PPOs1 Impact of an increase in the discount rate used in the calculation of present values of 100 basis points 68.2 76.0 Impact of a decrease in the discount rate used in the calculation of present values of 100 basis points (97.9) (109.4) Ogden2 as at 31 December 2016 Impact of the Group reserving at a discount rate of 0% compared to minus 0.75% at 31 December 2016 102.1 – Impact of the Group reserving at a discount rate of minus 1.5% compared to minus 0.75% at 31 December 2016 (156.4) – Ogden as at 31 December 2015 Impact of the Group reserving at a discount rate of 2.5% compared to 1.5% at 31 December 2015 – 131.9 Impact of the Group reserving at a discount rate of 0.5% compared to 1.5% at 31 December 2015 – (190.0)
When underwriting policies, the Group is subject to concentration risk in a variety of forms, including:  Geographic concentration risk – the Group purchases a catastrophe reinsurance programme to protect against a modelled one in 200-year loss. The retained deductible is £150 million at 31 December 2016 (2015: £150 million);  Product concentration risk – the Group’s business is heavily concentrated in the UK general insurance market. However, the Group offers a diversified portfolio of products and a variety of brands sold through a range of distribution channels to its customers; and
 Sector concentration risk – the concentration of the Group to any given industry sector is monitored and analysed in respect of commercial customers.
It is important to note that none of these risk categories is independent of the others and that giving due consideration to the relationship between these risks is an important aspect of the effective management of insurance risk.
Reinsurance risk This is the risk of inappropriate selection and / or placement of a reinsurance arrangement, with either individual or multiple reinsurers which renders the transfer of insurance risk to the reinsurer(s) inappropriate and / or ineffective. Other risks include:  Reinsurance concentration risk – the concentration credit exposure to any given counterparty;  Reinsurance capacity being reduced and / or withdrawn;  Underwriting risk appetite and reinsurance contract terms not being aligned;  Reinsurance contract terms being inappropriate or ineffective resulting in classes or types of business not being appropriately reinsured;  Non-adherence to the reinsurance policy terms and conditions, in terms of both policy management and claims not being handled within the reinsurance contract terms and conditions or paid on an ex-gratia basis resulting in reinsurance recoveries not being made in full;  Inappropriate or inaccurate management information and / or modelling being used to determine the value for money and purchasing of reinsurance (including aggregate modelling); and
The Group uses reinsurance to:  protect the underwriting result against low-frequency, high-severity losses through the transfer of catastrophe claims volatility to reinsurers;  protect the underwriting result against unforeseen volumes of, or adverse trends in, large individual claims in order to reduce volatility and to improve stability of earnings;  reduce the Group’s capital requirements; and / or
Using reinsurance, the Group cedes insurance risk to reinsurers but, in return, assumes counterparty default risk against which a reinsurance bad debt provision is assessed. The financial security of the Group’s panel of reinsurers is therefore important and both the quality and amount of the assumed counterparty default risk are subject to an approval process whereby reinsurance is only purchased from reinsurers that hold a credit rating of at least A- at the time cover is purchased. The Group’s leading counterparty exposures are reviewed on a monthly basis by the Head of Reinsurance and Corporate Insurance. The Group aims to contract with a diverse range of reinsurers on its contracts to mitigate the credit and / or non-payment risks associated with its reinsurance exposures.
The investment management objectives are to:  Maintain the safety of the portfolio’s principal both in economic terms and from a capital, accounting and reporting perspective;  Maintain sufficient liquidity to provide cash requirements for operations, including in the event of a catastrophe; and
 Maximise the portfolio’s total return within the constraints of the other objectives and the limits defined by the investment guidelines and capital allocation.
The fixed interest rate up to 27 April 2022 on the Group’s 30-year maturity £500 million of subordinated guaranteed dated notes has been exchanged for a floating rate of interest (note 31).
Direct Line Group Annual Report & Accounts 2016 140 3. Risk management continued The Group also invests in floating rate debt securities, whose investment income is influenced by the movement of the short-term interest rate. A movement of the short-term interest rate will affect the expected return on these investments.
The market value of the Group’s financial investments with fixed coupons is affected by the movement of interest rates. For the majority of investments in US Dollar corporate bonds, excluding £432.0 million of short duration high yield bonds (2015: £336.9 million), the Group hedges the exposure of this portfolio to the US Dollar interest rate risk using swaps. These derivatives reduce the duration of the portfolio to close to zero.
Sensitivity analysis The table below provides a sensitivity analysis of the potential impact of a change in a single factor with all other assumptions left unchanged. Other potential risks beyond the ones described in the table could have an additional financial impact on the Group.
Spread Impact of a 100 basis points increase in spreads on financial investments1,2,4. – – (183.1) (183.5) Interest rate Impact of a 100 basis points increase in interest rates on financial investments and derivatives1,2,3,4. 21.5 22.1 (101.5) (119.9) Investment property Impact of a 15% decrease in property markets (49.4) (52.1) (49.4) (52.1)
4. The subordinated liabilities and associated interest rate swap are excluded from the sensitivity analysis. 5. These sensitivities exclude the impact of taxation. 6. The sensitivities set out above have not considered the impact of the general market changes on the value of the Group’s insurance liabilities or retirement benefit obligations. They reflect one off impacts at 31 December and should not be interpreted as a prediction.
Counterparty default risk This is the risk of loss from unexpected default of the counterparties and debtors of Group undertakings. This risk is primarily managed by the 1st Line of Defence and monitored by three forums: the Investment risk forum monitors credit spreads as indicators of potential losses on investments incurred but not yet realised, the Credit risk forum monitors reinsurance and corporate insurance counterparty default risk; and the NIG credit committee is responsible for monitoring broker credit risk. The main responsibility of these fora is to ensure that all material aspects of counterparty default risk within the Group are identified, monitored and measured.
The main sources of counterparty default risk for the Group are:  Investments – this arises from the investment of funds in a range of investment vehicles permitted by the investment policy; and
 Reinsurance recoveries – counterparty exposure to reinsurance counterparties arises in respect of reinsurance claims against which a reinsurance bad debt provision is assessed. PPOs have the potential to increase the ultimate value of a claim and, by their very nature, to significantly increase the length of time to reach final payment. This can increase reinsurance counterparty default risk in terms of both amount and longevity.
Reinsurance assets 1,371.8 – – – 1,371.8 Insurance and other receivables 937.8 38.0 12.5 – 988.3 Derivative assets 79.7 – – – 79.7 Debt securities 4,730.3 – – – 4,730.3 Infrastructure debt 337.0 – – – 337.0 Commercial real estate loans 79.7 – – – 79.7 Cash and cash equivalents1 1,166.1 – – – 1,166.1
Notes: 1. This represents money market funds with no notice period for withdrawal and cash at bank and in hand.
Direct Line Group Annual Report & Accounts 2016 144 3. Risk management continued The table below analyses the distribution of debt securities by geographical area (infrastructure debt is all within the UK).
Direct Line Group Annual Report & Accounts 2016 146 3. Risk management continued The tables below analyse the credit quality of financial and insurance assets that are neither past due nor impaired (excluding debt securities analysed above). The tables include reinsurance exposure, after provision. Note 3.3.1 details the Group’s approach to reinsurance counterparty default risk management.
Notes: 1. Includes receivables due from policyholders, agents, brokers and intermediaries which generally do not have a credit rating. 2. This represents money market funds with no notice period for withdrawal and cash at bank and in hand.
3.3.4 Operational risk This is the risk of loss due to inadequate or failed internal processes, people, systems or from external events. Sources of operational risk for the Group include: Change risk This is the risk of failing to manage the Group’s change portfolio resulting in conflicting priorities and failure to deliver strategic outcomes to time, cost or quality.
Information Security Risk This is the risk of loss, corruption to Group or customer data or intellectual property, resulting in lost reputation, regulatory censure, supervision and fines or loss of competitive advantage.
The Group has in place agreed policies and standards to establish key controls relating to operational risk.
The tables below analyse the maturity of the Group’s derivative assets and liabilities.
At fair value through the income statement: Foreign exchange contracts (forwards) 1,110.0 21.4 – – 21.4 Designated as hedging instruments: Foreign exchange contracts (forwards) 14.8 1.6 0.1 – 1.7
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 27.1 0.4 – – 0.4 Designated as hedging instruments: Foreign exchange contracts (forwards) 5.0 0.3 – – 0.3
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 1,876.3 42.2 – – 42.2 Designated as hedging instruments: Foreign exchange contracts (forwards) 0.7 0.1 – – 0.1
Trade and other payables including insurance payables 699.2 688.9 9.8 0.2 0.3 –
Deposits with credit institutions with maturities in excess of three months 44.9 44.9 – – – –
overnance Financial statem ents www.directlinegroup.com 149 3.4 Capital adequacy (unaudited) Capital is managed in accordance with the Group’s capital management minimum standard, the objectives of which are to manage capital efficiently and maintain an appropriate level of capitalisation and solvency. The Group determines the appropriate level of capital on the basis of a number of criteria, including economic, regulatory and rating agency capital requirements. The Group seeks to hold capital resources consistent with an ‘A’ range credit rating.
Home This segment consists of home insurance together with associated legal protection cover. The Group sells home insurance through its own brands, Direct Line, Churchill and Privilege, and through partnership brands.
Rescue and other personal lines This segment consists of rescue products sold through the Group’s own brand, Green Flag, and other personal lines insurance, including travel, pet and creditor sold through its own brands, Direct Line, Churchill and Privilege, and through partnership brands.
Restructuring and other one-off costs Restructuring costs are costs incurred in respect of the business activities where the Group has a constructive obligation to restructure its activities. One-off costs were costs that were non-recurring in nature.
Restructuring costs (39.9) Operating profit 390.2 Finance costs (37.2) Profit before tax 353.0
The table below analyses the Group’s assets and liabilities by reportable segment at 31 December 2016.
The table below analyses the Group’s revenue and results for continuing operations by reportable segment for the year ended 31 December 2015. Discontinued operations are detailed in note 5.
Operating profit before restructuring and other one-off costs 338.0 109.9 52.0 20.8 520.7 73.1 593.8 Restructuring and other one-off costs (48.7) Operating profit 545.1 Finance costs (37.6) Profit before tax 507.5 Underwriting profit / (loss) 95.5 65.6 33.9 (19.8) 175.2 Loss ratio 63.6% 51.5% 59.9% 62.7% 59.5% Commission ratio 2.6% 20.9% 6.4% 19.6% 10.9% Expense ratio 26.2% 19.8% 24.9% 22.2% 23.6% COR 92.4% 92.2% 91.2% 104.5% 94.0%
All continuing operations are in the UK. The reportable segment net assets do not represent the Group’s view of the capital requirements for its operating segments.
The segmental analysis of assets and liabilities is prepared using a combination of asset and liability balances directly attributable to each operating segment and an apportionment of assets and liabilities managed at a Group wide level.
Items that may be reclassified subsequently to income statement: Exchange differences on the translation of foreign operations 14.4 Cash flow hedge (1.2) Fair value gain on AFS investments 0.6 Less: realised net gains on AFS investments included in income statement (31.8) Tax relating to items that may be reclassified 10.1 Other comprehensive loss for the year net of tax (7.9)
Gross earned premium: Gross written premium 3,274.1 3,152.5 Movement in unearned premium reserve (71.3) (42.4)
Investment income: Interest income from debt securities 136.5 140.1 Cash and cash equivalent interest income 4.2 6.7 Interest income from infrastructure debt 7.8 4.4 Interest income from commercial real estate loans 1.0 – Interest income 149.5 151.2 Rental income from investment property 18.4 17.9
Derivative (losses) / gains: Foreign exchange forward contracts2 (425.7) 19.1 (82.4) (19.1) Associated foreign exchange risk 151.0 253.0 44.9 61.9 Net (losses) / gains on foreign exchange forward contracts (274.7) 272.1 (37.5) 42.8
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations. 2. Foreign exchange forward contracts are at fair value through the income statement and interest rate swaps are designated as hedging instruments.
overnance Financial statem ents www.directlinegroup.com 155 8. Other operating income £m 20151 £m
Vehicle replacement referral income 14.1 12.5 Revenue from vehicle recovery and repair services 19.3 15.5 Other income2 24.8 22.7 Total 58.2 50.7
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations. 2. Other income includes legal services revenue, salvage income and fee income from insurance intermediary services.
Current accident year claims paid 1,131.7 – 1,131.7 1,037.0 – 1,037.0 Prior accident year claims paid 905.2 (18.8) 886.4 941.9 (15.9) 926.0 Increase / (decrease) in insurance liabilities 142.1 (356.4) (214.3) (149.6) (146.5) (296.1) Total 2,179.0 (375.2) 1,803.8 1,829.3 (162.4) 1,666.9
Commission expenses 246.8 253.2 Expenses incurred under profit participations 97.2 66.1 Total 344.0 319.3
The aggregate remuneration of those employed by the Group’s operations comprised: £m 20151 £m
The table below analyses auditor’s remuneration in respect of the Group’s operations.
Salaries, fees, bonuses and benefits in kind 3.1 3.5 Gains on exercise of share options 3.5 4.9 Defined contribution pension scheme contributions – 0.1
Interest expense on subordinated liabilities 46.3 46.3 Net interest received on designated hedging instrument2 (8.0) (8.0) Unrealised (gain) / loss on designated hedging instrument2 (19.6) 4.5 Unrealised loss / (gain) on associated interest rate risk on hedged item2 17.8 (5.9) Amortisation of arrangement costs and discount on issue of subordinated liabilities 0.7 0.7 Total 37.2 37.6
Current taxation: Charge for the year 84.4 103.5 Over provision in respect of prior year2 (7.7) (4.6)
(2.5) 9.4 Current taxation 76.7 98.9 Deferred taxation (note 14) (2.5) 9.4 Tax charge for the year 74.2 108.3
The following table analyses the difference between the actual income tax charge and the expected income tax charge computed by applying the standard rate of corporation tax of 20.0%1 (2015: 20.25%).
Profit before tax 353.0 507.5 Expected tax charge 70.6 102.8 Effects of: Disallowable expenses 9.7 7.8 Effect of change in corporation taxation rate (1.0) (0.7) Over provision in respect of prior year (5.1) (1.6)
2. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations.
Per balance sheet: Current tax assets 0.1 0.1 Current tax liabilities (0.5) (10.3) Deferred tax liabilities (46.0) (29.9)
In addition, the Group has an unrecognised deferred tax asset at 31 December 2016 of £7.5 million (2015: £4.1 million) in relation to capital losses of which £4.1 million (2015: £1.0 million) relates to realised losses and £3.4 million (2015: £3.1 million) relates to unrealised losses.
Amounts recognised as distributions to equity holders in the period: 2015 final dividend of 9.2p per share paid on 19 May 2016 126.0 – 2014 final dividend1 of 8.8 pence per share paid on 17 April 2015 – 131.6 2016 first interim dividend of 4.9 pence per share paid on 9 September 2016 67.1 – 2015 first interim dividend of 4.6 pence per share paid on 11 September 2015 – 63.0 2016 first special interim dividend of 10.0 pence per share paid on 9 September 2016 136.9 – 2015 first special interim dividend of 27.5 pence per share paid on 24 July 2015 – 411.5 2015 second special interim dividend of 8.8p per share paid on 19 May 2016 120.6 – 2014 second special interim dividend of 4.0 pence per share paid on 17 April 2015 – 59.9
Proposed dividends: 2016 final dividend of 9.7 pence per share 133.4 – 2015 final dividend of 9.2 pence per share – 126.5 2015 second special interim dividend of 8.8 pence per share – 121.0
The proposed final dividend for 2016 has not been included as a liability in these financial statements.
On 30 June 2015, the Group completed an 11 for 12 share consolidation which had the effect of reducing the number of shares in issue from 1,500 million Ordinary Shares of 10 pence each to 1,375 million new Ordinary Shares of 10 10/11 pence each. The weighted average number of Ordinary Shares used in calculating basic and diluted earnings per share for the year ended 31 December 2015 reflects this share consolidation.
Direct Line Group Annual Report & Accounts 2016 160 16. Earnings per share continued Diluted Diluted earnings per share is calculated by dividing the earnings attributable to the owners of the Company by the weighted average number of Ordinary Shares during the period adjusted for dilutive potential Ordinary Shares. The Company has share options and contingently issuable shares as categories of dilutive potential Ordinary Shares.
Net assets 2,521.5 2,630.0 Goodwill and other intangible assets (508.9) (524.8) Tangible net assets 2,012.6 2,105.2 Number of Ordinary Shares (millions) 1,375.0 1,375.0 Shares held by employee share trusts (millions) (9.9) (6.3) Closing number of Ordinary Shares (millions) 1,365.1 1,368.7 Net asset value per share (pence) 184.7 192.2 Tangible net asset value per share (pence) 147.4 153.8
overnance Financial statem ents www.directlinegroup.com 161 18. Goodwill and other intangible assets
Accumulated amortisation and impairment At 1 January 2015 – 122.0 122.0 Charge for the year relating to continuing operations – 63.1 63.1 Disposals and write-off1 – (8.0) (8.0) Impairment losses – 4.3 4.3
Charge for the year – 57.4 57.4 Disposals and write-off1 – (5.8) (5.8) Impairment losses2 – 39.3 39.3
Notes: 1. Disposals and write-off include fully amortised intangible assets no longer utilised by the Group in its operating activities. 2. The impairment losses relate to capitalised software development costs for ongoing IT projects primarily relating to development of new systems. The impairment losses result from a review of the projected benefits and the charge which reduced the carrying value of impaired assets to £nil, is reflected in the Motor segment.
Direct Line Group Annual Report & Accounts 2016 162 18. Goodwill and other intangible assets continued The table below analyses the goodwill of the Group by CGU.
The recoverable amount is the higher of the CGU fair value less the costs to sell and its value-in-use. Value-in-use is the present value of expected future cash flows from the CGU. Fair value is the estimated amount that could be obtained from the sale of the CGU in an arm’s length transaction between knowledgeable and willing parties.
The recoverable amounts of all CGUs were based on the value-in-use test, using the Group’s five-year strategic plan. The long-term growth rates have been based on GDP rates adjusted for inflation. The risk discount rates incorporate observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
Motor 3.0 11.6 686.0 (189.9) (260.5) (24.8) Home 3.0 11.6 667.9 (66.6) (68.2) (9.0) Rescue and other personal lines 3.0 11.6 611.6 (56.6) (76.9) (6.9) Commercial 3.0 11.6 374.1 (62.1) (84.5) (7.6)
overnance Financial statem ents www.directlinegroup.com 163 19. Property, plant and equipment Freehold land and buildings £m
Transfer to assets held for sale (note 28) (22.6) – (22.6)
Accumulated depreciation and impairment At 1 January 2015 1.7 55.1 56.8 Depreciation charge for the year relating to continuing operations 1.2 29.5 30.7
Impairment losses – 4.8 4.8 Transfer to assets held for sale (note 28) (0.5) – (0.5)
The Group is satisfied that the aggregate value of property, plant and equipment is not less than its carrying value.
Additions at cost 1.4 16.0 Increase in fair value during the year 5.4 24.2
Note: 1. The cost included in carrying value at 31 December 2016 is £275.3 million (2015: £295.5 million).
Direct Line Group Annual Report & Accounts 2016 164 21. Subsidiaries The principal subsidiary undertakings of the Group, over which it exercises 100% voting power, are shown below. Their capital consists of Ordinary Shares which are unlisted. All subsidiaries (a full list of which is included in note 2 of the Company financial statements) are included in the Group’s consolidated financial information.
On 29 May 2015, the Group completed the sale of its International business comprising Direct Line Insurance S.p.A and Direct Line Versicherung AG for a cash consideration of £438.1 million. Details of the fair value of assets and liabilities disposed of and the gain on disposal are set out in note 5B.
The Group did not dispose of any other subsidiaries in the years ended 31 December 2016 and 31 December 2015.
Receivables arising from insurance contracts: Due from policyholders 820.8 800.1 Impairment provision of policyholder receivables (0.3) (0.7) Due from agents, brokers and intermediaries 66.4 60.0 Impairment provision of agent, broker and intermediary receivables (1.0) (1.3)
overnance Financial statem ents www.directlinegroup.com 165 25. Derivative financial instruments £m 2015 £m
Cash at bank and in hand 166.6 131.8 Short-term deposits with credit institutions1 999.5 831.9 Cash and cash equivalents 1,166.1 963.7 Bank overdrafts2 (55.3) (61.3) Cash and bank overdrafts3 1,110.8 902.4
Notes: 1. This represents money market funds with no notice period for withdrawal. 2. Bank overdrafts represent short-term timing differences between transactions posted in the records of the Group transactions flowing through the accounts at the bank. 3. Cash and bank overdrafts is included for the purposes of the consolidated cash flow statement.
Issued and fully paid: equity shares Ordinary Shares of 10 10/11 pence each 1,375 1,375 150.0 150.0
Revaluation during the year – gross 119.6 (100.5) Revaluation during the year – tax (20.2) 22.0 Realised gains – gross (15.3) (12.5) Realised gains – tax 2.6 2.5 Realised gain on disposal of subsidiary – gross – (31.8) Realised gain on disposal of subsidiary – tax – 10.1
Transfer (to) / from retained earnings (152.9) 28.0 At 31 December – 152.9
The non-distributable reserve is a statutory claims equalisation reserve that is calculated in accordance with the rules of the PRA. With the introduction of Solvency II on 1 January 2016 the requirement to maintain the reserve ceased and the non-distributable reserve transferred into retained earnings. A new model to calculate the Group’s capital requirements under Solvency II was agreed with the PRA in June 2016.
Notes: 1. Arose on the cancellation of a debt payable to a shareholder. 2. Arose on the reduction of nominal value of each share in issue with a corresponding transfer to capital reduction reserve.
The notes, with a nominal value of £500 million, have a redemption date of 27 April 2042. The Group has the option to repay the notes on specific dates from 27 April 2022. If the notes are not repaid on that date, the rate of interest will be reset at a rate of the six-month LIBOR plus 7.91%.
Gross liability recognised in balance sheet 197.5 116.4 182.5 207.0 198.2 218.3 339.7 625.5 727.4 1,138.3 3,950.8 2006 and prior 636.5 Claims handling provision 79.3 Total 4,666.6
Accident year 2007 £m 2010 £m £m £m £m £m 2016 £m Total £m
Estimate of ultimate net claims costs: At end of accident year 3,970.3 3,334.7 3,790.6 3,902.0 2,644.4 2,271.8 2,093.9 1,971.0 1,926.7 1,922.2 One year later (64.3) 52.0 70.0 (125.2) (131.5) (146.7) (123.6) (29.7) (67.0) Two years later (14.5) 15.9 (17.4) (120.4) (82.1) (107.8) (134.4) (42.0) Three years later 32.9 (22.8) (54.1) (44.0) (76.5) (35.6) (27.8) Four years later (8.9) (45.8) (67.0) (93.6) (48.7) (11.6) Five years later (17.6) (48.7) (29.6) (52.3) (37.3) Six years later (19.6) (30.9) (74.6) (43.9) Seven years later (16.0) (24.5) (38.2) Eight years later (12.5) (16.2) Nine years later (7.5)
Current estimate of cumulative claims 3,842.3 3,213.7 3,579.7 3,422.6 2,268.3 1,970.1 1,808.1 1,899.3 1,859.7 1,922.2
Direct Line Group Annual Report & Accounts 2016 170 34. Retirement benefit obligations Defined contribution scheme The pension charge in respect of the defined contribution scheme for the year ended 31 December 2016 was £24.9 million (2015: £23.5 million).
The weighted average duration of the defined benefit obligations at 31 December 2016 is 20 years (2015: 20 years) using accounting assumptions.
Index-linked bonds 28.6 21.5 Government bonds 16.9 13.7 Corporate bonds – 43.8 Liquidity fund1 56.3 5.5
The majority of debt and equity instruments held directly or through the liquidity fund have quoted prices on active markets.
Income statement: Net interest income / (cost)1 2.8 (2.7) 0.1 Statement of comprehensive income: Actuarial gains arising from experience adjustments (1.9) 1.2 (0.7) Actuarial gains arising from changes in demographic assumptions – 1.1 1.1 Actuarial gains arising from changes in financial assumptions – 6.3 6.3
Present value of defined benefit scheme obligations (90.5) (72.0) (79.6) (68.0) (61.2) Fair value of defined benefit scheme assets 102.5 85.1 83.1 66.0 63.7
Experience adjustment gains / (losses) on scheme liabilities 1.2 1.2 1.0 (0.2) (0.1) Experience adjustment gains / (losses) on scheme assets 13.7 (1.9) 12.9 (1.3) 2.2
Direct Line Group Annual Report & Accounts 2016 172 34. Retirement benefit obligations continued Sensitivity analysis The table below provides a sensitivity analysis of the potential impact of a change in a single factor with all other assumptions left unchanged. Other potential risks beyond the ones described in the table could have an additional financial impact on the Group. This sensitivity analysis has been selected to reflect the changes to discounted cash flows as a result of changes to the discount rate, inflation rate and mortality assumptions. The methodology adopted involves actuarial techniques.
Discount rate 0.25% increase in discount rate (0.2) (0.2) (4.7) (3.7)
Inflation rate 0.25% increase in inflation rate – – 2.3 1.7 0.25% decrease in inflation rate – – (2.3) (1.7) Life expectancy 1 year increase in life expectancy 0.1 0.1 2.7 2.0 1 year decrease in life expectancy (0.1) (0.1) (2.7) (2.0)
The most recent funding valuation of the defined benefit scheme took place as at 1 October 2014. The Group agreed with the trustees to make a contribution of £2.8 million in 2016 with further contributions of up to £1.5 million per annum in 2017 and 2018 to meet the scheme’s funding requirements. As a result of the latest funding update no contribution is expected to be payable in 2017.
Weighted average assumptions during the year: Share price (pence) 368 339 Exercise price (pence) 0 0 Volatility of share price 18% 20% Average comparator volatility 29% 27% Expected life 3 years 3 years Risk-free rate 0.3% 0.8%
Restricted Shares Plan The purpose of the Restricted Shares Plan is to facilitate the wider participation in Group share-based awards to eligible employees. These awards can be granted at any time during the year, generally have no performance criteria, and vest over periods ranging between one and three years from the date of the grant, subject to continued employment. During the year awards were made over 0.3 million Ordinary Shares (2015: 0.0 million Ordinary Shares) with an estimated fair value of £0.9 million (2015: £0.1 million) using the market value at the date of grant.
Deferred Annual Incentive Plan To incentivise delivery of performance over a one-year operating cycle, Executive Directors and certain members of senior management are eligible for awards under the Annual Incentive Plan, of which at least 40% is granted in the form of a nil-cost option under the DAIP with the remainder being settled in cash following year end. During the year awards were made over 1.0 million Ordinary Shares (2015: 1.0 million Ordinary Shares) under this plan with an estimated fair value of £3.7 million (2015: £3.4 million) using the market value at the date of grant.
The awards outstanding at 31 December 2016 have no performance criteria attached, other than the requirement that the employee remains in employment with the Group for three years from the date of grant.
Direct Line Group Share Incentive Plans: Free Share awards In 2016, the Group offered all eligible UK employees a Free Share award granting 71 Ordinary Shares (2015: 122 Ordinary Shares) free of charge. These awards have no performance criteria attached and vest on the third anniversary of the award grant date, subject to completion of three years, continuing employment. The Group initially granted 0.8 million Ordinary Shares (2015: 1.3 million) with an estimated fair value of £2.8 million (2015: £4.2 million) using the market value at the date of grant.
In the year ended 31 December 2016, matching share awards were granted over 0.4 million Ordinary Shares (2015: 0.3 million Ordinary Shares) with an estimated fair value of £1.3 million (2015: £1.1 million). The fair value of each matching share award is estimated using the market value at the date of grant.
The weighted average share price for awards exercised during the year ended 31 December 2016 was £3.68 (2015: £3.95).
The Group recognised total expenses in the year ended 31 December 2016 of £16.8 million (2015: £12.1 million) relating to equity-settled share-based compensation plans.
Further information on share-based payments, in respect of Directors, is provided in the Directors’ remuneration report.
Direct Line Group Annual Report & Accounts 2016 174 36. Trade and other payables including insurance payables £m 2015 £m
Lease payments under operating leases recognised as an expense in the year 18.3 18.4
Within one year 16.3 15.7 In the second to fifth years inclusive 53.0 53.6 After five years 78.9 89.3 40. Fair value
At 31 December 2016 Carrying value £m Level 1 £m £m Fair Value £m
Assets held at fair value: Investment property (note 20) 329.0 – – 329.0 329.0
Commercial real estate loans (note 26) 79.7 – – 79.8 79.8
At 31 December 2015 Carrying value £m Level 1 £m £m Fair Value £m
Other financial assets: HTM debt securities (note 26) 13.5 – – 12.7 12.7 Deposits with credit institutions > three months (note 26) 44.9 – – 44.9 44.9
Movement in amounts owed by and to related parties Amounts owed by related parties Amounts owed to related parties £m £m 2015 £m
Parent Company balance sheet As at 31 December 2016 www.directlinegroup.com 179
Current tax assets 4 0.8 – Derivative financial instruments 5 1.7 0.4
Parent Company statement of comprehensive income For the year ended 31 December 2016
Direct Line Group Annual Report & Accounts 2016 180 £m 2015 £m
Other comprehensive income / (loss) net of tax 0.4 (1.2) Total comprehensive income for the year attributable to owners of the Company 765.3 538.3
The attached notes on pages 182 to 186 form an integral part of these separate financial statements.
Total comprehensive income for the year – – – – (1.2) 539.5 538.3 Dividends paid – – – – – (666.0) (666.0) Credit to equity for equity-settled share-based payments – – 12.1 – – – 12.1 Shares distributed by employee trusts – – (11.0) – – – (11.0)
Net cash used by operating activities 12 (5.1) (3.1) Cash flows from investing activities Interest received on loans to subsidiary undertakings 47.6 47.5 Interest received on AFS debt securities 4.7 – Dividends received from subsidiary undertakings 780.6 671.0 Net increase in loans advanced to subsidiary undertakings (28.8) (21.8) Capital contribution to subsidiary undertakings (16.9) (225.0) Disposal of assets held for sale – 224.3 Proceeds on disposal / maturity of AFS debt securities 5.0 – Purchase of AFS debt securities (136.9) (2.0) Net cash generated from investing activities 655.3 694.0 Cash flows from financing activities Dividends paid 11 (450.6) (666.0) Purchase of employee trust shares (25.6) – Finance costs (46.3) (46.3) Net cash used by financing activities (522.5) (712.3) Net increase / (decrease) in cash and cash equivalents 127.7 (21.4) Cash and cash equivalents at the beginning of the year 7 29.8 51.2 Cash and cash equivalents at the end of the year 7 157.5 29.8
Notes to the Parent Company financial statements www.directlinegroup.com 182 1. Accounting policies 1.1 Basis of preparation Direct Line Insurance Group plc, registered in England and Wales (company number 02280426), is the ultimate parent company of the Direct Line Group. The principal activity of the Company is managing its investments in subsidiaries, providing loans to those subsidiaries, raising funds for the Group and the receipt and payment of dividends.
1.2 Investment in subsidiaries Investment in subsidiaries is stated at cost less any impairment.
Directly held by the Company: Direct Line Group Limited1 United Kingdom Intermediate holding company DL Insurance Services Limited1 United Kingdom Management services Finsure Premium Finance Limited1 United Kingdom Non-trading company Inter Group Insurance Services Limited1 United Kingdom Non-trading company UK Assistance Accident Repair Centres Limited1 United Kingdom Motor vehicle repair services UK Assistance Limited1 United Kingdom Dormant U K Insurance Business Solutions Limited1 United Kingdom Insurance broking services U K Insurance Limited2,3 United Kingdom General insurance Indirectly held by the Company: 10-15 Livery Street, Birmingham UK Limited4 Jersey Non-trading company Churchill Insurance Company Limited1 United Kingdom General insurance Direct Line Insurance Limited1 United Kingdom Dormant DLG Legal Services Limited5 United Kingdom Legal services DLG Pension Trustee Limited1 United Kingdom Dormant DL Support Services India Private Limited6 India Support and operational services Farmweb Limited1 United Kingdom Non-trading company Green Flag Group Limited2 United Kingdom Intermediate holding company Green Flag Holdings Limited1 United Kingdom Intermediate holding company Green Flag Limited2 United Kingdom Breakdown recovery services Intergroup Assistance Services Limited1 United Kingdom Non-trading company National Breakdown Recovery Club Limited1 United Kingdom Dormant Nationwide Breakdown Recovery Services Limited1 United Kingdom Dormant The National Insurance and Guarantee Corporation Limited1 United Kingdom Dormant UKI Life Assurance Services Limited1 United Kingdom Dormant
Per balance sheet: Current tax assets 0.8 – Current tax liabilities – (3.0) Deferred tax liabilities1 (0.4) –
5. Derivative financial instruments Notional amount Fair value Notional amount Fair value £m £m 2015 £m
Derivative assets Designated as hedging instruments: Subsidiary undertakings – – 0.7 0.1
Note: 1. The AFS debt securities which are fixed interest UK Sovereign debt are classified as level 1 within the Group’s fair value hierarchy set out in note 40 of the consolidated financial statements.
The aggregate fair value of subordinated guaranteed dated notes at 31 December 2016 was £625.0 million (2015: £623.2 million).
Tax (paid) / received (3.0) 1.2 Cash flow hedges 1.2 – Cash used by operating activities (5.1) (3.1)
Direct Line Group Annual Report & Accounts 2016 186 13. Related parties Direct Line Insurance Group plc, which is incorporated in England and Wales, is the ultimate parent undertaking of the Direct Line Group of companies.
Interest income from loans to subsidiary undertakings was charged at rates ranging from 0.4% to 9.5% (2015: 0.5% to 9.5%).
Interest charged on borrowings from related parties in the year ended 31 December 2016 was nil (2015: 0.5% to 0.6%).
16. Directors and key management remuneration The Directors and key management of the Group and the Company are the same. The aggregate emoluments of the Directors are set out in note 11 to the consolidated financial statements, the compensation for key management is set out in note 41 to the consolidated financial statements and the remuneration and pension benefits payable in respect of the highest paid Director are included in the Directors’ remuneration report in the Governance section of the Annual Report & Accounts.
Corporate website The Group’s corporate website is www.directlinegroup.com. It contains useful information for the Company’s investors and shareholders. For example, it includes press releases, details of forthcoming events, essential shareholder information, a dividend history, a financial calendar, and details of the Company’s AGM. You can also subscribe to email news alerts.
 Do not converse with them. Note the name of the person and firm contacting you, then end the call
 To see if the person and firm contacting you are authorised by the FCA, check the Financial Services Register at www.fca.org.uk
 Beware of fraudsters claiming to be from an authorised firm; copying its website; or giving you false contact details
 If you want to phone the caller back, use the firm’s contact details listed on the Financial Services Register at www.fca.org.uk
 If the firm does not have contact details on the Register or they tell you the details are out of date, call the FCA on 0800 111 6768
 Remember that if you buy or sell shares from an unauthorised firm, you cannot access the Financial Ombudsman Service or Financial Services Compensation Scheme
 Get independent financial and professional advice before handing over any money
Additional information continued 188 Direct Line Group Annual Report & Accounts 2016
Tips on protecting your shares  Keep all your certificates in a safe place. Alternatively, consider holding your shares in the UK’s electronic registration and settlement system for equity, called CREST, or via a nominee
 Keep correspondence from the Registrar that shows your shareholder reference number in a safe place, and shred unwanted correspondence
 Inform the Registrar as soon as you change your address
 If you receive a letter from the Registrar regarding a change of address and you have not recently moved, contact them immediately
 Find out when your dividends are paid and contact the Registrar if you do not receive them
 Consider having your dividends paid direct into your bank account. You will need to complete a dividend mandate form and send it to the Registrar. This reduces the risk of cheques being stolen or lost in the post
You can call or email the Registrar regarding its share-dealing facility using this contact information:  For telephone sales, call +44 (0)370 703 0084 between 8.00 am and 4.30 pm, Monday to Friday, excluding public holidays
Actuarial best estimate The probability-weighted average of all future claims and cost scenarios. It is calculated using historical data, actuarial methods and judgement. A best estimate of reserves will therefore normally include no margin for optimism or, conversely, caution.
Adjusted diluted earnings per share is calculated by dividing the adjusted profit after tax of ongoing operations by the weighted average number of Ordinary Shares during the period adjusted for dilutive potential Ordinary Shares (see page 192 alternative performance measures).
Financial assets that are classified as available-for-sale. Please refer to the accounting policy note 1.12 on page 130.
Buy-As-You-Earn The HM Revenue & Customs approved Buy-As-You-Earn Share Incentive Plan gives all employees the opportunity to become shareholders in the Company.
Capital The funds invested in the Group, including funds invested by shareholders and retained profits. Capital coverage ratio The ratio of Solvency II own funds to the solvency capital requirement. Claims frequency The number of claims divided by the number of policies per year. Claims reserve (provision for losses and lossadjustment expense)
Funds the Group sets aside to meet the estimated cost of paying claims, and related expenses that the Group considers it will ultimately need to pay.
The sum of the loss, commission and expense ratios. The ratio measures the amount of claims costs, commission and expenses, compared to net earned premium generated. A ratio of less than 100% indicates profitable underwriting.
Discontinued operations The Group has sold its International division to Mapfre, S.A. See note 5 to the consolidated financial statements on page 152.
Investment return yield The return earned from the investment portfolio, recognised through the income statement during the period divided by the average AUM. This includes unrealised and realised gains and losses, impairments, and fair-value adjustments. The average AUM derives from the period’s opening and closing balances (see page 193 alternative performance measures).
It includes claims payments and movements in claims reserves. Net earned premium The element of gross earned premium less reinsurance premium ceded for the period where insurance cover has already been provided. Ogden discount rate The discount rate set by the relevant government bodies, the Lord Chancellor and Scottish Ministers.
Operating profit The pre-tax profit that the Group’s activities generate, including insurance and investment activity, but excluding finance costs.
Risk and business mix Risk and business mix measures the premium impact of channel, tenure and underlying risk mix. It reflects the risk models used in the period, the outputs of which are revised when models are updated.
This is a representation of the underlying earnings over the number of shares in issue adjusted for potential dilutions from the exercise of options.
COR is defined in the glossary on page 189. The constituent parts: Operating profit – Ongoing operations is discussed below; and Net earned premium (note 4).
Loss ratio is defined in the glossary on page 190 and is reconciled in note 4.
This measure shows the underlying performance (after tax and finance costs) of the business activities without the impact of business that is in run-off and non-repeating restructuring and one-off expenses.
Tangible equity Equity Tangible equity is defined as Equity less intangible assets within the Balance Sheet and is reconciled on page 192.
This shows the equity excluding intangible assets for comparability with companies who have not acquired businesses or capitalised intangible assets.
This represents the total value of operating expenses included those allocated to the insurance claims line as claims handling expenses.
Notes: 1. See glossary on pages 189 and 190 for definitions 2. See notes to the condensed consolidated financial statements 3. Mean average of opening and closing balances
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations 2. See note 2 on page 45
Glossary and appendices continued 192 Direct Line Group Annual Report & Accounts 2016
Appendix A – Alternative performance measures continued Additionally, the current-year attritional loss ratio within the analysis by division section and total costs have also been identified as alternative performance measures, similarly reconciled to the financial statements and notes, on page 40, and defined in the glossary.
Appendix B – Proforma results The table below presents the Group’s results on a proforma basis for 2016 in order to exclude the impact on the income statement of the recent reduction in the Ogden discount rate to minus 0.75%, as management believe that this provides a clearer comparison to 2015.
Of which Ongoing operations 293.0 433.1 385.3 Key metrics – Ongoing operations Loss ratio1 prior to the reduction in Ogden discount rate 55.0% 55.0% 59.5% Loss ratio1 due reduction in Ogden discount rate 5.9% – –
Gross written premium 3,274.1 3,274.1 3,152.4 Net earned premium 3,000.6 3,000.6 2,920.8
Basic earnings per share (pence) 1 20.4 33.1 27.9 Return on equity 10.8% 17.0% 21.3%
Forward-looking statements are not guarantees of future performance. The Group’s actual results of operations, financial condition and the development of the business sector in which the Group operates may differ materially from those suggested by the forward-looking statements in this document; for example directly or indirectly as a result of, but not limited to, UK domestic and global economic business conditions, the result of the UK’s withdrawal from the European Union; market-related risks such as fluctuations in interest rates and exchange rates, the policies and actions of regulatory authorities (including changes related to capital and solvency requirements or the Ogden discount rate), the impact of competition, currency changes, inflation and deflation, the timing impact and other uncertainties of future acquisitions, disposals, joint ventures or combinations within relevant industries, as well as the impact of tax and other legislation and other regulation in the jurisdictions in which the Group and its affiliates operate. Additionally, even if the Group’s actual results of operations, financial condition, and the development of the business sector in which the Group operates are consistent with the forward-looking statements in this document, those results or developments may not indicate results or developments in subsequent periods.
The forward-looking statements in this document reflect knowledge and information available as of the date this document was prepared. The Group and the Directors expressly disclaim any obligations or undertaking to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, unless an applicable law or regulation requires them to do so. Nothing in this document should be construed as a profit forecast.
Morgan Stanley & Co International plc 25 Cabot Square Canary Wharf London E14 4QA