– Vested options will remain exercisable for up to the tenth anniversary of grant – Malus and clawback provisions apply to the LTIP. Further explanatory notes can be found on the Direct Line Group website, under the ‘Results and reports’ heading on the Investors page, and on pages 128 to 138 in the 2019 Directors’ Remuneration Report.
– Executive Directors are expected to retain all the Ordinary Shares vesting under any of the Company’s share incentive plans, after any disposals for paying applicable taxes, until they have achieved the required shareholding level; unless such earlier sale, in exceptional circumstances, is permitted by the Chair
– In exceptional circumstances, earlier sale is permitted subject to the Chair’s discretion
– Not applicable 138 Direct Line Group Annual Report and Accounts 2020
– Outcomes for performance between threshold and maximum will be determined on a straight-line basis
– Each year, at least 50% of the bonus is based on financial measures. The remainder of the bonus may be based on a combination of, for example, strategic, operational, shared or individual performance measures
– Before any payment can be made, the Committee will perform an additional gateway assessment (including in respect of any risk concerns). This will determine whether the amount of any bonus is appropriate in view of facts or circumstances which the Committee considers relevant. This assessment may result in moderating (positively or negatively) each AIP performance measure, subject to the individual maximum bonus levels
– For Executive Directors, at least 40% of the AIP is deferred into shares under the DAIP – This typically vests three years after grant (with deferred awards also capable of being settled in cash at the discretion of the Committee, for example, when it gives rise to legal difficulties to settle in shares). The remainder of the award is paid in cash following the year end
The Board would like to draw your attention to the forwardlooking statements disclaimer which can be found on page 231.
Directors’ report disclosures The Board takes the view that some of the matters required to be disclosed in the Directors’ report are of strategic importance and these are, therefore, included in the Company’s Strategic report which is on pages 1 to 75 as permitted by the Companies Act 2006. These matters, and all matters referenced in the table below, are incorporated into this Directors’ report: Subject Pages
Use of financial instruments 26, 33, 34 Important events since the financial year-end
Details of shareholder dividend waivers 141 Controlling shareholder agreements Not applicable
Dividends The Board recommends a final dividend of 14.7 pence per share to shareholders. Subject to shareholder approval at the Company’s 2021 AGM, this will become payable on 20 May 2021 to all holders of Ordinary Shares on the Register of members at close of business on 9 April 2021.
You can find information on dividend and capital management, including the share buyback programme, in the Finance review, on pages 20 to 35.
The Company’s Articles of Association set out the Directors’ powers. You can view these on the Company’s website at www.directlinegroup.co.uk. The Directors’ powers are also subject to relevant legislation and, in certain circumstances, including in relation to the issuing or buying back of shares, authority from the Company’s shareholders. You can find details of the Directors’ remuneration, service contracts, employment contracts and interests in the shares of the Company in the Directors’ Remuneration Report on pages 113 to 139.
At the 2021 AGM, shareholders will be asked to renew these authorities. The Company has not held any shares in treasury during the period under review. You can find out more about the Company’s share capital and shares under option as at 31 December 2020 in notes 30 and 36 of the consolidated financial statements.
Employees of the Company and Directors must comply with the UK Market Abuse Regulation and the Company’s share dealing rules. These rules restrict particular employees’ and Directors’ ability to deal in the Company’s shares at certain times, and require the employee or Director to obtain permission to deal before doing so. Some of the Company’s employee share plans also include restrictions on transferring shares while the shares are held within the plans.
Articles of Association Unless expressly specified to the contrary in the Articles of Association, they may only be amended by a special resolution of the Company’s shareholders at a general meeting.
Substantial shareholdings The table below shows the direct and indirect holdings of major shareholders in the Company’s ordinary issued share capital, as at 31 December 2020 and as at 5 March 2021, as notified in accordance with the provisions of Chapter 5 of the FCA’s Disclosure Guidance and Transparency Rules. It should be noted that these holdings may have changed since the Company was notified. However, notification of any change is not required until the next notifiable threshold is crossed. Information provided by the Company pursuant to the FCA’s Disclosure Guidance and Transparency Rules is publicly available via the regulatory information services and on the Company’s website.
The Group is a leading motor, home and commercial insurer which depends on the trust and confidence of its stakeholders to operate sustainably in the long term. Direct Line Group seeks to put its customers’ best interests first, invests in its employees, supports the communities in which it operates and strives to generate sustainable profits for shareholders.
The Board aims to maintain the highest possible standards of integrity in business relationships with suppliers and partners. The Group is a long-standing signatory of the Prompt Payment Code. There are mechanisms in place for the Board to be alerted to problems with payment expectations.
The Board monitors customer engagement by receiving a customer and conduct report at each of its scheduled meetings. We put our customers at the heart of everything that we do. The Board believes that the Company’s long-term sustainability is driven by understanding customers’ needs and acting in their best interests.
Employee engagement The Board encourages a culture that celebrates difference and seeks to empower people so that they can thrive. The Board values the involvement and engagement of its employees and continues to listen to employees’ views and opinions.
For more on key decisions and considerations relating to stakeholders see pages 86 to 87 and for more information on Board-sponsored initiatives to support the workforce, including in connection with the Covid-19 crisis, the Agile transformation programme, diversity and inclusion and on culture see the Sustainability Pillars – People on page 50, the Sustainability Committee Report on pages 109 to 110 and for wider workforce engagement and pay considerations in 2020 see the Directors’ Remuneration Report on pages 113 to 139.
Directors’ report continued 142 Direct Line Group Annual Report and Accounts 2020
Going concern The Directors believe that the Group has sufficient financial resources to meet its financial needs, including managing a mature portfolio of insurance risk. The Directors further believe the Group is well positioned to manage its business risks successfully in the current economic climate. The Finance review on pages 20 to 35 describes the Group’s capital management strategy, including the capital actions taken in the year to ensure the continued strength of the balance sheet. The Group’s financial position is also covered in that section, including a commentary on cash and investment levels, reserves, currency management, insurance liability management, liquidity and borrowings. Additionally note 3 to the consolidated financial statements describes capital management needs and policies. The note also covers insurance, market, liquidity and credit risks which may affect the Group’s financial position.
The Directors have assessed the principal risks of the Group over the duration of the planning cycle. These included the implementation of the FCA’s Pricing Practices Review, possible adverse implications of Brexit, change risk and possible challenging market conditions due to the impact of Covid-19 on the economy and customer behaviour. The 2020 Plan modelled a number of different scenarios which were directly and indirectly influenced by the Covid-19 pandemic. These included delay to improvements in technological capability, the impact of Covid-19 on claims frequency levels and the impact of Brexit on the investment return. The key judgements applied were in relation to the likely time period of Covid-19 related restrictions, and the subsequent impact on customer behaviour and the economic recovery.
In addition, the Group’s Risk function has carried out an assessment of the risks to the Plan and the dependencies for the success of the Strategic Plan. This included running stress tests on the Plan to consider the 1 in 8 years and 1 in 25 years loss simulations based on the internal economic capital model.
Therefore, having made due enquiries, the Directors reasonably expect that the Group has adequate resources to continue in operational existence for at least 12 months from 5 March 2021 (the date of approval of the financial statements). Accordingly, the Directors have adopted the going concern basis in preparing the financial statements.
Company law requires the Directors to prepare such financial statements for each financial year in accordance with UK-adopted international accounting standards.
Each of the Directors, whose names and functions are listed on pages 78 to 80, confirms that, to the best of their knowledge: – the financial statements, prepared in accordance with IFRS, 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; – the Strategic report (on pages 1 to 75) and Directors’ report (on pages 140 to 144) include a fair review of: (i) the business’s development and performance; and (ii) the position of the Group and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties they face; and
Notes to the Consolidated Financial Statements 1. Accounting policies 162 2. Critical accounting judgements and key sources of estimation uncertainty 3. Risk management 172 4. Segmental analysis 185 5. Net earned premium 188 6. Investment return 188 7. Other operating income 189 8. Net insurance claims 189 9. Commission expenses 189 10. Operating expenses 189 11. Finance costs 190 12. Tax charge 191 13. Current and deferred tax 191 14. Dividends and appropriations 192 15. Earnings per share 193 16. Net asset value per share and return on equity 17. Goodwill and other intangible assets 194 18. Property, plant and equipment 195 19. Right-of-use assets 196 20. Investment property 196 22. Reinsurance assets 197 23. Deferred acquisition costs 197 24. Insurance and other receivables 197 25. Prepayments, accrued income and other assets 26. Derivative financial instruments 198 27. Retirement benefit obligations 198 28. Financial investments 202 29. Cash and cash equivalents and borrowings 202 30. Share capital 202 31. Other reserves 203 33. Subordinated liabilities 204 34. Insurance liabilities 205 35. Unearned premium reserve 208 36. Share-based payments 208 38. Trade and other payables, including insurance payables 39. Notes to the consolidated cash flow statement 40. Commitments and contingent liabilities 212 42. Fair value 213 43. Related parties 214 44. Post balance sheet event 214
1. Opinion In our opinion: – the financial statements of Direct Line Insurance Group plc (the “Parent Company”) and its subsidiaries (together the “Group”) give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2020 and of the Group’s profit for the year then ended; – the Group financial statements have been properly prepared in accordance with international accounting standards in conformity with the requirements of the Companies Act 2006, International Financial Reporting Standards ("IFRSs") as adopted by the European Union and IFRSs as issued by the International Accounting Standards Board (“IASB”); – the Parent Company financial statements have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice, including FRS 101 ‘Reduced Disclosure Framework’; and
We have audited the financial statements which comprise: – the Consolidated Income Statement; – the Consolidated and Parent Company Statements of Comprehensive Income; – the Consolidated and Parent Company Balance Sheets; – the Consolidated and Parent Company Statements of Changes in Equity; – the Consolidated Cash Flow Statement; and – the related notes 1 to 44 on the Consolidated financial statements and related notes 1 to 17 on the Parent Company financial statements, excluding the capital adequacy disclosures in note 3 calculated in accordance with the Solvency II regime which are marked as unaudited.
2. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) ("ISAs (UK)") and applicable law. Our responsibilities under those standards are further described in the auditor’s responsibilities for the audit of the financial statements section of our report.
Key audit matters The key audit matters that we identified in 2020 were: – valuation of insurance liabilities: 1) The frequency and severity assumptions for large bodily injury claims; 2) The inflation and discount rate assumptions for valuing periodic payment orders (“PPOs”); and 3) The judgement applied in setting the margin above the actuarial best estimate. – valuation of illiquid investments: 1) Commercial real estate loans, infrastructure debt and private placement bonds; 2) Investment property; – general ledger migration.
Materiality The materiality that we used for the Group financial statements was £28 million, which approximates to 5.6% (2019: 5.3%) of the three year average profit before tax, excluding the impact of the Ogden discount rate change to 0% in the 2018 results and minus 0.25% in the 2019 results which we elected to exclude due to the non-recurring nature of these events.
We have also extended two existing key audit matters in relation to: a. the valuation of insurance liabilities, which now includes the judgement applied in setting the margin above the actuarial best estimate; and b. the valuation of illiquid investments, which now includes investment property.
We considered as part of our risk assessment the nature of the Group, its business model and related risks including where relevant the impact of climate change, Brexit and Covid-19, the requirements of the applicable financial reporting framework and the system of internal control.
5. Key audit matters Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) that we identified. These matters included those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team.
The Group’s insurance liabilities total £3.6 billion (2019: £3.8 billion) and represent the single largest liability on the balance sheet. Valuation of these liabilities requires management to select methods and assumptions that are subject to high levels of estimation uncertainty. Consequently, small changes in these methods or assumptions can materially impact the valuation of these liabilities. We have identified the following three key areas of focus for our audit given their significance to the Group’s result and the high level of estimation uncertainty. We have also identified these as potential fraud risk areas.
Key audit matter description The frequency and severity of bodily injury claims have a significant impact on the valuation of the insurance liabilities and the setting of these assumptions is driven by a variety of factors. These factors include the completeness and accuracy of source data, the transparency of any changes in the reporting of bodily injury claims, and actuarial assumptions being consistent with emerging data, market factors and the Group’s reserving policy. As a result of these factors, there is a significant level of estimation uncertainty in the valuation of these claims, which increases the susceptibility of the balance to material misstatement due to error and fraud.
How the scope of our audit responded to the key audit matter We have gained a detailed understanding of the end-to-end claims and reserving process and obtained an understanding of relevant controls.
Having done this, we worked with our actuarial specialists to: – inspect and challenge the reserving process in relation to bodily injury claims undertaken by assessing relevant documentation and meeting with the Actuarial Director and his team; and
– inspect and challenge the Group’s documented methodology and key assumptions in respect of the prior years as well as the current year, with particular reference to Covid-19 impacts. This included: – using our in-house reserving software to help us challenge the Group’s response to emerging claims trends; – inspecting the Group’s models and conducting sensitivity testing on model methodology and assumptions including prior-year changes to assumptions; – comparing the Group’s burning cost and frequency diagnostics to market benchmarks and independent reserve review results; and
Key audit matter description The Group is required to settle a proportion of large bodily injury claims as PPOs rather than lump sum payments. The valuation of PPOs has a material impact on the financial statements, with liabilities totalling £814.8 million (2019: £800.1 million) on a discounted gross basis as detailed in note 34.
Given the ongoing uncertainty in the UK’s inflation environment and investment markets, the selection of the inflation and discount rate assumptions is highly judgemental and has a material impact on the financial statements. The PPOs are sensitive to economic assumptions selected and as at 31 December 2020, the Group valued PPOs using an inflation rate of 3.5% (2019: 4%) and a discount rate of 3.5% (2019: 4%). These assumptions represent a key source of estimation uncertainty for the Group which increases the susceptibility of the balance to material misstatement due to error and fraud.
How the scope of our audit responded to the key audit matter We have gained a detailed understanding over management’s process for setting these assumptions and obtained an understanding of the relevant controls surrounding the setting of the PPO inflation rate and discount rate, which is the challenge and approval of these assumptions by the Loss Ratio Committee and Audit Committee. In addition, we tested the relevant direct and precise business control, performed weekly, over the completeness of the PPO listing. This is a key data input which has a material impact on the PPO assumptions and hence the valuation.
How the scope of our audit responded to the key audit matter We worked with our in-house actuarial specialists to challenge the appropriateness of the recommended margin to be applied to the actuarial best estimate. In doing so we performed the following procedures: – Inspected and challenged the approach to, and analysis performed in, setting the margin by reviewing relevant documentation and meeting with the Chief Financial Officer and Actuarial Director; – Leveraged third party economic studies to challenge the appropriateness of management’s adverse scenarios, with a specific focus on care worker wage inflation given the sensitivity of the Group’s bodily injury claims to this assumption, whilst looking back to outcomes from previous economic downturns; and
– Performed a ‘stand back’ test to challenge the level of prudence in the overall insurance liabilities between periods in light of the level of uncertainties that exist at each respective reporting date.
Key observations We have determined that the margin remains appropriate and is on balance slightly more prudent than in previous periods. In combination with the conclusion drawn in relation to large bodily injury claims above, we have concluded in overall terms the total insurance liabilities show a consistent level of prudence with previous years.
5.2.1 Commercial real estate loans, infrastructure debt and private placement bonds
Key audit matter description We have identified a key audit matter in relation to these credit portfolios totalling £575.1 million (2019: £587.8 million).
Given the Group continues to recognise and measure financial instruments under IAS 39, these instruments are measured at amortised cost and require the recognition of an impairment when an incurred loss event arises. Significant management judgement is required in determining if an incurred loss event has occurred and, in the instance an event has occurred, there is significant estimation uncertainty in determining the impairment charge.
We deem there to be an increasing risk of default or delinquency on these less liquid assets owing to high and sustained levels of uncertainty in the UK economy from Covid-19 restrictions coupled with the ongoing impact of the UK's exit from the European Union.
5.2.1 Commercial real estate loans, infrastructure debt and private placement bonds continued
We considered the valuation of the investment properties to be a key audit matter as the determination of fair value involves significant judgement by the external valuation experts in light of Covid-19 and long-term trends in the use of various types of property. Valuation methodology for investment properties is subjective in nature and involves various key assumptions. The use of different valuation methodology and assumptions could produce significantly different estimates of fair value. With the outbreak of Covid-19, the property valuers can attach less weight to previous market evidence in determining a fair value. This leads to greater levels of estimation uncertainty in determining the valuation.
– We tested the data inputs used in the valuation model for investment properties, by agreeing occupation rates, unit sizes, and contracted rent to the underlying signed agreements and property reports. We then re-performed the calculation of the yields applied using this data.
Key observations We considered the accounting treatment applied to be reasonable. In performing our procedures, we did not note any indicators of material impairment.
5.3 General ledger migration Refer to page 99 (Audit Committee Report).
Given the increased data integrity risks inherent to the migration of financial information and the importance of maintaining complete and accurate accounting records throughout the reporting period, we consider the general ledger migration to be a key audit matter.
Independent Auditor’s Report to the shareholders of Direct Line Insurance Group plc continued 150 Direct Line Group Annual Report and Accounts 2020
6. Our application of materiality 6.1 Materiality We define materiality as the magnitude of misstatement in the financial statements that makes it probable that the economic decisions of a reasonably knowledgeable person would be changed or influenced. We use materiality both in planning the scope of our audit work and in evaluating the results of our work.
Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: Group financial statements Parent Company financial statements
Group materiality is used for setting audit scope and the assessment of uncorrected misstatements. Materiality is set for each significant component in line with the component's proportion of the chosen benchmark. This is capped at the lower of 90% of Group materiality and the component materiality determined for a standalone audit. The main UK insurance trading entity, U K Insurance Limited, which makes up 100% of Group gross earned premium and 86% of Group statutory profit before tax, is scoped to a component materiality of £25.2 million (2019: £25.2 million). Component materialities for other entities within the scope of our Group audit ranged from £0.8 million to £8.8 million (2019: £0.8 million to £9.0 million).
6. Our application of materiality continued 6.2 Performance materiality We set performance materiality at a level lower than materiality to reduce the probability that, in aggregate, uncorrected and undetected misstatements exceed the materiality for the financial statements as a whole.
7. An overview of the scope of our audit 7.1 Identification and scoping of components The scope of our Group audit was determined by obtaining an understanding of the Group and its environment, including group wide controls and assessing the risks of material misstatement at Group level.
At the Group level we also tested the consolidation process and carried out analytical procedures to confirm our conclusion that there were no significant risks of material misstatement of the aggregated financial information of the remaining components not subject to audit or audit of specified account balances.
Full audit scope Full audit scope Specified audit procedures Review at group level
IT Controls In planning our 2020 audit we identified 13 systems that were material to the Group’s financial reporting processes. These systems handled data relating to premiums, claims, expenses and payroll and we intended to rely on the IT and business controls associated with these systems. Having worked with our in-house IT specialists to assess the operating effectiveness of the IT controls associated with these systems, as well as the wider general IT control environment across the Group, we were able to rely upon the IT controls associated with all 13 systems identified.
8. Other information The other information comprises the information included in the annual report, other than the financial statements and our auditor’s report thereon. The Directors are responsible for the other information contained within the annual report. Our opinion on the financial statements does not cover the other information and, except to the extent otherwise explicitly stated in our report, we do not express any form of assurance conclusion thereon.
Our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the course of the audit, or otherwise appears to be materially misstated.
11. Extent to which the audit was considered capable of detecting irregularities, including fraud Irregularities, including fraud, are instances of non-compliance with laws and regulations. We design procedures in line with our responsibilities, outlined above, to detect material misstatements in respect of irregularities, including fraud. The extent to which our procedures are capable of detecting irregularities, including fraud is detailed below.
As a result of these procedures, we considered the opportunities and incentives that may exist within the organisation for fraud and identified the greatest potential for fraud in the following areas: the valuation of the insurance liabilities. In common with all audits under ISAs (UK), we are also required to perform specific procedures to respond to the risk of management override.
In addition, we considered provisions of other laws and regulations that do not have a direct effect on the financial statements but compliance with which may be fundamental to the Group’s ability to operate or to avoid a material penalty. These included the Group’s operating licence, regulatory solvency requirements such as those under the relevant Solvency II requirements and those required by the PRA and FCA and environmental regulations.
11.2 Audit response to risks identified As a result of performing the above, we identified valuation of insurance liabilities and valuation of intangible assets as key audit matters related to the potential risk of fraud or non-compliance with laws and regulations. The key audit matters section of our report explains the matter in more detail and also describes the specific procedures we performed in response to those key audit matters.
– in addressing the risk of fraud through management override of controls, testing the appropriateness of journal entries and other adjustments; assessing whether the judgements made in making accounting estimates are indicative of a potential bias; and evaluating the business rationale of any significant transactions that are unusual or outside the normal course of business.
Independent Auditor’s Report to the shareholders of Direct Line Insurance Group plc continued 154 Direct Line Group Annual Report and Accounts 2020
12. Opinions on other matters prescribed by the Companies Act 2006 In our opinion the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.
13. Corporate governance statement The Listing Rules require us to review the Directors' statement in relation to going concern, longer-term viability and that part of the Corporate Governance Statement relating to the Group’s compliance with the provisions of the UK Corporate Governance Code specified for our review.
14.2 Directors’ remuneration Under the Companies Act 2006 we are also required to report if in our opinion certain disclosures of Directors’ remuneration have not been made or the part of the Directors’ remuneration report to be audited is not in agreement with the accounting records and returns.
15.2 Consistency of the audit report with the additional report to the Audit Committee Our audit opinion is consistent with the additional report to the Audit Committee we are required to provide in accordance with ISAs (UK).
In our opinion, based on the work undertaken in the course of the audit: – the information given in the Strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements; and
15.2 Consistency of the audit report with the additional report to the audit committee Our audit opinion is consistent with the additional report to the Audit Committee we are required to provide in accordance with ISAs (UK).
16. Use of our report This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
Tax relating to items that will not be reclassified 13 0.3 1.3
Less: net gains on AFS investments transferred to income statement on disposals 31 (1.1) (16.5)
Tax relating to items that may be reclassified 31 (9.9) (17.3)
Other comprehensive income for the year net of tax 36.2 77.6
The financial statements were approved by the Board of Directors and authorised for issue on 5 March 2021. They were signed on its behalf by: PENNY JAMES CHIEF EXECUTIVE OFFICER
(note 32) Total equity £m £m £m £m £m £m £m £m £m
Credit to equity for equitysettled share-based payments (note 36) — — — — — 18.4 18.4 — 18.4
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2020 160 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020
Consolidated Statement of Changes in Equity For the year ended 31 December 2020 160 Direct Line Group Annual Report and Accounts 2020
Proceeds on issue of subordinated Tier 2 notes 39 257.2 —
Cash and cash equivalents at the end of the year 29 1,168.2 896.3
Consolidated Cash Flow Statement For the year ended 31 December 2020 www.directlinegroup.co.uk 161
1. Accounting policies Basis of preparation As required by the Companies Act 2006 and Article 4 of the EU IAS Regulation, the Group’s consolidated financial statements are prepared in accordance with IFRSs issued by the IASB as adopted by the EU on 31 December 2020 and by the UK’s Department of Business, Energy & Industrial Strategy (“BEIS”) in 2021. The BEIS has been given the power of endorsing and adopting international accounting standards while the UK Endorsement Board (“UKEB”) is still being established. The Group has elected to prepare its parent entity financial statements in accordance with FRS 101 ‘Reduced Disclosure Framework’.
Going concern The Directors believe that the Group has sufficient financial resources to meet its financial needs, including managing a mature portfolio of insurance risk. The Directors believe the Group is well positioned to manage its business risks successfully in the current economic climate. The Finance review on pages 20 to 35 describes the Group’s capital management strategy, including the capital actions taken in the year to ensure the continued strength of the balance sheet. The Group’s financial position is also covered in that section, including a commentary on cash and investment levels, reserves, currency management, insurance liability management, liquidity and borrowings. Additionally, note 3 to the consolidated financial statements describes capital management needs and policies. The note also covers insurance, market, liquidity and credit risks which may affect the Group’s financial position.
A reverse stress test was also performed to identify the most probable combination of stresses that would result in capital loss and thus threaten the viability of the Group, i.e. a reduction of own funds to below the solvency capital requirement.
Adoption of new and revised standards The Group has adopted the following new amendments to IFRSs and International Accounting Standards (“IASs”) that became mandatorily effective for the Group for the first time during 2020.
‘Amendments to References to the Conceptual Framework in IFRS Standards’ amends some references to previous versions of the Conceptual Framework in IFRS Standards and their accompanying documents and IFRS Practice Statements.
1.1 Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and the entities that are controlled by the Group at 31 December 2020 and 31 December 2019. Control exists when the Group is exposed, or has rights, to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. In assessing whether the Group controls another entity, the existence and effect of the potential voting rights that are currently exercisable or convertible are considered.
Notes to the Consolidated Financial Statements 162 Direct Line Group Annual Report and Accounts 2020
1.2 Foreign currencies The Group’s consolidated financial statements are presented in sterling, which is the presentational currency of the Group.
Once a contract has been classified as an insurance contract, it remains an insurance contract for the remainder of its lifetime, even if the insurance risk reduces significantly during this period, unless all rights and obligations are extinguished.
Instalment income Instalment income comprises the interest income earned on policyholder receivables, where outstanding premiums are settled by a series of instalment payments. Interest is earned using an effective interest rate method over the term of the policy.
1.5 Insurance claims continued A court can award damages for future pecuniary loss in respect of personal injury or for other damages in respect of personal injury and may order that the damages are wholly or partly to take the form of PPOs. These are covered in more detail in note 2.4. Costs for both direct and indirect claims handling expenses are also included.
The provision for unexpired risks is calculated separately by reference to classes of business that are managed together after taking account of relevant investment returns.
1.8 Goodwill and other intangible assets Acquired goodwill, being the excess of the cost of an acquisition over the Group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary, associate or joint venture acquired, is initially recognised at cost and subsequently at cost less any accumulated impairment losses. Goodwill arising on the acquisition of subsidiaries, associates and joint ventures is included in the balance sheet category "goodwill and other intangible assets". The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill.
Expenditure on internally generated goodwill and indirect advertising costs is written off as incurred. Direct costs relating to the development of internal-use computer software and associated business processes are capitalised once technical feasibility and economic viability have been established. These costs include payroll costs, the costs of materials and services and directly attributable overheads. Capitalisation of costs ceases when the software is capable of operating as intended.
Depreciation is charged to the income statement on a straight-line basis so as to write off the depreciable amount of property, plant and equipment over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. The estimated useful lives are as follows: Freehold and leasehold buildings 50 years or the period of the lease if shorter
1.10 Impairment of intangible assets, goodwill and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets, goodwill or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss, if any. Goodwill is tested for impairment annually or more frequently, if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent of those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit (“CGU”) to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use.
If the recoverable amount of an intangible or a tangible asset is less than its carrying value, an impairment loss is recognised immediately in the income statement and the carrying value of the asset is reduced by the amount of the impairment loss.
Where the Group is a lessor Leases where a significant proportion of the risks and rewards of ownership is retained by the lessor are classified as operating leases. Lease income from operating leases is recognised in the income statement on a straight-line basis over the lease term.
1.12 Investment property Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. Investment property is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties adjusted for the specific characteristics of each property. Any gain or loss arising from a change in fair value is recognised in the income statement.
1.13 Financial assets Financial assets are classified as available-for-sale, held-tomaturity, designated at fair value through profit or loss, or loans and receivables.
If the market for a financial asset is not active, the Group establishes the fair value by using a valuation technique. Valuation techniques include using recent arm’s-length market transactions between knowledgeable and willing parties (if available), reference to the current fair value of another instrument that is substantially the same, discounted cash flow analysis and option pricing models. If there is a valuation technique commonly used by market participants to price the instrument, and that technique has been demonstrated to provide reliable estimates of prices obtained in actual market transactions, the Group uses that technique.
Impairment losses are assessed individually, where significant, or collectively for assets that are not individually significant.
1.16 Subordinated liabilities Subordinated liabilities comprise subordinated guaranteed dated notes which are initially measured at the consideration received less related transaction costs. Subsequently, subordinated liabilities are measured at amortised cost using the effective interest rate method.
The Group makes provision for all insurance industry levies, such as the Financial Services Compensation Scheme and Motor Insurance Bureau.
Provision for taxation is calculated using tax rates that have been enacted, or substantively enacted, by the balance sheet date and is allocated over profits before taxation or amounts charged or credited to components of other comprehensive income and equity, as appropriate.
Deferred taxation is accounted for in full using the balance sheet liability method on all temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes.
1.20 Share-based payment The Group operates a number of share-based compensation plans under which it awards Ordinary Shares and share options to its employees. Such awards are generally subject to vesting conditions that can alter the amount of cash or shares to which an employee is entitled.
The cost of employee services received in exchange for an award of shares or share options granted is measured by reference to the fair value of the shares or share options on the date the award is granted and takes into account nonvesting conditions and market performance conditions (conditions related to the market price of the Company’s Ordinary Shares).
As a result, the Group has decided to defer the application of IFRS 9 and continues to do so. The amendments to IFRS 4 also require certain interim disclosures in relation to the fair value movements of financial assets as outlined below.
– commercial real estate loans £3.8 million decrease (2019: £2.5 million decrease).
In note 3.3.3 the Group has disclosed the carrying amount of financial assets at the end of the reporting period by credit risk rating grade, as defined in IFRS 7 ‘Financial Instruments: Disclosures’. The fair value and the carrying amount of financial assets that meet the 'solely payments of principal and interest' criteria, and at the end of the reporting period do not have a low credit risk, was £377.2 million (2019: £390.8 million).
As the effective date of IFRS 17 has since been delayed to 1 January 2023, ‘Amendments to IFRS 4 – Deferral of IFRS 9’ was issued in June 2020 which delays the effective date of IFRS 9 so as to remain in line with IFRS 17. The amendments were endorsed by the UK’s Department of Business, Energy & Industrial Strategy (“BEIS”) in January 2021.
The Group will not discontinue hedge accounting should the retrospective assessment of hedge effectiveness fall outside the 80‑125% range where the hedging relationship is subject to interest rate benchmark reforms. However, for those hedging relationships that are not subject to the interest rate benchmark reforms the entity continues to cease hedge accounting if retrospective effectiveness is outside the 80‑125% range.
In August 2020, the IASB issued ‘Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16 ‘Interest Rate Benchmark Reform – Phase 2’.
The Phase 2 amendments are effective for annual periods starting on or after 1 January 2021 and were endorsed by the BEIS in January 2021.
In January 2020 the IASB issued ‘Classification of Liabilities as Current or Non-Current (Amendments to IAS 1)' which clarifies the requirements for classifying liabilities as current or non-current. More specifically: – The amendments specify that the conditions which exist at the end of the reporting period are those which will be used to determine whether a right to defer settlement of a liability exists.
– The amendments clarify the situations that are considered to determine settlement of a liability.
In July 2020 a further amendment was made: 'Classification of Liabilities as Current or Non-Current — Deferral of Effective Date (Amendment to IAS 1)' to defer the effective date of the January 2020 ‘Classification of Liabilities as Current or Non-Current (Amendments to IAS 1)’ to annual reporting periods beginning on or after 1 January 2023.
1.23 Accounting developments continued The new guidance is effective for annual periods starting on or after 1 January 2023 and will require endorsement by the UKEB.
– Amendments to IAS 16 ‘Property, Plant and Equipment’ prohibit a company from deducting from the cost of property, plant and equipment amounts received from selling items produced while the company is preparing the asset for its intended use. Instead, a company will recognise such sales proceeds and related cost in profit or loss.
– IFRS 16 ‘Leases’ which removes the illustration of payments from the lessor relating to leasehold improvements.
Accounting judgement The Group makes a judgement that financial assets are impaired when there is objective evidence that an event or events have occurred since initial recognition that have adversely affected the amount or timing of future cash flows from the asset. The determination of which events could have adversely affected the amount or timing of future cash flows from the asset requires judgement. In making this judgement, the Group evaluates, among other factors: the normal price volatility of the financial asset; the financial health of the investee; industry and sector performance; changes in technology or operational and financing cash flow; and whether there has been a significant or prolonged decline in the fair value of the asset below its cost. Impairment may be appropriate when there is evidence of deterioration in these factors. There was a small impairment of £2.7 million within the loans and receivables portfolio in the year ended 31 December 2020 (2019: £nil). On a quarterly basis, the Group reviews whether there is any objective evidence that a financial asset is impaired based on the following criteria: – actual, or imminent, default on coupon interest or nominal; – adverse movements in the credit rating for the investee/ borrower; – price performance of a particular AFS debt security, or group of AFS debt securities, demonstrating an adverse trend compared to the market as a whole; and
Had all the declines in AFS asset values met the criteria above at 31 December 2020, the Group would have suffered a loss of £3.0 million (2019: £4.0 million), being the transfer of the total AFS reserve for unrealised losses to the income statement. However, these movements represent mark-tomarket movements and, as there was no objective evidence of any loss events that could affect future cash flows, no impairments have been recorded.
Notes to the Consolidated Financial Statements continued 170 Direct Line Group Annual Report and Accounts 2020
Sources of estimation uncertainty The Group holds a portfolio of investment properties, with a value at 31 December 2020 of £292.1 million (2019: £291.7 million). Where quoted market prices are not available, valuation techniques are used to value these properties. The fair value was determined using a methodology based on recent market transactions for similar properties, which have been adjusted for the specific characteristics of each property within the portfolio. The valuation in the financial statements is based on valuations by independent registered valuers and the techniques used include some unobservable inputs. The valuations used for investment properties are classified in the level 3 category of the fair value hierarchy (see note 42).
Accounting judgement Judgement is applied to determine whether there is indication of impairment to intangible assets. In making this judgement, the Group considers: the projection of the economic benefits associated with each asset; subsequent re-measurement of these benefits through the development cycle and into use; the projected ultimate cost of each asset at each point through the development cycle due to specification changes; and the likelihood of obsolescence of any component parts.
Source of estimation uncertainty The Group makes provision for the full cost of outstanding claims from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and associated claims handling costs. Outstanding claims provisions net of related reinsurance recoveries at 31 December 2020 amounted to £2,591.7 million (2019: £2,670.0 million).
Claims reserves are assessed separately for large and attritional claims, typically using standard actuarial methods of projection. Key sources of estimation uncertainty include those arising from the selection of specific methods as well as assumptions for claims frequency and severity through the review of historical claims and emerging trends. The Group seeks to adopt a conservative approach to assessing claims liabilities, as evidenced by the favourable development of historical claims reserves.
The Covid-19 pandemic has led to the largest shock to the UK economy on record and the outlook remains unusually uncertain at year end 2020. Much depends on the evolution of the pandemic and measures taken to protect public health, as well as the transition to the new trading arrangements between the EU and the UK. In addition to concerns about general indicators of economic health, such as falls in gross domestic product ("GDP"), rising unemployment and rising public sector debt ratios, the Group's reserves are exposed to the risk of changes in claims development patterns and claims inflation resulting from the pandemic. Changes in claims frequency present greater uncertainty for the unearned part of the business, whereas uncertainty over the level of claims severity has a greater impact on the earned claims reserves. Claims severity risk is particularly acute with respect to care costs for large bodily injury claims and car repair costs due to potential supply chain interruptions. The Group has therefore developed additional claims inflation scenarios, which look at 100 basis point changes in the claims inflation assumed in the actuarial best estimate over the next two years.
The table in note 34 to the financial statements provides an analysis of outstanding PPO claims provisions on a discounted and an undiscounted basis at 31 December 2020 and 31 December 2019 and further details on sources of estimation uncertainty. Details of sensitivity analysis to the discount rate applied to PPO claims and the impact of changes in claims inflation are shown in note 3.3.1.
3.2 Risk and capital management modelling The Board has ultimate responsibility for ensuring that the Group has sufficient funds to meet its liabilities as they fall due. The Group carries out detailed modelling of its assets, liabilities and the key risks to which these are exposed. This modelling includes the Group’s own assessment of its SCR, using its partial internal model approved by the PRA in 2016. The SCR quantifies the insurance, market, credit, operational and liquidity risks that the regulated entities are undertaking.
Impact of an increase in the discount rate used in the calculation of present values of 100 basis points 45.9 48.5
Impact of the Group reserving at a discount rate of minus 1.25% compared to minus 0.25% (2019: minus 1.25% compared to minus 0.25%) (61.1) (75.0)
Claims inflation Impact of a decrease in claims inflation by 100 basis points for two consecutive years (new scenario in 2020) 32.4 —
Impact of an increase in claims inflation by 100 basis points for two consecutive years (new scenario in 2020) (32.2) —
Notes: 1. These sensitivities are net of reinsurance and exclude the impact of taxation. 2. These sensitivities reflect one-off impacts at 31 December and should not be interpreted as predictions. 3. The sensitivities relating to an increase or decrease in the real discount rate used for PPOs illustrate a movement in the time value of money from the assumed level of 0% for reserving. The PPO sensitivity has been calculated on the direct impact of the change in the real internal discount rate with all other factors remaining unchanged.
There is the risk that claims are reserved or paid inappropriately, including the timing of such activity. However, there are claims management controls in place to mitigate this risk, as outlined below: – claims are managed utilising a range of IT system-driven controls coupled with manual processes outlined in detailed policies and procedures to ensure claims are handled in an appropriate, timely and accurate manner; – each member of staff has a specified handling authority, with controls preventing them handling or paying claims outside their authority, as well as controls to mitigate the risk of paying invalid claims. In addition, there are various outsourced claims handling arrangements, all of which are monitored closely by management, with similar principles applying in terms of the controls and procedures; – loss adjustors are used in certain circumstances to handle claims to conclusion. This involves liaison with the policyholder, third parties, suppliers and the claims function; – specialist bodily injury claims teams are responsible for handling these types of losses, with the nature of handling dependent on the level and type of claim. Claims exceeding a certain threshold are referred to the technical and large loss teams who also deal with all other claim types above defined limits or within specific criteria; and
– a process is in place to deal with major weather and other catastrophic events, known as the ‘Surge Demand Plan’. A surge is the collective name given to an incident which significantly increases the volume of claims reported to the Group’s claims function. The plan covers surge demand triggers, stages of incident, operational impact, communication and management information monitoring of the plan.
Underwriting risk This is the risk that future claims experience on business written is materially different from the results expected, resulting in current-year losses. The Group predominantly underwrites personal lines insurance including motor, residential property, roadside assistance, creditor, travel and pet business. The Group also underwrites commercial risks primarily for low-tomedium risk trades within the small and medium-sized enterprises market. Contracts are typically issued on an annual basis which means that the Group’s liability usually extends for a 12-month period, after which the Group is entitled to decline to renew or can revise renewal terms by amending the premium or other policy terms and conditions such as the excess as appropriate.
3. Risk management continued 3.3.1 Insurance risk continued The key risks relating to climate change today are UK floods and major UK windstorms.
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 1-in-200 year catastrophe loss. The programme renews annually on 1 July and has a retention of £130 million and an upper limit of £1,125 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
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 Group has a property portfolio and an infrastructure debt portfolio to generate a real return which, from an asset and liability matching perspective, is used to offset the liability arising from longer duration PPOs.
Concentration risk on investments arises through excessive exposure to particular industry sectors, groups of business undertakings or similar activities. The Group may suffer significant losses in its investment portfolio as a result of overexposure to particular sectors engaged in similar activities or having similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic, political or other conditions.
The table below analyses the distribution of debt securities by geographical area (commercial real estate loans and infrastructure debt are all within the UK).
Social, of which: The Group uses its internal economic capital model to determine its capital requirements and market risk limits and monitors its market risk exposure based on a 99.5% value-at-risk measure. The Group also applies market risk stress and scenario testing for the economic impact of specific severe market conditions. The results of this analysis are used to enhance the understanding of market risk. The market risk minimum standard explicitly prohibits the use of derivatives for speculative or gearing purposes. However, the Group is able to and does use derivatives for hedging its currency risk and interest rate risk exposures.
The Group has subordinated guaranteed dated Tier 2 notes with fixed coupon rates which were issued on 27 April 2012 at a fixed rate of 9.25% and have a redemption date of 27 April 2042; at the time of issue, the Group entered into a 10-year interest rate swap, to exchange the fixed rate of interest on these notes to a floating rate, to hedge exposure to interest rates. This was treated as a designated hedging instrument.
Of the £500 million notes issued, the Group has bought back a total nominal value of £250 million.
The hedging relationship between the subordinated debt and the interest rate swap was redesignated to reflect this transaction and ensure continuing hedge effectiveness. However, on 31 July 2020 the Group identified that the hedge no longer met the criteria of hedge effectiveness under IAS 39 ‘Financial Instruments: Recognition and Measurement’ and, under the rules of the standard, the accumulated hedging adjustment is being amortised to the income statement from the date of the last successful hedge effectiveness test over the remaining life of the subordinated debt using an effective interest rate calculation.
– sector concentration risk – the concentration of the Group to any given industry sector is monitored and analysed in respect of commercial customers.
The Group has in place an IBOR transition plan which is updated regularly. The most recent version of the plan was reviewed by the Investment Committee in November 2020. The plan identifies where the Group has IBOR exposures and the departments responsible for ensuring a suitable plan is in place to enable a smooth transition to alternative benchmark rates. Delivering the plan is under the governance of the Chief Financial Officer. The Group has also provided the plan and data in response to data submission requests from the PRA in 2020.
In the course of 2020 and early 2021 the following steps were undertaken as part of the transition process: – amendments were made to the intra-company loan agreements to ensure that they contain LIBOR fall-back language; – U K Insurance Limited adhered to the International Swaps and Derivative Association fall-back protocol which covers the interest rate swap held to hedge issued subordinated debt which references GBP LIBOR; the external asset managers too have to adhere to the protocol, thus covering the interest rate swaps in the managed portfolios; – the Loan Market Association published the exposure drafts of facility agreements which in the first half of 2021 will be used to add LIBOR fall-back clauses to the existing loan agreements in the infrastructure debt and commercial real estate loan portfolios; and
The designated hedging instruments and hedged items in scope of the IFRS 9/IAS 39 amendments due to benchmark interest rate reform are set out in the table below by hedge type.
Portfolio fair value hedge of the 3-month USD LIBOR component of US dollar denominated fixed rate debt securities
Pay Euro fixed, receive 6-month EURIBOR interest rate swaps 2023 - 2041 €107 million Portfolio fair value hedge of the 6-month EURIBOR component of Euro denominated fixed rate debt securities
The Group will continue to apply the amendments to IFRS 9/IAS 39 until the uncertainty arising from the interest rate benchmark reforms with respect to the timing and the amount of the underlying cash flows to which the Group is exposed ends. The Group has assumed that this uncertainty will not end until the Group’s contracts that reference IBORs are amended to specify the date the interest rate benchmark will be replaced, the cash flows of the alternative benchmark rate and any resulting spread adjustments. This will, in part, be dependent on the introduction of fall-back clauses which have yet to be added to some of the Group’s contracts and the negotiation with borrowers.
Property risk This is the risk of loss arising from sensitivity of assets and financial investments to the level or volatility of market prices, rental yields, or occupancy rates of properties. At 31 December 2020, the value of these property investments was £292.1 million (2019: £291.7 million). The property investments are located in the UK.
Exposure to currency risk is generated by the Group’s investments in US dollar and Euro denominated debt bonds.
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 2,182.8 63.5 — — 63.5 Interest rate swaps1 250.0 1.0 7.2 — 8.2 Designated as hedging instruments: Foreign exchange contracts (forwards) 4.1 0.1 — — 0.1 Interest rate swaps 150.3 — — 1.6 1.6 Total 2,587.2 64.6 7.2 1.6 73.4
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 696.4 12.3 — — 12.3 Designated as hedging instruments: 1. The 2012 interest rate swap which was entered into at at the same time as the issue of the 9.25% subordinated Tier 2 notes due 2042 was treated as a designated hedging instrument in 2019 and as fair value through the income statement in 2020.
Designated as hedging instruments: Foreign exchange contracts (forwards) 7.8 0.4 — — 0.4
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 652.6 10.1 — — 10.1
Designated as hedging instruments: Foreign exchange contracts (forwards) 10.4 0.2 — — 0.2
Notes to the Consolidated Financial Statements continued 180 Direct Line Group Annual Report and Accounts 2020
Decrease in total equity1 at 31 December £m £m £m £m
3. The increase or decrease in total equity does not reflect any fair value movement in infrastructure debt, HTM debt securities and commercial real estate loans that would not be recorded in the financial statements under IFRSs as they are classified as loans and receivables and HTM respectively, which are carried at amortised cost. It is estimated that a fair value reduction in these asset categories resulting from a 100 basis points increase in spreads would have been £15.1 million (2019: £16.7 million) and a 100 basis points increase in interest rates would have been £4.4 million (2019: £4.9 million).
3. Risk management continued 3.3.3 Credit risk continued 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 quarterly basis by the Head of Reinsurance and Corporate Insurance. The Group aims to deal with a diverse range of reinsurers on its contracts to mitigate the credit and/or non-payment risks associated with its reinsurance exposures.
Reinsurance assets 1,129.1 — 0.1 1,129.2 Insurance and other receivables 802.6 45.0 0.6 848.2 Derivative assets 73.4 — — 73.4 Debt securities 4,207.0 — — 4,207.0 Infrastructure debt 264.5 — — 264.5 Commercial real estate loans 206.7 — — 206.7 Cash and cash equivalents1 1,220.1 — — 1,220.1 Total 7,903.4 45.0 0.7 7,949.1
Within the analysis of debt securities above are bank debt securities at 31 December 2020 of £1,282.8 million (2019: £1,292.2 million) that can be further analysed as: secured £16.2 million (2019: £20.9 million); unsecured £1,125.2 million (2019: £1,105.5 million); and subordinated £141.4 million (2019: £165.8 million).
The tables below analyse the credit quality of debt securities that are neither past due nor impaired.
AAA AA+ to AA– A+ to A– BBB+ to BBB– BB+ and below Total
AAA AA+ to AA− A+ to A− BBB+ to BBB– BB+ and below Not rated Total
Reinsurance assets — 766.9 359.7 1.9 — 0.6 1,129.1 Insurance and other receivables1 — 17.3 40.2 16.4 — 728.7 802.6 Derivative assets — 8.5 64.9 — — — 73.4 Infrastructure debt — — 71.7 192.8 — — 264.5 Commercial real estate loans 1.2 44.7 117.8 32.3 10.7 — 206.7 Cash and cash equivalents2 995.2 55.7 169.2 — — — 1,220.1 Total 996.4 893.1 823.5 243.4 10.7 729.3 3,696.4
Information security risk This is the risk of loss or corruption to Group or customer data, intellectual property or failure of business-critical systems resulting in reputational damage, regulatory censure, supervision, fines and/or loss of competitive advantage.
Partnership contractual obligations This is the risk of contractual obligations not being delivered for business partners resulting in damaged reputation, the loss of contract at renewal, significant liability payments and/or the early termination of a partnership scheme.
3. Risk management continued 3.3.5 Liquidity risk This is the risk of being unable to access cash from the sale of investments or other assets in order to settle financial obligations as they fall due.
The measurement and management of the Group’s liquidity risk is undertaken within the limits and other policy parameters of the Group’s liquidity risk appetite and is detailed in the liquidity risk minimum standard. As part of this process the Investment and Treasury team are required to put in place a liquidity plan which must consider expected and stressed scenarios for cash inflows and outflows that is reviewed at least annually by the Investment Committee. Compliance is monitored in respect of both the minimum standard and the regulatory requirements of the PRA.
The following table analyses the carrying value of financial investments and cash and cash equivalents, by contractual maturity, which can fund the repayment of liabilities as they crystallise.
Debt securities 407.7 1,053.8 1,133.6 1,492.8 119.1 4,207.0 Infrastructure debt 14.0 31.4 34.9 98.1 86.1 264.5 Commercial real estate loans 35.0 106.3 65.4 — — 206.7 Cash and cash equivalents1 1,220.1 — — — — 1,220.1 Total 1,676.8 1,191.5 1,233.9 1,590.9 205.2 5,898.3
Trade and other payables, including insurance payables 543.6 6.1 0.2 — — 549.9 549.9
At 31 December 2019 £m £m £m £m £m £m £m
Trade and other payables, including insurance payables 473.7 4.2 0.2 — — 478.1 478.1
Note: 1. Insurance liabilities exclude unearned premium reserves as there are no liquidity risks inherent in them.
Notes to the Consolidated Financial Statements continued 184 Direct Line Group Annual Report and Accounts 2020
The Group manages capital in accordance with the Group’s capital management minimum standard, the aims of which are to manage capital efficiently and generate long-term sustainable value for shareholders, while balancing operational, regulatory, credit rating agency and policyholder requirements. The Group seeks to hold capital resources such that, in normal circumstances, the solvency capital ratio is around the middle of the target range of 140% to 180%.
The Group’s regulatory capital position is assessed against the Solvency II framework. From 1 July 2016, the Group gained approval to assess its SCR using a partial internal model, including a full internal economic capital model for the U K Insurance Limited underwriting entity. The model is calibrated to a 99.5% confidence interval and considers business written to date and one year of future written business over a one-year time horizon, in line with Solvency II requirements.
3.5 Capital adequacy (unaudited) Using the Group’s partial internal model, there is a capital surplus of approximately £1.22 billion above an estimated SCR of £1.34 billion as at 31 December 2020 (31 December 2019: £0.85 billion and £1.32 billion respectively). The Group’s capital requirements and solvency position are produced and presented to the Board on a regular basis.
Commercial This segment consists of commercial insurance for small and medium-sized enterprises sold through the Group’s brands NIG, Direct Line for Business and Churchill. NIG sells its products exclusively through brokers operating across the UK. Direct Line for Business sells its products directly to customers, and Churchill sells its products directly to customers and through PCWs.
No inter-segment transactions occurred in the year ended 31 December 2020 (2019: £nil). If any transaction were to occur, transfer prices between operating segments would be set on an arm’s-length basis in a manner similar to transactions with third parties. Segment income, expenses and results will include those transfers between business segments which will then be eliminated on consolidation.
4. Segmental analysis continued For each operating segment, there is no individual policyholder or customer that represents 10% or more of the Group’s total revenue.
Gross written premium 1,616.9 577.9 417.8 567.8 3,180.4 Gross earned premium 1,635.3 581.9 425.6 546.5 3,189.3 Reinsurance premium (150.5) (26.1) (2.7) (49.5) (228.8) Net earned premium 1,484.8 555.8 422.9 497.0 2,960.5 Investment return 62.8 10.3 3.4 18.6 95.1 Instalment income 80.1 19.2 3.0 7.0 109.3 Other operating income 38.4 0.2 8.9 2.4 49.9 Total income 1,666.1 585.5 438.2 525.0 3,214.8 Insurance claims (889.2) (316.5) (279.1) (245.6) (1,730.4) Insurance claims recoverable from / (payable to) reinsurers 1.1 7.4 18.0 (9.7) 16.8 Net insurance claims (888.1) (309.1) (261.1) (255.3) (1,713.6) Commission expenses (47.4) (45.0) (69.4) (92.9) (254.7) Operating expenses before restructuring and one-off costs (367.1) (130.0) (100.9) (126.4) (724.4) Total expenses (414.5) (175.0) (170.3) (219.3) (979.1) Operating profit 363.5 101.4 6.8 50.4 522.1 Restructuring and one-off costs (39.4) Finance costs (31.3) Profit before tax 451.4
Notes to the Consolidated Financial Statements continued 186 Direct Line Group Annual Report and Accounts 2020
Operating expenses before restructuring and one-off costs (345.6) (136.7) (94.0) (117.4) (693.7)
Reinsurance premium paid and payable: Movement in reinsurance unearned premium reserve 2.2 (1.8)
Note: 1. All foreign exchange forward contracts and certain interest rate swaps are measured at fair value through profit and loss. There are also interest rate swaps designated as hedging instruments.
Notes to the Consolidated Financial Statements continued 188 Direct Line Group Annual Report and Accounts 2020
Claims handling expenses1 for the year ended 31 December 2020 of £208.2 million (2019: £202.9 million) have been included in the claims figures above.
Note: 1. Includes costs in respect of low value leases of £0.8 million (2019: £0.3 million).
Expenses incurred under profit participations 73.8 40.3 10. Operating expenses £m £m
2. Staff costs and other operating expenses attributable to claims handling activities are allocated to the cost of insurance claims. 3. IT and other operating expenses include professional fees and property costs.
4. For year ended 31 December 2020, depreciation and amortisation include a £6.6 million impairment charge (2019: £1.3 million), which relates to capitalised software development costs for ongoing IT projects primarily relating to development of new systems. 5. Includes depreciation on right-of-use assets of £14.8 million (2019: £14.2 million).
The aggregate remuneration of those employed by the Group’s operations comprised: £m £m
Unrealised loss / (gains) on associated interest rate risk on hedged item2 0.9 (0.8)
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 19.0%1 (2019: 19.0%).
Under / (over) provision in respect of prior year 0.1 (6.7)
2019 first interim dividend of 7.2 pence per share paid on 6 September 2019 — 98.6 2018 final dividend of 14.0 pence per share paid on 16 May 2019 — 191.8 2018 special dividend of 8.3 pence per share paid on 16 May 2019 — 113.7
Proposed dividends: 2020 final dividend of 14.7 pence per share 199.3 —
Note: 1. Coupon payments on the Tier 1 notes issued in December 2017 are treated as an appropriation of retained profits and, accordingly, are accounted for when paid.
The proposed final dividends for 2020 have not been included as a liability in these financial statements.
The Board has also approved a share buyback of up to £100 million, with an initial tranche of up to £50 million expected to be completed by the time of the half-year results.
Following the cancellation of the dividend as announced on 8 April 2020, the final dividend for 2019 was not paid. A special interim dividend of 14.4 pence per share reflecting a full catch-up of the cancelled 2019 final dividend was paid on 4 September 2020.
The trustees of the employee share trusts waived their entitlement to dividends on shares held to meet obligations arising on the Long-Term Incentive Plan, Deferred Annual Incentive Plan and Restricted Share Plan awards, which reduced the total dividends paid for the year ended 31 December 2020 by £1.6 million (2019: £1.5 million).
As noted in note 30, the Group cancelled the share buyback programme on 19 March 2020. At the time of cancellation, the Group had repurchased 10.4 million Ordinary Shares.
Diluted Diluted earnings per share is calculated by dividing the earnings attributable to the owners of the Company less coupon payments in respect of Tier 1 notes by the weighted average number of Ordinary Shares during the period, excluding Ordinary Shares held as employee trust shares, adjusted for the dilutive potential Ordinary Shares. The Company has share options and contingently issuable shares as categories of dilutive potential Ordinary Shares.
Diluted earnings per share (pence) 25.5 29.2 16. Net asset value per share and return on equity Net asset value per share is calculated as total shareholders’ equity (which excludes Tier 1 notes) divided by the number of Ordinary Shares at the end of the period excluding shares held by employee share trusts.
16. Net asset value per share and return on equity continued Return on equity The table below details the calculation of return on equity.
Charge for the year — 49.8 49.8 Impairment losses2 — 6.6 6.6 At 31 December 2020 — 512.9 512.9
Included within other intangible assets are assets still in development of £370.7 million (2019: £343.5 million). These assets are tested for impairment during the Group’s annual impairment review at each reporting date.
Note: 1. Reflects a 1% decrease in the profit for each year of the strategic plan, which is five years.
The table below details the recoverable amounts in excess of carrying value for the CGUs where goodwill and other intangible assets are held. Sensitivity information is included to enhance user understanding of the influence of key assumptions. Following the annual impairment review, no reasonable possible change in these key assumptions would have resulted in an impairment of goodwill and other intangible assets.
Recoverable amount in excess of carrying value 1% decrease in terminal growth rate 1% increase in pre-tax discount rate 1% decrease in forecast pre-tax profit1
Depreciation charge for the year 1.1 14.0 15.1 Disposals — (11.1) (11.1) At 31 December 2020 7.5 122.1 129.6
The valuation conforms to international valuation standards. The fair value was determined using a methodology based on recent market transactions for similar properties, which have been adjusted for the specific characteristics of each property within the portfolio. This approach to valuation is consistent with the methodology used in the year ended 31 December 2019.
21. Subsidiaries The principal subsidiary undertakings of the Group, over which it exercises 100% voting power, are shown below. Their capital consists of Ordinary Shares which are unlisted. All subsidiaries (a full list of which is included in note 2 of the Parent Company’s financial statements) are included in the Group’s consolidated financial statements.
On 15 September 2020, the Group acquired 100% of the issued share capital of Brolly UK Technology Limited. The Group did not dispose of any subsidiaries in the year ended 31 December 2020 (31 December 2019: no acquisitions or disposals).
For the period ended 31 December 2020, it is expected that Brolly UK Technology Limited will be exempt from the requirements of the Companies Act 2006 relating to the audit of individual accounts by virtue of section 479 A.
Notes to the Consolidated Financial Statements continued 196 Direct Line Group Annual Report and Accounts 2020
27. Retirement benefit obligations Defined contribution scheme The pension charge in respect of the defined contribution scheme for the year ended 31 December 2020 was £26.2 million (2019: £25.5 million).
The table below sets out the principal assumptions used in determining the defined benefit scheme obligations.
Notes to the Consolidated Financial Statements continued 26. Derivative financial instruments £m £m
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 63.5 112.1
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 12.3 10.1
2. Foreign exchange contracts (forwards) are designated as cash flow hedges in relation to supplier payments.
The weighted average duration of the defined benefit obligations at 31 December 2020 is 20 years (2019: 20 years) using accounting assumptions.
198 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020 26. Derivative financial instruments £m £m
Notes: 1. As described in note 33, the 2012 interest rate swap, which was entered into at the same time as the issue of the 9.25% subordinated Tier 2 notes due 2042, was treated as a designated hedging instrument in 2019 and as fair value through the income statement in 2020.
The trustee invests the scheme’s assets in an appropriate mix of return-seeking assets and liability matching assets to better match the assets to future pension obligations. The main risks impacting funding levels are interest rates, changes in inflation expectations and the performance of the dynamic bond fund. The split of scheme assets is shown below. The matching assets are invested in liability-driven investment strategies, primarily UK gilts and index-linked gilt funds, but also including some leveraged gilt funds and interest rate and inflation swap funds. These are used to reduce the scheme’s inflation and duration risks against its liabilities.
Return on plan assets excluding amounts included in the net interest on the defined benefit asset 4.4 — 4.4
Income statement: Net interest income / (cost)1 1.9 (1.8) 0.1 Administration costs (0.4) — (0.4)
Experience gains — 2.4 2.4 Loss from change in demographic assumptions — (1.7) (1.7) Loss from change in financial assumptions — (10.1) (10.1)
Present value of defined benefit scheme obligations (98.7) (90.3) (78.6) (87.3) (90.5)
Fair value of defined benefit scheme assets 107.7 100.0 95.6 101.7 102.5
Sensitivity analysis The sensitivity analysis has been calculated by valuing the pension scheme liabilities using the amended assumptions shown in the table below and keeping the remaining assumptions the same as disclosed in the table above, except in the case of the inflation sensitivity where other assumptions that depend on assumed inflation have also been amended correspondingly. The pension cost has been determined allowing for the estimated impact on the scheme’s assets. The sensitivity to discount rates is based on movements in credit spreads, rather than gilt yields, which are hedged in the scheme’s assets. The selection of these movements to illustrate the sensitivity of the defined benefit obligation to key assumptions should be viewed as illustrative, rather than providing a view on the likely size of any change.
Impact on present value of defined benefit scheme obligations £m £m £m £m
Inflation rate 0.25% increase in inflation rate — — 2.5 2.3 0.25% decrease in inflation rate — — (2.5) (2.3)
2. An equity fund which is valued based on external valuation reports received from a third-party fund manager.
30. Share capital Issued and fully paid: equity shares 2020 2019
Ordinary Shares of 10 10/11 pence each1 millions £m £m millions £m
Net gains transferred to income statement on disposals – gross (1.1) (16.5)
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 redemption reserve. An additional £1.1 million arose in 2020 when shares repurchased through buyback were cancelled.
The Group has the option to cancel the coupon payment. Cancellation becomes mandatory if: the Solvency condition1 is not met at the time of, or following, coupon payment; there is non-compliance with the SCR or the minimum capital requirement; the Group has insufficient distributable reserves; or the relevant regulator requires the coupon payment to be cancelled.
33. Subordinated liabilities £m £m £250 million 9.25% subordinated Tier 2 notes due 2042 Subordinated guaranteed dated notes with a nominal value of £500 million were issued on 27 April 2012 at a fixed rate of 9.25%. On the same date, the Group also entered into a 10-year interest rate swap to exchange the fixed rate of interest for a floating rate of 3-month LIBOR plus a spread of 706 basis points which was credit value adjusted to 707 basis points with effect from 29 July 2013. This was treated as a designated hedging instrument.
The remaining notes, with a nominal value of £250 million, have a redemption date of 27 April 2042 with the option to repay the notes on 27 April 2022. If the notes are not repaid on that date, the terms of the notes provide that the rate of interest will be reset at a rate of 6-month LIBOR plus 7.91%. If LIBOR has been discontinued by this time, the terms of the notes provide for an ultimate fall back rate of interest of 9.25% for subsequent interest periods. The terms of the notes do not automatically provide for the transition of LIBOR to SONIA, which would require a separate agreement between the Group and the noteholders.
During 2020 the Group identified that the hedge no longer met the criteria of hedge effectiveness under IAS 39 ‘Financial Instruments: Recognition and Measurement’ and, under the rules of the standard, the accumulated hedging adjustment has begun to be amortised to the income statement from the date of the last successful hedge effectiveness test over the remaining life of the subordinated debt using an effective interest rate calculation.
£260 million 4.0% subordinated Tier 2 notes due 2032 On 5 June 2020, the Group issued subordinated Tier 2 notes at a fixed rate of 4.0%. The notes have a redemption date of 5 June 2032 and may be redeemed at the option of the Group commencing on 5 December 2031 until the maturity date.
The 2032 and 2042 notes are unsecured and subordinated obligations of the Group and rank pari passu and without any preference among themselves. In the event of a winding-up or of bankruptcy they are to be repaid only after the claims of all other senior creditors have been met and will rank at least pari passu with the claims of holders of other Tier 2 capital.
Accident year £m £m £m £m £m £m £m £m £m £m Total £m
Current estimate of cumulative claims 2,208.5 1,890.5 1,698.1 1,796.5 1,837.3 1,888.8 1,955.6 2,185.8 2,043.2 1,847.3
Gross liability recognised in balance sheet 25.5 16.7 14.6 113.9 148.5 195.0 289.8 445.0 575.9 951.6 2,776.5 2010 and prior 762.5 Claims handling provision 78.0 Total 3,617.0
Net liability recognised in balance sheet 21.8 13.4 12.2 42.7 68.2 125.7 220.3 326.0 447.4 796.5 2,074.2 2010 and prior 439.5 Claims handling provision 78.0 Total 2,591.7
Notes to the Consolidated Financial Statements continued 206 Direct Line Group Annual Report and Accounts 2020
Cash paid for claims settled in the year (2,103.6) 25.3 (2,078.3)
Increase / (decrease) in liabilities: Arising from current-year claims 2,311.3 (169.2) 2,142.1
Movement in prior-year net claims liabilities by operating segment £m £m
34. Insurance liabilities continued Analysis of outstanding PPO claims provisions on a discounted and an undiscounted basis The Group settles some large bodily injury claims as PPOs rather than lump sum payments.
Written in the period 3,180.4 (231.0) 2,949.4 Earned in the period (3,189.3) 228.8 (2,960.5) At 31 December 2020 1,497.1 (103.9) 1,393.2 36. Share-based payments The Group operates equity-settled, share-based compensation plans in the form of a Long-Term Incentive Plan ("LTIP"), a Restricted Shares Plan, a Deferred Annual Incentive Plan ("DAIP") and Direct Line Group Share Incentive Plans, including both the Free Share awards and a Buy-As-You-Earn Plan, details of which are set out below. All awards are to be satisfied using market-purchased shares.
Long-Term Incentive Plan Executive Directors and certain members of senior management are eligible to participate in the LTIP with awards granted in the form of nil-cost options. Under the plan, the shares vest at the end of a three-year period dependent upon the continued employment by the Group and also the Group achieving predefined performance conditions associated with Total Shareholder Return ("TSR") and return on tangible equity ("RoTE"). For awards since August 2017, the Directors are subject to an additional two-year holding period following the three-year vesting period.
Awards were made in the year ended 31 December 2020 over 4.7 million Ordinary Shares with an estimated fair value of £13.2 million at the 2020 grant dates (2019: 4.5 million Ordinary Shares with an estimated fair value of £14.4 million).
Notes to the Consolidated Financial Statements continued 208 Direct Line Group Annual Report and Accounts 2020
Weighted average assumptions during the year: Share price (pence) 290 318
Expected life was based on the contractual life of the awards and adjusted based on management’s best estimate, for the effects of exercise restrictions and behavioural considerations.
Restricted Shares Plan The purpose of the Restricted Shares Plan is to facilitate the wider participation in Group share-based awards of eligible employees. These awards can be granted in the form of a nil-cost option at any time during the year, generally have no performance criteria, and vest over periods ranging up to seven years from the date of the grant, subject to continued employment. During the year awards were made over 1.0 million Ordinary Shares (2019: 0.2 million Ordinary Shares) with an estimated fair value of £2.9 million (2019: £0.7 million) using the market value at the date of grant.
Direct Line Group Share Incentive Plans: Free Share awards In early 2020, the Group offered all eligible employees a Free Share award granting 180 Ordinary Shares free of charge as a measure of thanks to the employees for the part they played in the good results that the Group reported for 2019. 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 1.9 million Ordinary Shares with an estimated fair value of £5.4 million using the market value at the date of grant. No free shares were awarded in the year ended 31 December 2019.
Direct Line Group Share Incentive Plans: Buy-As-You-Earn Plan The Buy-As-You-Earn Plan entitles employees to purchase shares from pre-tax pay for between £10 and £150 per month and receive one matching share for every two shares purchased.
In respect of the outstanding options at 31 December 2020, the weighted average remaining contractual life is 1.61 years (2019: 1.57 years). No share awards expired during the year (2019: nil).
The Group recognised total expenses in the year ended 31 December 2020 of £18.5 million (2019: £18.4 million) relating to equity-settled share-based compensation plans. An equivalent credit was recognised in retained earnings.
Further information on share-based payments, in respect of Executive Directors, is provided in the Directors’ Remuneration Report.
At 1 January 2020 40.0 2.5 31.8 74.3 Additional provision 59.3 26.5 45.6 131.4 Utilisation of provision (57.7) (1.8) (23.9) (83.4) Released to income statement — (1.3) (6.2) (7.5) At 31 December 2020 41.6 25.9 47.3 114.8
Adjustments for: Defined benefit pension scheme – net interest charge 0.7 —
Net (increase) / decrease in accrued income and other assets (9.9) 4.5
Net increase / (decrease) in trade and other payables, including insurance payables and provisions 106.8 (1.7)
Net cash generated from operating activities before investment of insurance assets 268.8 88.2
Repayments of infrastructure debt and commercial real estate loans 56.7 40.6
Unrealised (loss) / gain on associated interest rate risk on hedged item
Notes: 1. As described in note 33, the Group entered into a 10-year interest rate swap on the same date as issuing the £250 million 9.25% subordinated Tier 2 notes due 2042.
2. As described in note 33, on 5 June 2020 the Group issued £260.0 million of subordinated Tier 2 notes at a fixed rate of 4.0%. The notes have a redemption date of 5 June 2032 and may be redeemed at the option of the Group commencing on 5 December 2031 until the maturity date. Proceeds are net of issue costs of £2.8 million.
40. Commitments and contingent liabilities The Group did not have any material commitments and contingent liabilities at 31 December 2020 (2019: none).
Note: 1. At year ended 31 December 2020, £116.6 million of the total operating lease commitments where the Group is the lessor relates to the lease of investment properties detailed in note 20 (2019: £119.6 million).
Other leases disclosures Sublease income in respect of property right-of-use assets was £0.2 million during the year (2019: £0.3 million). Expenses relating to short-term and variable lease payments were not included in the measurement of lease liabilities as they were not significant. Total cash outflow in respect of leases for the year ended 31 December 2020 was £18.7 million (2019: £20.1 million).
Notes to the Consolidated Financial Statements continued 212 Direct Line Group Annual Report and Accounts 2020
Assets held at fair value: Investment property (note 20) 292.1 — — 292.1 292.1 Derivative assets (note 26) 73.4 — 73.4 — 73.4 AFS debt securities (note 28) 4,103.1 25.2 4,077.9 — 4,103.1 Equity investments (note 28) 3.2 — — 3.2 3.2 Other financial assets: HTM debt securities (note 28) 103.9 — 14.2 93.7 107.9 Infrastructure debt (note 28) 264.5 — — 273.6 273.6 Commercial real estate loans (note 28) 206.7 — — 202.9 202.9 Total 5,046.9 25.2 4,165.5 865.5 5,056.2 Liabilities held at fair value: Derivative liabilities (note 26) 57.2 — 57.2 — 57.2 Other financial liabilities: Carrying value Level 1 Level 2 Level 3 Fair value
Assets held at fair value: Other financial assets: Commercial real estate loans (note 28) 205.7 — — 203.0 203.0
Liabilities held at fair value: Other financial liabilities: WWW.DIRECTLINEGROUP.CO.UK 213www.directlinegroup.co.uk 213
Note: 1. The methodology of valuation reflects commercial property held within U K Insurance Limited.
There were no sales or purchases of products and services to or from related parties in the year ended 31 December 2020 (2019: £nil).
Notes to the Consolidated Financial Statements continued 214 Direct Line Group Annual Report and Accounts 2020
They were signed on its behalf by: PENNY JAMES CHIEF EXECUTIVE OFFICER
The profit for the year net of tax was £343.0 million (2019: £143.3 million).
Other comprehensive loss for the year net of tax (0.1) —
Total comprehensive income for the year — — — — 143.3 143.3 — 143.3
PARENT COMPANY STATEMENT OF COMPREHENSIVE INCOME For the year ended 31 December 2020 216 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020
Parent Company Statement of Comprehensive Income For the year ended 31 December 2020
Other comprehensive loss Items that may be reclassified subsequently to income statement: Loss on fair value through other comprehensive income investments (0.1) —
Shares distributed by employee trusts — — (15.4) — — (15.4) — (15.4)
Total comprehensive income for the year — — — (0.1) 343.0 342.9 — 342.9 Dividends and appropriations paid (note 13) — — — — (312.5) (312.5) — (312.5) Shares cancelled following buyback (1.1) 1.1 — — (30.0) (30.0) — (30.0) Credit to equity for equitysettled share-based payments — — 18.5 — — 18.5 — 18.5 Shares distributed by employee trusts — — (13.7) — — (13.7) — (13.7) Balance at 31 December 2020 148.9 1,451.1 7.2 (0.1) 1,329.5 2,936.6 346.5 3,283.1
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 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.
The address of the Company’s registered office is Churchill Court, Westmoreland Road, Bromley, BR1 1DP.
In accordance with the exemption permitted under section 408 of the Companies Act 2006, the Company’s income statement and related notes have not been presented in these separate financial statements.
1.3 Financial assets Financial assets are classified at initial recognition and subsequently measured at amortised cost or fair value through other comprehensive income. The classification of financial assets at initial recognition depends on the financial asset’s contractual cash flow characteristics and the Company’s business model for managing them.
Fair value through other comprehensive income Assets which are held both to collect contractual cash flows and to sell the financial asset, where the contractual terms of the asset give rise to cash flows which are solely payments of principal and interest on the principal amount outstanding, are measured at fair value through other comprehensive income, unless designated as fair value through profit or loss. The Company’s financial assets at fair value through other comprehensive income relate to UK sovereign debt securities. Movements in the carrying amount are taken through other comprehensive income, except for gains or losses recognised in the income statement when the asset is derecognised, modified or impaired.
At each balance sheet date, the Company assesses on a forward-looking basis whether there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as held at amortised cost or fair value through other comprehensive income is expected. The Company measures the expected loss as the difference between the carrying amount of the asset or group of assets, including the allowance for expected losses at initial recognition, and the present value of estimated future cash flows from the asset or group of assets discounted at the effective interest rate of the instrument at initial recognition.
The Company applies the simplified impairment approach to trade receivables due from subsidiary undertakings.
December 2020, it is expected that Brolly UK Technology Limited will be exempt from the requirements of the Companies Act 2006 relating to the audit of individual accounts by virtue of section 479 A(2)(d).
218 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020 www.directlinegroup.co.uk 217
Directly held by the Company: Direct Line Group Limited1 02811437 United Kingdom Intermediate holding company
UK Assistance Accident Repair Centres Limited1 02568507 United Kingdom Motor vehicle repair services
The National Insurance and Guarantee Corporation Limited1 00042133 United Kingdom Dormant8
Notes: 1. Registered office at: Churchill Court, Westmoreland Road, Bromley, BR1 1DP. 2. Registered office at: The Wharf, Neville Street, Leeds, LS1 4AZ. 3. U K Insurance Limited has a branch in the Republic of South Africa and a branch in the Republic of Ireland. 4. Registered office at: 22 Grenville Street, St Helier, JE4 8PX, Jersey. 5. On 15 September 2020, DL Insurance Services Limited acquired 100% of the issued share capital of Brolly UK Technology Limited. For the period ended 31
Note: 1. At 31 December 2019, the fair value through other comprehensive income debt securities are corporate debt securities of £79.9 million classified as level 2 and fixed interest UK sovereign debt of £5.1 million classified as level 1 within the Group’s fair value hierarchy which is set out in note 42 of the consolidated financial statements.
Of the Company's total equity, £1,329.5 million (2019: £1,329.0 million), being the total of its retained earnings, is considered to be distributable reserves.
£260 million 4.0% subordinated Tier 2 notes due 2032 On 5 June 2020, the Company issued subordinated Tier 2 notes at a fixed rate of 4.0%. The notes have a redemption date of 5 June 2032 and may be redeemed at the option of the Company commencing on 5 December 2031 until the maturity date.
The 2032 and 2042 notes are unsecured, and subordinated obligations of the Company and rank pari passu and without any preference among themselves. In the event of a winding-up or of bankruptcy they are to be repaid only after the claims of all other senior creditors have been met and will rank at least pari passu with the claims of holders of other Tier 2 capital.
220 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020220 Direct Line Group Annual Report and Accounts 2020
17. 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 10 to the consolidated financial statements, the compensation for key management is set out in note 43 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.
221 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020 7. Cash and cash equivalents £m £m
8. Share capital, capital reserves and distributable reserves Full details of the share capital and capital reserves of the Company are set out in notes 30 and 31 to the consolidated financial statements.
The remaining notes, with a nominal value of £250 million, have a redemption date of 27 April 2042 with the option to repay the notes on 27 April 2022. If the notes are not repaid on that date, the terms of the notes provide that the rate of interest will be reset at a rate of 6-month LIBOR plus 7.91%. If LIBOR has been discontinued by this time, the terms of the notes provide for an ultimate fall-back rate of interest of 9.25% for subsequent interest periods. The terms of the notes do not automatically provide for the transition of LIBOR to SONIA, which would require a separate agreement between the Group and the noteholders.
The aggregate fair value of subordinated guaranteed dated notes at 31 December 2020 was £589.0 million (2019: £297.8 million).
Note: 1. Included in the above is a loan of £71.4 million (2019: £84.4 million) from UK Assistance Accident Repair Centres Limited. All loans from fellow Group subsidiaries are repayable by 31 December 2024 and are subject to interest on outstanding balances based on the average 3-month LIBOR rate.
220 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020 www.directlinegroup.co.uk 221
Date Event 08 March Preliminary Results 2020 announcement 08 April “Ex-dividend” date for 2020 final dividend 09 April Record date for 2020 final dividend 05 May Final date for election under the Dividend Reinvestment Plan 05 May Trading update for the first quarter of 2021 13 May Annual General Meeting 20 May Payment date for 2020 final dividend 03 August Half-year Report 2021 12 August "Ex-dividend" date for 2021 interim dividend 13 August Record date for 2021 interim dividend 19 August Final date for election under the Dividend Reinvestment Plan 03 September Payment date for 2021 interim dividend 09 November Trading update for the third quarter of 2021
Annual General Meeting The 2021 AGM will be held at, and broadcast live from, the registered office of the Company at Churchill Court, Westmoreland Road, Bromley, BR1 1DP on 13 May 2021, starting at 11.00 am. All shareholders will receive a separate notice convening the AGM. This will explain the resolutions to be put to the meeting.
Share ownership Share capital You can find details of the Company’s share capital in note 30 to the consolidated financial statements.
Dividends The Company pays its dividends in sterling to shareholders registered on its register of members at the relevant record date.
222 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020222 Direct Line Group Annual Report and Accounts 2020
How to avoid share fraud – Remember that FCA-authorised firms are unlikely to contact you unexpectedly offering to buy or sell shares.
– 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/register.
– Search the list of unauthorised firms to avoid at www.fca.org.uk/consumers/unauthorised-firmsindividuals.
– For internet sales, go to www.investorcentre.co.uk/ directline. You will need your shareholder reference number, as shown on your share certificate, or your welcome letter from the Chair.
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.
The trade body that represents the insurance and long-term savings industry in the UK.
Available-for-sale investments are non-derivative financial assets that are designated as such, or are not classified as loans and receivables, held-to-maturity, or financial assets at fair value through profit or loss.
Capital The funds invested in the Group, including funds invested by shareholders and Tier 1 notes. In addition, the subordinated liability in the Group’s balance sheet is classified as Tier 2 capital for Solvency II purposes.
Claims frequency The number of claims divided by the number of policies per year.
Commission ratio The ratio of commission expense divided by net earned premium. (See page 227 alternative performance measures.)
The loss ratio for the current accident year, excluding the movement of claims reserves relating to previous accident years and claims relating to major weather events. (See page 227 alternative performance measures.)
This is calculated using the normalised operating profit adjusted for prior-year reserve movements. (See page 227 alternative performance measures.)
Gross written premium The total premiums from contracts that were incepted during the period.
The investment return divided by the average AUM. The average AUM derives from the period’s opening and closing balances. (See page 227 alternative performance measures.)
Net asset value The difference between the Group’s total assets and total liabilities, calculated by subtracting total liabilities (including Tier 1 notes) from total assets.
Net insurance claims The cost of claims incurred in the period less any claims costs recovered under reinsurance contracts. It includes claims payments and movements in claims reserves.
This is calculated in the same way as investment income yield but includes the cost of hedging. (See page 227 alternative performance measures.)
Ogden discount rate The discount rate set by the Lord Chancellor and used by courts to calculate lump sum awards in bodily injury cases.
These are claims payments as awarded under the Courts Act 2003. PPOs are used to settle certain large personal injury claims. They generally provide a lump-sum award plus inflationlinked annual payments to claimants who require long-term care.
The PRA is a part of the Bank of England. It is responsible for regulating and supervising insurers and financial institutions in the UK.
Reserves Funds that have been set aside to meet outstanding insurance claims and IBNR.
Restructuring costs These are costs incurred in respect of the business activities where the Group has a constructive obligation to restructure its activities.
Return on equity This is calculated by dividing the profit attributable to the owners of the Company after deduction of the Tier 1 coupon payments by average shareholders’ equity for the period.
Science-Based Targets are a set of goals developed by a business to provide it with a clear route to reduce greenhouse gas emissions. An emissions reduction target is defined as "science-based" if it is developed in line with the scale of reductions required to keep global warming below 2°C from pre-industrial levels.
UK Endorsement Board The UK Endorsement Board endorses and adopts new or amended International Financial Reporting Standards issued by the International Accounting Standards Board.
Expresses claims performance in the current accident year in relation to net earned premium.
This is a measure of underwriting profitability, excluding the effect of prior-year reserve movements.
Loss ratio is defined in the glossary on page 225 and is reconciled in note 4 on page 185.
Net investment income yield is defined in the glossary on page 225 and is reconciled on page 228.
Expresses a relationship between the net investment income and the associated opening and closing assets adjusted for portfolio hedging instruments.
This is a measure of underwriting profitability excluding the effects of weather, Ogden discount rate changes and restructuring and one-off costs. It also excludes non-insurance income. A ratio of less than 100% represents an underwriting profit and a ratio of more than 100% represents an underwriting loss.
Operating expenses are defined in the glossary on page 226 and reconciled in note 4 on page 185.
Group APM Closest equivalent IFRS measure Definition and / or reconciliation Rationale for APM
This shows the underlying performance (before tax and excluding finance costs and restructuring and one-off costs) of the business activities.
Tangible equity Equity Tangible equity is defined in the glossary on page 226 and is reconciled in note 16 on page 193.
This shows the equity excluding Tier 1 notes and intangible assets per share for comparability with companies which have not acquired businesses or capitalised intangible assets.
Net realised and unrealised (losses) / gains excluding hedging (11.7) 10.3
228 DIRECT LINE GROUP ANNUAL REPORT & ACCOUNTS 2020228 Direct Line Group Annual Report and Accounts 2020
Notes: 1. See glossary on page 226 for definition. 2. See notes to the consolidated financial statements.
This Annual Report & Accounts has been prepared for, and only for, the members of the Company as a body, and no other persons. The Company, its Directors, employees, agents or advisers do not accept responsibility to any other person to whom this document is shown, or into whose hands it may come, and any such responsibility or liability is expressly disclaimed.
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 contained in this document, for example directly or indirectly as a result of, but not limited to: – United Kingdom (“UK”) domestic and global economic business conditions; – the direct and indirect impacts and implications of the Covid-19 pandemic on the economy, nationally and internationally, on the Group, its operations and prospects, and on the Group’s customers and their behaviours and expectations; – the trade and co-operation agreement between the UK and the European Union (“EU”) regarding the terms, following the end of the Brexit transition period, of the trading relationships between the UK and the EU and its implementation, and any subsequent trading and other relationship arrangements between the UK and the EU and their implementation; – the terms of trading and other relationships between the UK and other countries following Brexit; – market-related risks such as fluctuations in interest rates and exchange rates; – the policies and actions of regulatory authorities and bodies (including changes related to capital and solvency requirements or to the Ogden discount rate or rates in response to the Covid-19 pandemic and its impact on the economy and customers) and changes to law and/or understandings of law and/or legal interpretation following the decisions and judgements of courts; – regulations and requirements arising out of the FCA pricing practices review and changes in customer and market behaviours and practices arising out of that review and such regulations and requirements; – the impact of competition, currency changes, inflation and deflation; – the timing, impact and other uncertainties of future acquisitions, disposals, partnership arrangements, joint ventures or combinations within relevant industries; and
– the impact of tax and other legislation and other regulation and of regulator expectations, interventions and requirements and of court, arbitration, regulatory or ombudsman decisions and judgements (including in any of the foregoing in connection with the Covid-19 pandemic) in the jurisdictions in which the Group and its affiliates operate.