Churchill, whose mascot has become a household name, markets its products in the UK through the phone and internet, including PCWs. We target customers who have a high brand affinity and value the need for support.
Privilege targets customers who predominantly buy through PCWs, focusing on a quick customer experience at the best price.
Green Flag is our roadside rescue and recovery product, which is sold both as a stand-alone service and as an additional optional product alongside motor insurance.
NIG is our specialist commercial insurance brand focused towards small- and mediumsized enterprises (“SMEs”) and micro businesses in the UK through brokers, including an in-house intermediary that arranges all of Royal Bank of Scotland (“RBS”) and National Westminster Bank plc (“NatWest”) commercial insurance.
Note: 1. Ranked number one by total in-force policies in the motor and home markets combined, including Direct Line Group partner brands: RBS, NatWest, Nationwide, Prudential, Egg © GfK NOP Ltd 2014, Financial Research Survey (FRS) 6 months ending December 2013, 13,263 adults interviewed for motor insurance and 13,107 for home insurance.
Financial statements 104 Contents 105 Independent auditor’s report 108 Consolidated financial statements 113 Notes to the consolidated financial statements 168 Parent Company financial statements 171 Notes to the Parent Company financial statements
This has been a year of progress towards our strategic targets. We introduced new customer initiatives, including telematics; enhanced our technical pricing capability; continued the transformation of our claims capability; and increased our operating efficiency. Our strong customer focus remains integral: we aspire to provide our customers with products that best suit their evolving needs and encourage them to expect a high quality of service throughout their relationship with us. For more on our strategy see p.18
In our first full year as a listed company, we continued to make good progress in our financial performance and advance our transformation plan.
• Operating profit from ongoing operations1 of £526.5 million for 2013, up 14.2% (2012: £461.2 million); and total Group profit before tax of £423.9 million (2012: £249.1 million)
• Investment in improved customer-focused capabilities and propositions, launch of two telematics products and start of roll-out of smartphone and tablet optimised websites
• Extended efficiency programme particularly in head office functions and announced additional cost savings, targeting a reduced total cost base2 of approximately £1,000 million in 2014
Notes: 1. Ongoing operations include the Group’s ongoing divisions: Motor, Home, Rescue and other personal lines, Commercial and International.
20.9p 5. For 2013, total special interim dividends of 8.0 pence per share were paid. For 2012, pro forma full year dividend is based on the final dividend of 8.0 pence per share representing two-thirds of the full year payout ratio.
We protect micro, small and medium-sized businesses, through our own brands NIG and Direct Line for Business, as well as through RBS and NatWest.
We have multiple brands, products and distribution channels that enable customers to choose the right level of cover to protect their cars, homes, holidays, businesses and pets.
Our business divisions We tailor our products to target specific market segments.
Home We are one of Britain’s largest home insurers, with a 17% share of in-force policies2. We reach our customers by selling home insurance products both through our own brands and through partners such as Sainsbury’s Bank, RBS, NatWest, Nationwide Building Society and Prudential.
For information on our divisional performance see our operating review see p.28
Our shareholders Our shareholders form a crucial part of our business model by investing in us, in the expectation of achieving a return. We aim to deliver value for our shareholders by sustaining the generation of business profit, which is reinvested in the business or distributed to shareholders in the form of dividends.
For information on key performance indicators that measure the effectiveness of our business model see p.20
Product distribution We aim to make our products easy to access and to give our customers what they are looking for, to ensure they are appropriately covered when unexpected events happen.
We apply a multi-brand, multi-product and multi-distribution channel business model to sell to retail customers and businesses. Products can be purchased online, including via PCWs, by phone and indirectly through partners and in our Commercial business, via brokers. Each brand provides products targeted at one or more insurance segment: motor, home, rescue, pet, travel and commercial. By tailoring the mix of distribution channel for each product, we can offer our customers a combination of brands, products and services that best suits their needs.
Pricing and underwriting The scale of our business, which has been operating for almost 30 years, gives us deep insight into the risks we underwrite, which enables us to improve pricing accuracy. It also allows us to invest more heavily in data and achieve efficiencies, which means we can more accurately set the appropriate price for the risks we underwrite.
We have a conservative approach to reserving and this may result in significant prior-year reserve releases.
Managing risk We ensure that our products meet regulatory standards and that customers understand what they are purchasing from us. We also aim to make sure we price our policies prudently and we invest our assets appropriately to minimise any potential losses. We mitigate risks by adopting policies and minimum standards that are regularly reviewed and updated to ensure that we are in line with the risk appetite set by the Board. Regular reviews by external experts supplement this internal control framework.
In June 2013, we moved from a test and learn phase to launching our telematics propositions on our own motor brands, Direct Line, Churchill and Privilege. This included our black box solution for young drivers aged 17 to 25, and our downloadable app available to all ages. We are now selling approximately 400 telematics policies a week and have sold 12,000 to date. This represents a growing proportion of our new motor business and we believe telematics has an increasingly important role to play in motor insurance, not just with young drivers but across the market.
Improving our customers’ experience We identified that providing timely updates during car repairs is a key challenge in our claims business and important to our customers.
Supporting our customers on the ground We have been looking at how we can best use our people on the ground to support our customers when they make a home claim.
To make access to us more convenient, we are introducing the use of smartphone technology to capture and send claim details while connected to a customer services adviser. The cost of the repairs can then be priced using our home estimation tool, thereby getting the claim moving much faster.
Before the storm hits, we ensure there are extra people available to help you on the phone and on the ground
CHARLIE, our emergency response vehicle, is sent to the worst affected areas2
“The Board is encouraged by the progress made on the Group’s transformation plan and endorses management’s actions to drive efficiency in the current competitive markets.
“Over the longer term, the Board believes that a continued focus on our strategic priorities should generate sustainable value.”
The Board considers that the Group is currently strongly capitalised with a risk-based capital coverage ratio at the upper end of its risk-based capital coverage target range and an ‘A’ rating with stable outlook from its credit rating agencies.
The Board and its Committees undertook formal evaluations of their performance in 2013. The Company engaged the services of an external facilitator, who met with me as Chairman to agree the structure, scope and content of the evaluations. The individual Directors were subject to a review of their effectiveness and I have met with each Director to provide feedback on a one-to-one basis. Committee Chairs also received feedback on the performance of the Committees.
Summary I have been very impressed by the commitment of our employees whenever our customers need their support. In a challenging year, they have remained determined to help our customers get back on their feet after an accident or an event in their lives. The Group is only as good as its people and everyone has contributed to this success, and I would like to thank employees and senior management for everything that has been achieved in 2013.
Overview of financial performance I am pleased that in 2013 we continued to make good progress with our strategic priorities and financial targets, while maintaining our disciplined approach to underwriting in a highly competitive and deflationary marketplace in the UK. We delivered an operating profit from ongoing operations of £526.5 million, an increase of 14.2% compared to 2012 (£461.2 million); and total Group profit before tax of £423.9 million (2012: £249.1 million).
With a COR of 96.1% we achieved our COR target of 98% for 2013. This contributed to a RoTE of 16.0%, ahead of our long-term target of 15.0%. While our results were helped by higher reserve releases than expected, the momentum of our transformation and ‘self-help’ agenda continued to create benefits and opportunities. We took positive steps towards reducing costs across the business and improving our operating efficiency. Within other areas of our strategy, such as pricing and claims, we continued to deliver sustainable benefits for our customers and shareholders.
Delivering value for our customers Our focus on improving our pricing capability and claims infrastructure has particularly helped us to reduce prices for UK motor customers. In addition, we have been exploring new ways in which we can innovate to achieve better outcomes for customers. Direct Line’s heritage is rooted in the revolution it unleashed by using the telephone to bypass the traditional high street insurance broker model and provide customers with more competitive products. That innovation gave way to the advent of PCWs, which emerged in response to the growing purchase of insurance via the internet.
We have also been working hard to reduce customer complaints across the Group and for the second half of 2013 our complaint volumes decreased by 19% compared to the same period in 2012. This is a key area of focus for us. To ensure we are tracking how well we are responding to our customers’ needs, we have introduced a new key performance indicator to measure the volume of customer complaints across the Group.
Regulatory environment We have continued to operate within a highly dynamic and evolving regulatory landscape, particularly in the UK motor insurance market where over the past two years a number of reviews and initiatives have been announced by the UK Government, the Ministry of Justice (“MoJ”), the Financial Conduct Authority (“FCA”), and the Competition Commission (“CC”).
Strategic priorities for 2014 During 2014 we aim to progress further towards delivering the remainder of the strategic financial targets we have set ourselves. In particular, we aim to deliver our target of a total cost base1 of approximately £1 billion, as well as our Commercial business achieving a COR2 of less than 100%.
Outlook The UK motor and home markets remain highly competitive. In this trading environment, we will continue to prioritise targeting appropriate margins, even if this is at the expense of premium or policy volumes. We continue to progress initiatives supporting our strategic priorities in order to seek to improve our competitive position and performance in the longer term.
Notes: 1. See note 2 on page 2 2. This assumes a normal level of claims from weather-related events and large losses. 3. See note 3 on page 2 4. See note 4 on page 2 5. See note 1 on page 2
Distribution We aim to improve our distribution efficiency and effectiveness through a focus on digital capability and customer value.
We employ a multi-distribution channel model and look to optimise the mix of these channels for each of our products and brands. This includes selling our products directly via the phone and internet, through the UK’s four largest PCWs, and via selected partners.
• Developed and launched two telematics propositions – black box and smartphone app
• Used improved rating models to optimise exposure in higher premium segments
Delivering our strategy We continue to transform our business to move towards our ambition to be Britain’s best retail general insurer. Our strategy is based on five key priorities.
Costs We aim to improve efficiency throughout the business to reduce costs, enable faster decision making and improve customer propositions.
2013 progress: • Achieved cost reduction target set at the time of IPO and taken further steps to improve efficiency throughout the organisation, particularly in head office
Priorities for 2014: • Make substantial progress on the migration of IT applications, reducing dependency on RBS Group systems
Claims We aim to maintain top quartile performance by achieving efficient and effective claims management.
We have fundamentally redesigned our claims operating model with simpler processes in fewer sites, giving our people more control and our customers a better experience. By managing claims through our own professional loss adjusters and repairing cars through our own accident repair centres, we aim to give customers the benefit of our scale and strength.
As the characteristics of our personal and commercial lines businesses increasingly come together, we aim to leverage our skills across the Group particularly in the areas of technical pricing, claims management, telematics and flood mapping.
• Maintain progress in Germany with over 9% growth in in-force policies in January 2014
Notes: 1. See note 2 on page 2 2. See note 2 on page 17
Aim We aim to make an underwriting profit, and in 2013 set and achieved a target of a 98% COR. For 2014, we are providing guidance of a COR in the range of 95% to 97% for the Group. This assumes a normal level of claims from weather events.
Aim We aim to maximise investment income subject to the risk appetite set by the Board. The investment portfolio assets are currently invested in credit and sovereign debt securities, cash and property.
Definition We adjust earnings to exclude restructuring and other one-off costs, the result of our Run-off segment and other one-off items. These adjusted earnings, which reflect the ongoing operations, are divided by the average number of shares in issue adjusted for dilutive potential Ordinary Shares.
For information on our performance rewards see our remuneration report on p.76
Notes: 1. See note 3 on page 2 2. See note 4 on page 2 3. See note 5 on page 3 4. Adjusted for final and second special interim dividends
Aim We have set a target to achieve a 15% RoTE.
Aim We have adopted a progressive dividend policy and aim to grow the dividend in real terms each year. In addition, we look to return excess capital to shareholders when appropriate.
Definition The number of complaints received during the year as a proportion of the average number of in-force policies.
Aim This measure indicates the level of customer service provided and over time we aim to improve this.
Managing risk We have a robust and integrated risk management framework. This framework sets out and enables the monitoring of the responsibilities and accountabilities for risk management and internal control for the whole business.
2. The 2nd line of defence is provided by specialist control functions, including Risk and Compliance, which are responsible for the provision of proportionate oversight of the business and related or emerging risks.
The Chief Risk Officer is a member of the Executive and reports to the Chief Executive Officer, with a right of access to the Board Risk Committee and the Audit Committee, assuring independence of the function. The Chief Risk Officer chairs the Risk Management Committee, which reviews material policies for the effective management of risk across the Group.
Chief Executive Officer Risk Management Committee 1st line of defence Risk ownership 3rd line of defence Independent assurance 2nd line of defence Oversight, challenge and support of 1st line
Managing risk in line with Group strategy Group strategy development is the responsibility of management and ultimately the Board.
Our strategic planning process aims to ensure that we have developed a clear set of objectives and targets and have identified the action plans necessary to deliver them. These must be consistent with our overall objective of a 15% RoTE and be delivered in line with our risk appetite. For information on our strategy see page 18.
We have an appetite for general insurance risk, with a focus on personal lines and commercial SME insurance in the UK and direct motor insurance in selected overseas countries. To support our primary activity of insurance, we have an appetite for appropriate non-insurance risks.
The risk appetite statements are aligned with the Board’s strategic risk objectives.
• Realigned risk management and oversight responsibilities as part of the ‘three lines of defence’ model
• Increased our focus on customer conduct risks in line with our Group objectives as well as with the objectives of the FCA.
Maintain sufficient economic capital consistent with the aim of achieving a stand-alone credit rating in the ‘A’ range.
No appetite for material risks leading to reputational damage, regulatory or legal censure, fines or prosecutions and other types of operational risk losses associated with the firm’s conduct and activities.
ERM is the process of organising and controlling the activities of the whole Group so as to ensure the Group remains within risk appetite. To enable ERM we have developed a framework comprising a number of components which are fundamental to good risk management. These are set out in the graphic overleaf.
A central component of the ERM framework is our policy framework, consisting of policies and minimum standards. These inform the business how it needs to conduct its activities so as to remain within risk appetite.
The policies cover the key risks to which we are exposed. Policies are supported by minimum standards which set out the minimum level of risk management and other corporate and personal behaviours that must be complied with. Where appropriate, these minimum standards are in turn supported by detailed guidance documents.
We also employ a number of risk tools to manage and monitor our risks, the output of which is tested and reported upon both internally and externally.
Our risk culture focuses on the key areas of strategy, employees, promoting good governance, communication, systems and reporting. We believe that the ERM framework is made stronger by the promotion of a good risk culture across the Group.
The ICAS+ process will also enable firms to obtain feedback on their progress towards Solvency II. U K Insurance Limited has engaged with this ICAS+ process and has used the new internal model for this purpose. This ICAS+ submission included Pillar II elements which are currently in development. The Group’s internal model produces Solvency II, Individual Capital Adequacy and economic capital requirements for the UK general insurance business.
Culture Our culture and ERM framework are mutually supportive. Our culture encompasses all risk management activity and helps embed risk management within our business.
Group strategy, ERM strategy, risk appetite and policy framework are approved by the Board.
The ERM strategy is enabled using risk management tools such as risk appetite and the capital model.
Underpinning these tools are IRISS, our specialist risk management software, comprehensive risk management training and communication.
Notes: MRA – Material risk assessment IRISS – Internal Risk Intelligence Software System facilitates a robust and consistent approach to the way we capture risk information.
• We have agreed strategic targets which are monitored and managed
Underwriting risk includes catastrophe risk arising from losses due to unpredictable natural and man-made events affecting multiple covered risks, particularly given the concentration of our Home business in the UK.
• We have set underwriting guidelines for all business transacted, restricting the types and classes of business that may be accepted
Reserving risk is our biggest risk, generated by our large Motor portfolio. Reserving risk is heightened in the case of periodic payment orders (“PPOs”) because of their long-term nature and is discussed further in the finance review on page 39 and in notes 2.1 and 3 to the consolidated financial statements on pages 120 and 123 respectively.
• We estimate the technical reserves using a range of actuarial and statistical techniques. Projections of ultimate claims cost involve assumptions across a range of variables, including estimates of trends in claims frequency and average claim amounts. These are based on facts and circumstances at a given point in time
• We ensure that management’s best estimate of reserves is not less than the actuarial best estimate
Counterparty risk We partner with many suppliers and the failure of any of these to perform their financial obligations in a timely manner could result in a financial loss.
• We set credit limits for each counterparty • Our reinsurance is purchased only from reinsurers that hold a minimum credit rating of ‘A-’ at the time cover is purchased • The business actively monitors broker credit exposures • The Chief Financial Officer owns and manages this risk
Market risk We are subject to the risk that, as a result of market movements, we may be exposed to fluctuations in the value of our assets or the income from our assets.
• We use risk reduction techniques such as hedging foreign currency exposures with forwards and hedging foreign interest rates with swaps
Operational risk We potentially face the risks of direct or indirect losses resulting from inadequate or failed internal processes or fraudulent claims; from systems and people; or from external events.
• We have developed a bespoke risk capture, management and reporting system (IRISS)
• Ongoing migration of IT away from RBS Group on to a new enhanced platform is continually monitored and managed by experienced personnel
• In addition to mandatory training, employees are encouraged to use the large number of training tools available to enhance their abilities
• Specific members of the Executive own and manage the different aspects of operational risks
Regulatory risk also includes the risk that business practices are not efficiently modified following a regulatory change. Further, there is a risk that current legal or regulatory requirements are not complied with.
• We have a constructive and open relationship with our regulators
• In addition, we use specific risk management tools and resources, such as our upstream risk team, to help manage our exposure to regulatory risk
• We exercise risk-based monitoring to ensure our resources are used to greatest impact
Conduct risk We are subject to the risk of failing to deliver the appropriate treatment for our customers throughout all stages of the customer journey and the risk that our people fail to behave with integrity.
This includes the risk that our organisational culture is not appropriate, with a failure to communicate the correct tone from the top.
Brand and reputational risk We are dependent on the strength of our brands, our reputation with customers and distributors in the sale of products and services. We have entered into various strategic partnerships that are important to the marketing, sale and distribution of our products.
Evolving risks Risks can emerge and evolve over time, often as a result of changes in the environment in which we operate. As part of our risk management framework, we aim to identify these risks as they first emerge, working efficiently to mitigate their potential impact on the business. Set out below are examples of current significant evolving risks and the way in which we monitor and mitigate these risks.
Insurance risk: claims costs Bodily injury claims costs are a key source of uncertainty with several regulatory, legal and market pressures facing the Group, including: • Underlying trends in bodily injury claims frequency and average cost per claim inflation
• The propensity for large injury claims to settle as PPOs, and the inflation and longevity assumptions used to value PPOs
• The impact on claims costs of the MoJ consultation and Transport Committee investigation into whiplash injuries.
Regulatory risk: regulatory environment The UK insurance market is subject to several regulatory reviews and potential areas of focus which are sources of uncertainty, including: • The CC investigation into aspects of the private motor insurance market
• The impacts of Flood Re and the proposed levy on home insurance premiums
There is also uncertainty around the way in which the FCA may apply the principles underpinning behavioural economics to the insurance industry and the impact that this has on our business.
The EU is currently developing new EU Data Protection Regulations which will replace the UK Data Protection Act. This may impact our ability to use and benefit from our stored data. Specifically, restrictions or bans on profiling may impact our ability to identify the most appropriate products or solutions for our customers.
• Investigating proposed changes in regulation and legislation and using risk fora to discuss these changes and develop a business response
Strategic risk: business transformation and project delivery The Group is carrying out initiatives to improve its operational efficiency as part of the implementation of its business transformation plan.
Uncertainties include the potential changes in the market around use of PCWs, changes in customer behaviour and the increasing use of telematics.
• Monitoring of the project milestones ensures we remain on track and enables us to make adjustments where appropriate
Risks can emerge over the very long term as a result of significant changes in the environment including technology, weather patterns and socio-economic behaviours. Examples of these risks would include driverless cars, new types of competitor entering the market and climate change.
Group performance Achieved our combined operating ratio1 target of 98% and this contributed to a return on tangible equity2 16.0%, ahead of our long-term target of 15.0%.
Notes: 1. See note 1 on page 2 2. See note 3 on page 2 3. See note 4 on page 2 4. See note 6 on page 3
“UK Personal Lines delivered good results within a competitive market and a changing regulatory landscape. We continue to develop compelling customer propositions, deepen customer relationships and enhance our capability.” Tom Woolgrove, Managing Director of Personal Lines
• Operating profit up 32.8%, despite significant reduction in other operating income
Gross written premium of £1,421.1 million fell 12.5% compared with 2012, as we maintained pricing discipline. Average premium per policy was down over the year by approximately 7% due to market competitiveness, the channel shift to PCWs and a reduction in risk mix, but also our focus on value and retaining customers. We seek to pass on lower premiums to customers based on our observed claims experience and during 2013 reduced motor prices by 3%. In-force policies were also slightly lower.
Prudential and Egg © GfK NOP Financial Research Survey (FRS) 6 months ending October 2013, 15,260 adults interviewed for motor insurance.
Highlights • Retained position as one of Britain’s largest home insurers with a 17% share of in-force policies1
• Continued to improve our technical pricing models, which contributed to increased retention in 2013
• Customer initiatives rolled out, such as the claims’ home estimation tool
Market The UK housing market remained flat for the majority of 2013, and ongoing limited mortgage availability has caused an increase in the number of people renting. Lower disposable incomes have also driven price sensitivity. However, there have been indications of a UK economic recovery.
The loss ratio improved, reflecting fewer claims from major weather events and continued reserve releases. On an underlying current-year attritional basis, it was in line with last year at 51.3%. The commission ratio rose due to profit-share payments reflecting higher profitability of partnership business, mainly as a result of the lower loss ratio. Underwriting profit improved on last year mainly due to the fewer claims from major weather events. The expense ratio improved by 1.7 percentage points due to cost improvements across the Group. Overall, operating profit improved by 13.8%, reflecting fewer major weather events across 2013 in the UK.
• Loss ratio increased and operating profit reduced due to the non-repeat of 2012 one-offs, primarily in the legacy creditor book
Performance We focused on new Rescue customer propositions and a refreshed marketing campaign, with Green Flag’s one hour response commitment, which aimed to differentiate the brand. A positive contribution continued to be received from the pet insurance line, while the travel business experienced a loss due to increased claims frequencies from packaged bank accounts. In November, we completed the sale of the closed Life business for £62 million, and returned the proceeds of sale to shareholders by way of a special interim dividend in December.
• Continue to rationalise the back office, improve efficiency and streamline the operating model
Market UK economic growth has continued to strengthen in 2013 and optimism is increasing about the general business situation. Interest rates remain at low levels, reducing investment returns. There has been some evidence of insurers exiting historically unprofitable business.
Insurers are also seeking to reduce costs and there have been instances of insurers reviewing their regional structures and branch networks. Furthermore, there is a desire for brokers and insurers to adopt e-trading solutions for SME and micro-sized businesses, in order to reduce costs and speed up the underwriting process.
Performance We continued to grow in-force policies, particularly in Direct Line for Business. NIG’s full cycle broker e-trading platform ‘The Hub’ continued to be rolled out across the year to new products. Where business has been migrated to the new platform, broker take up has been encouraging. We have established two online newspaper partnerships aimed towards small businesses and social media channels have been introduced to interact directly with customers. Proposition development continues to be a strength for Direct Line for Business, with a number of new initiatives launched. Furthermore, to streamline our operating model, we separated our trading and operational functions, and restructured the regional functions to enhance new business focus and improve efficiency.
Gross written premium increased by 8.9% compared to 2012 due to the transfer of the van business from the Motor division and growth in Direct Line for Business. In 2013, some components of the portfolio were de-risked.
Outlook Normalising the 2013 performance for claims from weather events, the division made progress towards its 2014 COR target of sub-100%. Actions taken during 2013 on pricing, risk selection and the cost base are expected to continue to flow through in 2014 and the division’s target for this year is unchanged. This assumes a normal level of claims from weather-related events and large losses. Up to 22 February 2014, approximately £20 million of such claims have been received.
“The International division has continued to develop in line with our plans. We maintained profit in Italy and increased gross written premium in Germany, where profitability was affected by hailstorms.” Jamie Brown, Managing Director of International
Highlights • In-force policies grew by 10.1% on 2012 and now exceed 1.6 million
• Gross written premium, in local currency, grew by 4.9% reflecting strong growth in Germany offset by a modest decline in Italy
• Implemented ClaimCenter in Italy and continue to evolve technology to deliver efficient digital platform
In Italy, the use of telematics to collect information at the claims stage is already fairly extensive. As a consumer proposition it is continuing to develop. We have a number of pilots to understand how best to operate in this area. In Germany, the first introduction has recently occurred.
Performance We continue to focus on extracting value from the Italian and German businesses. Growth arose from Germany where we benefited from positive market conditions allowing our efficient platform to enable us to grow our share of year-end business without significant additional cost. We remain cautious in Italy given the uncertain economic environment and competitive conditions. We implemented ClaimCenter in Italy and continue to evolve technology to deliver an efficient digital platform. Italy, Germany and the UK continued to share and leverage best practice, for example on claims processes and telematics.
The COR remained broadly stable at 103.9%, with higher than normal hailstorm claims in Germany which resulted in a COR of 109.8%, offset by lower claims frequency in Italy with a COR of 101.6%. The loss ratio in Germany similarly reflects the £8 million of claims relating to the severe hailstorms. A higher commission ratio was attributable to a change in mix towards PCWs and partners. Total operating profit of £16.6 million was split £14.1 million from Italy and £2.5 million from Germany. Operating profit, in local currency, was €20.4 million a decrease of 16.7% on the previous year (2012: €24.5 million).
Outlook In Italy, more competitive market conditions and increased customer switching during 2013 have lowered premium growth expectations for 2014. With this more cautious stance, we will continue to focus on creating value through improving operating and pricing efficiency. Germany has once again experienced a good start to the year, which has increased in-force policies to approximately 628,000 at the end of January 2014. Following average premium rate increases over the last two years, an increase in competition is now expected to place pressure on average premiums.
Highlights • Operating profit1 of £526.5 million for 2013, up 14.2%
• Gross written premium1 4.1% lower for 2013, reflecting competitive market conditions in UK personal lines, partially offset by growth in International and Commercial
• Return on tangible equity2 from ongoing operations of 16.0% for 2013 (2012: 11.5% and pro forma3 13.4%)
“In our first full year as a stand-alone listed Group, we showed good progress towards our targets and delivered improved returns to shareholders.”
Gross written premium for Commercial of £474.5 million increased by 8.9% (2012: £435.6 million) due to the transfer of van business and growth in Direct Line for Business.
The Group’s COR for ongoing operations improved by 3.1 percentage points to 96.1% (2012: 99.2%), resulting in an increase in underwriting profit for ongoing operations to £138.2 million (2012: £28.2 million).
Notes: 1. See note 1 on page 2 2. See note 3 on page 2 3. See note 4 on page 2 4. Ongoing operations, adjusted for finance costs excluding gain on disposal of subsidiary and stated after charging tax (using the standard rate of 23.25%; (2012: 24.5%))
On a segmental basis, the COR improved in Motor, Home and Commercial compared with 2012. Rescue and other personal lines COR increased in 2013 as positive one-off benefits in 2012 mainly from the creditor business were not repeated. The International COR remained broadly stable.
Overall prior-year reserve releases from ongoing operations increased to £435.1 million (2012: £322.0 million), equivalent to 12.4% of net earned premium (2012: 8.7% of net earned premium). Although the Group expects to continue to see significant reserve releases, the overall level experienced in 2013 is higher than would normally be expected. Assuming claims trends continue, a significant contribution from prior-year reserve releases is currently expected in 2014, albeit at a lower level than in 2013.
The COR for Rescue and other personal lines increased to 92.4% (2012: 82.7%). The 2012 result benefited from positive one-offs (relating primarily to the run-off of the legacy creditor business) that were not repeated in 2013. The performance was also affected by higher claims frequency on the travel book and increased Green Flag marketing costs. The Life business, which contributed £6.4 million to operating profit in 2013 (2012: £8.1 million), was sold in November 2013.
The expense ratio improved by 0.7 percentage points to 22.3% due to a reduction in operating expenses compared with 2012, partially offset by the impact of lower net earned premium.
Ongoing operating expenses of £786.4 million were reduced by 8.0% from the prior year (2012: £854.8 million). The reduction was principally due to the benefits from the Group’s cost savings plan announced in 2012, tight cost control and the non-repeat of certain expenses under the historic RBS Group recharge.
From 1 July 2012, the Group no longer paid a management fee to RBS Group and this was replaced by directly paying third-party suppliers for the majority of services that RBS Group had previously provided. Consequently, expenses previously reported under management fees are now reflected within their relevant line items. The Group continues to pay RBS Group for transitional IT infrastructure, the costs of which are included within other operating expenses.
The Group is targeting a total cost base1 of approximately £1,000 million in 2014 and the total cost base1 in 2013 of £1,031.9 million showed good progress towards this target.
Instalment income, representing interest charged on insurance premiums paid by instalments, of £117.8 million reduced by £7.6 million compared with the prior year (2012: £125.4 million) as a result of lower in-force policies in Motor and Home and changes to business mix.
In February 2014, the Group sold its stolen vehicle recovery business, Tracker. In 2013, Tracker’s revenue was £18.4 million (2012: £18.2 million) which was included in the above. Operating losses from the business were £1.4 million (2012: £3.9 million).
Notes: 1. See note 2 on page 2 2. Vehicle recovery includes post-accident and pay on use recovery and vehicle tracking. Repair services constitute the provision of non-insurance related services.
The total investment return reduced to £221.1 million compared with 2012, due to a decrease in realised gains and lower investment income resulting from lower AUM.
During 2013, the investment asset base decreased by 8.5% to £8.6 billion. Key reasons for the reduction include the repayment of the £258.5 million Tesco loan note and investment outflows resulting from a net reduction in insurance liabilities.
The investment income yield on the total portfolio for 2013 was 2.1% (see page 41), an improvement on 2012 driven primarily by management actions to increase the credit and property weighting within the target investment mix.
In the year ended 31 December 2013, all divisions were profitable, with all except Rescue and other personal lines and International improving profit versus 2012.
Restructuring and other one-off costs Restructuring and other one-off costs for 2013 fell to £140.5 million (2012: £189.5 million) as a result of the non-repeat of costs associated with separation and divestment from RBS Group. This includes £60.2 million relating to IT migration and £80.3 million relating to the Group’s cost saving initiatives. The Group currently expects that restructuring and other one-off costs in 2014 will be approximately £80 million.
Finance costs Finance costs increased to £37.7 million (2012: £28.7 million), primarily reflecting a full year of interest on the £500 million of long-term subordinated debt issued in April 2012.
Taxation The Group has an important responsibility to its stakeholders to manage its tax position effectively to ensure that the Group is fully compliant with all laws and regulations; and to meet all its obligations as both a contributor of taxes and a collector of taxes on behalf of the tax authorities.
RoTE from ongoing operations increased to 16.0% (2012: 11.5% and pro forma 13.4%) as a result of both the improved operating result and the capital actions taken to improve the efficiency of the Group’s capital position.Notes: 1. Investment income yield excludes net gains 2. Investment return includes net gains
Earnings per share Basic earnings per share of 20.9 pence increased 69.9% (2012: 12.3 pence), reflecting the improved operating profit from ongoing operations and the Run-off segment, and a decrease in Restructuring and other one-off costs. Diluted earnings per share were 20.8 pence (2012: 12.3 pence).
Adjusted basic earnings per share, which excludes the Run-off segment, Restructuring and other one-off costs and gain on disposal of subsidiary, increased by 15.1% to 25.1 pence (2012: 21.8 pence). Diluted adjusted earnings per share were 25.0 pence (2012: 21.8 pence).
Dividends The Board is proposing a final dividend of 8.4 pence per share making a total regular dividend for 2013 of 12.6 pence per share. This represents 5.0% growth over the pro forma1 2012 regular dividend and is in line with the Group’s aim to grow dividends annually in real terms.
In addition, the Board is also declaring a further special interim dividend of 4.0 pence per share, in addition to the 4.0 pence per share paid in December 2013. This second special interim dividend reflects the better than planned performance in the Run-off segment and the proceeds from the recently announced sale of Tracker. Both these items are considered to be one-off in nature and as a result the Board believes it is appropriate in this instance to return this capital to shareholders.
Cash flow Net cash used by operating activities before investment of insurance assets reduced to £307.0 million (2012: £966.0 million). This reflected a reduction of cash used by operations of £226.7 million (2012: £731.4 million) and reduction of taxes paid of £80.2 million (2012: £232.4 million). The reduction of cash used by operations resulted from an increase in trade and other payables and in payments of current and prior-year claims, partially offset by a decrease in insurance and other receivables.
Overall, net cash generated from operating activities totalled £126.0 million (2012: £1,038.8 million).
Net cash used by investing activities of £145.3 million (2012: £154.2 million), primarily comprised £115.5 million purchase of intangibles relating to ongoing software investment (2012: £96.6 million).
The net asset value at 31 December 2013 was £2,790.0 million (31 December 2012: £2,831.6 million) with tangible net asset value of £2,289.9 million (31 December 2012: £2,410.1 million). This equates to 186.6 pence and 153.2 pence per share respectively as at 31 December 2013 (31 December 2012: 189.1 pence and 161.0 pence, respectively).
The reduction in net asset value and tangible net asset value principally reflects the payment of the final 2012, interim and first special interim 2013 dividends, a reduction in the level of unrealised gains in the debt securities portfolio, and increased investment in intangible assets offset by profit for the period.
Given this uncertainty, the Group adopts a conservative approach to the assessment of liabilities. This conservative approach is supported by historical claims reserve releases. These can be observed in the gross and net ultimate claims cost development triangles shown on pages 153 and 154. The triangles demonstrate that, for all accident years, the estimated ultimate claims cost has reduced over time from the year of first validation. Reductions in ultimate claims cost have fluctuated over the period, with the accident years from 2003 to 2006 and 2010 showing the largest decreases. The 2009 accident year has shown the lowest reduction; this followed a significant increase in claims relating to motor over the 2009 and 2010 financial years, in response to the market-wide adverse development in bodily injury claims. This resulted in part from the rise of claims management companies, an increase in no-win no-fee litigation, and an increase in the number of PPOs.
During 2013, key achievements included: • Undertaking a major asset and liability management study on U K Insurance Limited, which reconfirmed liquidity requirements and proposed some changes to the current asset mix to deliver a better overall risk adjusted return
• Investing into externally managed securitised credit, with the focus on investment into the highest-quality debt tranches and having a well-diversified range of collateral types and pools backing such investments
Total debt securities are £7,045.3 million (2012: £7,164.3 million), of which 12.9% are rated as ‘AAA’ and a further 70.5% are rated as ‘AA’ or ‘A’. Corporate, local government and supranational debt securities account for 63.2% of the portfolio.
The total value of the investment portfolio as at 31 December 2013 was £8,557.6 million, 8.5% lower than as at 31 December 2012. AUM provide adequate access to liquidity, with 15.1% of the funds held in cash and cash equivalents at the year end.
The duration as at 31 December 2013 of total investment assets was 2.0 years, with the breakdown being: UK 1.9 years; Italy 3.3 years; and Germany 2.4 years (2012: 1.8 years; UK 1.7 years; Italy 2.8 years; and Germany 2.5 years).
Investment property holdings shown as at 31 December 2013 comprised 20 properties. The primary sector exposures are industrial warehouses (26.5%) and supermarkets (19.7%).
Asset and liability management Asset and liability management influences the Group’s investment strategy through the matching of assets and liabilities, for further information please see the table below: Liabilities Asset Characteristics
Long term >10 years PPOs Property, infrastructure debt1 Inflationary linked or floating Short and medium term All other claims Investment grade credit Key rate duration matched Debt Tier 2 sub debt (swapped fixed to floating) Securitised credit and cash Floating Surplus Tangibles Investment grade credit, cash and government debt securities Fixed or floating
Note: 1. Infrastructure debt is a new asset class which the Group plans to invest in 2014.
Asset studies for the UK portfolio resulted in the introduction of securitised credit as a new asset class in 2013. The benchmark holding for fixed income credit was increased during the year from 60% to 63%. Further investment properties were acquired during the year to bring the holding closer to the allocated level. Following an asset liability management review, the Group plans to start investing into infrastructure debt in 2014. Investment holdings and yields – total Group
Total Group 8,557.6 188.6 9,355.7 199.3 Corporate debt securities5 57.3% 2.7% 47.9% 2.9%
Current capital position and outlook The Board considers the Group is currently strongly capitalised with a risk-based capital coverage ratio at the upper end of its risk-based capital coverage target range and an ‘A’ rating with stable outlook from its credit rating agencies.
In determining this position, the Board has considered a number of factors that may positively and negatively affect the Group’s capital position over the next 12 months. In particular, the Group’s UK regulated general insurance underwriters are currently going through the new ICAS+ process with the PRA to assess the Group’s future individual capital guidance. The ICAS+ process will also enable firms to obtain feedback on their progress towards Solvency II. This process is more involved than previous years and includes a detailed assessment of the Group’s internal risk-based capital model. In addition, the introduction of Solvency II from 2016 and changes to capital requirements and reporting are still being confirmed, especially in the area of long-term guarantees.
During 2013, the Group updated its investment target asset mix and in 2014 is developing further its asset and liability management solutions for longer tail insurance liabilities. This includes investing in infrastructure debt. As these changes take affect, it is expected that there will be an increase in the capital allocated to market risk. Furthermore with current bond yields remaining low, the Group expects to continue to see its level of unrealised bond gains reduce as bonds mature and are reinvested.
The Group continues to invest in its operations and is likely to see an increase in intangible assets that may not qualify fully towards the Group’s capital base.
Dividends In relation to 2013, the Group has paid, or is recommending, dividends amounting to £308.7 million and 20.6 pence per share. This consists of a regular dividend of 12.6 pence per share, representing 5.0% growth on the pro forma 2012 full year dividend, and two special interim dividends totalling 8.0 pence per share. The regular dividend is consistent with the Group’s policy to aim to raise dividends annually in real terms.
The two special interim dividends relate to specific items in 2013 that the Board considers to be one-off in nature – the disposal of its closed Life business and the higher than planned profit in the Run-off segment. Total dividends are equivalent to 98.6% of post-tax profit. The regular dividend represents 50.4% of post-tax profit from ongoing operations.
Capital position and leverage The Group is well capitalised with key capital metrics within the Group’s risk appetite and significantly above regulatory minima.
Notes: 1. Includes that element of the subordinated dated notes applicable for regulatory capital purposes.
2. Based on the IGD for the Group and 2012 adjusted to include the capital requirement for Direct Line Versicherung AG acquired on 2 April 2012.
The table below sets out the Group’s financial leverage ratio: As at 31 December £m £m
The Group’s leverage ratio remains conservative with a financial leverage of 14.9% at 31 December 2013 (31 December 2012: 21.8%). The main change during 2013 was the repayment of the Tesco loan note in January. Excluding this the leverage ratio at 31 December 2012 would have been 15.7%.
Credit ratings Standard & Poor’s and Moody’s Investors Service provide insurance financial strength ratings for U K Insurance Limited, the Group’s principal UK general insurance underwriter. U K Insurance Limited is currently rated ‘A’ (strong) with a stable outlook by Standard & Poor’s and ‘A2’ (good) with a stable outlook by Moody’s.
“During 2013, the Corporate Social Responsibility Committee has overseen the development of the Group’s approach to CSR, taking care to embed it in Direct Line Group’s core purpose and values. This ensures CSR is relevant to every employee, creating a clear value chain – doing the right thing builds trust, trust builds reputation, and reputation builds value – and weaving it into business processes.
”This approach reflects the way the Group and I believe our customers want us to do business, and ensures our strategy mirrors the themes of empowerment and trust which the Board actively leads in the Group’s relationships with its stakeholders.
“Against the backdrop of a challenging operating environment, I am pleased to report that good progress has been made in establishing solid foundations to enable us to live up to our broad responsibilities as Britain’s leading personal lines motor and home insurer.”
Our approach and priorities drive a clear value chain; doing the right thing builds trust, trust builds reputation, and reputation builds value.
Sustainable business practices Our products, services, business processes and supply chain have a tangible impact on each of our many stakeholders. By aiming to embed CSR in all our enterprise’s activity, we hope to deliver better outcomes for our customers and our wider stakeholders across society.
The industry has compromised to reach agreement and, although there remain a number of issues that need to be overcome, it is committed to continuing to work closely with the UK Government with the objective of ensuring these can be resolved. In the meantime, we will meet our flood-related commitments to our customers under the existing Statement of Principles.
Innovation We believe that ultimately customers determine our future. That is why we are investing in technology to help give our customers the products and services they want and need.
For higher risk motorists, such as young drivers between the ages of 17 and 24, who tend to pay higher premiums, telematics provide a way for these customer groups to pay only for how they drive, rather than also pay for how other drivers behave on the roads.
Above all else, we believe the use of telematics technology encourages safer and more considerate driving, which will ultimately lead to safer roads for all. It is an excellent way of encouraging drivers to manage their speed – one of the biggest causes of collisions on European roads.
Living Wage While not accredited to the Living Wage Foundation, we ensured that all our employees were paid at or above the Living Wage. We are also factoring the Living Wage into contract renewal discussions with external suppliers.
Responsible investment During the year, we set out our approach to responsible investment. The asset classes in which we invest are cash, government and corporate debt securities, and commercial property. We do not hold equities or have direct equity investments and are therefore unable to use share ownership to influence other companies. Although we do not set ethical parameters for our asset managers regarding the issuers in which they can or cannot invest, we have, however, committed to mandating only those external asset managers who demonstrate a strong commitment to using their market leverage to support social, environmental and ethical (“SEE”) objectives. We favour those managers with an active, ongoing demonstrable engagement in local or global SEE initiatives and expect, at a minimum, our managers to be signatories1 to the UN Principles of Responsible Investment. We will meet with each of our asset managers annually to review in detail the initiatives they have taken and successes accomplished.
Clearly this was a very difficult time for those leaving the business, but also unsettling for those remaining. Not surprisingly, it had an impact on morale, as evidenced in this year’s Employee Opinion Survey, although it was pleasing that overall engagement remained high at 71% relative to historical results. This survey also showed that there is a high degree of
Note: 1. One fund manager was selected before this new policy was adopted and our approach is to encourage them to move towards becoming signatories in due course.
Recognition Recognition is an important element of engagement. The Group has established a number of initiatives to recognise the efforts and contribution of our employees. These range from formal reward arrangements to informal recognition programmes. Examples of the latter include our Service Awards, which were relaunched in 2013, to recognise loyalty; and our Excellence Awards, which recognise employees for outstanding service, innovation, relationship building or leading by example. We also run a Chief Executive Awards programme. These awards recognise those individuals who clearly demonstrate behaviours in line with our corporate values, which are at the very heart of our culture and demonstrate the great things our people do for each other, our customers, and our business every day. Last year, there were a record 6,000 nominations. Those shortlisted attended an awards event where the entertainment was provided by our own people, in the form of ‘Direct Line Group’s Got Talent’.
Development Our Leadership Framework sets the expectation for leaders at all levels. We believe everyone can show leadership in their role. With the help of our employees, we have created a framework which outlines the behaviours, personal qualities, skills and knowledge needed for individuals to be successful in their role. The Leadership Framework is specific to Direct Line Group and helps drive the performance of our people.
For our people managers, there was significant focus this year on creating an environment where continuous and flexible development opportunities were made available. This challenged the traditional learning methodologies, reducing the dependency on face-to-face delivery, and has been built around a self-directed learning model where the emphasis is on the job development.
Over 1,000 people in our Claims business have been supported in embracing new ways of working to provide them with the skills and knowledge to handle claims in a more pro-active and efficient way.
Last year, the network had a particular focus on gender and working families. The ratio of female to male employees as at 31 December 2013 is shown in the charts along with a year on year comparison by headcount.
Our analysis has shown that we need to increase the number of female applicants for senior management positions and we shall look at ways in which we might achieve this in 2014.
Our Employee Opinion Survey indicated that 89% (2012: 92%) of respondents felt that we provide a working environment that is inclusive and accepting of differences in cultural backgrounds and lifestyles.
Recruitment We are actively supporting a range of initiatives to help alleviate youth unemployment, a continuing legacy of the financial crisis. During 2013, we joined the UK Government’s Wage Incentive scheme and will recycle any funds received into schemes to help young people into work. We have also provided partner funding to an online resource and careers platform for 11 to 24 year olds, entitled Plotr, which helps the young get into employment through supporting internships and mentoring. Additionally, we are working with Generation Talent, a joint initiative between the UK Government and BitC, to tackle the issues surrounding youth unemployment and to support young people into work.
Community Our aim is to build Britain’s best retail general insurer. We recognise that achieving this aim requires us to play an active role in our local communities.
According to our Employee Opinion Survey, last year, 26% of our staff volunteered or fundraised in company time.
Supporting employees We align our charitable giving with the interests of our employees in two ways. We match employee donations up to £50 per month through our Give As You Earn scheme (“GAYE”); and we provide individual grants of £250 to organisations for which our employees regularly volunteer or raise funds in their own time. In 2013, we donated £115,000 through GAYE and a further £48,500 in grants. Our employees also undertake their own fundraising at work, typically for local causes, but also for major fundraising events.
Energy and environment We aim to manage our operations in a sustainable way. We seek to reduce waste and make efficient use of resources; and we aim to cut emissions, as part of the transition to a low carbon economy.
Emissions We have established historical data records on energy use which has helped us better understand trends in our associated greenhouse gas (“GHG”) emissions. Group-wide GHG emissions in 2013 were 30,624 tonnes of carbon dioxide equivalent (“CO2e”), of which 95.1% related to our UK operations. Emissions are calculated in accordance with the Greenhouse Gas Protocol and include Scope 1 and Scope 2 emissions. More details on our emissions are given in the Directors’ report on page 100.
In 2014, we are targeting a reduction of 3% of our UK GHG emissions measured by tonnes of CO2e.
Waste We retendered our waste management services contract, excluding paper, for our main office sites and appointed SITA as provider in October. SITA has already significantly increased the percentage of our general office waste we recycle. Our longer-term aim is to increase recycling year on year and eliminate waste to landfill by 2016. Iron Mountain collects and recycles 100% of our waste paper. In 2013, we generated 1,355 tonnes of waste from our main office sites of which we recycled 55%. SWR collects waste from our accident repair centres. In 2013, these centres generated 1,085 tonnes of waste of which 86% was recycled or reused.
Resource use Through our desktop and printing transformation programme we are replacing our old hardware. This is expected to bring a significant reduction in both energy and paper use. Last year, we consumed some 416 tonnes of copier paper. Our default office paper has a 100% recycled content.
We are currently establishing an accurate measure for our water usage for the Group.
We have a number of local initiatives to improve our environmental performance, supported by a network of environmental champions. For example, we have made changes to the way in which we consume water in our restrooms in Bromley, resulting in a significant saving of half a million litres of water annually.
Charlton House was appointed as our new catering supplier in 2013. Significant in their selection was their sustainability credentials, including a commitment to healthy eating, a focus on sourcing local and seasonal produce, and membership of the Red Tractor Scheme (an industry recognised Kitemark covering animal welfare, food safety and environmental protection).
Dear shareholders and other stakeholders At Direct Line Group, we are committed to meeting the high standards of corporate governance rightly expected of a Group such as ours. Having complied with the UK Corporate Governance Code in relation to the key Board structure and processes by the time of the IPO in 2012, we undertook a governance review in 2013. This was designed to further test whether we have the most appropriate governance framework fit for a stand-alone listed company, with clarity as to accountabilities and responsibilities.
Our objective of good corporate governance influences everything that we do at Direct Line Group and is the responsibility not only of the Board and the executive management but of every member of staff.
• Dealing with customers We shall treat customers fairly, openly and honestly and operate an effective complaints process to address any perceived departure from these standards
• Dealing with employees We shall maintain a working environment that attracts, motivates and retains employees and shall be intolerant of any type of discrimination, harassment or victimisation
• Dealing with suppliers of goods and services and business partnerships We shall maintain the highest possible standards of integrity in business relationships with suppliers and partners by treating them honestly and with respect and avoiding compromising offers of gifts and hospitality1
• Dealing with communities and the environment We shall contribute to the social and economic well-being of those communities where we are an employer and encourage employees to participate in projects and initiatives to strengthen those communities
Note: 1. You may view our ethical code for suppliers on our website
Bring all of yourself to work Be the best you can be, the real and whole you; celebrate our diversity of skills, experiences and personalities; be a role model to others, demonstrate ‘can do’ spirit, have fun and make this a great place to be; be excited about our Company and our future; believe in yourself, feel confident and empowered.
We also place great emphasis on the values set out below that underpin these business principles. As we reported to you last year, the executive management engaged with employees to shape these, with the intention that they become central to our approach and behaviours. In line with those values, we seek to maintain an environment where everybody feels responsible for the future success of the business and is empowered to do the right thing.
Board composition The Board comprises myself as Chairman (independent upon appointment to the Board), five independent Non-Executive Directors, one Non-Executive Director nominated by RBS Group and therefore not independent, and two Executive Directors.
The changes in directorate during 2013 were in respect of the Directors nominated by RBS Group. Mark Catton stepped down from the Board when RBS Group ceded control of the Company in March 2013 (whereupon RBS Group became entitled to nominate only one and not two Directors to the Board). In October 2013 he was reappointed when Bruce Van Saun resigned in order take up an appointment as RBS Group’s Chief Executive Officer, Citizens and Head of Americas in the United States. Mark Catton will step down as a Director when RBS Group’s holding in the Company falls below 20%.
Governance review To help meet our goals of efficiency and strong governance, the Board undertook a planned post-IPO review of the Group’s governance arrangements.
Its aims were to clarify and simplify the governance framework, so as to help improve our day-to-day business operations while maintaining appropriate controls.
I believe that this exercise will increase ownership and oversight and that our governance arrangements have become more transparent and effective.
Chairman of the Board Appointment Mike joined the Board and became Chairman of the Group in April 2012 and is Chair of the Nomination Committee.
Experience and qualifications Mike has over 40 years’ experience of the UK and international financial services sector. He was Chief Executive Officer and Group Finance Director of Resolution plc, the FTSE 100 UK life assurance business, and latterly the Chairman of Resolution Limited until May 2013 when he stepped down following the combination of the boards of Resolution Limited and Friends Life Group. He was previously Group Finance Director of Aviva plc. He has a Masters degree in History from the University of Oxford and is an Associate of the Institute of Chartered Accountants of England and Wales. Mike is 61. External appointments None Key strengths and contribution Mike is a respected figure in the insurance industry and is well regarded by City investors. He brings the Group extensive insurance industry experience and a successful track record of flotations in this sector.
Experience and qualifications Paul was the Chief Executive Officer of RBS Group’s mainland UK retail banking business, having joined in 2004 as Managing Director with responsibility for products and marketing. Before joining RBS Group, Paul held a number of senior roles in multi-channel retailing in businesses that were then parts of the GUS and Kingfisher groups. Paul started his career in marketing, with UK and European roles at Procter & Gamble. Paul read Philosophy, Politics and Economics at the University of Oxford. He is a Fellow of the Chartered Institute of Bankers in Scotland. Paul is 44. External appointments Paul is a member of the ABI Board, a member of the FOS’s insurance industry steering group, and a member of the FCA Practitioner Panel.
Key strengths and contribution Paul’s experience in leading one of the UK’s largest retail banking businesses during a challenging period for the industry and improving its customer and financial performance against peers singled him out in 2009 as the Chief Executive able to lead the turnaround of Direct Line Group and its divestment from RBS Group.
3 John Reizenstein Chief Financial Officer Appointment John joined as Chief Financial Officer in December 2010.
Senior Independent Non-Executive Director Appointment Glyn joined the Board in September 2012 and is Chair of the Investment Committee. Experience and qualifications Glyn was Chairman of Towry Holdings Limited between 2006 and 2011. He also served as Chairman of Hermes Fund Managers from 2008 to 2011 and was Chairman of its sister company, BT Pension Scheme Management, for a part of this period. Glyn was Chief Executive Officer of the independent investment group, Thames River Capital, from 2005 to 2006. From 2000, he served as Chief Executive Officer of Gartmore Investment Management in the UK for four years. Before this, Glyn was Chief Executive Officer of Coutts NatWest Group and Coutts Group, having joined in 1997. Glyn joined Standard Chartered in Hong Kong in 1990 where he became the General Manager of Global Private Banking. He was a consulting partner with Coopers & Lybrand/Deloitte Haskins & Sells Management Consultants from 1981 to 1990. He is a graduate of the University of Cambridge and a Fellow of the Institute of Chartered Accountants in England and Wales. Glyn is 61. External appointments Glyn is Chairman of Aspen Insurance Holding Limited, a New York listed specialty lines insurer, and also Chairman of Aspen Insurance UK Limited, a principal operating subsidiary of the Aspen Group.
5 Mark Catton Non-Executive Director Appointment Mark rejoined the Board in October 2013, having previously served as a Non-Executive Director of the Company from September 2012 to April 2013.
Non-Executive Director Appointment Jane joined the Board in December 2011 and is Chair of the Board Risk and Corporate Social Responsibility Committees.
Key strengths and contribution Clare brings with her extensive experience and knowledge gained from roles across the professional services industry including as Lead Audit Partner at PwC where she guided companies through change and acted as an adviser to insurance companies. She gained significant experience of both general and life insurance in the latter role.
Non-Executive Director Appointment Priscilla joined the Board in September 2012 and is Chair of the Remuneration Committee.
Experience and qualifications Priscilla was most recently Group Human Resources Director at Prudential plc and a Non-Executive Director and member of the Audit Committee at the Ministry of Defence. Priscilla has previously held senior human resources positions across a number of financial services and customer facing industries, including roles at Abbey National plc, where she was Executive Director; Human Resources; BAA plc, where she was Group Human Resources Director; and Kingfisher plc. She graduated in Law (with Honours) from the University of North East London. Priscilla is 56. External appointments Priscilla has her own search and consultancy business.
1 Robert Bailhache Director of Communications “ Bringing a single, clear and consistent voice to what we say to all audiences, saving time and aiming to prove the shared interests of our customers, our people and our shareholders” Appointment Rob joined as Director of Communications in February 2012.
3 Darrell Evans Chief Customer Officer “ Aiming to improve our customer experience across all our channels, by making it easy for our customers to do business with us” Appointment Darrell joined the Group in October 2009.
Experience and qualifications Previously, Sara worked in a number of different industries from retail, to travel to financial services, including M&S, TUI and RBS/Direct Line Group. The early part of her career was in commercial and sales management, giving a broad general management and leadership background. She worked in management development culminating in a role as Head of Learning for First Choice Holidays. In 2008, she moved into generalist HR and her route to her current role has been through HR Business Partnering in a wide range of functions within Direct Line Group.
7 Angela Morrison Chief Information Officer “ Providing a value driven, easy and reliable experience for our customers and employees, which meets their ever increasing digital needs within a clear regulatory framework” Appointment Angela became Chief Information Officer (“CIO”) in 2010.
Experience and qualifications Prior to her current role, Angela was CIO at J Sainsbury’s and a member of their Operating Board. She previously worked for ASDA / Wal-Mart where she held a number of roles including European Strategy Director, CIO through the ASDA / Wal-Mart integration and e-Commerce Director which included establishing ASDA’s home grocery business. Angela started her career as a consultant and holds a degree in Electrical and Electronic Engineering from the University of Bristol.
8 Humphrey Tomlinson General Counsel and Company Secretary “ Providing governance, company secretarial, legal risk management and other legal advice and services to the Board, the Executive and the Group” Appointment Humphrey joined the Group in November 2011.
Experience and qualifications Humphrey is a solicitor with over 20 years’ experience including advising on corporate and commercial matters, a wide range of corporate transactions in the UK and internationally, legal risk management and corporate governance issues, with RSA, where he was Group Legal Director, and City law firm Ashurst Morris Crisp. He is a graduate of the University of Oxford.
Experience and qualifications José was previously Global Chief Risk Officer at HSBC Insurance, where he had responsibility for the Group Chief Actuary, and was a Board member of its captive insurance company. Prior to joining HSBC, José held various roles over 10 years at Zurich Insurance, initially in London Market Operations, then as Chief Actuary International Business Division and finally as Chief Actuary of the UK. José started his career as a consulting actuary, including six years as a consultant with KPMG in London where he worked on a wide range of domestic and European engagements. José is a Maths graduate from Brunel University and a Fellow of the Institute of Actuaries.
Throughout the year, Direct Line Insurance Group plc (the “Company”) has complied with the principles and provisions of the Code. A copy of the Code is available from www.frc.org.uk .
Leadership The role of the Board The role of the Board is to organise and direct the affairs of the Group in a manner that is most likely to promote its long-term success for the benefit of its shareholders as a whole. It has oversight of the Group’s operations, ensuring it is effectively managed and that there are appropriate controls in place to assess and manage the Group’s risks.
The Board has set the Group’s strategy of continuing on the transformation path required to bring us closer to our ambition to be Britain’s best retail general insurer. Set out on page 58 are the Board’s objectives for 2013, the actions the Board has undertaken during the year and our objectives for 2014.
In addition, the Senior Independent Director’s role is to provide a sounding board for the Chairman and to serve as an intermediary for the other Directors when necessary. His responsibilities include the evaluation of the performance of the Chairman and he is also available as an additional point of contact for shareholders.
The Board of Directors The Board currently comprises the Chairman, who was independent on his appointment to the Board, two Executive Directors, five independent Non-Executive Directors and one non-independent Non-Executive Director, Mark Catton. Mark Catton is not an independent Non-Executive Director under the Code by virtue of being nominated by The Royal Bank of Scotland Group plc. However, he demonstrates a level of independent challenge at Board meetings, which has led the Nomination Committee to determine that he is independent in character and judgement.
The names of the Directors who served as at the end of the year, together with their biographical details and other information, are shown on pages 52 to 53.
There were no new appointments during the year; however, Mark Catton resigned from the Board in April 2013 and re-joined the Board in October 2013 when Bruce Van Saun resigned. The respective dates are shown in the notes to the table opposite.
The Board programme for 2013, achievements and objectives for 2014 What did the Board say it would do?
Our objectives for 2013 Highlights of 2013 Our objectives for 2014
• Considered capital management policy • Approved capital allocation to the Group’s investment strategy • Considered the technology environment in which the Group operates • Considered the impact of emerging global economic conditions, regulatory developments and the outlook for the industry
• Oversee the substantial migration of Direct Line Group’s IT infrastructure away from RBS Group
• Monitor change from regulatory, legal and market pressures facing the industry and mitigate against potential risk of adverse reserve development
• Oversee the Group’s progress in pursuit of its targets, including those relating to COR and RoTE
• Oversee the Group’s total cost base1 reduction to approximately £1,000 million in 2014
• Reviewed the results of an Employee Opinion Survey and challenged management on the actions to be taken
• Considered the means by which cultural indicators can be measured and improved
• Give our customers fair outcomes • Oversaw new customer propositions, including the launch of telematics products in June
• Supported the ABI’s negotiations with Government to create a not-for-profit fund to insure the highest flood risk properties in the UK
• Review the main elements of governance architecture to ensure that they are fit for purpose for the newly listed entity
• Undertook a performance evaluation of the Board and its Committees and reviews of the Matters Reserved to the Board and Committees’ terms of reference
Board Committees The Board has established its Committees to assist it in meeting its responsibilities. Each Committee plays a vital role in ensuring that the Board operates efficiently and gives appropriate consideration to matters. The governance structure illustrating the relationship between the Board and its Committees is set out below. The composition, attendance, role and focus of each Committee are set out on pages 65 to 74.
Authority delegated to the Chief Executive Officer Although the Board is ultimately responsible for the success of the Company, Paul Geddes, the Chief Executive Officer, has received delegated authority from the Board to manage the Group’s day-to-day operations.
In turn, the senior executives who report to him take responsibility for managing the businesses and functions within the Group, and each member of the Executive Committee has the financial and other authorities needed to manage their respective areas.
The diagram ‘Direct Line Group’s Executive Committee’ below illustrates the management governance framework.
Whilst this review confirmed that the Group’s governance framework dealt with such areas as would be expected and necessary, nonetheless the opportunity was taken to improve the control environment whilst making its administration and operation more transparent and cost effective.
The review covered the entire Group and was primarily led by the Company Secretariat, Legal and Risk functions.
The overall objective of the project was to clarify and simplify the Group’s governance framework in order to help and improve its day-to-day operation whilst maintaining appropriate controls.
The review resulted in a significant revision to the High Level Controls and System of Governance Document, the creation of an Enterprise-wide Risk Management framework and an Executive Governance framework. In addition Policies and Minimum Standards were revised and clarified and various business and project approval processes and procedures were also reviewed in conjunction with the Delegated Authority framework.
The diagram below summarises the split of responsibilities for the different aspects of the governance framework.
Board High Level Governance framework, risk appetite and Group policies are set by the Board, following review by the Board Risk Committee, for implementation by the Executive.
Attributes • Widely recognised as an individual of high repute and integrity who can rapidly gain Executive and Non-Executive colleagues’ respect and trust
• A sound understanding of the requirements of good public reporting and the ability to identify whether what is being presented in meetings stands up against reporting standards
• Strong communication and presentation skills, with the ability to get under the skin of the business and a strong desire to gain a deep understanding of what is going on in and around the Group
Non-Executive Directors are normally expected to serve two fixed terms of three years, but may be invited to serve a third term of three years.
• Leeds – customer relations, complaint management, claims and call centre handling
The process took place between September and December 2013. The review of the Board included: • the role of the Board (including Directors’ input into group strategy and risk management); • information provided to Directors (including induction, continuing professional development and familiarity with group businesses); • people issues (including Directors’ skills, Board and committee composition, diversity, succession planning and time commitment); and
Similar themes were raised in relation to the Board’s committees, as well as committee-specific questions.
The Chairman held one-to-one meetings with each of the other Directors, providing them with feedback on their performance and contributions. Feedback on his own performance and contribution was provided by the Senior Independent Director, who had previously held discussions with the remaining Non-Executive Directors.
Based on the Board effectiveness review report, the Directors are satisfied that the Board has operated effectively during 2013. The Board considered the review in the December Board meeting and matters arising from the report will be further considered and where appropriate actions will be implemented in 2014.
As the composition of the Board shows, with three of its nine members being women, the Company is committed to the merits of diversity. However, whilst the Board will take care to consider gender diversity of its members when selecting new members, it is committed to appointing the most appropriate candidate and therefore no targets have been set against which to report.
Risk management and internal control system The Board acknowledges that it has overall responsibility for the Group’s risk management and internal control system, and has complied with the Code by establishing a continuous process for identifying, evaluating and managing the significant risks the Group faces. This process includes risks arising from social, environmental and ethical matters.
The Audit Committee, on behalf of the Board, regularly reviews the effectiveness of the Group internal control systems. Its monitoring covers all material controls, based principally on reviewing reports from management, the Group Audit function and external auditors, so that it may consider how to manage or mitigate risk in line with the Group’s risk strategy. The Committee did not identify or report any serious failings or weaknesses to the Board in 2013.
Role and focus The Committee is responsible for the oversight and challenge of the effectiveness of the Group’s systems of financial control, financial and regulatory reporting and other internal controls. The Committee reviews the adequacy and effectiveness of the Group’s internal financial controls and internal control systems, as well as the procedures for monitoring their effectiveness. It monitors the work of internal and external auditors and actuaries.
The Audit Committee’s terms of reference are available on our website at: www.directlinegroup.com .
• Provide oversight of the Group Audit programme of activity to ensure that Group Audit continues to meet the expectations of the Board and satisfy emerging regulatory and industry standards for internal audit
• Reviewed the draft preliminary statement and draft Annual Report & Accounts for the year ended 31 December 2013, with particular focus on accounting policies and critical estimates and judgements to confirm that it is fair, balanced and understandable
– the financial reporting control framework in a non-US Sarbanes Oxley (“SOX”) environment following separation from RBS Group.
• Considered the adequacy of the resources available to Group Audit and the results of the effectiveness review of the function and concluded that they were adequate
• Monitored Group Audit’s independent and objective reports regarding the appropriateness, effectiveness and sustainability of the Group’s system of internal controls
• Monitored key control issues reported by Group Audit on a quarterly basis with the aim of ensuring the Group’s risk exposure is properly mitigated
• Considered plans and key assumptions relating to the Group’s actuarial reserves, received regular updates regarding movements and emerging trends, and recommended the level of reserves to the Board each quarter
Notes: 1. Attendance is expressed as the number of meetings attended out of the number of meetings possible or applicable for the Director to attend. 2. Glyn Jones was unable to attend two scheduled Audit Committee meeting due to other commitments.
• Monitored the Group’s compliance with statutory and regulatory requirements and made recommendations within the scope of the Committee’s terms of reference
• Reviewed the appropriateness of all accounting policies including revenue recognition and those in relation to significant areas pertinent to changes taking place in the business, including provisions for restructuring costs
• Considered the ability of the Company and its principal subsidiaries to operate on a going concern basis
• Reviewed the draft Audit Committee report for inclusion in the Annual Report & Accounts for the year ending 31 December 2013
What will we be focusing on in 2014? In addition to its regular monitoring, challenge and oversight responsibilities, the focus for the Committee in 2014 is expected to include the following: • Considering the impact of ongoing regulatory changes on the assumptions and judgements used in our reserves and in our reporting
Frequency of meetings During 2013, the Committee met on seven occasions, six of which were scheduled meetings, and one was an ad hoc meeting. The members’ attendance record is set out on the previous page.
Committee expertise Committee members bring considerable financial and accounting experience to the Committee’s work. All members have past employment experience in either finance or accounting roles, or comparable experience in corporate activities, and are members of the Institute of Chartered Accountants in England and Wales.
The Board is satisfied that each of these members has recent and relevant financial experience, as recommended by the Code.
The key control issues that Group Audit reports to management and to the Committee are monitored on a quarterly basis with the aim of ensuring the related risk exposures have been properly mitigated.
At least half-yearly, the Committee reviews and challenges the key assumptions and judgements, the emerging trends, movements and analysis of uncertainties underlying the assessment of the actuarial best estimate reviews.
In addition to the focus on matters relating to reserving, issues considered by the Committee in 2013 and the judgements that were made included: • the overall presentation of the financial statements to ensure fairness and balance and, in particular, the presentation of adjusted performance, including the appropriateness of restructuring and other one-off costs; • reports on the assumptions underlying the provisions made for redundancy and onerous leases; • the assessments made for goodwill impairment and confirmed the carrying value remained supportable; • the judgements made in respect of tax, in particular the carrying value of any deferred tax assets and liabilities recognised; and
• the Committee receives an annual report on all services provided during the year and their related costs.
The Committee will review annually and where appropriate recommend updates to the Minimum Standard to ensure alignment with the latest standards and practice in establishing, maintaining and monitoring the independence and objectivity of auditors.
The key issues and areas of focus during 2013 The external auditor provided updates to the Committee on the following key issues during 2013: • reserve valuation; • investment valuation; • reinsurance asset valuation; • revenue recognition; • transformation projects; and
• planned migration of the Group’s IT systems to the Capgemini platform.
A breakdown of fees paid to the auditor for the year ended 31 December 2013 is set out below: Total fees for audit and other services £2.2 million
Re-appointment of auditor The Committee intends to undertake a formal review on a regular basis to assess whether the external audit should be re-tendered. Deloitte LLP, the external auditor, has been the Group’s auditor since 2000. Prior to listing in 2012, the Group was audited as a division of RBS Group.
The Committee is recommending to the Board that Deloitte LLP be re-appointed as auditor of the Company. A resolution for the re-appointment of Deloitte LLP as auditor of the Company will be put to a shareholder vote at the AGM on 15 May 2014.
The new UK Corporate Governance Code requires FTSE 350 companies to put the audit services contract out to tender at least once every 10 years, to enable the Committee to compare the quality and effectiveness of the services provided by the incumbent auditor with those of other audit firms. Transitional arrangements provided by the Financial Reporting Council (“FRC”) indicate the Company should tender the audit, at the latest, at the time of the next audit partner rotation. The latter is currently scheduled following the 2015 year end.
The Board Risk Committee’s terms of reference are available on our website at: www.directlinegroup.com .
• Reviewed, in conjunction with the Remuneration Committee, the incentive arrangements in the customer facing areas
• Reviewed the draft risk management report and the Board Risk Committee report for inclusion in the Annual Report & Accounts for the year ending 31 December 2013
What will we be focusing on in 2014? In addition to its regular monitoring, challenge and oversight responsibilities, the focus for the Committee in 2014 is expected to include the following: • Guiding the continued development of an embedded risk and control culture which reinforces adaptability, flexibility and improving efficiency, while overseeing alignment of culture to appropriate customer outcomes
• Overseeing a review of the maturity and effectiveness of the Risk Management Committee
– the design and implementation of risk management and measurement strategies across the Group.
• Received the annual report from the Money Laundering Reporting Officer
• Approved the Risk function’s target operating model, adjusted to align with the business transformation plan, and to differentiate clearly between the roles and responsibilities across the three lines of defence model
• Reviewed the Direct Line Group tax strategy for consistency with risk appetite
Role and focus The remit of the Committee is to ensure that the Group conducts its business in a responsible manner, including in relation to health and safety, environmental, corporate social responsibility, social and ethical matters. The Committee also oversees the allocation of charitable donations and community involvement.
What did the Committee say it would do in 2013? • Review the Group’s overall Corporate Social Responsibility
• Analysed and set the Health & Safety plan for 2014 • Determined the Group’s position on emerging CSR issues • Agreed the Group’s approach to responsible investment and identified activities to support our CSR strategy • Discussed and agreed the 2014 CSR strategy and sustainability targets • As part of the annual review, the Committee recommended to the Board revisions to its terms of reference • Reviewed the draft Corporate Social Responsibility report and the Corporate Social Responsibility Committee report for inclusion in the Annual Report & Accounts for the year ending 31 December 2013
What will we be focusing on in 2014? In addition to its regular monitoring, challenge and oversight responsibilities, the focus for the Committee in 2014 is expected to include the following: • Sustaining and measuring the Group’s CSR progress and impact, continuing to embed CSR into our business strategy and operations
• Reviewing and recommending the 2015 CSR strategy, plan and targets
Role and focus The role of the Investment Committee is to oversee the management and performance of the investment strategy of the Group.
Minimum number of meetings per annum The Committee meets at least three times a year.
What did the Committee say it would do in 2013? • Consider changes to the existing asset benchmark composition for the Group’s investment portfolio with the aim of improving the expected risk-adjusted returns, taking into account the Group’s investment risk appetite set by the Board
• Use the internal capital model to support asset strategy decisions by understanding and monitoring the capital and solvency implications
• Review the liquidity requirements of the business and consider the adequacy of liquidity available to meet such needs from the investment portfolio
• Monitor the selection and implementation process for any new asset classes approved for the investment portfolio
What have we achieved? • Reviewed a major asset and liability management study on UK Insurance Limited, particularly in the context of a low interest rate environment. The study used the internal capital model to examine the capital consequences of asset allocations proposed
• Determined an appropriate liquidity policy for the investment portfolio and how liquidity needs could continue to be met in a stressed scenario
• Considered reports from the Director of Investment Management and Treasury covering, inter alia key market developments, financial performance from investment activity, performance of external fund managers and the custodian, and compliance with risk and exposure limits set
• Agreed oversight and support arrangements in respect of the international businesses regarding treasury and investment activities
• Reviewed the findings and recommendations from the internal audit of the Investment and Treasury function and monitored resolution of the actions arising
• Considered how investment activities should support the Company’s corporate social responsibility agenda
• As part of the annual review, the Committee recommended to the Board revisions to its terms of reference
• Reviewed the draft Investment Committee report for inclusion in the Company’s Annual Report & Accounts for the year ended 31 December 2013
4. Clare Thompson was appointed a member of the Committee on 5. Glyn Jones and Clare Thompson attended a meeting of the Committee on 14 February 2013 before being appointed members of the Committee.
• Within the Board’s risk appetite, seeking to reduce further the excess liquidity above stressed requirements within the U K Insurance Limited portfolio and reinvesting this in assets offering an illiquidity premium and / or better risk adjusted returns
• Receiving an asset and liability management study covering the investment portfolios of the International division
Role and focus The Nomination Committee is responsible for considering and making recommendations to the Board regarding the appointment and re-appointment of Directors. It also makes recommendations regarding the membership and chairmanship of the Board Committees.
Other attendees include • Chief Executive Officer • General Counsel and Company Secretary
Note: 1. Attendance is expressed as the number of meetings attended out of the number of meetings possible or applicable for the Director to attend.
open advertising to fill the vacancy on Mr Van Saun’s resignation. Mr Catton will step down as a Director when RBS Group’s holding in the Company falls below 20%.
Please refer to page 63 for the Group’s approach to diversity, including gender diversity.
Terms of reference As part of the annual review, the Committee recommended to the Board revisions to its terms of reference.
The Committee works closely with the Chairs of the Board Risk Committee and the Audit Committee.
Notes: 1. Attendance is expressed as the number of meetings attended out of the number of meetings possible or applicable for the Director to attend. 2. The Committee met jointly with the Board Risk Committee on 3. Mike Biggs was unable to attend a scheduled meeting of the Committee due to another commitment.
• Approve the grants of awards under the Group’s share schemes
• Determine the share ownership guidelines for members of the Executive Committee
Board Risk Committee, approved the outcomes under the 2012 AIP and made awards under the Company’s deferred share incentive arrangements
• Reviewed the overall remuneration policy to ensure it continues to support the Company’s strategic objectives going forward
• Reviewed the implications for the 2013 Directors’ remuneration report of changes in regulations introduced by the Department for Business, Innovation and Skills
• Determined the implications for remuneration arising from the evolution of the Group’s strategy through liaison with the Audit Committee and Finance function
• Reviewed the draft Remuneration Committee report and the Directors’ remuneration report for inclusion in the Company’s Annual Report & Accounts for the year ending 31 December 2013
• Ensuring that short-term results are not driven at the expense of maximising shareholder value
Relations with shareholders We consider that actively engaging with our shareholders is fundamental to our business. We believe that ensuring an active dialogue and ongoing engagement is vital to keeping in touch with opinions, providing us with the opportunity to address any questions and concerns in a proactive way.
The Executive Directors frequently meet with investors. The Chairman, Senior Independent Director and Non-Executive Directors are available to attend meetings with major shareholders at the shareholders’ request so that they have the opportunity to discuss governance and strategy with shareholders and ensure that any particular shareholder views are communicated to the Board. The Board is also kept aware of shareholder views by the Company’s corporate brokers who regularly attend Board meetings for this purpose.
JP Morgan small mid cap conference, London Keefe, Bruyette & Woods conference, London Bank of America Merrill Lynch conference, London1
• Presentations of our financial results • Investor road shows in the UK, Europe, the United States and Canada • Attending key conferences to enable communication with a large number of existing and target investors in a time efficient manner
What arrangements are we making for the Annual General Meeting? The Notice of the AGM will be sent to shareholders well in advance of the meeting. We will propose all items requiring shareholder approval under separate resolutions.
• All Directors are expected to stand for re-election to the Board • Each Director has been formally evaluated by the
Nomination Committee before standing for re-election • The Board believes that each Director is effective and demonstrates commitment to his or her role • There will be a vote on the Directors’ remuneration policy.
Linking remuneration to overall business objectives – looking back to what we did in 2013 We remain committed to ensuring that Executive Directors are appropriately incentivised to deliver superior long-term business performance and that they will receive their full remuneration opportunity only when material value has been created for shareholders.
The resulting bonus award of 63% of the maximum bonus potential to Paul Geddes and 60% of the maximum bonus potential to John Reizenstein are therefore broadly at the on-target level of performance. We believe that this level of payout is appropriate and that it demonstrates that our remuneration policy effectively aligns pay with underlying performance.
• the approach to measuring performance under the AIP in 2014 will be similar to that followed in 2013 and the Committee will continue to apply judgement in assessing payouts. Additional financial and non-financial indicators will be considered which will include forward-looking metrics as opposed to purely historical ones
• we are not proposing any changes to the performance measures for 2014 awards under the 2012 LTIP and we will continue the practice of making LTIP awards twice a year at the same levels as during 2013, subject to stretching performance targets over each award’s performance period
Structure of remuneration report We have made some changes to the order in which this year’s remuneration report is presented, in line with the new regime for the reporting of executive pay in the UK.
I hope that you will find this report informative and accessible and I welcome any feedback you may have.
Questions and answers on our executive remuneration policy in the first full financial year of listing since the IPO1
Q How were 2013 bonuses determined for the Executive Directors? We started by setting a range of measures and targets reflecting the Committee’s assessment of what success would look like against the business plans set by the Board. Following the year-end, the Committee undertook a quantitative assessment of performance against the financial measures included within the AIP, and an assessment of performance against all other measures including each individual’s personal objectives. This assessment simply determined the initial outcomes under the AIP; however, no payments were approved until after the Remuneration Committee carried out a quality of earnings assessment of the financial elements and a ‘gateway assessment’ for all AIP outcomes.
Note: 1. This section and the Group remuneration policy on page 79 are not subject to the binding vote on remuneration policy.
The quality of earnings and gateway assessments resulted in the reduction of the initial bonus outcome for Executive Directors as explained on pages 94.
For both Executive Directors, 40% of the bonus awarded will be deferred in Company shares for a period of three years. This is in line with the approach followed for all our strategic leaders (around 60 of our most senior executives, including Executive Committee members, who are responsible for developing and executing Group strategy).
Q Why are the Executive Directors still receiving shares under RBS Group Long-Term Incentive Plans? In line with other Group employees previously granted awards under RBS Employee Share Plans, Paul Geddes and John Reizenstein continue to hold awards granted under the RBS Group Long-Term Incentive Plans (“RBS Group LTIP”) and the RBS Group Deferral Plan granted prior to the IPO.
It has been agreed with RBS that awards granted under the RBS Group LTIP in 2011 and 2012 will now be delivered in the form of Direct Line Insurance Group plc shares transferred by RBS Group, to the extent that the original performance conditions have been met. This ensures maximum alignment with the performance of Direct Line Group. Awards granted under the RBS Group Deferral Plan will continue to be delivered in RBS Group shares.
Although not impacting Directors’ pay, separately, following the publication of the FCA’s guidance on risks to customers from financial incentives, we have reviewed our remuneration systems for customer-facing employees to ensure that they are fit-for-purpose and that the risk of mis-selling and other risks identified by the FCA are appropriately managed. The Remuneration Committee and the Board Risk Committee contributed to (and reviewed the outcome of) this assessment. This forms the basis of an ongoing joint review. Our initial assessment concluded that our existing plans were broadly compliant and that evolutionary changes, where necessary, will take effect from 2014.
Companies Act 2006 and, on approval, will take effect immediately following the 2014 AGM.
The remuneration policy guides the design and implementation of reward programmes in the Group that are market competitive and aligned to business objectives, both financial and non-financial.
Financial, customer and other strategic and personal objectives RoTE and relative Total Shareholder Return
• We empower managers to genuinely lead and foster a culture consistent with the Group’s attitude to risk and values
• Individual performance is assessed both in terms of what is achieved and the way in which it is achieved
• Remuneration is benchmarked periodically to ensure continued competitiveness with the market
Element Purpose and link to strategy Operation Maximum opportunity Performance measures
• Salaries are typically reviewed against: – level of skill, experience and scope of responsibilities, individual and business performance, economic climate and market conditions; – the median market pay in the context of insurance peers and companies of a similar size, particularly FTSE 31-100 companies being companies which are considered to be reflective of the size and complexity of the Group; and
– general base salary movement across the Group. • The Committee does not strictly follow data but uses it as a reference point in considering, in its judgement, the appropriate level having regard to other relevant factors including corporate and individual performance and any changes in an individual’s role and responsibilities
• For Executive Directors, at least 40% of the award is deferred into shares under the Deferred Annual Incentive Plan (the “DAIP”) typically vesting three years after grant (with deferred awards also capable of being settled in cash). The remainder of the award is paid in cash following year-end
• The percentage deferred and the terms of deferral will be kept under review by the Committee to ensure that levels are in line with regulatory requirements and best practice and may be changed in future years but will not, in the view of the Committee, be changed to be less onerous overall
• For awards to be granted in 2014, vesting is determined based on two measures: RoTE and relative Total Shareholder Return (“TSR”) performance against the FTSE 350 (excluding investment trusts). The Committee may apply different performance measures and targets in future years
• For both the TSR and RoTE elements, 20% of the award vests for threshold performance with 100% vesting for maximum performance. The Committee reserves the discretion to make changes to these levels which it considers non-material
Policy report (pages 80 to 88) Policy table The policy shown for Directors will apply immediately after approval at the 2014 AGM. Information in relation to the operation of the policy for 2014 is set out in the annual remuneration report section starting on page 89 of this report.
• The maximum bonus level potential under the AIP is 175% of base salary per annum. The current maximum bonus level applying for each individual Executive Director is shown in the statement of implementation of policy in 2014 section of the annual remuneration report
• Before any payment can be made, the Committee will perform an additional gateway assessment to determine whether the amount of any bonus is appropriate in view of such facts or circumstances as the Committee considers relevant. This assessment may result in moderation (either positive or negative) of each AIP performance measure but subject to the individual maximum bonus levels
• The AIP remains a discretionary arrangement and the Committee reserves discretion to adjust the out-turn (from zero to the cap) should it consider that to be appropriate. In particular, the Committee will operate this discretion as a gateway in respect of any risk concerns 2012 Long-Term Incentive Plan (the “LTIP”)
• To motivate and incentivise delivery of sustained business performance over the long term, aligning executives’ interests with those of shareholders
• The Plan allows for awards over shares with an absolute maximum value of 200% of base salary per financial year (although awards of up to 300% of base salary are permitted in exceptional circumstances in relation to the recruitment or retention of an employee, as determined by the Remuneration Committee)
• Fuller details of the performance conditions and targets for 2014 awards are set out in the statement of implementation of policy in 2014 section of the annual remuneration report
• The Committee reserves the right to lengthen (but not reduce) any performance period and / or to introduce a separate holding period
• The Committee reserves the discretion to amend these levels in future years
Notes to the policy table Stating maximum amounts for each element of remuneration Where the table refers to the maximum amounts that may be paid in respect of any element of the policy (as required under the Regulations) these will operate simply as caps and not be indicative of any aspiration.
• A material failure of risk management or any other act or omission that has had a sufficiently significant impact on the reputation of the Company to justify such action
• The size of awards, within the overall limits disclosed in the policy table
• The treatment of awards in the case of change of control or restructuring
• The treatment of leavers within the rules of the plan and the termination policy summary shown on page 86
• Pension contributions are paid only in respect of base salary • Executive Directors are eligible to participate in the defined contribution pension arrangement or alternatively they may choose to receive a cash allowance in lieu of pension • This is in line with the approach taken for all Group employees
• In addition, the limit for any employee share plans in which the Executive Directors participate will be in line with the caps permitted by HMRC from time to time
• The Executive Directors may be entitled to retain fees received for any directorships held outside of the Group
• To further align the interests of Executive Directors with those of shareholders
The terms of incentive plan awards may be adjusted in the event of a variation of the Company’s share capital, demerger or a similar event that materially affects the price of the shares or otherwise in accordance with the plan rules.
For 2014, awards under the LTIP will therefore continue to be subject to performance against both RoTE and relative TSR targets, which are important KPIs for the business. The Committee believes that this combination provides a balanced approach to the measurement of Group performance over the longer term by using both a stated financial KPI that incentivises individuals to keep growing the business in an efficient way and a measure based on relative shareholder return. This combination of measures achieves an appropriate balance of absolute and relative returns.
Differences in remuneration policy from broader employee population When determining Executive Directors’ remuneration, the Committee takes into account pay throughout the Group to ensure that the arrangements in place remain appropriate.
• LTIP – our strategic leaders participate in the LTIP currently based on the same performance conditions as those for Executive Directors, although the Committee reserves the discretion to vary the performance conditions for awards made to employees below the Board for future awards
• Non-Executive Directors are paid a basic annual fee plus reasonable travel expenses. Additional fees may be paid to Non-Executive Directors who chair a Board Committee, sit on a Board Committee and for the Senior Independent Director. The level of fees for 2014 is shown in the annual remuneration section
• In setting the level of fees, the Company takes into account the expected time commitment of the role and fees at other companies of a similar size, sector and / or complexity to the Group
• Subject to a Non-Executive Director aggregate fee cap in the Articles of Association (currently £2,000,000 per annum), the Company reserves the right to change how the elements and weightings within the overall fees are paid and to pay a proportion of the fees in shares within this limit
Other items • The Non-Executive Directors are not entitled to receive any compensation for loss of office, other than fees for their notice period. They do not participate in the Group’s bonus, employee share plan or pension arrangements and do not receive any benefits
The elements of any package for a new recruit, including the maximum level of variable pay, but excluding buy-outs, and the approach taken by the Committee in relation to setting each element of the package will be consistent with the Executive Directors’ remuneration policy described in this report, as modified by the above statement of principles where appropriate. The Committee reserves the right to avail itself of the current Listing Rule 9.4.2 if needed in order to facilitate, in exceptional circumstances, the recruitment of an Executive Director. Awards granted under this provision will only be used for buy-out awards.
Termination policy summary It is appropriate for the Committee to retain discretion to consider the termination terms of any Executive Director, having regard to all the relevant facts and circumstances available to them at the time. A Director is deemed a “good leaver” if the following circumstances are met: • Annual Incentive Plan and Long-Term Incentive Plan – death, injury, ill-health, redundancy, retirement, the sale of the individual’s employing company or business out of the Group, or in such other circumstances as the Committee determines
The table below sets out the general position although it should be noted that the Committee, consistent with most other companies, has reserved a broad discretion to determine whether an Executive Director should be categorised as a ‘good leaver’ and that discretion forms part of the approved policy. Similarly, while the policy is generally to reduce AIP and LTIP awards on a pro-rata basis, the Committee has reserved discretion to disapply such reduction if, in the circumstances, it considers that to be appropriate taking into account the performance of the departing executive and the circumstances of leaving.
No awards made Bonus paid at the normal time and on a time pro-rata basis, unless the Committee determines otherwise.
All awards will lapse Awards will vest on the normal vesting date subject to performance and, unless the Committee determines otherwise, time pro rating. In exceptional circumstances, as determind by the Committee, for example in the case of the participant’s death, awards may vest on cessation.
Awards will vest subject to the application of the performance conditions and, unless the Committee determines otherwise, time pro rating.
Non-Executive Director letters of appointment Non-Executive Directors are appointed for a three-year term which may be renewed by mutual agreement. In common with the Executive Directors, all Non-Executives are subject to annual re-election by shareholders. Mark Catton, being the Director nominated by the RBS Group, will step down as Director when RBS Group owns less than 20% of Direct Line Group.
The Directors may appoint additional members to join the Board during the year. Directors appointed in this way will be subject to election by shareholders at the first AGM after their appointment. In subsequent years the Directors are required to submit themselves for re-election at each AGM.
Terms and conditions of appointment of all of the Directors are available for inspection by any person at the Company’s registered office and at the AGM.
The Chairman and Non-Executive Directors have notice periods of three months from either party, which do not apply in the case of a Director not being re-elected by shareholders or retiring from office under the articles of association. Other than fees for this notice period, the Chairman and Non-Executive Directors are not entitled to any compensation on exit.
In accordance with prevailing commercial practice, the Committee did not consult with employees in preparing the Directors’ remuneration policy.
Consideration of shareholders’ views The Committee takes into account the approval levels of remuneration related matters at the AGM in determining that the current Directors’ remuneration policy remains appropriate.
The Committee, consistent with its approach of operating within the highest standards of corporate governance, takes significant account of guidelines issued by the ABI and shareholder bodies (such as the National Association of Pension Funds) when setting the remuneration policy for the Company.
The following charts show the potential remuneration that may be earned by Executive Directors under three assumed performance scenarios as follows: Total fixed pay l Short-term incentives Long-term incentives
The elements of remuneration included in each scenario are as follows.
• Benefits measured as benefits paid in 2013 as set out in the single figure table on page 93
On-target Based on what the Director would receive if performance was on-target (excluding share price appreciation and dividends): • Fixed remuneration as above
Advisers to the Committee The Committee regularly consults with the Chief Executive Officer and the Human Resources Director on matters relating to the appropriateness of all elements of remuneration for Executive Directors and other strategic leaders. The Chief Executive Officer and the Human Resources Director are not present when their own remuneration is discussed. The Director of Performance and Reward provides advice on compensation and benefits to the Committee, and the General Counsel and Company Secretary advises the Committee on corporate governance guidelines and provides secretarial assistance to the Committee. The Committee works closely with the Chairs of the Board Risk Committee and the Audit Committee.
FIT provided advice during the year on market practice, corporate governance, incentive plan design and other matters under consideration by the Committee. FIT does not provide any other services to the Company, and accordingly the Committee is satisfied that the advice provided by FIT is objective and independent.
FIT’s total fees for the provision of remuneration-related advice in 2013 were £197,793 exclusive of VAT. FIT’s fees were charged on the basis of the firm’s standard terms of business for advice provided.
Distribution statement The following chart shows the overall expenditure on pay across all Group employees compared against the total value of dividends paid to shareholders for both 2012 and 2013.
Note: The £1,000 million dividend paid out in 2012 was to RBS Group and made prior to the IPO. There were no share buy-backs since the IPO other than shares purchased by the Employee Benefits Trust to satisfy the awards of shares under the Company’s share plans. Consistent with expected practice elsewhere, the overall expenditure on pay has been taken from note 10 to the income statement and has not, therefore, been calculated in a manner consistent with the single figure contained in this report.
Historical performance of Total Shareholder Return The following graph shows the Company’s TSR since trading of the Company’s shares began on the London Stock Exchange in October 2012 against the FTSE 350 Index (excluding investment trusts) over the same period. The FTSE 350 Index (excluding investment trusts) has been selected as it is a broad index, of which the Company is a constituent, and is also the same group of companies used for the purposes of measuring relative TSR under the LTIP.
Note: 1. The reduction in the value of benefits between 2012 and 2013 reflects the change in benefit arrangements with the corresponding increase in base pay to ensure total fixed pay was comparable both before and after separation from RBS Group.
Annual Incentive Plan 2014 The maximum annual incentive awards which may be payable to Executive Directors in respect of 2014 are shown below and have remain unchanged from the maximum awards payable under the AIP in respect of the financial year ended 31 December 2013.
Director Position Maximum annual incentive award for 2014 (% base salary) Percentage deferred under the Deferred Annual Incentive Plan
Other financial measures not reflected in the definition of profit, primarily movements in historic reserves, the performance of run-off businesses and management of tax and restructuring costs (which replaces COR for 2013)
Based on a balance of customer metrics (for 2014, this will include Net Promoter Score)
• Committee satisfaction that payment of the bonus does not give rise to major reputational concerns
Performance conditions for LTIP awards to be made in 2014 LTIP awards to be granted in 2014 will continue to be subject to the achievement of the following performance conditions: • 60% to be based on RoTE over a three-year performance period (2014, 2015 and 2016); and
Relative TSR 20% of portion of award vests for median performance
For both the TSR and RoTE elements, 20% of the award vests for threshold performance with 100% vesting for maximum performance. There is a straight-line interpolation between these points for the TSR measure (on a ranked basis). For the RoTE element, 40% vests for 15% RoTE, otherwise, similar to TSR, a straight-line interpolation occurs from threshold to target and then from target to maximum performance.
In addition, the LTIP awards will vest only to the extent that the Committee is satisfied that the outcome of the TSR and RoTE performance conditions reflects the underlying financial performance of the Group over the period from the date of grant until vesting. In making these considerations, the Committee will take into account whether there have been any material risk failings.
Benefits will continue to comprise the provision of a company car or car allowance, private medical insurance, life assurance, income protection and health screening. The Executive Directors are also eligible to receive certain Group products at a discount, in line with the approach for all employees.
Notes: 1. Base salary, benefits, pension contributions and cash allowance in lieu of pension during the financial year ending 31 December 2012 include part of the year as an employee of RBS Group and part of the year as an employee of Direct Line Group.
2. Includes amounts earned for performance during the year but deferred under the Deferred Annual Incentive Plan as shown on page 94. 3. Long-term incentives in 2012 and 2013 for Paul Geddes and in 2013 for John Reizenstein represent the vesting of the RBS Group Long-Term Incentive Plan awards granted in 2010 and 2011 respectively, with vesting amounts assessed by the RBS Group Remuneration Committee. For 2011 RBS Group LTIP awards vesting by reference to 2013 performance, the vesting outcome is calculated at 54.75% for Paul Geddes giving 274,514 Company shares and at 58% for John Reizenstein, giving 59,713 Company shares. These expected vesting outcomes are then accordingly multiplied by the average Company share price from 1 October 2013 to 31 December 2013 of £2.2658.
4. Details of the performance measures and targets applicable to the vesting of RBS legacy LTIP awards are shown on pages 98 to 99. 5. Benefits include a company car or allowance, private medical and income protection insurance. In 2012 the Executive Directors were participants in benefits provided by RBS Group prior to being appointed Directors of the Company on 1 September 2012. The benefits figure reported for 2012 has been updated from the figure presented for the 2012 accounts to reflect changes in the reporting rules.
6. Includes the value of matching shares under the Share Incentive Plan. For 2012, this also includes the free share awards made to each Director (valued at £289 for each Director). All figures in the table are rounded to the nearest thousand.
2013 AIP Outcomes against the specific performance metrics during the year both before and after the exercise of judgement by the Committee were as follows: Group performance metrics Personal objectives
In considering outcomes against the specific measures, the Committee applied judgement in relation to the quality of earnings assessment of the financial elements, gateway considerations as described elsewhere in this report and its overriding judgement in assessing the actual payment for each Executive Director and, where appropriate, outcomes were moderated accordingly. The Committee intends to operate a similar approach in future years and will explain the use of its judgement accordingly.
Overall, the Committee felt that a broadly on-target level of performance was warranted for the financial elements, with the exception of the cost reduction target where all of the stretch objectives were met. In respect of the customer experience metric, despite a strong performance on customer conduct, with improvements in many measures, the Committee considered that the Group had not met its own stretching objectives to develop and differentiate customer propositions, and this remains a priority in 2014. The Committee therefore reduced this element to below threshold to recognise this.
Actual annual incentive award for 2013 (including cash and deferred element)
Unlike the bonus in respect of 2012, when Paul Geddes’s bonus was deferred on terms comparable to those applying to all members of the RBS Group Executive Committee, due to his having been a member of the RBS Group Executive Committee for part of 2012, the deferral terms for the bonus outcome in respect of 2013 will be the same for both Executive Directors.
Non-Executive Directors Remuneration for the Non-Executive Directors for the year ended 31 December 2013 is shown in the table below. The only remuneration paid to the Non-Executive Directors in 2012 and 2013 was in the form of fees.
Notes: 1. Non-Executive Directors are not eligible to participate in any of the Group’s bonus or share incentive schemes or join any Group pension scheme. 2. Mark Catton, a Director nominated by the RBS Group, resigned as a Director of the Company on 26 April 2013, following the reduction in the shareholding of RBS Group to less than 50% on 13 March 2013, and was reappointed as a Director on 1 October 2013 following the resignation of Bruce Van Saun. RBS Group is entitled, under its Relationship Agreement with the Company, to nominate one Non-Executive Director to the Board while its shareholding in the Company remains 20% or more. During their appointment as Non-Executive Directors, Bruce Van Saun and Mark Catton were RBS Group employees with any fees they may receive payable to RBS Group.
The total share interests of each Executive Director under share plans are shown in the table below: Share plan interests at 31 December 2013 Beneficial share interests
2. Includes matching and free shares held under the Share Incentive Plan (as disclosed on page 98) and deferred shares under the DAIP. RBS Group deferred awards are not included as these are to be settled in RBS Group shares.
Paul Geddes 188,5221 28 March 2013 2.0157 380,004 1 June 2013 – 1 March 20162
Awards granted during the year Grant date 3 day- average share price for grant of award £
Notes: 1. The Company’s share price on 31 December 2013 was £2.496 and the range of prices in the year was £1.982 to £2.496. 2. These awards take the form of nil cost options over the Company’s shares and are subject to performance conditions to be assessed by the Committee, which are the same as those for awards to be made in 2014 as described on page 92. Awards accrue dividend entitlements until the date of transfer of shares.
3. These figures do not include those RBS Group LTIP awards held by the Executive Directors which are included in the table on page 98.
The table below details the number of shares held by John Reizenstein under the SIP. Paul Geddes does not participate in the plan.
Director Matching shares granted during the year Matching shares cancelled during the year
Note: 1. The accumulated market value of matching shares at the time of each award. Purchase of the matching shares takes place within 30 days of the BAYE
Legacy RBS Group awards The Executive Directors continue to hold unvested awards previously granted to them under the RBS Group Employee Share Plans as employees of the RBS Group. These awards have been included as they were granted to the Executive Directors in respect of their work as directors of RBS Insurance, as the Group was previously known.
RBS Group Long-Term Incentive awards Awards originally granted under the RBS Group Long-Term Incentive Plans (“RBS Group LTIP”) in 2011 and 2012 will be delivered in Company shares transferred by RBS Group to the extent that the originally set performance conditions for these awards are considered achieved by the RBS Group Remuneration Committee.
RBS Group LTIP 2012 797,000 797,000 9 March 2012 2.80 9 March 2015
Awards held as at 31 December 2013 Grant date Vesting date
Note: 1. The market price of RBS Group shares at vesting was £2.9477. These awards were subject to performance conditions assessed by the RBS Group Remuneration
RBS Group deferred awards Awards which were originally awarded under the RBS Group Deferral Plan will continue to be delivered in RBS Group shares. The awards detailed below under the RBS Group Deferral Plan give a conditional right to acquire ordinary shares under the RBS Group 2010 Deferral Plan. No awards were granted or lapsed during the year.
The Directors present their report for the financial year ended 31 December 2013.
The subsidiary and associated undertakings which principally affect the profits or net assets of the Group in the year are listed in note 19 to the consolidated financial statements.
Post-balance sheet events and likely future developments Details of events after the statement of financial position date are contained in note 40 to the consolidated financial statements and form part of this report.
In addition, the Company paid a special interim dividend of 4.0 pence per share in December and the Board is now declaring a second special interim dividend of 4.0 pence per share. Both these special interim dividends relate to items in 2013 that were not expected at the start of the year. The second special interim dividend will be paid on 20 May 2014 to all holders of Ordinary Shares on the Register of members at close of business on 14 March 2014.
Directors Details of the Company’s rules on the appointment and term of appointment of Directors are given on pages 61 to 62.
Remuneration of Directors The Remuneration report starting on page 76 forms part of the Directors’ report and includes details of the nature and amount of each element of the remuneration (including share options) of each of the Directors.
Secretary Details of the Company Secretary of Direct Line Insurance Group plc, including his qualifications and experience, are set out on page 55.
The Company also purchased directors’ and officers’ liability insurance during the year, which provides appropriate cover for legal actions brought against its Directors.
Share capital and control The issued and fully paid share capital of the Company is 1,500,000,000 Ordinary Shares of 10 pence each.
During the AGM held on 6 June 2013, the Directors were authorised to: • allot shares in the Company up to an aggregate nominal amount of £50,000,000, or grant rights to subscribe for or to convert any security into shares; • allot shares up to an aggregate nominal amount of £100,000,000, for the purpose of a rights issue; and
These authorities have not been used to date and shareholders will be asked to renew them at the 2014 AGM. Details are contained in the Notice of AGM.
Details of the Company’s share capital and shares under option at 31 December 2013 are given in notes 27 and 33 of the consolidated financial statements which form part of this report.
The Company held no Treasury Shares during the year or at the date of this report.
Relationship Agreement with RBS Group Under the terms of a Relationship Agreement between the Company and RBS Group, RBS Group has the right to nominate Directors to the Board of the Company; whilst RBS Group held over 50% of the shares of the Company RBS Group was entitled to nominate two Directors and such Directors were Bruce Van Saun and Mark Catton.
Following the reduction of RBS Group’s shareholding below 50% on 13 March 2013, RBS Group became entitled to nominate one rather than two Directors and Mark Catton accordingly resigned on 26 April 2013. On the resignation of Bruce Van Saun on 1 October 2013 on account of his work for RBS Group moving to the United States, Mark Catton re-joined the Board as RBS Group’s nominated Director in place of Bruce Van Saun.
Under the terms of the agreement, after ceding control of the Company, RBS Group may only nominate one Director until such time as its shareholding reduces below 20%.
With the exception of the Relationship Agreement, there is no arrangement or understanding with any shareholder, customer, supplier, or any other external party, providing the right to appoint a Director or a member of the Executive Committee.
Other than those specified above, there are no restrictions on the voting rights attached to the Company’s Ordinary Shares or the transfer of securities in the Company. There are no special rights with regard to control of the Company attached to the Company’s Ordinary Shares. The Company is not aware of any agreements between holders of shares that may result in restrictions on the transfer of shares or voting rights.
• All of the Company’s employee share incentive plans contain provisions relating to a change of control. Outstanding awards would typically vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions, and normally with an additional time based pro-rata reduction where performance conditions apply
Substantial shareholdings In accordance with the provisions of chapter 5 of the Disclosure and Transparency Rules of the Financial Conduct Authority, the following shareholder has provided the Company with notice of interests in the Company’s voting rights.
Employee consultation The Group’s statement on our employees is set out in the Strategic report on page 46. In summary, we encourage open, honest and transparent communication and dialogue with employees.
These bodies are consulted as part of future change programmes, and in particular about collective redundancies and TUPE transfers. They complement our existing communication processes and represent their constituents’ interests.
The Group values the diversity of its employees and is committed to creating a working environment that is inclusive of all. The Group embraces people’s differences in order to attract and retain talent and seeks to enable employees to reach their potential; these differences include but are not limited to age, belief, disability, ethnic or national origin, gender, gender identity, marital or civil partnership status, political opinion, race, religion and sexual orientation. These commitments extend to recruitment and selection, training, career development, flexible working arrangements, promotion and performance appraisal.
Political contributions The Group made no political donations during the year (2012: nil).
Greenhouse gas emissions The Group has followed the 2013 UK Government environmental reporting guidance for greenhouse gas (“GHG”) emissions, used the UK Government’s greenhouse gas conversion factors and adopted the financial-control approach. GHG emissions are classified as either direct or indirect, and are divided into Scope 1 and Scope 2 emissions.
Direct GHG emissions are those from sources that are owned or controlled by the Group. Indirect GHG emissions are those that are a consequence of the activities of the Group, but that occur at sources owned or controlled by another organisation. The Group has considered the six main GHGs, reported in CO2e tonnes equivalent and have set 2013 as the base year. The Group has included emissions from all of its overseas subsidiaries. It has not included emissions associated with its investment portfolio.
• Scope 2 – indirect emissions resulting from the generation of electricity purchased for office buildings and accident repair centres
Further information on the Group’s approach to energy and the environment can be found in the corporate social responsibility report on page 44.
Going concern The Group has sufficient financial resources to meet its financial needs including the management of a mature portfolio of insurance risk. The Directors believe that the Group is well positioned to manage its business risks successfully in the current economic environment.
Statement of disclosure of information to auditors Each Director at the date of the approval of this Annual Report & Accounts confirms that: • so far as the Director is aware, there is no relevant audit information of which Deloitte LLP, the Company’s external auditor, is unaware; and
• the Director has taken all the steps that he or she ought to have taken as a Director to make himself or herself aware of any relevant audit information and to establish that Deloitte LLP is aware of that information.
Company law requires the Directors to prepare such financial statements for each financial year. Under that law, the Directors are required to prepare the Group financial statements in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the EU and Article 4 of the International Accounting Standard (“IAS”) Regulation and have also chosen to prepare the Parent Company financial statements under IFRSs as adopted by the EU. Under company law, the Directors must not approve the accounts unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, IAS 1 requires that Directors: • properly select and apply accounting policies; • present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; • provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance; and
Each of the Directors, whose names and functions are listed on pages 52 to 53 confirm, 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; and
• the Strategic report (given on pages 2 to 49) includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
In arriving at this conclusion, the Board was supported by a number of processes which included: • the Annual Report & Accounts were drafted by management with overall governance and co-ordination provided by a steering group comprised of a team of cross-functional senior management to ensure consistency across sections; • a verification process was undertaken to ensure that the content was factually accurate; • drafts of the Annual Report & Accounts were reviewed by members of the Executive Committee; • an advanced draft was reviewed by the Company’s Disclosure Committee and legal advisers; and
• the substantially final draft was reviewed by the Audit Committee prior to consideration by the Board.
This Directors’ report was reviewed and approved by the Board on 25 February 2014.
Consolidated financial statements Consolidated income statement 108 Consolidated statement of comprehensive income 109 Consolidated balance sheet 110 Consolidated statement of changes in equity 111 Consolidated cash flow statement 112
Parent Company financial statements Parent Company balance sheet 168 Parent Company statement of comprehensive income 169 Parent Company statement of changes in equity 169 Parent Company cash flow statement 170
Opinion on the financial statements of Direct Line Insurance Group plc In our opinion: • the financial statements give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2013 and of the Group’s profit for the year then ended; • the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the European Union; • the Parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and
The financial statements comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated and Parent Company balance sheets, the consolidated and Parent Company cash flow statements, the consolidated and Parent Company statements of changes in equity and the related notes 1 to 40 on the consolidated financial statements, and the related notes 1 to 16 on the Company financial statements. The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union and, as regards the Parent Company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
Our assessment of risks of material misstatement The assessed risks of material misstatement described below are those that had the greatest effect on our audit strategy, the allocation of resources in the audit and directing the efforts of the engagement team.
The Audit Committee’s consideration of these risks is set out on page 67.
We determined materiality for the Group to be £40 million, which is below 10% of normalised pre-tax profit, and below 1.5% of equity. Pre-tax profit was normalised by taking the average pre-tax profit from ongoing operations, which excludes the impact of discontinued activities and the transformation costs, for current year and the previous two years to exclude the effect of year-on-year volatility from our determination.
We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £800,000, as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. We also report to the Audit Committee on disclosure matters that we identified when assessing the overall presentation of the financial statements.
An overview of the scope of our audit 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 the Group level. Based on that assessment, we focused our group audit scope on the audit work at three primary operating locations the UK, Italy and Germany.
Four entities at these locations were subject to a full audit, a further two were subject to an audit of specified account balances where the extent of our testing was based on our assessment of the risks of material misstatement and of the materiality of the Group’s operations at those locations. These six entities represent the principal business units and account for 98% of the Group’s net assets, 99% of the Group’s revenue and 95% of the Group’s profit before tax. They were also selected to provide an appropriate basis for undertaking audit work to address the risks of material misstatement identified above. Our audit work at the three locations was executed at levels of materiality applicable to each individual entity which were lower than Group materiality.
The group audit team followed a programme of planned visits that has been designed so that the Senior Statutory Auditor visits each of the locations where the group audit scope was focused at least once a year.
Transformation projects There is a risk that the business transformation programmes undertaken by the Group could negatively impact the internal financial reporting control environment, in particular in areas of the business where there has been significant headcount reduction or new processes and procedures. There is a risk that there may no longer be an appropriate level of review and adequate segregation of duties.
We have tested the design and implementation and operating effectiveness of key business processes that have been subject to change. We have tested to determine whether appropriate segregation of duties exists within the Group’s system of internal controls. For example, the procedures included an assessment of the wider implementation of the new claims system.
We have tested the design and implementation and operating effectiveness of the key controls over the reinsurance asset valuation process. We have challenged management’s key assumptions over counterparty risk and the calculation methodology, including a comparison of the underlying credit ratings for key reinsurance counterparties to independent sources. We have also considered the consistency of the approach with the prior year.
Matters on which we are required to report by exception Adequacy of explanations received and accounting records Under the Companies Act 2006 we are required to report to you if, in our opinion: • we have not received all the information and explanations we require for our audit; or
• adequate accounting records have not been kept by the Parent Company, or returns adequate for our audit have not been received from branches not visited by us; or
Corporate governance statement Under the Listing Rules we are also required to review the part of the corporate governance statement relating to the Company’s compliance with nine provisions of the UK Corporate Governance Code. We have nothing to report arising from our review.
In particular, we are required to consider whether we have identified any inconsistencies between our knowledge acquired during the audit and the Directors’ statement that they consider the Annual Report is fair, balanced and understandable and whether the Annual Report appropriately discloses those matters that we communicated to the Audit Committee which we consider should have been disclosed. We confirm that we have not identified any such inconsistencies or misleading statements.
Gain on disposal of subsidiary 19 12.0 – Profit before tax 423.9 249.1 Tax charge 12 (111.1) (64.8) Profit for the year attributable to owners of the Company 312.8 184.3
Direct Line Group Annual Report & Accounts 2013 110 £m 2012 £m
Assets Goodwill and other intangible assets 16 500.1 421.5 Property, plant and equipment 17 102.3 92.4
Deferred tax assets 13 19.3 22.5 Current tax assets 12 1.3 5.5 Deferred acquisition costs 21 321.5 327.6 Insurance and other receivables 22 1,122.0 1,164.0 Prepayments, accrued income and other assets 95.7 82.6 Derivative financial instruments 23 40.7 37.5 Retirement benefit asset 32 – 2.5
Cash and cash equivalents 25 908.3 1,508.4 Assets held for sale 26 1.0 1.0 Total assets 11,787.8 12,697.9
Profit for the year – – – – – – 184.3 184.3 Other comprehensive income / (loss) – – – 21.7 – (2.4) (2.8) 16.5
Transfer to non-distributable reserve – – – – 32.9 – (32.9) – Capital contribution1 – – – – – – 30.9 30.9 Movement in net assets of Direct Line Versicherung AG2 – – – – – 1.0 (9.2) (8.2) Shares acquired by employee trusts – (5.0) – – – – – (5.0) Credit to equity for equity-settled share-based payments – – – – – – 0.3 0.3 Issue of own shares 150.0 – – – – – – 150.0 Own shares redeemed (1,500.0) – 1,350.0 – – – – (150.0)
Direct Line Group Annual Report & Accounts 2013 112 £m 2012 £m
Net cash used by operating activities before investment of insurance assets 35 (307.0) (966.0) Cash generated from investment of insurance assets 35 433.0 2,004.8 Net cash generated from operating activities 126.0 1,038.8 Cash flows from investing activities Purchases of property, plant and equipment 17 (39.1) (63.7) Purchases of intangible assets 16 (115.5) (96.6) Net cash flows from disposal of subsidiary 19 18.8 – Cash flows from net investment hedges (9.5) 6.1 Net cash used by investing activities (145.3) (154.2) Cash flows from financing activities Dividends paid 14 (242.7) (1,000.0) Repayment of borrowings and subordinated liabilities (258.5) (246.4) Proceeds on issue of subordinated liabilities – 493.0 Finance costs (37.8) (16.1) Purchase of employee trust shares (5.7) (5.0) Net cash used by financing activities (544.7) (774.5) Net (decrease) / increase in cash and cash equivalents (564.0) 110.1 Cash and cash equivalents at the beginning of the year 25 1,417.5 1,309.6 Effect of foreign exchange rate changes (0.3) (2.2) Cash and cash equivalents at the end of the year 25 853.2 1,417.5
As part of the divestment from RBS Group, the treatment of expenses incurred by RBS Group on behalf of the Group changed. Up until 30 June 2012, only some of these expenses were recharged to the Group by RBS Group. From 1 July 2012, some of the services previously provided by RBS Group have been brought in-house and so the related expenses are now incurred directly by the Group and reflected in expenses in the income statement; other services are still provided by RBS Group under transitional services agreements and the related expenses are charged to the Group. In order to aid comparability, the Group’s accounting policy was changed on 1 January 2011 so that all expenses were included within the income statement. For the avoidance of doubt, this includes external costs incurred by the Group and costs incurred by RBS Group, irrespective of whether RBS Group recharged them to the Group. In the case of expenses incurred by RBS Group and not recharged to the Group, a capital contribution was credited to retained earnings in the statement of changes in equity to reflect this contribution from a shareholder. In addition there was a further contribution of £6.3 million in respect of overseas taxation.
The effect of the above on the Group profit for the year ended 31 December 2012 was to decrease profit after tax by £30.9 million, with an equal and opposite credit in the statement of changes in equity.
IAS 19 ‘Employee Benefits’ was revised and requires the immediate recognition of all actuarial gains and losses eliminating the ‘corridor approach’; interest costs to be calculated on the net pension liability or asset at the appropriate bond rate; and all past service costs to be recognised immediately when a scheme is curtailed or amended.
Direct Line Group Annual Report & Accounts 2013 114 1. Accounting policies continued 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 2013 and 31 December 2012. 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 if the Group controls another entity, the existence and effect of the potential voting rights that are currently exercisable or convertible are considered.
1.2 Foreign currencies The Group’s consolidated financial statements are presented in Pounds Sterling which is the presentational currency of the Group. Group entities record transactions in the currency of the primary economic environment in which they operate (their functional currency), translated at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date. Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in the income statement except for differences that arise on hedges of net investments in foreign operations, which were reported in other comprehensive income.
Assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition, are translated into Pounds Sterling at the foreign exchange rates ruling at the balance sheet date. Income and expenses of foreign operations are translated into Pounds Sterling at average exchange rates unless these do not approximate the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on the translation of a foreign operation are recognised in the consolidated statement of comprehensive income. The amount accumulated in equity is reclassified from equity to the consolidated income statement on disposal or partial disposal of a foreign operation.
1.4 Revenue recognition Premiums earned Insurance and reinsurance premiums comprise the total premiums receivable for the whole period of cover provided by contracts incepted during the financial year, adjusted by an unearned premium provision, which represents the proportion of the premiums incepted in prior periods and that relate to periods of insurance cover after the balance sheet date. Unearned premiums are calculated over the period of exposure under the policy, on a daily basis, 24ths basis or allowing for the estimated incidence of exposure under policies.
Investment return Interest income on financial assets is determined using the effective interest rate method. The effective interest rate method is a way of calculating the amortised cost of a financial asset (or group of financial assets) and of allocating the interest income over the expected life of the asset. In the case of financial assets classified as AFS, estimates are based on the straight-line method, which is a close approximation to the effective interest rate.
Other operating income Solicitors’ referral fee income Revenue relating to this activity is recognised when the service is rendered. The provision of these services is contractual and the associated cost is recognised when incurred.
The Group’s income also comprises vehicle repair services provided to other third-party customers. Income in respect of repairs to vehicles is recognised upon completion of the service. The price is determined using market rates for the services and materials used after discounts have been deducted where applicable.
Management systems income represents the sale of tracking units, installation services and monitoring services. Revenue is recognised immediately, with the exception of the noncancellable network subscriptions receivable in advance, which are classified as deferred income in the balance sheet and recognised on a straight-line basis over the stated term of the subscription.
A liability adequacy provision is made for unexpired risks arising where the expected value of net claims and expenses attributable to the unexpired periods of policies in force at the balance sheet date exceeds the unearned premium reserve in relation to such policies after the deduction of any acquisition costs deferred and other prepaid amounts (for example, reinsurance). The expected value is determined by reference to recent experience and allowing for changes to the premium rates. 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.
Direct Line Group Annual Report & Accounts 2013 116 1. Accounting policies continued A reinsurance bad debt provision is assessed in respect of reinsurance debtors, to allow for the risk that the reinsurance asset may not be collected or where the reinsurer’s credit rating has been downgraded significantly. This also includes an assessment in respect of the ceded part of claims provisions to reflect the counterparty risk exposure to long-term reinsurance assets particularly in relation to periodical payments. This is affected by the Group reducing the carrying value of the asset accordingly and the impairment loss is recognised in the income statement.
Expenditure on internally generated goodwill and brands 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. During and after development, accumulated costs are reviewed for impairment against the projected benefits that the software is expected to generate. Costs incurred prior to the establishment of technical feasibility and economic viability are expensed as incurred, as are all training costs and general overheads. The costs of licences to use computer software that is expected to generate economic benefits beyond one year are also capitalised.
1.12 Financial assets Financial assets are classified as held-to-maturity, AFS, designated at fair value through profit or loss, or loans and receivables. The Group only has AFS financial assets and 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
(b) the probabilities of the various estimates within the range can reasonably be assessed and used in estimating fair value.
Loans and receivables Non-derivative financial assets with fixed or determinable repayments that are not quoted in an active market are classified as loans and receivables, except those that are classified as AFS. Loans and receivables are initially recognised at fair value plus directly related transaction costs and are subsequently measured at amortised cost using the effective interest rate method less any impairment losses.
Insurance receivables comprise outstanding insurance premiums where the policyholders have elected to pay in instalments, or amounts due from third parties where they have collected or are due to collect the money from the policyholder.
Impairment losses are recognised in the income statement and the carrying amount of the financial asset or group of financial assets is reduced by establishing an allowance for the impairment losses. If in a subsequent period the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance.
For amounts due from policyholders, the bad debt provision is calculated based upon prior loss experience. For all balances outstanding in excess of three months, a bad debt provision is made. Where a policy is subsequently cancelled, the outstanding debt that is overdue is charged to the income statement and the bad debt provision is released back to the income statement.
1.15 Subordinated liabilities Subordinated liabilities comprise subordinated dated loan notes and undated loans, which are initially measured at the consideration received less related transaction costs. Subsequently, subordinated liabilities are measured at amortised cost using the effective interest rate method.
1.17 Leases Payments made under operating leases are charged to the income statement on a straight-line basis over the term of the lease.
Deferred tax assets and liabilities are calculated at the tax rates expected to apply when the assets are realised or liabilities are settled based on laws and rates that have been enacted or substantively enacted at the balance sheet date. Deferred tax is charged or credited in the income statement, except when it relates to items charged or credited to other comprehensive income, in which case the deferred tax is also dealt with in other comprehensive income.
The cost is expensed on a straight-line basis over the vesting period (the period during which all the specified vesting conditions must be satisfied) with a corresponding increase in equity in an equity-settled award, or a corresponding liability in a cash-settled award. The cost is adjusted for vesting conditions (other than market performance conditions) so as to reflect the number of shares or share options that actually vest.
In August 2012, the MoJ announced a review of the approach to setting the Ogden discount rate within the existing legal framework in light of the current economic climate. The consultation has now taken place and the results are pending. In addition, in February 2013, a further consultation was initiated on the legal framework within which the rate is set as well as consideration of the usage of PPOs as a form of settlement. The latest consultation closed in June 2013 and the results are pending.
Net of reinsurance Approved PPO claims provisions 162.8 443.6 125.0 345.0
The provision for PPOs have been categorised as either claims which have already settled as PPOs (approved PPO claims provisions) and those expected to settle as PPOs in the future (anticipated PPOs). Anticipated PPOs consists of both existing large loss case reserves including allowances for development as well as claims yet to be reported to the Group. Reinsurance is applied at claim level and the net cash flows are discounted for the time value of money. The discount rate is consistent with the long duration of the claims payments and the assumed future indexation of the claims payments.
In the majority of cases, the inflation index agreed in the settlement is the Annual Survey of Hours and Earnings inflation published by the Office for National Statistics, for which the long-term rate is assumed to be 4.0% (2012: 4.0%). The rate of interest used for the calculation of present values is 4.0% (2012: 4.0%), which results in a real discount rate of 0.0% (2012: 0.0%).
Direct Line Group Annual Report & Accounts 2013 122 2. Critical accounting estimates and judgements continued 2.3 Fair value Financial assets classified as AFS debt securities are recognised in the financial statements at fair value. The fair value of all AFS debt securities was determined using observable market input and at 31 December 2013 amounted to £7,005.5 million (2012: £7,156.5 million).
Estimation of the fair value of assets and liabilities In estimating the fair value of financial assets and investment properties the methods and assumptions used by the Group incorporate: Financial assets and liabilities For fixed maturity securities, fair values are generally based upon quoted market prices. Where market prices are not readily available, fair values are estimated using values obtained from quoted market prices of comparable securities.
Investment property Investment property is recorded at fair value, measured by independent valuers who hold a recognised and relevant professional qualifications. The valuation model is driven predominantly by unobservable inputs, as although in part the valuations are compared with recent market transactions for similar properties, they are adjusted for the specific characteristics of each property.
Level 3 fair value measurements used for investment properties are those derived from a valuation technique that include inputs for the asset that are unobservable.
whose goodwill is being reviewed. Details of a sensitivity analysis on the recoverable amount in excess of carrying value are shown in note 16.
The Group is satisfied that the aggregate value of property, plant and equipment are not less than their carrying value.
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 capital requirements for solvency purposes. The assessment is submitted to the PRA as the ICA in respect of its UK regulated entities. The ICA quantifies the insurance, market, counterparty, liquidity, operational and Group risk that the UK regulated entities are undertaking.
3.3 Principal risks from insurance activities and use of financial instruments The Risk management section of the Strategic Report sets out all the risks assessed by the Group as principal risks. Detailed below is the Group’s risk exposure arising from its insurance activities and use of financial instruments specifically in respect of insurance risk, market risk and counterparty risk.
3.3.1 Insurance risk Insurance risk can arise from: • fluctuations in the timing, frequency and severity of insured events and their ultimate settlement, relative to the expectations of the Group at the time of underwriting, including those driven by inaccurate pricing, inappropriate underwriting guidelines and terms and conditions, and holding inadequate reserves; • inadequate reinsurance protection; and
• concentration of business leading to unexpected claim levels (frequency and severity) from a single source.
Reserving risk Reserving risk relates to both premiums and claims. It is the risk that reserves are assessed incorrectly, such that either insufficient funds have been retained to pay or handle claims as the amounts fall due both in relation to those claims which have already been incurred (in relation to claims reserves) or will be incurred in future periods of insurance (in relation to premium reserves), or a surplus of funds has been retained resulting in opportunity costs.
• assessing the volatility in the reserves to help the Board set management best estimate reserves.
The Group’s reserves are particularly susceptible to potential retrospective changes in legislation and new court decisions, for example, a change in the Ogden discount rate. This is the discount rate set by the relevant government bodies and used by courts to calculate lump sum awards in bodily injury cases. The rate is currently 2.5% per annum but is under review by the MoJ. From 2010, the Group has calculated its estimated reserve based on an assumed Ogden discount rate of 1.5%, in recognition of the uncertainty regarding the future rate.
As referred to on page 25, uncertainty in claims reserve estimation is larger for claims such as PPOs for which annually indexed payments are made periodically over several years or even the lifetime of the injured party. Claims reserves for PPOs are held on a discounted basis and the table below indicates the sensitivity of discounted claims reserves to changes in the discount rate.
The table below provides a sensitivity analysis of the potential impact of a change in a single factor with all other assumptions left unchanged. Other potential risks beyond the ones described in the table and above could have an additional financial impact on the Group.
Notes: 1. The sensitivities relating to an increase or decrease in the discount rate used for PPOs illustrate a movement in the time value of money from the assumed level of 4.0%. An increase in the discount rate reflects a decrease in the time value of money and therefore the present value of future liabilities which increases the total equity which would be reflected in the income statement.
2. The selection of these sensitivities should not be interpreted as a prediction.
Claims management risk Claims management risk is the risk that claims are paid or handled inappropriately.
Specialist bodily injury claims teams in the UK are responsible for handling these types of losses with the nature of handling dependent on the level and type of claim. Where applicable, they are referred to the technical and large loss teams who also deal with all other claim types above defined limits or within specific criteria.
A process is in place in the UK business 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 functions. The plan covers surge demand triggers, stages of incident, operational impact, communication and management information monitoring of the impact.
Reinsurance risk The Group uses reinsurance to: • protect the insurance results against low-frequency, high-severity losses through the transfer of catastrophe claims volatility to reinsurers; • protect the insurance results against unforeseen volumes of, or adverse trends in, large individual claims in order to reduce volatility and to improve stability of earnings; • reduce the Group’s capital requirements; and / or
Using reinsurance the Group cedes insurance risk to reinsurers but, in return, assumes back counterparty risk against which a reinsurance bad debt provision is assessed. The financial security of the Group’s panel of reinsurers is therefore extremely important and both the quality and quantum of the assumed counterparty 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 represent the accumulated counterparty risk for all Group underwriting entities and are reviewed on a monthly basis. The Group aims to contract with a diverse range of reinsurers on its contracts to mitigate the credit and / or non-payment risks associated with its reinsurance exposures.
Certain reinsurance contracts have long durations as a result of PPOs, and insurance reserves therefore include provisions beyond the levels created for shorter-term reinsurance bad debt.
Reinsurance risk arises from: • a failure of reinsurance to control exposure to losses, to reduce volatility or to protect capital; • an inability to place reinsurance cost effectively or on acceptable terms; and / or
Insurance concentration risk The Group is subject to concentration risk in a variety of forms, including: • geographic concentration risk – the Group purchases a UK catastrophe reinsurance programme to protect against a modelled 1 in 200 year loss. The retained deductible is £150 million at 31 December 2013 (2012: £125 million). There are also relevant covers to protect the Group’s international businesses; • 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; • sector concentration risk – the concentration of the Group to any given industry sector is monitored and analysed in respect of commercial customers; and
The strategic asset allocation within the investment portfolio is agreed by the Investment Committee. The Investment Committee determines policy and controls, covering such areas as safety, liquidity and performance. The Investment Committee meets at least three times a year to evaluate risk exposure, the current strategy, associated policies and investment guidelines and to consider investment recommendations submitted to it. Oversight of the implementation of decisions taken by the Investment Committee is via various risk fora.
Direct Line Group Annual Report & Accounts 2013 126 3. Risk management continued 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; • to maintain sufficient liquidity to provide cash requirements for operations, including in the event of a catastrophe; and
• to maximise the portfolio’s total return within the constraints of the other objectives and the limits defined by the investment guidelines and capital allocation.
Spread risk Spread risk represents the risk of adverse fluctuation of the value of assets due to changes in the level of spreads. The level of spread is the difference between the risk free rate and actual rate paid on the asset, with larger spreads being associated with higher risk assets. The Group is exposed to spread risk through its investments in investment grade bonds and securitised credit.
Foreign currency risk The exposure to currency risk is generated by the Group’s investments in US Dollar corporate bonds, US Dollar securitised credit and its investment in subsidiaries.
The Group is also exposed to currency risk through its investments in subsidiaries in Italy and Germany (that is, investments in equity). In September 2013, the Group changed its currency hedging strategy on these investments to accept the long-term foreign exchange fluctuation impact on its investment in subsidiaries.
Spread Impact of an increase in AFS debt securities of 100bps movement in spreads1 – – (187.8) (155.3) Interest rate Impact on AFS debt securities of an increase in interest rate of 100bps1,2 18.0 12.9 (170.5) (168.6) Investment property Impact of a decrease in property markets of 15% (33.5) (19.3) (33.5) (19.3)
2. The sensitivities set out above reflect one-off impacts at 31 December with the exception of the income statement interest rate sensitivity on AFS debt securities, which projects a movement in a full year’s interest charge as a result of the increase in the interest rate applied to the AFS debt securities and interest rate hedges on those positions held at 31 December.
4. The selection of these sensitivities should not be interpreted as a prediction.
6. The sensitivities set out above exclude the impact of taxation.
Direct Line Group Annual Report & Accounts 2013 128 3. Risk management continued The tables below analyse the maturity of the Group’s derivative assets and liabilities.
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 1,315.8 23.8 – – 23.8
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) – – – – –
Interest rate futures – – – – – Designated as hedging instruments: Foreign exchange contracts (forwards) 9.6 0.8 0.7 – 1.5
The Group has a number of open interest rate and foreign exchange derivative positions. Collateral management arrangements are in place for significant counterparty exposures. At 31 December 2013, £4.9 million (2012: £4.6 million) in cash and a £20.0 million (2012: £nil) UK Gilt have been pledged by the Group to cover out of the money derivative positions. £18.0 million (2012: £0.8 million) in cash and £nil (2012: £1.1 million) US Treasury bonds have been pledged to the Group to cover in the money derivative positions.
3.3.2.2 Counterparty risk Counterparty risk arises from the potential that losses are incurred from the failure of counterparties to meet their credit obligations, due to either their failure and / or their inability to pay or their unwillingness to pay amounts due.
• reinsurance recoveries – counterparty exposure to reinsurance counterparties arises in respect of reinsurance claims against which a reinsurance bad debt provision is assessed. The Courts Act 2003, implemented in April 2005, gave the courts the power to award PPOs in place of lump sum awards to cover the future costs element of claims (that is, loss of future earnings and / or cost of future care). PPOs have the potential to increase the ultimate value of a claim and, by their very nature, to significantly increase the length of time to reach final payment. This has increased reinsurance counterparty risk in terms of both quantum and longevity.
The tables below analyse the carrying value of financial and insurance assets that bear counterparty risk between those assets that have not been impaired, by age in relation to due date, and those that have been impaired.
AFS debt securities 7,001.2 – – 4.3 7,005.5 Deposits with credit institutions 1,036.5 – – – 1,036.5 Reinsurance assets 1,011.0 – – – 1,011.0 Derivative assets 40.7 – – – 40.7 Cash at bank and in hand 307.5 – – – 307.5 Insurance and other receivables 1,075.8 42.8 3.4 – 1,122.0
There were no material financial assets that would have been past due or considered for impairment had the contractual terms not been renegotiated.
Within the analysis of AFS debt securities above are bank debt securities at 31 December 2013 of £1,625.2 million (2012: £1,510.8 million), that can be further analysed as: secured £135.9 million (2012: £211.1 million); unsecured £1,297.4 million (2012: £1,153.4 million); and subordinated £191.9 million (2012: £146.3 million).
Note: 1. Securitised credit is all in the form of prime mortgage backed securities, collateralised loan obligations, securitised student loans and commercial mortgage backed securities.
Deposits with credit institutions 545.8 60.0 430.7 – – – 1,036.5
Cash at bank and in hand – – 193.2 4.2 4.3 – 201.7
The measurement and management of liquidity risk within the Group is undertaken within the limits and other policy parameters of the Group’s liquidity risk appetite and is detailed within the liquidity risk policy and supporting minimum standards. Compliance is monitored in respect of both the internal policy and the regulatory requirements of local regulators.
In addition to the above, the Group held cash and cash equivalents at 31 December 2013 of £908.3 million (2012: £1,508.4 million) to cover short-term liabilities arising from insurance contracts.
The tables below analyse insurance and financial liabilities by remaining duration, in proportion to the cash flows expected to arise during that period, for each category.
Borrowings 90.9 90.9 – – – – Trade and other payables including insurance payables 654.6 648.7 2.1 0.6 3.2 – Total 7,931.5 2,878.9 1,752.0 858.5 1,309.5 1,132.6
The above tables exclude unearned premium reserves as there are no liquidity risks inherent in them.
Direct Line Group Annual Report & Accounts 2013 132 3. Risk management continued Concentration risk 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 over-exposure to particular sectors engaged in similar activities or similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic, political or other conditions.
Direct Line Group Annual Report & Accounts 2013 134 3. Risk management continued The table below analyses the distribution of AFS debt securities by industry sector classifications.
The Group determines the appropriate level of capital on the basis of a number of criteria, including its risk-based capital requirement, the maintenance of a prudent excess capital over its regulatory capital requirements and its rating agency capital. The Group also seeks to hold capital coverage in the range of 125% to 150% of its risk-based capital requirement which is consistent with an ‘A’ range credit rating.
The capital for European entities is maintained in accordance with the local regulatory solvency requirements. The Group manages its subsidiaries on an ongoing basis to ensure that capital resources exceed regulatory minima in accordance with its risk appetite.
The Group has an IGD surplus at 31 December 2013 of approximately £1.8 billion (2012: £1.8 billion).
4. Segmental analysis The Directors manage the Group primarily by product type and present the segmental analysis on that basis. The segments reflect the management structure whereby a member of the Executive Committee is accountable to the Chief Executive Officer for each of the following operating segments: Motor This segment consists of personal car insurance cover together with the associated legal expenses business. The Group sells motor insurance through its own brands – Direct Line, Churchill and Privilege – and through partnership brands directly to customers or through PCWs. As a result, the Group has a brand and product offering that covers most major retail customer segments for motor insurance in the UK.
Home This segment consists of the underwriting of home insurance together with associated legal expenses cover. The Group sells home insurance through its own brands – Direct Line, Churchill and Privilege – and through partnerships or PCWs. The Group’s brand and product offering covers most of the major retail customer segments for home insurance in the UK.
Rescue and other personal lines This segment consists of the underwriting of rescue and recovery insurance products and other personal lines business, including travel, pet, life (conducted by Direct Line Life Insurance Company Limited which was sold on 28 November 2013) and creditor.
The Group sells its other personal lines insurance through its own brands – Direct Line, Churchill and Privilege – and through partnerships.
Certain income and charges are not allocated to the specific operating segments above as they are considered by management to be outside underlying business activities by virtue of their one-off incidence, size or nature. Such income and charges are categorised as either run-off, described below, or restructuring and other one-off costs.
Run-off The segment consists of two principal lines, policies previously written through the personal lines broker channel and Tesco business. These residual businesses are now in run-off.
Direct Line Group Annual Report & Accounts 2013 136 4. Segmental analysis continued The table below is an analysis of the Group’s revenue and results by reportable segment in the year ended 31 December 2013: Motor £m Home £m
Insurance claims recoverable from reinsurers 38.1 (13.7) 20.2 4.2 169.6 218.4 (37.9) 180.5
Underwriting profit / (loss) 98.1 56.2 27.9 (29.6) (14.4) 138.2 Loss ratio 65.1% 53.9% 60.1% 62.3% 77.3% 62.6% Commission ratio 2.5% 19.6% 7.5% 21.2% 15.8% 11.2% Expense ratio 25.6% 20.3% 24.8% 23.3% 10.8% 22.3% Combined operating ratio 93.2% 93.8% 92.4% 106.8% 103.9% 96.1%
Notes: 1. The Group’s revenue and results for the year ended 2013 relating to the Life business which was disposed of on 28 November 2013 was recorded in two segments: Rescue and other personal lines (net earned premium: £11.8 million, net insurance claims: £1.8 million and operating profit: £6.4 million) and Run-off (net earned premium: £2.8 million, net insurance claims: £0.7 million and operating profit: £1.2 million).
Gross earned premium 1,677.8 1,005.2 402.5 433.2 510.3 4,029.0 19.5 4,048.5 Reinsurance premium ceded (48.6) (54.4) (19.7) (30.4) (167.2) (320.3) (6.2) (326.5) Net earned premium 1,629.2 950.8 382.8 402.8 343.1 3,708.7 13.3 3,722.0 Investment return 140.0 34.1 7.5 29.4 23.7 234.7 47.1 281.8 Instalment income 88.4 25.9 1.2 3.5 6.4 125.4 – 125.4 Other operating income 59.7 0.6 9.5 2.4 0.7 72.9 0.4 73.3 Total income 1,917.3 1,011.4 401.0 438.1 373.9 4,141.7 60.8 4,202.5 Insurance claims (1,364.8) (560.7) (218.1) (278.2) (401.9) (2,823.7) (51.6) (2,875.3) Insurance claims recoverable from reinsurers 148.3 6.0 23.2 24.1 133.9 335.5 115.5 451.0 Net insurance claims (1,216.5) (554.7) (194.9) (254.1) (268.0) (2,488.2) 63.9 (2,424.3)
Operating profit before restructuring and other one-off costs 261.8 93.3 84.4 2.2 19.5 461.2 6.1 467.3
Restructuring and other one-off costs2 (189.5) Operating profit 277.8 Finance costs (28.7) Profit before tax 249.1
Notes: 1. The Group’s revenue and results for the year ended 2012 relating to the Life business which was disposed of on 28 November 2013 was recorded in two segments: Rescue and other personal lines (net earned premium: £18.1 million, net insurance claims: £1.6 million and operating profit: £8.1 million) and Run-off (net earned premium: £3.8 million, net insurance claims: £0.5 million and operating profit: £1.3 million).
The tables below analyse the Group’s assets and liabilities by reportable segment.
Net realised gains: AFS debt securities 25.7 66.3 Other investment funds – 23.2
Net gains / (losses) on foreign exchange forward contracts 23.2 (21.3) 21.4 (20.9)
Associated interest rate risk (0.9) (20.5) 0.2 3.0 Net (losses) / gains on interest rate derivatives (1.7) (0.9) (3.6) 0.9
Note: 1. Following changes to LASPO the payment of referral fees in personal injury cases were prohibited with effect from 1 April 2013.
Current accident year claims paid 1,360.0 (71.3) 1,288.7 Prior accident years claims paid 1,612.1 (55.6) 1,556.5 Movement in insurance liabilities (96.8) (324.1) (420.9)
A decrease in the liability adequacy provision for the year ended 31 December 2013 of £4.3 million (2012: £0.7 million increase) has been included in the movement in claims provision.
Note: 1. 2012 includes a one-off retirement benefit contribution of £31.3 million in respect of separation from RBS Group (see note 32).
Further information about the remuneration of individual Directors is provided in the Directors’ remuneration report.
At 31 December 2013, one Director (2012: one) had retirement benefits accruing under the defined contribution pension scheme in respect of qualifying service.
Interest expense on subordinated dated notes1 37.7 26.7 Other interest expense – 2.0
Direct Line Group Annual Report & Accounts 2013 142 12. Tax charge £m 2012 £m
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 UK corporation tax of 23.25% (2012: 24.5%).
Per balance sheet: Current tax assets 1.3 5.5 Current tax liabilities (21.1) (34.5)
13. Deferred tax The table below analyses the major deferred tax assets and liabilities recognised by the Group and movements thereon.
Amounts recognised as distributions to equity holders in the period: Final dividend for the year ended 31 December 2012 of 8.0p (2011: nil) per share 120.0 – Interim dividend for the year ended 31 December 2013 of 4.2p (2012: 66.6p) per share 62.8 1,000.0 First special interim dividend for the year ended 31 December 2013 of 4.0p (2012: nil) per share 59.9 –
Second special interim dividend for the year ended 31 December 2013 of 4.0p (2012: nil) per share 60.0 – Proposed final dividend for the year ended 31 December 2013 of 8.4p (2012: 8.0p) per share 126.0 120.0
Net assets 2,790.0 2,831.6 Goodwill and other intangible assets (500.1) (421.5) Tangible net assets 2,289.9 2,410.1
Net asset value per share (pence) 186.6 189.1 Tangible net asset value per share (pence) 153.2 161.0
Opening shareholders’ equity 2,831.6 3,612.8 Closing shareholders’ equity 2,790.0 2,831.6 Average shareholders’ equity 2,810.8 3,222.2
Charge for the year – 37.2 37.2 Effect of foreign currency exchange adjustment – 0.5 0.5 Disposal of subsidiary (1.8) – (1.8)
Direct Line Group Annual Report & Accounts 2013 146 16. Goodwill and other intangible assets continued The table below analyses the goodwill of the Group by CGU.
There have been no impairments in goodwill in the year ended 31 December 2013 (2012:nil).
The recoverable amounts of all CGUs at 30 September were based on the value in use test, using the Group’s five-year strategic plan. The long-term growth rates have been based on GDP rates adjusted for inflation. The risk discount rates incorporate observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
Direct Line Group Annual Report & Accounts 2013 148 19. Subsidiaries The principal subsidiary undertakings of the Group are shown below. Their capital consists of ordinary shares which are unlisted.
The above information is provided in relation to principal related undertakings as permitted by Section 410(2) of the Companies Act 2006. Full information on all related undertakings is included in the Annual Return available from Companies House by visiting www.companieshouse.gov.uk .
The Group did not dispose of any other subsidiaries in the year ended 31 December 2013 (2012: no subsidiary disposals).
Additional provision (3.5) (7.6) Utilisation of provision 2.0 – Release to income statement 9.0 0.8 21. Deferred acquisition costs 2013 £m 2012 £m
Net (decrease) / increase in the year (7.3) 18.5 Effect of foreign currency exchange adjustment 1.2 (1.4)
Derivative assets At fair value through the income statement 40.7 37.5
Derivative liabilities At fair value through the income statement 17.8 4.1 Designated as hedging instruments 1.5 2.4
Note: 1. Derivative financial instruments as shown above are all classified as level 2 under the fair value hierarchy as described in note 2.3. These are measured at fair value, which equates to carrying value.
Direct Line Group Annual Report & Accounts 2013 150 24. Financial investments continued The following table analyses financial instruments held at fair value, which equates to their carrying value, by level of the fair value hierarchy.
Notes: 1. Please refer to note 2.3 for details of the fair value hierarchy.
The following table details cash and bank overdrafts for the purposes of the cash flow statement.
Issued and fully paid: equity shares Ordinary Shares of 10 pence each 1,500.0 1,500.0
On 31 August 2012, Board and shareholder resolutions were approved to subdivide the share capital of Direct Line Insurance Group plc from 1.5 billion Ordinary Shares of £1 each to 1.5 billion Ordinary Shares of 10 pence each and 1.5 billion deferred shares of 90 pence each.
The deferred shares were then transferred back to the Company by its then parent, The Royal Bank of Scotland Group plc, for no value and immediately cancelled by the Company. This cancellation has created a non-distributable capital redemption reserve in the Company of £1,350.0 million.
At 31 December 2013, 5,204,771 Ordinary Shares (2012: 2,848,991) were owned by the employee share trusts with a cost of £10.2 million (2012: £5.0 million), with an undertaking to satisfy the awards of shares in the Company under the Group’s share plans.
These shares were purchased by the employee share trusts and are carried at cost. At 31 December 2013, they had an aggregate nominal value of £0.5 million (2012: £0.3 million) and a market value of £13.0 million (2012: £6.2 million).
Revaluation during the year – gross 6.3 103.6 109.9 Revaluation during the year – tax (1.5) (19.1) (20.6) Realised gains – gross (23.2) (66.3) (89.5) Realised gains – tax 5.7 16.2 21.9
Revaluation during the year – gross – (108.2) (108.2) Revaluation during the year – tax – 27.7 27.7 Realised gains – gross – (23.9) (23.9) Realised gains – tax – 5.8 5.8 Realised gain on disposal of subsidiary – gross – (1.8) (1.8) Realised gain on disposal of subsidiary – tax – 0.4 0.4
During 2013, a credit value adjustment was made to the interest rate hedge to reflect the market value of counterparty credit risk resulting from the majority divestment from RBS Group. This has resulted in an increase in the floating rate to three-month LIBOR plus a spread of 707 bps with effect from 29 July 2013.
Direct Line Group Annual Report & Accounts 2013 152 29. Subordinated liabilities continued The nominal £500 million bonds have a redemption date of 27 April 2042. The Group has the option to repay the notes on specific dates from 27 April 2022. If the notes are not repaid on that date, the rate of interest would be reset at a rate of the six-month LIBOR plus 7.91%.
The undated subordinated loans were fully repaid on 8 January 2013.
Insurance liabilities Life insurance (note 31) – 107.2 General insurance 5,757.4 6,291.3
Gross general insurance (including unearned premium reserve) Claims reported 3,636.4 3,969.3 Claims incurred but not reported 1,992.7 2,153.9 Claims handling provision 128.3 163.8 Liability adequacy provision – 4.3
Current estimate of cumulative claims 3,359.9 3,566.7 3,731.9 4,325.7 3,827.0 4,099.5 3,993.4 2,900.7 2,628.6 2,652.5 35,085.9
Accident year 2004 £m 2007 £m £m £m £m £m £m 2013 £m Total £m
Eight years later (5.4) (27.1) – – – – – – – – (32.5) Nine years later (18.2) – – – – – – – – – (18.2)
Current estimate of cumulative claims 3,120.7 3,394.8 3,631.4 4,200.0 3,721.4 4,028.3 3,924.7 2,738.7 2,412.3 2,401.5 33,573.8
Liability recognised in balance sheet 91.5 77.5 163.4 242.4 230.6 497.3 614.7 628.3 664.2 1,355.1 4,565.0 2003 and prior 146.8 Claims handling provision 128.3 Total net liability 4,840.1
Cash paid for claims settled in the year (2,949.1) 108.6 (2,840.5) Increase / (decrease) in liabilities: Arising from current-year claims 3,038.2 (227.2) 2,811.0 Arising from prior-year claims (196.5) (193.0) (389.5)
Incurred but not reported 2,153.9 (511.6) 1,642.3 Claims handling provision 163.8 – 163.8 Liability adequacy provision 4.3 – 4.3
Effect of foreign currency exchange adjustment 12.2 (2.8) 9.4 Decrease in liability adequacy provision (4.3) – (4.3)
Movement in prior-year net claims liabilities by operating segment £m 2012 £m
Direct Line Group Annual Report & Accounts 2013 156 30. Insurance liabilities, unearned premium reserve and reinsurance assets continued Movement in unearned premium reserve
Provisions in respect of new and existing business 42.8 (24.7) 18.1 Expected change in existing business provisions (20.3) 18.3 (2.0) Variance between actual and expected experience (4.7) (6.1) (10.8) Other movements (7.9) – (7.9)
Note: 1. The Group’s Life business was sold on 28 November 2013.
32. Retirement benefit obligations Defined contribution scheme The pension charge in respect of the defined contribution scheme for the year ended 31 December 2013 was £25.3 million (2012: £26.0 million).
In addition, certain employees of the Group who were previously members of the RBS Group defined benefit pension scheme transferred to the Group’s defined contribution scheme in 2012. As a result of standardising employment terms for all Group employees, which included changes to the employment terms of a small number of Group employees who were members of the RBS Group defined benefit pension scheme, the Group crystallised a debt under section 75 of the UK Pensions Act 1995. Consequently the Group was required to pay into the RBS Group’s defined benefit pension scheme (in which those employees ceased to participate) as a result of a deficit in that scheme. The debt was calculated based on the amount needed to secure Direct Line Group’s share of the pension liabilities in the pension scheme with an insurance company. An amount of £31.3 million was paid to the RBS Group pension scheme on 29 June 2012 in full and final settlement.
Defined benefit scheme The Group’s defined benefit pension scheme was closed in 2003 although the Group remains the sponsoring employer for obligations to current and deferred pensioners based on qualifying years service and final salaries. The defined benefit scheme is legally separated from the Group with trustees who are required by law to act in the interest of the scheme and of all the relevant stakeholders. The trustees of the pension scheme are responsible for the investment policy with regard to the assets of the scheme.
The table below sets out the principal assumptions in respect of the defined benefit scheme.
Rate of increase in pension payment 2.1 2.1 Rate of increase of deferred pensions 2.6 2.1 Discount rate 4.4 4.5 Inflation rate 3.5 2.8
Life expectancy at age 60 in 20 years’ time: Males 90.3 89.5
Income statement: Net interest income / (cost)1,2 3.5 (2.7) 0.8 Statement of comprehensive income: Actuarial gains / (losses) arising from experience adjustments 2.2 (0.1) 2.1 Actuarial losses arising from changes in financial assumptions – (5.5) (5.5)
Contributions by employer 2.8 – 2.8 Benefits paid (1.5) 1.5 –
The table below details the history of the scheme for the current and prior years.
Present value of defined benefit obligations (68.0) (61.2) (54.1) (54.5) (60.8) Fair value of scheme assets 66.0 63.7 56.7 54.4 47.2
Experience adjustment (losses) / gains on scheme liabilities (0.2) (0.1) 0.4 0.5 2.6 Experience adjustment (losses) / gains on scheme assets (1.3) 2.2 (2.6) 3.1 5.4
Discount rate 0.25% increase in discount rate (0.2) (3.5) (0.2) (3.0)
The most recent funding valuation of the defined benefit scheme took place at 1 October 2011. The Group has agreed to make contributions of £2.8 million per annum from 2013 to 2016 to meet the funding deficit, and does not anticipate any material change to the level of contributions before the next valuation, which is due on 1 October 2014.
33. Share-based payments The Group operates equity-settled, share-based compensation plans in the form of free shares awards, a Long Term Incentive Plan, Direct Line Share Incentive Plans and an Annual Incentive Plan, details of which are set out below together with their financial impact: Free share awards During the year ended 31 December 2012, upon listing on the London Stock Exchange, the Group offered all employees a ‘free share’ award granting shares to the value of £250 to each eligible employee free of charge. These awards have no performance criteria attached, vest on the third anniversary of the award grant date subject to completion of three years’ continuing employment (or on leaving employment in certain circumstances) and will be satisfied using market-purchased shares. The number of shares initially granted was 1.9 million with an estimated fair value at grant of £3.9 million.
The estimated fair value of the LTIP share awards with market-based performance conditions was calculated using the MonteCarlo simulation model.
Weighted average assumptions during the year: Share price 208p 194p Exercise price 0p 0p Volatility of Company share price 26% 27% Average comparator volatility 32% 32% Expected life 3 years 3 years Risk-free rate 0.5% 0.3%
Direct Line Group Annual Report & Accounts 2013 160 33. Share-based payments continued As historic data is not available for the Group, expected volatility was determined by calculating the median historic volatility for a group of comparable companies using daily share price data over a period commensurate with the expected life assumption. These comparable companies are classified as being in the insurance sector in the FTSE 350.
The Group’s Share Incentive Plans entitle employees to purchase shares from pre-tax pay for between £10 and £125 per month, or Euro equivalent, and receive one matching share for every two shares purchased.
Since commencement of the Share Incentive Plans during the year ended 31 December 2013, matching share awards have been granted over 0.3 million Ordinary Shares in relation to these schemes in the year with an estimated fair value of £0.6 million. The fair value of each matching share award is estimated using the market value at the date of grant.