with the knowledge we obtained in the course of the audit, including the knowledge obtained in the evaluation of the Directors’ assessment of the Group’s and Parent Company’s ability to continue as a going concern, we are required to state whether we have anything material to add or draw attention to in relation to: – the disclosures on pages 46 and 47 that describe the principal risks and explain how they are being managed or mitigated; – the Directors’ confirmation on page 75 that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity; or
– the Directors’ explanation on page 49 as to how they have assessed the prospects of the Group, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.
Key audit matters Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) that we identified. These matters included those which had the greatest effect on: the overall audit strategy, the allocation of resources in the audit; and directing the efforts of the engagement team.
These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon. We do not provide a separate opinion on these matters.
The Group’s insurance reserves total £4.0 billion (2017: £4.2 billion). The determination of the value of the insurance reserves requires significant judgement in the selection of key actuarial methodologies and assumptions. Small changes in these methodologies or assumptions can materially impact the valuation of these liabilities. We have identified the following two key areas of focus for our audit given their significance to the Group’s result and the level of judgement involved. Therefore, we have also identified these as potential fraud risk areas.
1) The frequency and severity of large bodily injury claims Key audit matter description The insurance reserve valuation for large bodily injury claims has a significant impact on the Group’s results, with the ultimate quantum of large bodily injury claims being driven by a variety of factors. These factors include the completeness and accuracy of source data, the transparency of any changes in the reporting of large claims, and actuarial assumptions being consistent with emerging data, internal processes and market factors. As a result of these factors, there is a significant level of estimation uncertainty in the valuation of these claims, which increases the susceptibility of the balance to material misstatement due to error and fraud.
How the scope of our audit responded to the key audit matter We have gained a detailed understanding of the end-to-end claims and reserving process and assessed the design and implementation of selected controls, including peer review of actuarial workings and committees where the key assumptions are challenged. In order to gain assurance over the completeness and accuracy of source data used in the Group’s actuarial calculations and by our in-house actuarial specialists in performing their work, we have tested the operating effectiveness of data reconciliations controls and performed reconciliations on the data back to the financial ledger.
2) The inflation and discount rate assumptions for valuing PPOs Key audit matter description The Group is required to settle a proportion of large bodily injury claims as PPOs rather than lump sum payments. The valuation of PPOs has a material impact on the financial statements, with these liabilities totalling £875.9 million (2017: £898.7 million) on a discounted gross basis as detailed in note 2. PPOs are sensitive to the choice of inflation and discount rate used, with small rate changes resulting in material valuation differences. The significant judgement exercised by management in setting the inflation rate of 4% (2017: 4%) and discount rate of 4% (2017: 4%), increases the susceptibility of the balance to material misstatement due to error and fraud.
We have worked with our actuarial specialists to: – review and challenge the Group’s PPO inflation assumption through inquiries with the Actuarial Director, reviewing relevant supporting documentation and benchmarking against market economic data, including the potential risk of increased claims inflation caused by Brexit; – review the Group’s sensitivity testing on the PPO inflation assumption; – review and challenge the selected discount rate with reference to current and future performance of the assets backing the
PPO liabilities, taking account of the uncertainty created for investment markets by Brexit; and – challenge the consistency of the approach with that used in the 2017 year-end valuation and the appropriateness of maintaining that approach in light of the current economic climate and market benchmarking. Key observations We have determined that the inflation and discount rate assumptions used in the calculation of the PPO claims reserve are in the middle of a reasonable range. Given the current low yield environment, and the potential for increased risk of claims inflation in certain Brexit scenarios, we determined that these assumptions continue to require close monitoring going forward.
Valuation of intangible assets Refer to page 77 (Audit Committee Report), page 138 (Accounting policies) and page 166 (Financial statements).
Having decided to rework certain elements of the capitalised expenditure, which resulted in an impairment charge of £56.9 million in 2017, the Group has progressed in developing the asset with roll out scheduled to commence in 2019. Whilst this reduces the risk of delivery failure, in comparison to last year’s audit, until the assets are complete there continues to be a risk of future impairment charges, with the determination of which requiring a significant level of judgement. As a result of these factors, we continue to identify this as a key audit matter as well as a potential fraud risk.
In addition, we performed the following audit procedures: – inquired of system integrators and programme managers, and inspected internal reports, system architecture maps and meeting minutes in order to challenge management on which components of the capital expenditure will ultimately be used in the end-state system; – engaged our in-house IT consultants to assess the feasibility of the IT architecture in delivering the expected benefits across the Group; and
Key observations We have determined that the £nil impairment charge is reasonable. Based on the information available to date we deem the feasibility of successful project delivery and the expected benefits thereof to be reasonable.
In addition, we performed the following audit procedures: – traced a sample of interest payments to bank during the year to test for default or delinquency in interest payments; – engaged our in-house complex pricing team to determine an independent fair value of these assets and identify any significant decreases in fair value below book cost; – assessed the need for impairment on a collective basis through analysing significant macroeconomic and sector specific developments, such as the impact of Brexit on property valuations, as well as the high street decline; and – challenged management on loans of interest where indicators could point to issuer financial difficulty, obtaining evidence to assess whether the position taken by management is reasonable. Key observations We have determined that the £6 million impairment charge arising on non-performing credit assets is reasonable. In performing our procedures, we did not note any other indicators of material impairment.
Materiality was determined as approximately 5.2% (2017: 5.2%) of three-year average profit before tax, excluding the impact of the Ogden discount rate change on year-end results.
Materiality equates to less than 1% (2017: 1%) of shareholders’ equity and is capped at 90% (2017: 90%) of Group materiality.
We determined that the critical benchmark for the Group was average profit before tax. This measure uses a three-year average of profit before tax which we deemed appropriate due to the inherent volatility of profits in the insurance industry. We also elected to exclude the impact of the Ogden discount rate change on the 2016 results and the subsequent move to 0% in 2018 results due to the non-recurring nature of these events.
When determining materiality for the Parent Company, we also considered the appropriateness of this materiality for the consolidation of this set of financial statements to the Group’s results.
We determine performance materiality at a level lower than materiality to reduce the probability that, in aggregate, uncorrected and undetected misstatements exceed materiality for the financial statements as a whole. We have set Group performance materiality at £19.6 million (2017: £19.6 million) and the audit testing for UK Insurance Limited is carried out to a performance materiality of £17.6 million (2017: £17.6 million).
We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £1.4 million (2017: £1.4 million) for the Group financial statements, as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. We also report to the Audit Committee on disclosure matters that we identified when assessing the overall presentation of the financial statements.
These four entities represent the principal trading and service operations of the Group and account for 99% (2017: 99%) of the Group’s net assets, 100% (2017: 100%) of the Group’s gross earned premium and 98% (2017: 98%) of the Group’s profit before tax. They were also selected to provide an appropriate basis for undertaking audit work to address the risks of material misstatement identified above.
The Group audit team was responsible for all of the entities listed above, including the Parent Company.
– Directors’ statement of compliance with the UK Corporate Governance Code – the parts of the Directors’ statement required under the Listing Rules relating to the Company’s compliance with the UK Corporate Governance Code containing provisions specified for review by the auditor in accordance with Listing Rule 9.8.10R(2) do not properly disclose a departure from a relevant provision of the UK Corporate Governance Code.
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, and for such internal control as the Directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.
Details of the extent to which the audit was considered capable of detecting irregularities, including fraud, are set out below.
A further description of our responsibilities for the audit of the financial statements is located on the Financial Reporting Council’s website at: www.frc.org.uk/auditorsresponsibilities. This description forms part of our auditor’s report.
We identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, and then design and perform audit procedures responsive to those risks, including obtaining audit evidence that is sufficient and appropriate to provide a basis for our opinion.
– discussing among the engagement team and involving relevant internal specialists, including actuarial, tax, IT, valuations and pension specialists regarding how and where fraud might occur in the financial statements and any potential indicators of fraud. As part of this discussion, we identified potential for fraud in the following areas: the valuation of the insurance reserves as well as the valuation of the intangible assets due to the estimates and judgements exercised by management; and
– obtaining an understanding of the legal and regulatory framework that the Group operates in, focusing on those laws and regulations that had a direct effect on the financial statements or that had a fundamental effect on the operations of the Group. The key laws and regulations we considered in this context included the UK Companies Act, Listing Rules and tax legislation. In addition, we considered compliance with the terms of the Group’s regulatory solvency requirements when assessing the Group’s ability to continue as a going concern.
Our procedures to respond to risks identified included the following: – reviewing the financial statement disclosures and testing the supporting documentation to assess compliance with relevant laws and regulations discussed above; – enquiring of management, the Audit Committee and in-house legal counsel concerning actual and potential litigation and claims; – performing analytical procedures to identify any unusual or unexpected relationships that may indicate risks of material misstatement due to fraud; – reading minutes of meetings of those charged with governance, reviewing internal audit reports and reviewing correspondence with HMRC, PRA and FCA; and
Opinion on other matters prescribed by the Companies Act 2006 In our opinion the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.
In our opinion, based on the work undertaken in the course of the audit: – 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; and
Matters on which we are required to report by exception Adequacy of explanations and accounting records
Under the Companies Act 2006 we are required to report to you if, in our opinion: – we have not received all the information and explanations we require for our audit; or – adequate accounting records have not been kept by the Parent Company, or returns adequate for our audit have not been received from branches not visited by us; or – the Parent Company financial statements are not in agreement with the accounting records and returns.
Insurance claims recoverable from / (payable to) reinsurers 8 55.1 (183.1) Net insurance claims 8 (1,911.8) (1,754.2)
Profit for the year attributable to owners of the Company 473.7 434.0
Other comprehensive loss for the year net of tax (114.2) (11.3) Total comprehensive income for the year attributable to owners of the Company 359.5 422.7
The attached notes on pages 136 to 181 form an integral part of these consolidated financial statements.
Assets Goodwill and other intangible assets 17 566.8 471.1 Property, plant and equipment 18 156.2 174.4
Current tax assets 13 – 0.1 Deferred acquisition costs 22 171.0 185.4 Insurance and other receivables 23 875.9 981.2 Prepayments, accrued income and other assets 128.0 146.2 Derivative financial instruments 24 48.2 84.4 Retirement benefit asset 25 17.0 14.4
Derivative financial instruments 24 25.9 12.0 Trade and other payables, including insurance payables 36 554.1 658.0 Deferred tax liabilities 13 7.6 31.1 Current tax liabilities 13 46.0 40.7 Total liabilities 6,466.5 6,886.6 Total equity and liabilities 9,386.1 9,948.2
134 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1
Profit for the year – – – – – 434.0 434.0 – 434.0
Profit for the year – – – – – 473.7 473.7 – 473.7
Dividends and appropriations paid (note 14) – – – – – (503.8) (503.8) – (503.8) Shares acquired by employee trusts – (19.5) – – – – (19.5) – (19.5) Credit to equity for equity-settled share-based payments (note 35) – – – – – 21.0 21.0 – 21.0 Shares distributed by employee trusts – 18.4 – – – (18.4) – – – Tax on share-based payments – – – – – 0.8 0.8 – 0.8
136 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1
The fair value at the end of the reporting period for financial assets with contractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount are disclosed in note 40. The amount of change in the fair value during the period for these financial assets was: AFS debt securities £103.7 million decrease, held-to-maturity (“HTM”) debt securities £3.2 million decrease, infrastructure debt £18.2 million decrease and commercial real estate loans had a small increase.
Derivative assets do not have contractual terms that give rise on specified dates to cash flows that are solely payment of principal and interest on the principal amount outstanding. The fair value of these financial assets is disclosed in note 40 and the amount of change in the fair value during the period was £26.7 million.
The Group operates equity-settled share-based schemes only and has no obligation to withhold tax in respect of the employee’s personal tax liability. These amendments have no impact on the Group’s share-based payments accounting policy.
A number of further narrow scope amendments which became effective for the Group but do not have an impact on existing accounting policies, are as follows: The IASB amended IAS 40 ‘Investment Property’ to clarify when an entity should categorise a property as an investment property. Property should be transferred to or from investment property when there is evidence of a change in use meaning the property now satisfies, or ceases to satisfy, the definition of an investment property.
Annual Improvements to IFRS Standards 2014–2016 Cycle relating to IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ – the amendment deletes certain shortterm exemptions for first-time adopters, and IAS 28 ‘Investments in Associates and Joint Ventures’ – the amendment provides clarification that measuring investees at fair value through profit or loss is an investment-by-investment choice.
Non-monetary items denominated in foreign currencies that are stated at fair value are translated into the relevant functional currency at the foreign exchange rates ruling at the dates the values are determined. Translation differences arising on nonmonetary items measured at fair value are recognised in the income statement except for differences arising on AFS nonmonetary financial assets, which are recognised in other comprehensive income.
138 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 1.4 Revenue recognition continued The Group’s income also comprises vehicle repair services provided to other third-party customers. Income in respect of repairs to vehicles is recognised upon completion of the repair obligations. The price is determined using market rates for the services and materials used after discounts have been deducted where applicable.
A reinsurance bad debt provision is assessed in respect of reinsurance debtors, to allow for the risk that the reinsurance asset may not be collected or where the reinsurer’s credit rating has been downgraded significantly and this is taken as an indication of a reinsurer’s difficulty in meeting its obligations under the reinsurance contracts. This also includes an assessment in respect of the ceded part of claims provisions to reflect the counterparty default risk exposure to long-term reinsurance assets particularly in relation to PPOs. Increases in this provision affect the Group by reducing the carrying value of the asset and the impairment loss is recognised in the income statement.
Value in use is the present value of future cash flows from the asset or CGU, discounted at a rate that reflects market interest rates, adjusted for risks specific to the asset or CGU that have not been reflected in the estimation of future cash flows.
140 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 1.12 Financial assets continued If the market for a financial asset is not active, the Group establishes the fair value by using a valuation technique. Valuation techniques include using recent arm’s length market transactions between knowledgeable and willing parties (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.
Held-to-maturity and loans and receivables If there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as HTM or 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.
FINANCIALS V6.1 WWW.DIRECTLINEGROUP.CO.UK 141 1.13 Cash and cash equivalents and borrowings Cash and cash equivalents comprise cash in hand and demand deposits with banks together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.
Borrowings, comprising bank overdrafts, are measured at amortised cost using the effective interest rate method.
1.15 Subordinated liabilities Subordinated liabilities comprise subordinated guaranteed dated notes which are initially measured at the consideration received less related transaction costs. Subsequently, subordinated liabilities are measured at amortised cost using the effective interest rate method.
1.16 Provisions The Group recognises a provision for a present legal or constructive obligation from a past event when it is more likely than not that it will be required to transfer economic benefits to settle the obligation and the amount can be reliably estimated.
The current tax charge is based on the taxable profits for the year as determined in accordance with the relevant tax legislation, after any adjustments in respect of prior years. Taxable profit differs from net profit as reported in the income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible.
Provision for taxation is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date and is allocated over profits before taxation and amounts charged or credited to components of other comprehensive income and equity, as appropriate.
142 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 1.20 Share-based payment continued The fair value of options granted is estimated using valuation techniques which incorporate exercise price, term, risk-free interest rates, the current share price and its expected volatility.
1.23 Accounting developments New IFRSs and amendments that are issued, but not yet effective for the 31 December 2018 reporting period and have not been early adopted by the Group are disclosed below. The Group intends to adopt these standards, if applicable, when they become effective, except for IFRS 9 as explained below.
The Group expects to recognise right-of-use assets of approximately £150.0 million on 1 January 2019 and lease liabilities of approximately £165.0 million. The reduction to equity after tax is approximately £15.0 million. From 1 January 2019 lease charges previously recognised as rental expenses in profit or loss will instead comprise depreciation and finance costs. The profit or loss impact, had this standard been adopted on 1 January 2018, would have been a reduction in operating expenses of approximately £5 million and an increase in finance costs of approximately £7 million in the 2018 consolidated income statement.
In July 2014, the IASB issued the final version of IFRS 9 which replaces IAS 39 ‘Financial Instruments: Recognition and Measurement’ and all previous versions of IFRS 9; it was endorsed by the EU in 2016. IFRS 9 addresses the classification, measurement and derecognition of financial assets and financial liabilities, introduces new rules for hedge accounting and a new impairment model for financial assets; it is effective for annual periods beginning on or after 1 January 2018.
In September 2016, the IASB issued amendments to IFRS 4 to address issues arising from the different effective dates of IFRS 9 and IFRS 17. The amendments to IFRS 4 were endorsed by the EU in November 2017.
Amendments to IFRS 9: ‘Prepayment Features with Negative Compensation’ was issued in October 2017 to allow instruments with symmetric prepayment options to qualify for amortised cost or fair value through other comprehensive income measurement because they would otherwise fail the ‘solely payments of principal and interest on the principal amount’ condition. The amendments are effective from the same period as IFRS 9.
An assessment on the impact of IFRS 17 on the Group’s financial statements is in progress. The Group expects to be able to apply the simplified premium allocation approach to most of its insurance and reinsurance contracts.
IAS 12 ‘Income Taxes’ – the amendments clarify that all income tax consequences of dividends should be recognised in profit or loss, regardless of how the tax arises.
In March 2018 the IASB issued ‘Amendments to References to the Conceptual Framework in IFRS Standards’ – amending some references to previous versions of the Conceptual Framework in IFRS Standards and their accompanying documents and IFRS Practice Statements. This is effective from 1 January 2020.
In October 2018 the IASB issued ‘Amendments to IAS 1 and IAS 8 Definition of Material’ – this clarifies and aligns the definition of ‘material’ and provides guidance to help improve consistency in the application of that concept whenever it is used in IFRS Standards. This is effective from 1 January 2020.
In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting policies, Changes in Accounting Estimates and Errors’ 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 Group has made a judgement that there was objective evidence of impairment of an asset within the loan and receivables portfolio in the year ended 31 December 2018. The Group has also made an estimation of the recoverable value of the loan and this resulted in an impairment charge of £6.0 million (2017: £9.5 million).
2.2 Fair value The Group has made the judgement that level 1 of the Group’s fair value hierarchy set out in note 40 will include only sovereign debt securities issued by members of the G10 group of countries within the Group’s AFS debt securities portfolio, with all other financial assets and liabilities carried at fair value included in level 2 as they are not considered to be quoted in a deeply liquid market.
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 calculations have reference to a standardised annuity factor at a discount rate normally referenced to as the Ogden discount rate. The Ogden discount rate was at 2.5% from 2001 until 2017, when it was changed to minus 0.75% based on a 3-year average of yields on index-linked Government securities, in line with case law that claimants were entitled to invest their lump sum in a way which was very low or even zero risk. The Civil Liability Act 2018 changes this approach and instead requires the Government to reset the Ogden discount rate by reference to low risk rather than very low or zero risk investments. The process is due to conclude in 2019, but there is considerable uncertainty about its outcome and the date from which a new rate will apply.
The Group will continue to exercise judgement around the Ogden discount rate used in its reserves. Risks and uncertainties here are significant but the move to introduce additional asset classes into the assumed claimant portfolio points towards a higher rate than minus 0.75%. The Group has therefore made a judgement that it is likely that the Ogden discount rate will change and has selected an estimate of 0% to value its lump sum bodily injury reserves. An allowance for further movements in the Ogden discount rate is made within the Group’s solvency II balance sheet and capital requirements. Details of the IFRS sensitivity analysis to the assumed Ogden discount rate are shown in note 3.3.1.
The table below analyses the outstanding PPO claims provisions on a discounted and an undiscounted basis at 31 December 2018 and 31 December 2017. These represent the total cost of PPOs rather than any costs in excess of purely Ogden-based settlements.
The provisions for PPOs have been categorised as either claims which have already been determined by the courts as PPOs (approved PPO claims provisions) or those expected to settle as PPOs in the future (anticipated PPOs). The Group has made a judgement on the likelihood of large bodily injury claims settling as PPOs. The anticipated PPOs in the table above are based on historically-observed propensities adjusted for the assumed Ogden discount rate. They do not allow for any future changes in PPO propensity. Anticipated PPOs consist of both existing large loss case reserves including allowances for development and claims yet to be reported to the Group. Reinsurance is applied at claim level and the net cash flows are discounted for the time value of money. The discount rate is consistent with the long duration of the claims payments and the assumed future indexation of the claims payments.
146 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 3. Risk management 3.1 Enterprise Risk Management Strategy and Framework The Enterprise Risk Management Strategy and Framework sets out, at a high level, our approach and processes for managing risks. Further information can be found in the risk management section of the strategic report on page 45.
The Board is closely involved in the SCR process and reviews, challenges and approves its assumptions and results.
Reserve risk is controlled through a range of processes: – regular reviews of the claims and premiums, along with an assessment of the requirement for a liability adequacy provision for the main classes of business by the internal actuarial team; – the use of external actuaries to review periodically the actuarial best estimate reserves produced internally, either through peer review or through provision of independent reserve estimates; – accompanying all reserve reviews with actuarial assessment of the uncertainties through a variety of techniques including bootstrapping and scenario analysis; – oversight of the reserving process by relevant senior management and the Board; – regular reconciliation of the data used in the actuarial reviews against general ledger data and reconciliation of the claims data history against the equivalent data from prior reviews; and – regular assessment of the uncertainty in the reserves to help the Board set management best estimate reserves.
The Group’s reserves are subject to the risk of retrospective changes in judicial conditions such as the change in the Ogden discount rate announced on 27 February 2017. This is the discount rate set by the Lord Chancellor and used by courts to calculate lump sum awards in bodily injury cases. The rate had been 2.5% since 2001 but was changed to minus 0.75% from 20 March 2017. The Group revised its reserve estimation to be based on the new rate for year ended 31 December 2016. However, this rate is expected to change again in 2019 following the passing of the Civil Liability Act 2018. In anticipation of change, the Group has revalued its reserves based on an assumed Ogden discount rate of 0% for the year ended 31 December 2018. The new Ogden discount rate may differ from this assumption, and consequently further reserve revaluation may be required, both in 2019 and going forwards as part of the new Ogden discount rate review process introduced by the Civil Liability Act.
The table below provides a sensitivity analysis of the potential net impact of a change in a single factor (discount rate used for PPOs and separately the Ogden discount rate) with all other assumptions left unchanged. Other potential risks beyond the ones described could have an additional financial impact on the Group.
The reduction in sensitivity to a change in the Ogden discount rate since 31 December 2017 primarily reflects the overall reduction in bodily injury exposures. The reduction in exposure is due to continued positive prior-year development of claims reserves for large bodily injury claims, particularly for accident years where the reinsurance retention level was higher than the current level of £1.0 million.
There is the risk that claims are reserved or paid inappropriately, including the timing of such activity. However, there are claims management controls in place to mitigate this risk, as outlined below: – 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; – each member of staff has a specified handling authority, with controls preventing them handling or paying claims outside their authority, as well as controls to mitigate the risk of paying invalid claims. In addition, there are various outsourced claims handling arrangements, all of which are monitored closely by management, with similar principles applying in terms of the controls and procedures; – loss adjustors are used in certain circumstances to handle claims to conclusion. This involves liaison with the policyholder, third parties, suppliers and the claims function; – specialist bodily injury claims teams are responsible for handling these types of losses with the nature of handling dependent on the level and type of claim. Claims exceeding a certain threshold are referred to the technical and large loss teams who also deal with all other claim types above defined limits or within specific criteria; and
Underwriting risk includes catastrophe risk and the risk of loss, or of adverse change in the value of the insurance liabilities resulting from significant uncertainty of pricing, underwriting and provisioning assumptions related to extreme or exceptional circumstances.
Reinsurance risk This is the risk of inappropriate selection and/or placement of reinsurance arrangements, with either individual or multiple reinsurers, which renders the transfer of insurance risk to the reinsurer(s) inappropriate and/or ineffective. Other risks include: – reinsurance concentration risk – the concentration of credit exposure to any given counterparty; – reinsurance capacity being reduced and/or withdrawn; – underwriting risk appetite and reinsurance contract terms not being aligned; – reinsurance contract terms being inappropriate or ineffective resulting in classes or types of business not being appropriately reinsured; – non-adherence to the reinsurance policy terms and conditions, in terms of both policy management and claims not being handled within the reinsurance contract terms and conditions or paid on an ex-gratia basis resulting in reinsurance recoveries not being made in full; – inappropriate or inaccurate management information and/or modelling being used to determine the value for money and purchasing of reinsurance (including aggregate modelling); and
The Group has policies and limits approved by the Investment Committee for managing the market risk exposure. These set out the principles that the business should adhere to for managing market risk and establishing the maximum limits the Group is willing to accept having considered strategy, risk appetite and capital resources.
The strategic asset allocation within the investment portfolio is reviewed by the Investment Committee, which makes recommendations to the Board for its investment strategy approval. The Investment Committee determines policy and controls, covering such areas as risk, liquidity and performance. The Investment Committee meets at least three times a year to evaluate risk exposure, the current strategy, associated policies and investment guidelines and to consider investment recommendations submitted to it. Oversight of the implementation of decisions taken by the Investment Committee is via the First and Second Lines of Defence.
The Group uses its internal economic capital model to determine its capital requirements and market risk limits and monitors its market risk exposure based on a 99.5% value-at-risk measure. The Group also applies market risk stressed scenarios testing for the economic impact of specific severe market conditions. The results of this analysis are used to enhance the understanding of market risk. The asset liability matching, and investment management minimum standard explicitly prohibits the use of derivatives for speculative or gearing purposes. However, the Group is able to and does use derivatives for hedging its currency risk and interest rate risk exposures.
Spread risk This is the risk of loss from the sensitivity of the value of assets and investments to changes in the level or in the volatility of credit spreads over the risk-free interest rate term structure. The level of spread is the difference between the risk-free rate and actual rate paid on the asset, with larger spreads being associated with higher risk assets. The Group is exposed to spread risk through its asset portfolio, most notably through its investment in corporate bonds.