R e p o rt a n d A c c o u n ts
Profit before tax excluding certain foreign currency items* £156.2m (2007: £237.2m)
Total dividend for the year increased by 6.25% to 12.75p (2007: 12.0p)
Excellent combined ratio of 76.1% (2007: 84.4%) or 91.9% (2007: 85.5%) excluding foreign exchange
Richard Watson Managing Director, Hiscox Global Markets, Active Underwriter, Syndicate 33
£237.2 million) on a gross written premium income of £1,147.4 million (2007: £1,198.9 million). The combined ratio was 76.1% (2007: 84.4%). Earnings per share on profit after tax were 18.8p (2007: 48.4p) and net assets per share increased by 23% to 258.1p (2007: 209.5p). Return on equity was 9.2% (2007: 28.8%).
The current state of the market The market overall is solid and healthy. There is comment that rates are not rising fast everywhere, but much as I enjoy surging rates following a big loss, underwriters do tend to push prices too high which attracts new capital. And if rates are pushed too high, they have to come down and the momentum of the insurance cycle starts to swing down. Rates are being put up selectively, capital is tight, our current combined ratio is 91.9% stripping out currency distortions, so market conditions are profitable and improving. The better underwriters can make good money at these rates so we do not want to push them up faster which will just help the weaker ones.
The current state of our business I leave it to Bronek, our inestimable CEO who runs the company with remarkable passion and ability, to comment on the business in detail. Conditions at Hiscox are better than good. Our time honoured strategy has been to write internationally traded big ticket and catastrophe business (through Global Markets and Bermuda principally), and balance it with regional, smaller business in the UK, Europe and the USA.
A great asset of the insurance industry is that feast always follows famine. After big losses there is a shortage of capital and supply so we can put rates up and recoup our losses. Conversely, the curse of the industry is the ease of entry, with an instant inflow of capital when we get the rates into profit territory. The last quarter of 2008 saw a firming in rates in some of our key areas (particularly reinsurance which is a third of our book) and a stabilisation in others, but this time there is a global shortage of capital, which means we should be able to charge the right rate for some time to come.
Results The result for the year ended 31 December 2008 was a profit of £105.2 million (2007: Robert Hiscox Chairman
The future All areas of the company have good possibilities of profitable growth and there is a great feeling of dynamism throughout. We have taken on some excellent new people. I would like to thank them for joining us, and also thank the existing staff in all areas of the business for making Hiscox an exciting and constantly challenging environment.
Our direct household and small commercial business in the UK had good growth in 2008 and will be helped this year by our new marketing campaign.
Investments An investment return of -1.3% is a fair one, even a good one, in the circumstances of the worst year on record for most types of investment. Our staple diet consists of bonds, and trying to squeeze an extra point or two of yield could have led us into the toxic products that have done so much damage. However, we have only had one insolvency so far, a relatively small investment in Lehman Brothers bonds; otherwise we have marked to market, and as low as some of those valuations are, the instruments are all paying their coupons and heading for redemption.
The Board Carol Franklin Engler retired from the Board during the year having served nine years. Carol brought an underwriter’s eye to our deliberations with an uncanny talent for pricking balloons. She also had human resources experience, which together with her other outside activities made her an extremely effective Director. I would like to thank her for her valuable contribution through a period of great change.
We have been joined by Gunnar Stokholm and Ernst Jansen, both of whom have vital experience of building international insurance businesses. They bring considerable underwriting knowledge as well as international business experience to our strategic planning and Board discussions.
Our balance sheet is strong and sufficient for our current plans.
, s pe cie , po liti ca l r isk s, ae ro sp ac e
Tec h an d m edia erro rs a nd o mis sion s 6%
We now see opportunity ahead of us. Recent market turbulence has severely affected some of our competitors and we have seized the opportunity to attract good staff – particularly in the US.
Hiscox Global Markets rating index Index level (%). 12 month rolling period
Dec 98 6 Chief Executive’s report Hiscox Ltd Report and Accounts 2008
Group performance The pre-tax profit for the year was £105.2 million (2007: £237.2 million). Gross written premium shrank to £1,147.4 million (2007: £1,198.9 million). Earnings per share are 18.8p (2007: 48.4p). Return on equity was 9.2% (2007: 28.8%) and net asset value per share increased to 258.1p (2007: 209.5p). Net tangible assets increased to 244.9p (2007: 199.3p). Dividends increase to 12.75p (2007: 12p). These results were achieved despite a very challenging investment environment, which saw investment returns on financial assets falling to a loss of £27.6 million, in contrast to a positive contribution of £100.8 million in 2007.
The significant appreciation in net asset value reflects both our profit and the impact of the Dollar strengthening. At the end of the year, £603 million of shareholders’ funds were held in US Dollars.
Hiscox Global Markets Hiscox Global Markets underwrites a mix of big ticket international and reinsurance business, and specialty business where deep expertise in specific product lines draws the business to London. All of these lines take advantage of the Lloyd’s brand and licence network. During the year Global Markets showed exceptional discipline in shrinking in almost all its areas, rather than writing business at the wrong price.
Our global errors and omissions business was created this year to bring together our expertise in the technology and media fields with that in the broader error and omission field. The team had a difficult year as they dealt with a series of large claims. Rates in this area need to rise – and until they do we will continue to take a very cautious approach.
The growth of the business outside London brings with it inevitable conflict with those brokers, and indeed those underwriters, who are entirely London centric. Growth and activity in the US has not diminished our commitment to the London Market and we will seek to expand in both areas. The key to success in London is a continued investment by Hiscox, and the market as a whole, in efficiency and improving infrastructure. In 2008 Global Markets worked on a project to replace its core underwriting system. The project was due to be delivered in the second half of the year but, as seems inevitable when dealing with projects of this scale and complexity, completion is now expected in the first half of 2009. Once this new system is in place, we will be investing in connecting to the newly announced Lloyd’s Exchange, as we believe that over time it is in everyone’s interest that underwriting moves to a more electronic environment. If the London Market as a whole is able to achieve this it is our belief that it will continue to be the vibrant centre of the international insurance industry.
When planning for Global Markets in 2009 we initially announced a reduction in the size of Syndicate 33, however in response to market changes we have reconsidered our plans. We have increased the size of Syndicate 33 to £750 million (2008: £700 million) and renewed the Cougar Syndicate 6104 which is supported entirely by third-party capital at the increased level of £43 million (2008: £34 million). In addition we created Syndicate 3624 with a capacity of £80 million which is completely capitalised by Hiscox. Syndicate 3624 will provide capacity for all the new lines of business which we are planning to underwrite in the US, most of the business already generated by Hiscox USA and 50% of the technology and media business. These structures introduce an element of complexity into our business, but give us greater flexibility in planning our business expansion.
Growth and activity in the US has not diminished our commitment to the London Market and we will seek to expand in both areas.
Chief Executive’s report continued pleased with developments in our specialty commercial area and the new motor business which was launched in 2008. The successful launch of our luxury motor product demonstrates that people value quality insurance. We have continued to invest in the UK Direct business, which has made good progress. The brand building which has supported this business has had benefits not only here, but for the Group as a whole.
Hiscox Europe saw growth of 12.0% in the year as a whole and a strong improvement in underwriting profit in local currency. France and Belgium continued to deliver good profits and Germany and the
Charles Dupplin, currently Chairman of Hiscox’s Art and Private Client division and Director of Mergers and Acquisitions, will succeed Robert Childs as Chief Executive of Hiscox Bermuda. Charles will take up this new role in April 2009, subject to regulatory approval. As previously announced, Robert Childs will return to the UK towards the end of April 2009. He will continue in his roles as Group Director of Underwriting and Chairman of Hiscox USA and he will also serve as an internal Non Executive of Hiscox Bermuda. In the last three years our team in Bermuda, led by Robert, has built a vibrant business from nothing. I would like to thank Robert for his leadership. With Charles at the helm, I am confident that our Bermuda business will continue to develop.
Hiscox Guernsey had another good year. It grew its core kidnap and ransom and fine art accounts and responded rapidly with new products to the piracy threat on the Horn of Africa. It is this fast response to market conditions which sets this team apart from its competitors. We have a great business development team based in London and have now created a Miami office as a gateway to South America. Opportunities abound. Hiscox USA continued on its journey to build a specialist business in the USA. Top line grew 32% to $59.2 million (2007: $44.7 million) and the result was close to break even. The team continues to gain scale and build reputation amongst brokers. It has also taken advantage of the financial market turmoil to recruit new staff. New team members joined in New York and Lexington (where we have now opened an office) and members of the current team will relocate to Miami and the West Coast this year to build our local presence. The key constraint in the USA is the time taken to get rate and forms approved by the state regulators. We currently have 15 products going through this process.
Claims Effective claims management is essential to provide good customer service. As we expand we have been careful to make sure that our claims standards are preserved.
We have continued to invest in claims operations, including the strengthening of complex claims management capability for big ticket businesses in Global Markets and Bermuda and in developing our service culture to our policyholders in our retail operations. In the UK we settle 10% of our UK property claims in one day and 45% in 30 days.
In 2008, our claims teams settled our two largest historic outstanding claims. This required long and sensitive discussions with the assureds and it is to the team's credit that this was achieved while still retaining positive relationships with those clients.
Hiscox holds assets to match its insurance liabilities in original currencies, thereby reducing the impact of volatile exchange rates and making active use of shareholders funds. The majority of the net assets are in US Dollars and as the Dollar strengthened during the year, the decision was made to lock in some of the resulting gains by entering into economic hedge contracts to protect against further fluctuations. As the year progressed the Dollar strengthened further and the additional underlying gain was offset by the cost of the hedge. As a result of accountancy rules, this cost of £42.5 million was taken through the profit and loss account, while the underlying gain of £151.2 million was taken directly to the balance sheet.
Further FX gains arose in the trading accounts during the course of 2008. Together these contributed £57 million to our reported profits (2007: £7 million) net of foreign exchange on economic hedges and intragroup borrowings.
In 2008 loss reserves grew to £1.8 billion (2007: £1.2 billion). This includes our loss estimates of net $175 million for Hurricanes Ike and Gustav. Total reserve releases during the course of the year amounted to £123 million (2007: £60 million). This release is larger than previous years as two of our biggest outstanding historic claims were settled during the period.
During the course of the year Hiscox has benefited from a series of positive rating agency decisions. On 18 September 2008 A.M. Best announced an upgrade to the financial strength rating of Hiscox Insurance Company (Bermuda) Limited, Hiscox Insurance Company (UK) Limited and Hiscox Insurance Company (Guernsey) Limited to A (Excellent) from A- (Excellent). It has also affirmed a financial strength rating of A for Hiscox Syndicate 33 and Hiscox Insurance Company Inc. The outlook for the rating is stable. In December Standard & Poor’s also upgraded their rating for the Hiscox Insurance Company Ltd to A (Strong).
These rating actions reflect the strength of Hiscox’s diversified global portfolio and give us a competitive benefit in the new, more cautious world in which we operate. A key to retaining this balance is the need to balance the rewards from underwriting with the risks. We plan to continue to run our business so that it can survive a 1 in 250 catastrophic year. Of course we measure this by drawing on our extensive modelling capability, but as recent events show, models are inevitably flawed and we will continue to supplement the model output with instinct and pragmatic business judgement.
Capturing opportunities In the middle of the year we thought the market would continue to soften and that Hiscox would continue to invest in its regional business to offset the planned reduction of the big ticket insurance and reinsurance businesses. The financial crises which broke in mid September changed our view.
Overnight we went from defence to offence. We expanded our US domestic presence through the recruitment of 43 staff and the opening of five new offices. Our ambition is to build Hiscox into a top ten surplus lines market and a respected specialist player in the US admitted market.
In addition to the domestic US opportunities, we believe that there will be material benefits to our London operations as insureds re-discover the benefits of the subscription market where risks are shared between many participants. Our levels of expertise mean that Hiscox is a ‘must visit’ business in London – and we aim to keep it that way.
Conclusion 2008 will be remembered as one of the most challenging in history for the world economy, and 2009 is shaping up in the same vein. I hope I am not tempting fate by saying that whilst we are acutely aware of the dangers in this crisis, we believe that there are good opportunities ahead for Hiscox and that success in capturing them will bring considerable benefits to policyholders, staff and shareholders.
Panther Re The reinsurance contract with Panther Re was not renewed for the 2008 year of account and the 2007 year of account was successfully commuted during 2008.
Hiscox Insurance Company Limited Gross premiums written geographical split by origin (%)
Core Combined ratio 14 Insurance carriers Hiscox Ltd Report and Accounts 2008
Hiscox Insurance Company Hiscox purchased Hiscox Insurance Company Limited in 1996, in keeping with its aim of diversifying its activities outside of Lloyd’s and writing a focused book of regional specialist risks. The Group has reshaped the Company’s original portfolio to concentrate on high value household and smaller premium professional indemnity business. Hiscox Insurance Company has licences throughout Europe. It is the primary insurance vehicle used by the UK and mainland Europe offices for their business. The success of the reshaped portfolio can be seen in the chart below.
Hiscox Insurance Company Limited has achieved average compound growth in gross premiums written of 14% from 1997 to 2008, despite discontinuing almost all of its original business. It has also significantly improved its combined ratio.
Hiscox Insurance Company (Bermuda) Formed by Hiscox in late 2005, Hiscox Insurance Company (Bermuda) Limited completed its first full year of business in 2006. Initially capitalised at $502 million, it has access to reinsurance business shown to the growing Bermuda market and has also become a vehicle for intragroup reinsurance. During the year A.M. Best upgraded the rating of Hiscox Bermuda to A (Excellent). At the end of 2008, net assets were $803.8 million (2007: $760.7 million).
The reduction in profit before tax reflects the twin challenges of the unprecedented volatile investment markets and increased catastrophe losses prevalent during 2008. The Group’s investment portfolio negotiated difficult market conditions reasonably well however the protracted influence on valuations from widening credit spreads and the greater worldwide intolerance of equity risk assets outweighed the coupon returns from fixed
The Group’s reported profit before tax includes foreign currency items of £51 million in relation to foreign currency hedging contracts and foreign currency losses on intragroup borrowings. The hedging contracts were used to hedge part of the Group’s net investment in its Bermuda and Guernsey insurance operations and the £42.5 million of charges incurred are therefore economically linked to the underlying currency translation gains of £151.2 million recognised directly in equity. Not withstanding the fact that a formal hedge accounting treatment for this net investment relationship could not be achieved with these hedging contracts, the Group believes they are the most economically sound means of shielding foreign exchange movements in the investments’ value to an acceptable range. £8.5 million of foreign exchange losses on intercompany positions again are inseparable from similar and opposite gains recognised in the balance sheet.
It includes the results of the larger retail technology and media (TMT) business written by Hiscox Insurance Company Limited.
Gross premiums written decreased by 13.3% on the prior year as the business continued to strategically retreat from inadequately priced risks in certain lines of business which were increasingly contested during the year. This shrinkage was partially offset by the impact of reinstatement premiums on reinsurance business following Hurricane Ike and favourable exchange rate movements during the second half of the year. The percentage of reinsurance purchased by the Global Markets segment was 27.5% (2007: 22.4%). The reinsurance partnership with Panther Re was successfully commuted in January 2008 and the business utilised the quota share arrangement with the Cougar Syndicate and reinsurance contracts with commercial reinsurers on similar terms throughout 2008 in return for ceding and profit commissions. Net premiums written and earned fell representing in part the reduction in business volume.
Investment income reduced to £5.8 million negative (2007: £46.6 million positive) as widening spreads in fixed income markets compounded the effects of lower prevailing cash interest rates. The business incurred significant net catastrophe losses, mainly in respect of Hurricanes Ike and Gustav, in contrast to the relatively benign loss experience in 2007. The expense ratio declined to 36.7% (2007: 37.4%) as lower employee compensation costs offset the increased investment made in a number of operational areas.
Gross premiums written increased by over 10% for the second year running. Management successfully expanded underwriting activity across all core lines of retail business, especially in the direct product offerings and for the professional and specialty commercial risks.
Reinsurance outwards costs reduced by £7.7 million to £18.7 million (2007: £26.4 million) as the UK business retained additional aggregate exposure as comparable cover to the prior year became prohibitively expensive. The business also avoided any need for reinstatement premiums on its reinsurance programme unlike 2007 when £2.2 million was incurred subsequent to the summer flood events. The widespread de-leveraging in equity markets during 2008 resulted in all dividend income returns being more than erased by significant unrealised fair value losses in valuations.
The claims ratio reduced to 39.8% (2007: 45.6%), reflecting the absence of significant catastrophe losses in contrast to the prior year which was characterised by multiple unusual large loss events including Windstorm Kyrill and the UK summer flooding incidents.
Group financial performance Hiscox Ltd Report and Accounts 2008 12.75p Dividend for 2008 increased by 6.25%
Improved expense management and economies of scale accompanied the favourable prior year claims experience such that the combined ratio improved
In common with the UK business, reinsurance outwards costs fell to £7.5 million (2007: £10.9 million) mainly as a result of less low level reinsurance cover being purchased.
The expense ratio decreased for the second year running to 52.4% (2007: 56.2%) as the business continued to unlock scale benefits of premium growth outstripping expenses which grew more sparingly. There was an exchange gain of £23.2 million, partially offset through derivative losses, to manage the exposure to Euros. The combined ratio therefore improved overall to 70.6% (2007: 96.2%), primarily driven by exchange gains and favourable loss ratios across most European regions and product lines.
Hiscox International performance International comprises the results of Hiscox Insurance Company (Guernsey) Limited, Hiscox Insurance Company (Bermuda) Limited, Hiscox Inc. and Hiscox Insurance Company Inc.
Investment income reduced to £8.1 million negative (2007: £23.9 million positive) mainly attributed to adverse interest rate movements in addition to the unusually challenging market conditions outlined above. The claims ratio was 43.0% (2007: 40.1%) as catastrophe losses in Bermuda accrued from the more active 2008 hurricane season, and other large risk losses in the first half of the year. This dampened good loss conditions in Guernsey and the USA. The expense ratio was up at 38.8% (2007: 36.8%). This is as a result of a full year of ALTOHA Inc. Group and expansion costs to take advantage of opportunities in the US. Profit before tax therefore reduced to £0.9 million (2007: £69.1 million).
Hiscox Corporate Centre performance Corporate Centre comprises the investment return and administration costs associated with the Company and other Group management activities. These non-underwriting entities capture the majority of the Group’s funding costs.
Derivative charges of £42.5 million were incurred in protecting £47.6 million of the currency translation gains recognised directly in equity (2007: £nil), made prior to the execution of these contracts. This was far outweighed by the £151.2 million translation gains recognised in equity. Finance costs decreased markedly to £4.7 million (2007: £8.1 million) as the Group repaid its $182 million term loan facility early in May 2008.
Net cash inflows from operating activities during the year were £200.9 million (2007: outflow of £123.5 million). The cash inflow was mainly as a result of the strong underwriting result together with continued favourable collection and settlement of outstanding amounts from reinsurance partners. In addition, the Group’s investment in the current year in financial assets which do not qualify for presentation as cash equivalents reduced to £284.1 million compared with £489.7 million during 2007. The Group includes the purchase, maturity and disposal of financial assets as part of its insurance activities and as such they are classified as operating cash flows.
During the latter half of the year, the Group experienced defaults of £6 million on debt securities held with one financial institution. Net cash outflows from investing activities for the year were £16.7 million (2007: outflow £23.6 million). During the year the Group acquired Amershill Limited for a consideration of £2 million. Amershill is a wholly owned subsidiary and acts as an underwriting agent for the Group. The Group also purchased a holding in two new associate companies for total consideration of £5.4 million.
As at the year end £137.5 million of the Letter of Credit and £90.3 million of debt was drawn.
Group assets The Group’s invested assets grew to £2.52 billion (2007: £2.05 billion) with steady cash flow and the effect of a strong Dollar.
The investment return, excluding derivative positions, declined to £27.6 million negative (2007: £100.8 million positive) in the last year. Hiscox has a policy of focussing on high quality short duration bonds and this has held us in good stead during what has been a traumatic time for most investors. Despite our conservative stance the portfolio suffered from the extreme weakness in equity markets and the widening of spreads on non Government bonds.
During the year we reduced our exposure to equities which further mitigated the overall impact of the weak markets. In turn our risk assets outperformed the broader indices helped by our modest allocation to hedge funds which, as intended, provided a helpful buffer to our long only managers.
Insurance Catastrophe and systemic insurance losses The Group continues to underwrite significant risks in geographical regions that are prone to natural peril. This business remains a compelling proposition for the Group since it is capable of returning good margins over the mediumto long-term as the occurrence of catastrophes averages out. As with similar insurers, the Group’s earnings are affected by unpredictable external events such as natural and other catastrophes, legal developments, social and economic change and the emergence of latent risks. Such events can create significant levels of underwriting losses. The Group manages its exposure to these risks through having a clearly defined risk appetite which dictates the business plan and is realised through disciplined underwriting, close and continuous monitoring of exposures and aggregations and a prudent and disciplined reinsurance purchase programme to cap losses from risk concentrations.
Incentives ensure that underwriting staff make sound and objective judgements that are aligned with the Group’s overall strategic objectives.
We adjust our business plan, target products and reinsurance programme to deliver a welldiversified book with a large focus of uncorrelated business.
Competition and the insurance cycle We have continued to increase our presence in the USA and in Europe. In these markets, Hiscox competes against major international groups with similar offerings. At times, a minority of these groups may choose to underwrite for cash flow or market share purposes at prices that sometimes fall short of the break-even technical price. The Group is firm in its resolve to reject business that is unlikely to generate underwriting profits. Accepting insurance risk below the technical price is detrimental to the industry’s prospects, since it drives the prevailing rates in the market lower to the point where business failures occur, insurers’ capital is destroyed, customers receive sub-optimal service and the industry suffers from negative publicity. As capacity levels in the market fall, prices inevitably rise until the point where the cycle of irrational pricing may begin again. In common with all insurers, the Group is exposed to this price volatility. Prolonged periods of low premium rating levels or high levels of competition in the insurance markets are likely to have a negative impact on the Group’s financial performance.
Reserving The Group establishes provisions for unpaid claims, defence costs and related expenses to cover its ultimate liability in respect of both reported claims and incurred but not reported (IBNR) claims. These provisions take into account both the Group’s and the industry’s experience of similar business, historical trends in reserving patterns, loss payments and pending levels of unpaid claims and awards, as well as any potential changes in historic rates arising from market or economic conditions. Details of the actuarial and statistical methods and assumptions used to calculate reserves are set out in note 26 to the financial statements. The provision estimates are subject to rigorous review and challenge by senior management from all areas of the business and the final provision is approved by the reserving committees. The provision is set above the expected or mean reserve requirement to minimise the risk that actual claims exceed the amount provided.
Binding authorities Hiscox writes a considerable amount of premium income through agents to whom binding authority is given to accept risks on behalf of Hiscox Group carriers. All binding authorities are strictly controlled through tight underwriting guidelines and limits and extensive vetting, monitoring, and auditing of compliance. Agents to whom binding authorities are granted are regularly examined to ensure they meet the Group’s minimum standards. These checks are performed by staff independent of the underwriting function and the process is overseen by a committee comprising both underwriters and non-underwriters from the senior management team and the Group Head of Internal Audit.
Hiscox credit rating The external ratings granted to the Group and its subsidiaries are essential to maintaining profitability, particularly in relation to our reinsurance business and managing the costs of financing and access to capital. We have identified the key aspects of our business which are critical to maintaining our ratings and closely manage these to minimise the risk of an event which might jeopardise any rating and to ensure that we respond appropriately to unforeseen external events. We maintain regular and open communication with our rating agencies to ensure that we continue to meet their expectations and that careful consideration is given to the potential impact on a rating of any significant decision.
Capital The Group manages capital rigorously in order to maximise its return on capital whilst maintaining sufficient levels of financial resources to absorb unexpected losses and meet the requirements of regulators and rating agencies. Accurate measurement of potential losses under various scenarios is a critical aspect of our business planning and capital management cycle. Potential losses are calculated regularly using the most sophisticated modelling techniques available supported by stress and scenario assessments. We invest heavily in the most up to date risk management techniques and expert staff to ensure our procedures and analyses remain second to none.
Foreign exchange The US Dollar is the Group’s largest underwriting currency. The Group’s policy is to match US Dollar insurance liabilities with investments held in the same currency in order to minimise the effect of currency fluctuations. Whilst the Group’s functional and reporting currency is Sterling, a significant proportion of the Group’s operational cost base is located in the USA and Europe, and movements in foreign exchange rates may have a material adverse effect on its financial performance and position. In addition the capital base of the Bermuda, Guernsey and US insurance companies are in US Dollars. Net currency positions are closely monitored and currency hedging transactions are entered into where this is considered advantageous in the light of anticipated movements in exchange rates. Further details of the Group’s investment profile and its management of currency risks are provided in notes 3, 20 and 22 to the financial statements.
The majority of the Group’s cash inflows and outflows are routine and can be forecast well in advance. The primary source of inflows is insurance premiums whilst outflows are to policyholders for claims made. Cash flow is forecast on rolling daily, weekly, monthly and quarterly basis depending on the source, and, in the event of a major catastrophe, such forecasting may be up to three years in advance. Free cash is invested according to the Group’s investment policy and cash requirements can normally be met through regular income streams (i.e. premiums or investment income), existing cash balances or realising investments that have reached maturity.
The Group’s liquidity risk arises from large, unplanned cash demands and the principal source of risk is a major catastrophe resulting in a high value of claims. This could be exacerbated if we had to fund claims pending recovery from a reinsurance partner. We plan for this risk through a number of measures. First, we run stress tests to estimate the size and timing of claims that might have to be paid in the event of a number of major catastrophes all occurring within a short period of time. We also run scenario analyses that consider the impact on liquidity of a range of adverse events happening simultaneously; for example, an economic downturn and declining investment returns combined with unusual levels of insurance losses.
Third, our investment policy recognises that some investments may need to be realised before maturity or at short notice and hence a high proportion of investments must be held in liquid assets. This minimises the risk of loss in the event of having to sell assets quickly.
The chart above shows the variability in net loss the Group expects from individual losses of a given industry loss size.
.5 b m ar ke t lo ss ye ar re tu rn p er io d
b m ar ke t lo ss ye ar re tu rn p er io d
In the workplace Hiscox wants to employ the best people and provide them with the means and the motivation to excel. This is achieved with fair rewards and by providing staff with an environment in which they can enjoy their work and reach their full potential. Hiscox recognises how important it is for employees to maintain a healthy work/life balance and gives staff the option of flexible and home working wherever possible.
The Group believes that it has got this balance right and that it is one of its greatest strengths. The Group’s policies ensure that it continues to follow a best practice approach to managing its people and remains a fair and professional employer. In the unlikely event of an employee having a material concern relating to the operations of the business, a whistleblowing policy explains to staff how they can confidentially raise their misgivings. Hiscox also subscribes to Public Concern at Work, which provides free legal advice to any employee with a concern about possible danger or malpractice in the workplace.
Hiscox has started a two year programme of support for the Whitechapel Art Gallery in London.
Hiscox is a member of Climatewise, an insurance industry initiative which aims to reduce the economy’s and society’s long-term risk from climate change. Hiscox supports the principles of Climatewise and is encouraged by the actions taken by Lloyd’s to assist the market to meet the majority of the principles.
Bronislaw Edmund Masojada Chief Executive (Aged 47) Bronek Masojada joined Hiscox in 1993. From 1989 to 1993 he was employed by McKinsey and Co. Bronek served as a Deputy Chairman of Lloyd’s from 2001 to 2007. He was a Non Executive Director of Ins-sure Holdings Limited from 2002 to 2006 and is a past president of The Insurance Institute of London. He is Chairman of the Lloyd’s Tercentenary Foundation, a charity which supports research in areas of interest to the insurance industry.
Robert Simon Childs Chief Underwriting Officer and Chief Executive Officer of Hiscox Bermuda and Chairman of Hiscox USA (Aged 57) Robert Childs joined Hiscox in 1986, served as the Active Underwriter of the Hiscox Lloyd’s Syndicate 33 between 1993 and 2005, and is the Group’s Chief Underwriting Officer. Robert was Chairman of the Lloyd’s Market Association from January 2003 to May 2005.
Ernst Robert Jansen Non Executive Director (Aged 60) Ernst Jansen joined Hiscox on 20 November 2008. He held several Managing Director positions in the European chemical industry between 1980 and 1990. He was an Executive Director then Vice Chairman of Eureko B.V. between 1992 and 2007. Following retirement he became an adviser to the Executive Board and is a member of the Supervisory Board of a number of Eureko operating companies.
Solicitors Appleby Hunter Bailhache Canon’s Court 22 Victoria Street PO Box HM 1179 Hamilton HMEX Bermuda
The Board’s Terms of Reference include a Schedule of Matters Reserved for Board Decision, a copy of which can be found on the Group’s website: www.hiscox.com.
The Audit Committee The Audit Committee of Hiscox Ltd is chaired by Daniel Healy and comprises Ernst Jansen, Dr James King, Andrea Rosen, Gunnar Stokholm and Dirk Stuurop. Daniel Healy and Dr James King are considered by the Board to have
The Directors’ remuneration report is presented on pages 35 to 42.
The Conflicts Committee The Group has a Conflicts Committee which is comprised of independent Non Executive Directors from within the Group, and chaired by Dr James King. It meets as and when required. Conflicts of interest may arise from time to time because Syndicate 33, Syndicate 3624 and Syndicate 6104 are managed by a Hiscox-owned Lloyd’s Managing Agency. 27.4% of the Names on Syndicate 33 are third parties and 72.6% of Syndicate 33 is owned by a Hiscox Group company. 100% of Syndicate 3624 is owned by a Hiscox Group company. 100% of Syndicate 6104 is owned by third parties. The Conflicts Committee serves to protect the interests of the third-party Syndicate Names. Should such a potential conflict of interest arise, there is a formal procedure to refer the matter to this Committee.
Performance evaluation During the year, the Chairman led a review of the performance of the Board as a whole. The Non Executive Directors met with the Chairman to discuss a wide range of issues, including the performance of the Executive Directors. In addition the Non Executives met without the Chairman and the Executive Directors during the year. The performance of the Executive Directors and the Chairman was discussed. No major issues regarding the performance of the Board were raised in these discussions.
With the exception of the unavoidable absence of Sir Mervyn Pedelty, all Directors attended the Annual General Meeting.
The Company commissions independent research on feedback from shareholders and analysts on a regular basis following the Company’s results announcements. This research together with the analysts’ research notes are copied to the Non Executive Directors in full. The Chairman attends a number of meetings with shareholders as well as speaking at the analysts’ presentations. In addition, any specific items covered in letters received from major shareholders are reported to the Board. Major shareholders are invited to request meetings with the Senior Independent Director and/or the other Non Executive Directors, and they have been given the contact details of the Senior Independent Director.
The Board has reviewed the effectiveness of internal controls during 2008, including financial, operational and compliance controls. The Board confirms there is an ongoing process for identifying, evaluating and managing the significant risks faced by the Company, which has been in place throughout the year and up to the date of approval of the Annual Report and Accounts and accords with the guidance in the document ‘Internal Control: Guidance for Directors on the Combined Code’. The head of each business area is responsible for implementing the risk management programme in their area of operations. The Risk function collates risk management information and works with the risk committees to monitor significant risks and movements, and review the relevant internal controls.
Remuneration and Nomination Committee The Remuneration and Nomination Committee meets at least twice a year. The members of the Committee for 2008 were Sir Mervyn Pedelty (Chairman), Andrea Rosen (Acting Chairman), Carol Franklin Engler, Daniel Healy, Dr James King and Dirk Stuurop. Ernst Jansen and Gunnar Stokholm joined the Committee on
The Committee focuses on: the overall remuneration strategy, policy and cost for the Group; the determination of levels and make up of remuneration for the four Executive Directors; and the award of sizable bonuses to individuals.
The Committee is provided with data and has access to advice from Towers Perrin, independent remuneration consultants, who provide no other services to the Company.
The 2009 salary increases for Executive Directors will be a cost of living increase of 2%.
The Hurdle Rate for the 2008 bonus was reviewed. On balance the conclusion was for the Hurdle Rate to remain unchanged for 2008 but will continue to be reviewed for subsequent years depending on changes in the longer-term rate of return.
Once the overall bonus pool has been established, individual bonuses, including those for Executive Directors, are calculated based on the results of each business area and individual performance. The Remuneration and Nomination Committee determines the bonuses to be paid to the Executive Directors based on the performance of the Group and an assessment of individual performance. In this way, the bonus scheme aligns the interests of Executive Directors and employees with shareholders.
should be determined using profits based on the normalised investment return, mid-level employees assuming a 0% investment return and for senior employees based on the pre-tax profits which reflects the actual investment return of -1.3%. In 2009 bonuses for all staff will be based on the actual investment return. Additionally for the calculation of bonuses, foreign exchange gains or losses arising on intercompany loans and on balance sheet hedging contracts that are accounted through the profit and loss account with the equal gain or loss in the balance sheet are excluded from the calculation.
Dividend payments In order to better align senior managers with Total Shareholder Return, the concept which is applied to the Performance Share Plan awards is that the recipient is provided with the equivalent of the dividend either in shares or cash. This specifically works as follows: dividends (or amounts equal to dividends) on shares granted under the Performance Share Plan (including in respect of the 2006 and 2007 grants) roll up in the form of shares between the grant and vesting; at the end of the performance period the employee would have options over the proportion of the share grant which vests by reference to the satisfaction of the applicable performance target as well as over the number of shares representing the ‘rolled up’ dividends on those shares; and for UK based employees only, after vesting but before exercise, the employee would then receive ‘shadow dividends’ (i.e. amounts equal to dividends paid) on the total number of shares remaining under option. Up to a maximum of 200,000 shares under option per individual, these amounts would be paid in cash, twice yearly, at the same time as dividends are paid to shareholders, until the option is exercised (which could be for up to a further seven years, when the option expires). Above 200,000 shares under option, the ‘shadow dividends’ would be re-invested into shares within the trust. Executive Directors, however, would have the entire ‘shadow dividend’ re-invested in shares within an employee benefit trust.
Formal shareholding guidelines have been introduced this year which mean that within five years of becoming an Executive Director, Hiscox Partner (the top 5% of employees in the company) or a member of a subsidiary board, the employee will be expected to own Hiscox shares valued at 100% of salary for Hiscox Partners and members of subsidiary boards and 150% of salary for Executive Directors.
The Remuneration and Nomination Committee believes that using ROE as the long-term performance condition better aligns the interests of employees with shareholders because: ROE captures the efficiency with which the Company is using shareholder funds to generate earnings, whereas EPS growth gives no indication of the level of return on the investment required to generate those additional earnings; and the Company operates in a highly cyclical business where earnings can fluctuate considerably, which can have a distorting effect on EPS growth. Where EPS is used as a performance condition this can introduce an element of luck as to when in the cycle share grants are made which can operate to the disadvantage of both employees and shareholders. The Remuneration and Nomination Committee believes that an average ROE performance requirement over the three-year period smoothes out the cyclical fluctuations in earnings and ensures that over any given period shareholders will receive a minimum return on equity before awards granted to employees will vest.
Remuneration of Non Executive Directors Non Executive Directors receive an annual fee in respect of their Board appointments together with additional compensation for their further duties in relation to Board committees. All amounts are denominated in US Dollars. The structure of the fees paid are detailed below.
in accrued Total Transfer value Transfer value Transfer value (decrease) in pension accrued of increase of accrued of accrued transfer value of during the annual pension at in accrued pension at pension at accrued benefit year 31 Dec 08 pension 1 Jan 08 31 Dec 08 during the year
Share options The interests of the Directors and employees under the UK and International Sharesave Schemes of the Group are set out below: Number of Number of Market price options at Number of Number of Number of options at at date of Date from 1 January options options options 31 December Exercise price exercise which 2008 granted lapsed exercised 2008 £ £ exercisable Expiry date
Ernst Jansen and Gunnar Stokholm were appointed as Non Executive Directors on 20 November 2008 and have submitted themselves for election at the Annual General Meeting. Carol Franklin Engler resigned on 20 November 2008. Bronek Masojada, Daniel Healy and Dirk Stuurop retire by rotation in accordance with the Bye-Laws of the Company and they have each submitted themselves for re-election at the Annual General Meeting of the Company.
Major interests in shares The Company has been notified of the following shareholdings of 5% or more in the ordinary shares of the Company as at 9 March 2009: Number of shares % of total
Principal activity and business review The Company is a holding company for subsidiaries involved in the business of insurance in Bermuda, the US, the UK, Guernsey and Europe. An analysis of the development and performance of the business can be found within the Chief Executive’s report on pages 5 to 11. A description of the major risks can be found in the risk management section on pages 22 to 27.
Financial results The Group achieved a pre-tax profit for the year of £105.2 million (2007: £237.2 million). Detailed results for the year are shown in the consolidated income statement on page 46, and also within the Group financial performance section on pages 16 to 21.
Dividends An interim dividend of 4.25p (net) per share (2007: 4p (net)) was paid on 29 September 2008 by Hiscox Ltd in respect of the year ended 31 December 2008. The Directors recommend the payment of a final dividend of 8.5 (net) per share (2007: 8p (net)). If approved this will be paid on 16 June 2009 to shareholders on the register at the close of business on 15 May 2009, provided that such dividend will not be paid to those shareholders who, prior to 16 May 2009, have made an election to participate in the Company’s Dividend Access Plan if Hiscox plc subsequently declares a dividend
We confirm that to the best of our knowledge: the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole; and the Directors’ report includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
In addition to our audit of the consolidated financial statements, the Directors have engaged us to review their Corporate Governance statement as if the Company were required to comply with the Listing Rules of the Financial Services Authority in relation to those matters. We review whether the Corporate Governance statement reflects the Company’s compliance with the nine provisions of the 2006 Combined Code specified for our review by those rules, and we report if it does not. We are not required by the terms of our engagement to consider whether the Board’s statements on internal control cover all risks and controls, or to form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures.
Profit for the year 125,928 (55,120) 70,808 191,248 Other comprehensive income Currency translation differences (net of tax of £nil (2007: £nil)) 71,008 80,171 151,179 (4,269) Net investment hedge (net of tax £(238,000) (2007: £420,000)) (597) – (597) 1,400
Total equity (all attributable to owners of the Company) 951,026 824,304
Currency Share Share Contributed translation Retained capital premium surplus reserve earnings Total
Total recognised comprehensive income/(expense) for the year (all attributable to owners of the Company) – – – (2,869) 191,248 188,379 Employee share options: Equity settled share based payments – – – – 5,689 5,689 Proceeds from shares issued 24 204 4,955 – – – 5,159
Total recognised comprehensive income/(expense) for the year (all attributable to owners of the Company) – – – 150,582 70,808 221,390 Employee share options: Equity settled share based payments – – – – 5,269 5,269 Excess tax benefit on share based payments – – – – 883 883 Proceeds from shares issued 24 169 4,463 – – – 4,632
Purchase of own shares held in treasury – – – – (62,866) (62,866) Purchase of own shares held in trust – – – – (2,200) (2,200) Deferred tax – – – – 6,370 6,370 Dividends paid to owners of the Company 32 – – (46,756) – – (46,756)
Profit before tax 105,180 237,199 Adjustments for: Interest and equity dividend income (92,227) (90,205) Interest expense 5,158 8,177 Net fair value losses on financial investments, derivatives and borrowings 180,085 687 Non-cash movement in retirement benefit obligation – (3,801)
Cash outflow from the acquisition of subsidiary 33 (3,137) (11,133) Cash outflow from the sale of subsidiaries 34 (42) (936) Cash outflow from the acquisition of associates 17 (5,438) (1,273) Cash flows from the purchase of property, plant and equipment (4,521) (7,789) Cash flows from the purchase of intangible assets 15 (3,530) (2,500)
Cash and cash equivalents at 1 January 302,742 502,871 Net increase in cash and cash equivalents 75,794 (197,199) Effect of exchange rate fluctuations on cash and cash equivalents 62,086 (2,930)
The notes on pages 50 to 95 are an integral part of these consolidated financial statements.
After making enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts.
Notes to the financial statements 1 General information The Hiscox Group, which is headquartered in Hamilton, Bermuda, comprises Hiscox Ltd (the parent Company, referred to herein as the ‘Company’) and its subsidiaries (collectively, the ‘Hiscox Group’ or the ‘Group’). For the period under review the Group provided insurance and reinsurance services to its clients worldwide. It has operations in Bermuda, the UK, Europe, and USA and employs over 950 people.
The financial statements were approved for issue by the Board of Directors on 2 Significant accounting policies The principal accounting policies applied in the preparation of these consolidated Group financial statements are set out below. The most critical individual components of these financial statements that involve the highest degree of judgement or significant assumptions and estimations are identified at note 2.22.
The main change required by the revised standard is the introduction of ‘total comprehensive income’ which requires the presentation of changes in non-owner equity in either one statement, the statement of comprehensive income, or two statements, the income statement and a statement showing the profit or loss and all components of other comprehensive income. The revised standard also requires other minor changes in the presentation of financial statements.
The Group has not presented a consolidated balance sheet at the beginning of the earliest comparative accounting period, 1 January 2007, as no retrospective restatements, reclassifications, or changes in accounting policy have occurred.
IFRIC 14, IAS 19 The Limit on Defined Benefit Asset, Minimum Funding Requirements and their Interaction The International Financial Reporting Interpretations Committee (IFRIC) published IFRIC 14, IAS 19 The Limit on Defined Benefit Asset, Minimum Funding Requirements and their Interaction on 5 July 2007 with an effective date for annual periods beginning on or after 1 January 2008. The interpretation clarifies when refunds or reductions in future contributions in relation to defined benefit assets are available and also provides guidance on the impact of minimum funding requirements on such assets. The Group has applied the interpretation from 1 January 2008 with no impact on the carrying amount of the defined benefit pension scheme asset or on the financial results of the Group.
Hiscox Dedicated Corporate Member Limited underwrites as a corporate member of Lloyd’s on the main Syndicates managed by Hiscox Syndicates Limited
Unrealised gains arising from transactions with associates are eliminated to the extent of the Group’s interest in the entity. Unrealised gains arising from transactions with associates are eliminated against the investment in the associate. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment.
Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All other repairs and maintenance items are charged to the income statement during the financial period in which they are incurred.
2 Significant accounting policies continued 2.6 Intangible assets continued (a) Goodwill continued goodwill attributable to individual cash generating units exceeds its implied value. Any excess of goodwill over the recoverable amount arising from the review process indicates impairment. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.
(d) Rights to customer contractual relationships Costs directly attributable to securing the intangible rights to customer contract relationships are recognised as an intangible asset where they can be identified separately and measured reliably and it is probable that they will be recovered by directly related future profits. These costs are amortised on a straightline basis over the useful economic life which is deemed to be 20 years and are carried at cost less accumulated amortisation and impairment losses.
Internally developed computer software is only capitalised where the cost can be measured reliably, the Group intends to and has adequate resources to complete development and where the computer software will yield future economic benefits in excess of the costs incurred.
(a) Non-financial assets Objective factors that are considered when determining whether a non-financial asset (such as goodwill, an intangible asset or item of property, plant and equipment) or group of non-financial assets may be impaired include, but are not limited to, the following: adverse economic, regulatory or environmental conditions that may restrict future cash flows and asset usage and/or recoverability; the likelihood of accelerated obsolescence arising from the development of new technologies and products; and the disintegration of the active market(s) to which the asset is related.
(b) Financial assets Objective factors that are considered when determining whether a financial asset or group of financial assets may be impaired include, but are not limited to, the following: negative rating agency announcements in respect of investment issuers, reinsurers and debtors; significant reported financial difficulties of investment issuers, reinsurers and debtors; actual breaches of credit terms such as persistent late payments or actual default; the disintegration of the active market(s) in which a particular asset is traded or deployed; adverse economic or regulatory conditions that may restrict future cash flows and asset recoverability; and the withdrawal of any guarantee from statutory funds or sovereign agencies implicity supporting the asset.
(b) Recognition and measurement Gross premiums written comprise premiums on business incepting in the financial year together with adjustments to estimates of premiums written in prior accounting periods. Estimates are included for pipeline premiums and an allowance is also made for cancellations. Overrider and profit commissions earned on ceded reinsurance are also included within premiums. Premiums are stated before the deduction of brokerage and commission but net of taxes and duties levied. Premiums are recognised as revenue (premiums earned) proportionally over the period of coverage except where time does not approximate to the pattern of risk, where previous claims information and other factors determine revenue recognition. The portion of premium received on in-force contracts that relates to unexpired risks at the balance sheet date is reported as the unearned premium liability.
(c) Deferred acquisition costs (‘DAC’) Commissions and other direct and indirect costs that vary with and are related to securing new contracts and renewing existing contracts are capitalised as deferred acquisition costs. All other costs are recognised as expenses when incurred. DAC are amortised over the terms of the insurance contracts as the related premium is earned.
2.14 Deferred tax Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. However, if the deferred income tax arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss, it is not recognised. Deferred tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
Deferred tax assets are recognised to the extent that it is probable that the future taxable profit will be available against which the temporary differences can be utilised. Deferred tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the Group controls the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future.
The fair value of the employee services received, measured at grant date, in exchange for the grant of the awards is recognised as an expense with the corresponding credit being recorded in retained earnings within equity. The total amount to be expensed over the vesting period is determined by reference to the fair value of the awards granted, excluding the impact of any non-market vesting conditions (e.g. profitability or net asset growth targets). Non-market vesting
Notes to the financial statements continued 2 Significant accounting policies continued 2.15 Employee benefits continued (c) Share based compensation continued conditions are included in assumptions about the number of awards that are expected to become exercisable. At each balance sheet date, the Group revises its estimates of the number of awards that are expected to vest. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity, over the remaining vesting period.
2.17 Net investment hedge accounting In order to qualify for hedge accounting, the Group is required to document in advance the relationship between the item being hedged and the hedging instrument. The Group is also required to document and demonstrate an assessment of the relationship between the hedged item and the hedging instrument, which shows that the hedge will be highly effective on an ongoing basis. This effectiveness testing is re-performed at each period end to ensure that the hedge remains highly effective.
2.21 Dividend distribution Dividend distribution to the Company’s shareholders is recognised as a liability in the Group’s financial statements in the period in which the dividends are approved.
2 Significant accounting policies continued 2.22 Use of critical estimates, judgements and assumptions The preparation of financial statements requires the use of significant estimates, judgements and assumptions. The Directors consider the accounting policies for determining insurance liabilities, the valuation of investments, the valuation of retirement benefit scheme obligations and the determination of current and deferred tax assets and liabilities as being most critical to an understanding of the Group’s result and position.
The inherent uncertainty of insurance risk requires the Group to make estimates, judgements and assumptions that affect the reported amounts of insurance and reinsurance assets and liabilities at the balance sheet date. This is the most significant area of potential uncertainty in the Group’s financial statements.
The Group carries its financial investments at fair value through profit or loss with fair value determined using published price quotations in the most active financial markets in which the assets trade.
During periods of economic distress and diminished liquidity, the ability to obtain quoted bid prices may be reduced and as such as a greater degree of judgment is required in obtaining the most reliable source of valuation. Note 3.2 to the financial statements discusses the reliability of the Group’s fair values.
The Group’s overall appetite for accepting and managing varying classes of risk is defined by the Group’s Board. The Board has developed a governance framework and set Group-wide risk management policies and procedures which cover specific areas such as risk identification, risk management and mitigation, and risk reporting. The objective of these policies and procedures is to protect the Group’s shareholders, policyholders and other stakeholders from negative events that could hinder the Group’s delivery of its contractual obligations and its achievement of sustainable profitable economic and social performance.
The Group, in common with the non-life insurance industry generally, is fundamentally driven by a desire to originate, retain and service insurance contracts to maturity, rather than engaging in mass distribution of the risks assumed through large scale securitisation. The Group’s business is therefore fundamentally different to other types of financial institutions in that its cash flows are funded mainly through advance premium collections rather than assuming cash deposits, and the timing of such
Notes to the financial statements continued 3 Management of risk continued premium inflows is reasonably predictable. In addition, the majority of material cash outflows are typically triggered by the occurrence of insured events noncorrelated to financial markets, and not by the inclination or will of policyholders.
Reinsurance inwards The Group’s reinsurance inwards acceptances are primarily focused on large commercial property, homeowner and marine and crop exposures held by other insurance companies predominantly in North America and other developed economies. This business is characterised more by large claims arising from individual events or catastrophes than the high frequency, low severity attritional losses associated with certain other business written by the Group. Multiple insured losses can periodically arise out of a single natural or man-made occurrence.
The main circumstances that result in claims against the reinsurance inwards book are conventional catastrophes, such as earthquakes or storms, and other events including fires and explosions. The occurrence and impact of these events is very difficult to model over the short-term which complicates attempts to anticipate loss frequencies on an annual basis. In those years where there is a low incidence of severe catastrophes, loss frequencies on the reinsurance inwards book can be relatively low.
Notes to the financial statements continued 3 Management of risk continued 3.1 Insurance risk continued
Maximum gross line sizes and aggregate exposures are set for each type of programme.
Sources of uncertainty in the estimation of future claim payments The Group’s procedures for estimating the outstanding costs of settling insured losses at the balance sheet date, including those not yet notified by, or apparent to, the insured, are detailed in note 26.
The key financial risk for the Group is that the proceeds from its financial assets are not sufficient to fund the obligations arising from its insurance contracts and financial liabilities. The most important entity and economic variables that could result in such an outcome relate to risk factors such as equity price risk, interest rate risk, credit risk, liquidity risk and currency risk. The Group’s policies and procedures for managing exposure to these specific categories of risk are detailed below.
Valuation of these securities will continue to be impacted by external market factors including default rates, rating agency actions, and liquidity. The Group will make adjustments to the investment portfolio as appropriate as part of its overall portfolio strategy, but its ability to mitigate its risk by selling or hedging its exposures may be limited by the market environment. The Group’s future results may be impacted, both positively and negatively, by the valuation adjustments applied to these securities.
One amendment to enhance the disclosure of fair value measurements is based on a three level fair value hierarchy similar to that issued by the US Financial Accounting Standard Board in SFAS 157. The fair value hierarchy classifies financial instruments into Level 1 to Level 3 based on the significance of the inputs used in measuring their fair value with Level 1 being the most reliable. The levels within the fair value hierarchy are defined as follows: Level 1 – Quoted prices in active markets for the same instrument.
Level 2 – Quoted prices in active markets for similar assets or liabilities or other valuation techniques for which all significant inputs are based on observable market data.
The Group will adopt the amended standard from its effective date and endorsement by the EU. Given the instability of the global markets in the fourth quarter of 2008, the Group has classified its financial investments as at 31 December 2008 using the above proposed fair value hierarchy in order to present useful information on the inputs used to measure fair value.
The level within the hierarchy that a financial instrument is placed is based on the lowest level of any input that is significant to its fair value measurement. Where a valuation technique is used, the Group selects inputs using the most reliable source of data and where possible observable market data. The models used to measure fair value in these cases may not be the same across the industry and as such fair value measurements may differ.
(a) Equity price risk The Group is exposed to equity price risk through its holdings of equity and unit trust investments. However this is limited to a small and controlled proportion of the overall investment portfolio and the equity and unit trust holdings involved are well diversified over a number of companies and industries. The fair value amounts held at the balance sheet date may be analysed as follows: %weighting % weighting
Government issued bonds and instruments 35 26 Agency and Government supported debt 17 9 Asset backed securities 10 16 Mortgage backed instruments – Agency 8 7 Mortgage backed instruments – Non-agency 8 13 Corporate bonds 20 27 Lloyd’s and money market deposits 2 2
The $182 million facility drawn down at 31 December 2007 was fully repaid in the year. The Group negotiated a new loan facility with its primary lender for £350 million. At 31 December 2008, $130 million was drawn on this facility. The Group has no other significant borrowings or other assets or liabilities carrying interest rate risk, other than the facilities and Letters of Credit outlined in note 35.
The Group’s maximum exposure to credit risk is represented by the carrying values of financial assets and reinsurance assets included in the consolidated balance sheet. The Group does not use credit derivatives or other products to mitigate maximum credit risk exposures. The Group structures the levels of credit risk accepted by placing limits on their exposure to a single counterparty, or groups of counterparties, and having regard to geographical locations. Such risks are subject to an annual or more frequent review. There is no significant concentration of credit risk with respect to loans and receivables, as the Group has a large number of internationally dispersed debtors with unrelated operations.
Reinsurance is used to contain insurance risk. This does not, however, discharge the Group’s liability as primary insurer. If a reinsurer fails to pay a claim for any reason, the Group remains liable for the payment to the policyholder. The creditworthiness of reinsurers is therefore continually reviewed throughout the year.
The largest counterparty exposure within AAA rating is with the US Treasury. A significant proportion of ‘other/not rated’ reinsurance assets at 31 December 2008 are supported by Letter of Credit guarantees issued by financial institutions with Standard & Poor’s or equivalent credit or financial strength ratings of A or better.
At 31 December 2008 the Group held no material debt and fixed income assets that were past due or impaired beyond their reported fair values, either for the current period under review or on a cumulative basis (2007: £nil ). For the current period under review, the Group experienced defaults on debt securities with one financial institution. The total market value of those securities is negligible to the overall portfolio. No defaults occurred in investments during the prior year.
(d) Liquidity risk The Group is exposed to daily calls on its available cash resources mainly from claims arising from insurance contracts. Liquidity risk is the risk that cash may not be available to pay obligations when due at a reasonable cost. The Board sets limits on the minimum level of cash and maturing funds available to meet such calls and on the minimum level of borrowing facilities that should be in place to cover unexpected levels of claims and other cash demands.
Property – marine and major assets 53,458 53,688 15,932 7,947 131,025 *Includes a diverse mix of certain specialty lines such as kidnap and ransom, terrorism, bloodstock and other risks which contain a mix of property and casualty exposures.
Operational foreign exchange risk is controlled within the Group’s operations. The assets of the Group’s overseas operations are generally invested in the same currencies as their underlying insurance and investment liabilities producing a natural hedge. Due attention is paid to local regulatory solvency and risk based capital requirements.
Notes to the financial statements continued 3 Management of risk continued 3.2 Financial risk continued (e) Currency risk continued
Property, plant and equipment 16,378 2,404 886 – 19,668 Investments in associates 6,504 – 696 – 7,200
Property, plant and equipment 17,281 1,499 598 – 19,378 Investments in associates 986 – 516 – 1,502
Employee retirement benefit obligations – – – – – Deferred tax 9,751 – – – 9,751
Sensitivity analysis The Group performs sensitivity analysis before and after the impact of US Dollar derivative contracts. The estimated impact of a 10% strengthening or weakening of the following currencies against Pound Sterling occurring on 31 December 2008 on total equity and profit before tax is shown below. This analysis assumes that all other variables, in particular interest rates, remain constant and that the underlying valuation of assets and liabilities in their base currency is unchanged. The process of deriving the undernoted estimates takes account of the linear retranslation movements of foreign currency monetary assets and liabilities together with the impact on the retranslation of those Group entities with non-sterling functional currency financial statements. Cognizance is also paid to non-linear estimated changes in the valuation of certain foreign currency linked derivative contracts. No account is taken of potential management actions such as the instigation of stop loss procedures on foreign currency derivative contracts that would have been contemplated if a change towards the actual scenarios had actually arisen.
Effect on profit Effect on profit Effect on equity before tax Effect on equity before tax excluding the excluding the including the including the impact of impact of impact of impact of US Dollar US Dollar US Dollar US Dollar derivative derivative derivative derivative contracts contracts contracts contracts
Strengthening of US Dollar 71.8 19.5 21.7 (30.6) Weakening of US Dollar (59.8) (15.9) (24.7) 19.3
The sensitivity analysis performed as at 31 December 2007 showed an impact on equity of £58.2 million and an impact on profit of £42.1 million based on the US Dollar and Euro strengthening by 10% against Pound Sterling.
The Group’s activities are funded by a mixture of capital sources including issued equity share capital, retained earnings, Letters of Credit, bank debt and other third-party insurance capital.
The Board ensures that the use and allocation of capital are given a primary focus in all significant operational actions. With that in mind, the Group has developed and embedded sophisticated capital modelling tools within its business. These join together short-term and long-term business plans and link divisional aspirations with the Group’s overall strategy. The models provide the basis of the allocation of capital to different businesses and business lines, as well as the regulatory and rating agency capital processes.
Gearing The Group currently utilises short- to mediumterm gearing as an additional source of funds to maximise the opportunities from strong markets and to reduce the risk profile of the business when the rating environment shows a weaker model for the more volatile business. The Group’s gearing is obtained from a number of sources, including: Letter of Credit and revolving credit facility – the Group's main facility currently in place is for a total of £350 million which may be drawn as cash (under a revolving credit facility) or letter of credit or a combination thereof, providing that the cash portion does not exceed £200 million. This facility was secured during 2008 by the Company’s subsidiary Hiscox plc. The Letter of Credit availability period ends on 31 December 2009. This enables the Group to utilise the Letter of Credit as Funds at Lloyd’s to support underwriting on both the 2009 and 2010 years of account. Subject to agreement by the banks, the Group is able to extend the Letter of Credit availability period to 2011, which would provide Fund’s at Lloyd’s cover up to and including the 2012 year of account. The revolving credit facility has a maximum five year contractual period for repayment. At 31 December 2008 £137,500,000 was drawn by way of Letter of Credit to support the Funds at Lloyd's requirement and a further US$130,000,000 by way of cash to support general trading activities; external Names – 27.5% of Syndicate 33’s capacity is capitalised by thirdparties paying a profit share of approximately 17.5%; Syndicate 6104 at Lloyd’s – with an approximate capacity of £43 million (2007: £34 million). This Syndicate is wholly backed by external members and takes a pure 2009 year of account quota share of Syndicate 33’s international property catastrophe reinsurance account; gearing quota shares – historically the Group has used reinsurance capital to fund its capital requirement for short-term expansions in the volume of business underwritten by the Syndicate; and qualifying quota shares – these are reinsurance arrangements that allow the Group to increase the amount of premium it writes in hard markets.
Capital modelling and regulation The capital requirements of an insurance group are determined by its exposure to risk and the solvency criteria established by management and statutory regulations.
In 2005, the UK Financial Services Authority (FSA) and Lloyd’s introduced a new capital regime that requires insurance companies to calculate their own capital requirements through Individual Capital Assessments (ICA). Hiscox Insurance Company Limited and Syndicate 33 maintain ICA models in accordance with this regime. The models are concentrated specifically on the particular product lines, market conditions and risk appetite of each entity. If the FSA considers an ICA to be inadequate, it can require the entity to maintain an increased capital safeguard. The Directors are also required to certify that the Group has complied, in all material aspects, with the provisions of the Interim Prudential Sourcebook: Insurers (IPRU(INS)), the Integrated Prudential Sourcebook for Insurers (INSPRU) and General Prudential Sourcebook (GENPRU) when completing the ICA return.
Another key area of capital modelling for Hiscox is to identify which insurance vehicle produces the best return on capital employed for the Group, given certain restraints from licences, reinsurance and the regulatory environment. This modelling takes into account transactional costs and tax, in addition to the necessary capital ratios. It proves the capital efficiency of Lloyd’s, despite a tax disadvantage against offshore entities, and the cost advantage of processing smaller premium business outside of Lloyd’s.
In addition to the ICA modelling process, the EU Insurance Group’s Directive of 1998, as amended by the Financial Group’s Directive (FGD), compels insurance companies that are members of a group to consider the solvency margin of their ultimate parent company. This consideration must refer to the surplus assets of the ultimate parent’s related insurers, reinsurers, intermediate holding companies and other regulated entities.
(a) Profit before tax by segment Year to 31 December 2008 Year to 31 December 2007
Share of profit of *Interest revenues included total £89,608,000 (2007: £85,435,000).
Group capital resources are less than the Group’s total equity value primarily as a result of the inadmissibility of certain assets including intangible assets for regulatory purposes.
UK and Europe comprises the results of Hiscox Insurance Company Limited, the results of Syndicate 33’s fine art, UK regional events coverage and nonUS household business, together with the income and expenses arising from the Group’s retail agency activities in the UK and in continental Europe. It excludes the results of the larger retail TMT business written by Hiscox Insurance Company Limited.
International comprises the results of Hiscox Insurance Company (Guernsey) Limited, Hiscox Inc., Hiscox Insurance Company (Bermuda) Limited and the ALTOHA sub-group.
All amounts reported below represent transactions with external parties only, with all inter-segment amounts eliminated. Performance is measured based on each reportable segment’s profit before tax.
Notes to the financial statements continued 4 Operating segments continued (a) Profit before tax by segment continued
Global UK and Corporate Global UK and Corporate Markets Europe International Centre Total Markets Europe International Centre Total
Global UK and Corporate Global UK and Corporate 100% ratio analysis Markets Europe International Centre Total Markets Europe International Centre Total
Global UK and Corporate Global UK and Corporate Markets Europe International Centre Markets Europe International Centre
At 100% level (note 4b) 1% change in claims or expense ratio 6,531 3,168 1,793 – 7,660 2,598 1,695 –
Global UK and Corporate Intragroup items Markets Europe International Centre and eliminations Total
Capital expenditure comprises expenditure on intangible assets (note 15) other than goodwill, and additions to property, plant and equipment (note 16), but excluding assets acquired on business combinations.
(d) Geographical information The Group’s operational segments underwrite business domestically in Bermuda and from locations in the UK and Ireland, the USA, Guernsey, France, Germany, Belgium, the Netherlands, Spain, Portugal, Sweden and Austria.
(total equity) per share (total equity) per share £000 pence £000 pence
The net asset value per share is based on 368,477,595 shares (2007: 393,386,041), being the adjusted number of shares in issue at 31 December.
Profit for the period 70,808 191,248 Opening shareholders’ equity 824,304 682,085 Adjusted for the time weighted impact of: – Distribution and other movements in capital (55,700) (18,029)
(ii) Investment yields Global Markets UK and Europe International Corporate Centre 2008 Total
Debt and fixed income securities 43,802 5.2 9,599 5.6 11,553 6.1 5,734 6.1 70,688 5.5 Equities and shares in unit trusts – – 1,131 1.3 2,181 9.1 3,647 6.4 6,959 4.1 Deposits with credit institutions/
Agency related income 5,324 4,626 Profit commission 14,382 10,468 Other income 152 3,950
Other expenses 76,499 82,269 10 Employee benefit expense The aggregate remuneration and associated costs were: Wages and salaries, including holiday pay and sabbatical leave charges 79,048 68,135 Social security costs 10,468 8,909 Share based payments cost of options granted to Directors and employees 24 5,269 5,689 Pension costs – defined contribution 5,794 7,256 Pension costs – net expense/(credit) arising on defined benefit schemes 30 – (3,801)
The average monthly number of staff employed by the Group was 914 (2007: 804) comprising 335 underwriting and 579 administrative staff (2007: 301 and 503 respectively). Of the total remuneration shown above, an amount of £21,053,000 (2007: £19,838,000) was recharged to Syndicate 33.
Interest and expenses associated with bank borrowings carried at fair value 20 3,201 6,278 Interest and charges associated with Letters of Credit 35 1,922 1,845 Interest charges arising on finance leases 36 35 54
The above excludes profits or losses on foreign exchange derivative contracts which are included within the investment result and are outlined in note 22.
Impact of foreign exchange related items in consolidated income statement (51,003) 108,095 57,092 7,291
Other intangible additions during 2007 primarily relate to the costs of acquiring rights to customer contractual relationships held previously by AON Limited, the additions during 2008 relate to software licence and development costs.
16 Property, plant and equipment Furniture, fittings and Land and Leasehold equipment buildings improvements Vehicles and art Total
Assets with a net book value of £582,000 were held under finance leases (2007: £510,000). The total depreciation charge for the year in respect of assets held under finance leases was £116,000 (2007: £106,000) and is included in other expenses.
At 31 December 2008 there were £3,106,000 of assets under construction, upon which no depreciation has yet been charged (2007: £2,336,000).
Notes to the financial statements continued 17 Investments in associates continued
Associates incorporated in the UK From 25.2% to 49% 11,981 8,809 6,214 877
Associates incorporated in the UK From 25.2% to 49% 1,634 758 1,898 290
The amounts expected to be recovered before and after one year are estimated as follows: Within one year 126,136 117,442 After one year – –
The amounts expected to be recovered before and after one year, based on historical experience, are estimated as follows: Within one year 238,472 147,987 After one year 249,248 132,101
Total financial assets carried at fair value 2,177,209 2,081,772 1,714,652 1,747,827
An analysis of the credit risk and contractual maturity profiles of the Group’s debt and fixed income securities is given in notes 3.2(c) and 3.2(d).
Included in financial liabilities at 31 December 2007 were foreign currency borrowings from credit institutions totalling US$182,000,000 that were designated as a hedging instrument in a net investment hedge relationship. The hedged item was the first US$182,000,000 of the Group’s net investment in its Bermudian and Guernsey subsidiaries.
Notes to the financial statements continued 21 Loans and receivables including insurance receivables
Prepayments and accrued income 7,948 9,562 Other loans and receivables: Net profit commission receivable 11,959 13,850 Accrued interest 9,480 9,003 Share of Syndicate’s other debtors’ balances 13,546 12,705 Other debtors including related party amounts 10,190 12,338
The amounts expected to be recovered before and after one year are estimated as follows: Within one year 491,529 381,639 After one year 2,786 3,583
22 Derivative financial instruments The Group entered into both exchange-traded and over the counter derivative contracts for a number of purposes during 2008. The Group had the right and intention to settle all contracts on a net basis. The assets and liabilities of these contracts at 31 December 2008 all mature within one year of the balance sheet date and are detailed below: Gross contract Fair value Fair value Net balance notional amount of assets of liabilities sheet position
Foreign exchange option collar contracts US$600,000 – 42,540 42,540 Foreign exchange forward contracts €68,680 – 10,532 10,532
Foreign exchange option collar contracts During 2008 the Group’s capital benefited from a significant uplift in net asset value due to the appreciation of the US Dollar to Pound Sterling exchange rate which increased the translated values of its net investments in the Bermuda and Guernsey insurance operations. During September and October 2008 the US Dollar fluctuated significantly and in order to protect the majority of the exchange gains earned to date the Group progressively hedged the risk of subsequent US Dollar weakness impacting this capital by entering into a series of currency option collar contracts. These over the counter instruments have no initial purchase cost and consist of covered call and protective put options which essentially protect the Group against material downside movements in US Dollar to Pound Sterling exchange rate whilst at the same time limiting further participation in material US Dollar strengthening beyond an upper cap. The Group made a loss on these contracts of £42,540,000 (2007: £1,842,000) as included in notes 7 and 14. The related exchange gain earned on the retranslation of the portion of underlying net investments concerned was £67,591,000 and is included within the overall gain of £151,179,000 recognised in other comprehensive income (note 13).
Foreign exchange forward contracts During 2008 the Group entered into a series of conventional over the counter forward contracts in order to secure translation gains made on Euro denominated monetary assets which had been subject to significant appreciation in value since 31 December 2007. The contracts required the Group to forward sell a fixed amount of Euros for Pound Sterling at pre-agreed future exchange rates. The Group made a loss on these forward contracts of £10,123,000 (2007: gain of £732,000) as included in note 7. An opposite exchange gain of £10,163,000 was earned on the retranslation of the underlying assets concerned.
Cash at bank and in hand 353,542 236,417 Short-term bank deposits 87,080 66,325
The amounts presented in the equity structure of the Group above relate to Hiscox Ltd, the legal parent Company.
Notes to the financial statements continued 24 Share capital continued Ordinary share Share Contributed capital premium surplus
Share options and performance share plan awards Performance share plan awards are granted to Directors and to senior employees. Up until 2005, share options were also granted. The exercise price of the granted options is equal to the closing mid-market price of the shares on the day before the date of the grant. No exercise price is attached to performance plan awards, although their attainment is conditional on the employee completing three year’s service (the vesting period) and the Group achieving targeted levels of returns on equity. Share options are also conditional on the employee completing three years’ service (the vesting period) or less under exceptional circumstances (death, disability, retirement or redundancy). The options are exercisable starting three years from the grant date only if the Group achieves its targets of return on equity; the options have a contractual option term of ten years. The Group has no legal or constructive obligation to re-purchase or settle the options in cash.
The range of principal Group assumptions applied in determining the fair value of share based payment instruments granted during the year under review are: Assumptions affecting inputs to fair value models 2008 2007
Annual risk free rates of return and discount rates (%) 3.2-5.6 5.5 Long-term dividend yield (%) 4.75 4.75 Expected life of options (years) 3.25 3.25 Implied volatility of share price (%) 27-30 26 Weighted average share price (p) 247.9 268.5
The weighted average fair value of each share option granted during the year was 60.5p (2007: 67.9p). The weighted average fair value of each performance share plan award granted during the year was 213.4p (2007: 232.8p).
24 Share capital continued Share options and performance share plan awards continued
Included within Group retained earnings is an amount of £23,932,000 (2007: £21,578,000), which is not distributable and is held to meet solvency capital requirements to maintain an equalisation provision. The amounts in the equalisation provision are realised when particular entities in the Group have suffered insurance losses in excess of levels set out in the relevant solvency capital regulations.
Gross Claims reported and loss adjustment expenses 885,905 642,252 Claims incurred but not reported 881,823 573,635 Unearned premiums 509,688 498,000
Chain Ladder techniques are less suitable in cases in which the insurer does not have developed claims history data for a particular class of business (e.g. in relation to more recent underwriting years or years of account). In these instances the Group’s actuaries make reference to the Bornhuetter-Ferguson method.
Current estimate of cumulative claims 877,941 419,824 475,401 753,543 1,378,982 593,856 774,105 1,210,449 6,484,101
Liability recognised in respect of prior accident years at 100% level 109,247
Less: Attributable to external Names 192,092 71,607 87,967 139,519 282,694 83,531 63,755 44,032 965,197
Group’s share of cumulative payments (588,875) (288,261) (311,327) (454,897) (832,138) (326,313) (321,059) (230,949)(3,353,819)
Liability for 2001 to 2008 accident years recognised on Group’s balance sheet 70,875 44,969 57,189 123,831 200,639 143,813 302,592 738,806 1,682,714 Liability for accident years before 2001 recognised on Group’s balance sheet 85,014
Current estimate of cumulative claims 492,765 277,270 370,818 617,474 811,585 544,493 680,514 837,864 4,632,783
Total net liability to external parties at 100% level 1,734,198 *The foreign exchange adjustment arises from the retranslation of the estimates at each date using the exchange rate ruling at 31 December 2008. **This represents the claims element of the Group’s insurance liabilities.
Notes to the financial statements continued 26 Insurance liabilities and reinsurance assets continued 26.1 Insurance contracts assumptions continued (b) Claims development tables continued
Current estimate of cumulative claims 492,765 277,270 370,818 617,474 811,585 544,493 680,514 837,864 4,632,783 Less: Attributable to external Names (116,349) (54,903) (82,082) (143,775) (195,548) (114,412) (133,508) (165,857)(1,006,434)
Less: Attributable to external Names 93,966 43,464 64,586 112,341 142,587 77,956 54,658 34,627 624,185
Group’s share of cumulative payments (316,172) (188,684) (237,862) (366,360) (452,071) (297,829) (263,299) (197,452)(2,319,729)
Liability for 2001 to 2008 accident years recognised on Group’s balance sheet 60,244 33,683 50,874 107,339 163,966 132,252 283,707 474,555 1,306,620 Liability for accident years before 2001 recognised on Group’s balance sheet 34,805
Total at beginning of year (1,215,887) 222,672 (993,215) (1,128,329) 265,073 (863,256) Claims and loss adjustment expenses for year (698,471) 219,091 (479,380) (498,568) 75,203 (423,365) Cash paid for claims settled in the year 549,106 (117,582) 431,524 452,235 (131,505) 320,730 Exchange differences and other movements (402,476) 102,122 (300,354) (41,225) 13,901 (27,324)
Total claims and claims handling expense (698,471) 219,091 (479,380) (498,568) 75,203 (423,365)
Creditors arising out of direct insurance operations 35,089 30,353 Creditors arising out of reinsurance operations 175,134 114,317
Reinsurers’ share of deferred acquisition costs 18 4,994 5,639 Accruals and deferred income 58,050 64,657
The amounts expected to be settled before and after one year are estimated as follows: Within one year 284,892 234,828 After one year 11,940 1,047
All material tax assets and liabilities relate to the same tax authority.
The applicable rate for deferred tax from 1 April 2008 is 28%.
(b) Group deferred tax liabilities analysed by balance sheet headings and Syndicate participation Income statement Transfer to Transfer to 2007 (charge)/credit current tax equity 2008
Open years of account and Section 107 disclaimers (39,544) (50,544) 1,281 – (88,807)
As the fair value of scheme assets exceeds the present value of funded obligations and unrecognised net actuarial gains, the scheme reports a surplus. However, the surplus arising on the pension scheme is not recognised on the Group’s balance sheet due to uncertainty of recoverability.
During the prior year under review a series of changes to the scheme’s investment mix were executed by Trustees so as to achieve a greater degree of protection against interest rate volatility following the scheme’s recent closure. These changes resulted in the majority of the scheme’s debt and fixed income assets at 31 December 2007 and 2008 now being held through the ownership of equity units in liability managed credit funds issued by Standard Life Assurance Limited which invest in a broad spread of high quality corporate bonds with derivatives used in controlled conditions to extend durations in some cases.
The amounts recognised in the Group’s income statement are as follows: Current service cost 200 200 Interest cost 6,135 6,657 Expected return on scheme assets (7,720) (7,711) Net actuarial gain recognised (433) – Settlement gain recognised – (4,913) Effect of deemed irrecoverability of surplus 1,818 1,966
The actual return on scheme assets was a loss of £10,387,000 (2007: positive return of £7,786,000).
Notes to the financial statements continued 30 Employee retirement benefit obligations continued
A reconciliation of the present value of funded obligations of the scheme is as follows: Benefit obligation at beginning of year 106,793 137,461 Current service cost 200 200 Interest cost 6,135 6,657 Actuarial gains (9,490) (18,742) Benefits paid from scheme (2,023) (2,183) Settlements with scheme members – (16,600)
A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme liabilities – 2,783 (3,310) (1,223) 992 Experience gains/(losses) on scheme assets (18,107) 75 6,480 10,764 1,316
Additional memorandum information at the end of the current and previous four accounting periods is presented below: Present value of funded obligations 101,615 106,793 137,461 137,533 99,229 Fair value of scheme assets (115,166) (127,576) (133,660) (101,409) (65,020)
The expected return on scheme assets is based on historical data and management’s expectations of long-term future returns.
The Group has estimated the sensitivity of the net obligation recognised in the consolidated balance sheet to isolated changes in these assumptions at 31 December 2008 as follows: Present value (Increase) of unfunded Present value /decrease obligations of unfunded in obligation before change obligations recognised on in assumption after change balance sheet
Effect of an increase in inflation Use of inflation assumption of 3.25% (13,551) (11,810) –
31 Earnings per share Basic earnings per share is calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of shares in issue during the year, excluding ordinary shares purchased by the Group and held in treasury as own shares.
Profit attributable to the Company’s equity holders (£000) 70,808 191,248 Weighted average number of ordinary shares (thousands) 377,506 395,308 Basic earnings per share (pence per share) 18.8p 48.4p
A final dividend in respect of 2008 of 8.5p per share, amounting to a total dividend of 12.75p for the year, is to be proposed at the Annual General Meeting on 3 June 2009. These financial statements do not reflect this final dividend as a distribution or liability in accordance with IAS 10 Events after the reporting period.
33 Acquisitions On 30 September 2008, the Group acquired 100% of the issued share capital of Amershill Limited. Cash consideration of £2,000,000 was paid and goodwill of £1,909,000 was recognised. The fair value of the identifiable net assets acquired was £91,000. The effect on the Group’s income statement would have not been materially different if the acquisition had occurred on 1 January 2008.
34 Disposals The Group disposed of its Hiscox Select A to J Limited subsidiaries on 3 November 2008. The fair value of the net assets were £nil and a cash payment and loss on disposal of £42,000 was incurred. These entities were all non-trading corporate capital vehicles.
The Group’s wholly owned subsidiary, Hiscox Investment Management Limited was sold on 5 December 2007. This business did not constitute a discontinued operation as defined by IFRS 5 Non Current Assets Held for Sale and Discontinued Operations due to its relative insignificance to the Group and the fact that it did not represent a major line of business or operating segment.
(b) During 2008 Hiscox plc negotiated a new Letter of Credit and revolving credit facility with Lloyds TSB Bank, for a total of £350 million which may be drawn as cash (under a revolving credit facility) or Letter of Credit or a combination thereof, providing that the cash portion does not exceed £200 million. In addition, the terms also provide that upon request the facility may be drawn in foreign currency. At 31 December 2008 £137.5 million (2007: £137.5 million on previous facility) was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and a further US$130 million by way of cash (2007: US$182 million on previous facility repaid in full during the current year).
(d) The managed syndicate is subject to the New Central Fund annual contribution, which is an annual fee calculated on gross premiums written. This fee was 0.5% for 2008 and 2009. 0.75% was loaned to the central fund for 2007 which was repaid during 2007. No loan exists for 2008 or 2009. In addition to this fee, the Council of Lloyd’s has the discretion to call a further contribution of up to 3% of capacity if required.
92 Notes to the financial statements Hiscox Ltd Report and Accounts 2008
Operating lease commitments The Group acts as both lessee and lessor in relation to various offices in the UK and overseas which are held under non-cancellable operating lease agreements. The leases have varying terms, escalation clauses and renewal rights. The Group also has payment obligations in respect of operating leases for certain items of office equipment. Operating lease rental expenses for the year totalled £5,499,000 (2007: £4,691,000). Operating lease rental income for the year totalled £468,000 (2007: £468,000).
Later than one year and no later than five years Land and buildings 17,913 14,032 Office equipment 99 199
Finance lease interest expense for the year totalled £35,000 (2007: £54,000).
The present value of the minimum lease payments is not materially different to the currently disclosed obligation.
Hiscox plc* Holding company Great Britain Hiscox Insurance Company Limited General insurance Great Britain Hiscox Insurance Company (Guernsey) Limited* General insurance Guernsey Hiscox Inc. Underwriting agent USA (Delaware) Hiscox Holdings Inc. Insurance holding company USA (Delaware) ALTOHA Inc. Holding company USA (Delaware) American Live Stock Inc. Underwriting agent USA (Illinois) Hiscox Insurance Company Inc. General insurance USA (Illinois) Hiscox ASM Limited Insurance intermediary Great Britain Hiscox Insurance Company (Bermuda) Limited* General insurance and reinsurance Bermuda Hiscox Dedicated Corporate Member Limited Lloyd’s corporate Name Great Britain Hiscox Select Insurance Fund PLC Insurance holding company Great Britain Hiscox Select Holdings Limited Insurance holding company Great Britain Hiscox Holdings Limited** Insurance holding company Great Britain Hiscox Insurance Holdings Limited Insurance holding company Great Britain Hiscox Assurances Services SARL Underwriting agent France Hiscox International Holdings B.V. Insurance holding company Netherlands Hiscox Syndicates Limited Lloyd’s managing agent Great Britain Hiscox Underwriting Ltd Underwriting agent Great Britain Hiscox AG Underwriting agent Germany Hiscox Overseas Holdings B.V.* Holding company Netherlands Hiscox bv Underwriting agent Netherlands Hiscox Connect Limited Online intermediary Great Britain Hiscox Underwriting Group Services Limited Service company Great Britain Hiscox NV Underwriting agent Belgium Hiscox Trustees Limited† Corporate trustee Great Britain Hiscox Pension Trustees Limited Pension trustee Great Britain Hiscox Qualifying Employees Share Ownership Trustees Limited Share scheme trustee Great Britain Amershill Limited Underwriting agent Great Britain *Held directly.
**Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd (2007: 54,560) at 31 December 2008. †Hiscox Trustees Limited is the trustee of the Hiscox Employee Share Ownership Plan (ESOP). The ESOP owned 132,399 shares in Hiscox Ltd (2007: 132,399) at 31 December 2008. The shares have been purchased by the ESOP for future use in employee share option schemes and are held as own shares. None of these shares are currently under option to employees, nor have any been conditionally gifted to them.
Financial assets carried at fair value 2,081,772 1,747,827 1,241,910 1,237,778 980,731