Net asset value per share (p) – increased by 15.9% 299.2 258.1
2 Why invest in Hiscox? Hiscox Ltd Report and Accounts 2009
We are a leading specialist insurer with: balance that creates opportunity throughout the cycle strong financial performance a transparent approach to risk specialist expertise that is valued by our customers.
A transparent approach to risk The very business of insurance is managing risk. The understanding of risk is intrinsic to every level of decision-making in the Group. We devote a great deal of expertise to understanding the impact of global events and model these rigorously. We also draw on over 100 years of history in insurance to assess these risks.
Specialist expertise that is valued by our customers We are market leaders in many of our specialist areas and our customers value the expertise and cover we provide.
96% of business insurance customers were satisfied that we spoke to them in a clear way and avoided using financial jargon 99% of home insurance customers were satisfied that we answered their questions and provided the information they needed today over 90% of our home insurance customers surveyed were satisfied with the way we settled their claim.
A balanced portfolio that creates opportunity throughout a cyclical market Hiscox’s strategy is to balance the more volatile catastrophe-exposed insurance and reinsurance with steady local specialty insurance. Our diversity by product and geography gives us great flexibility, particularly in a tough commercial environment. We are able to grow and shrink the catastropheexposed lines according to market conditions. Currently, rates for reinsurance, which makes up almost a third of our income, are close to an all-time high, and we are therefore making the most of this opportunity. However, we have the flexibility to shrink this side of the business when rates are no longer favourable. Our local specialty insurance business tends to be steadier throughout the insurance cycle and we have successfully grown our retail lines by 10% year-on-year over the last five years.
Strong financial performance Hiscox has a strong record of top-line growth with a focus on ROE. Performance highlights between 2005 and 2009 include: nearly doubled in size to produce gross written premiums of over £1.4 billion healthy combined ratio averaging 86.2% delivered average ROE of 22% maintained a progressive dividend policy with compound growth of 16.5%.
last year but decided to sweat our capital and avoid dilution. This excellent profit has allowed us to pay an increased dividend, added sufficient capital for our current plans, and enabled us to set aside a buffer of capital to maintain appropriate capital ratios in case of reduced investment income in 2010.
I agree that the general insurance industry has been blighted by poor underwriting in the past when investment profits were easier to make and underwriting didn’t seem to matter too much. In my youth, insurance companies were described as investment trusts with an expensive habit. But the investment market is now offering slim pickings, so underwriting – our basic trade – matters totally, and there are firm signs that managements appreciate that fact. Reinsurance underwriting is dominated by models which we know are not right, but which impose a discipline and are an indispensable guide. The great attraction of the general insurance business is that everyone has to buy it; in fact, more and more so as governments continue to impose countless regulations, any breach of which can lead to litigation. Demand for our products is continuous; it is up to us to price them properly and to supply products which customers want at that price.
During 2009 we implemented a new marketing campaign to attract our chosen customers and to continue to strengthen the brand. We want people to reach for a Hiscox policy because they trust it to perform better than standard commodity products. We are differentiating ourselves from the herd which will build value for shareholders.
Since I have been at Hiscox we have grown from a premium income of around £3 million to nearly £1.5 billion, and from profits of a few thousand to £300 million. Not in a straight line of either income or profit as the nature of our business is to absorb the unpredictable from others, but I can guarantee you that this business has the determination and talent to continue that profitable growth.
And our strategy of growing our specialist retail businesses internationally to balance the catastrophe accounts continued apace.
Results The result for the year ending 31 December 2009 was a profit before tax of £320.6 million (2008: £105.2 million) on a gross written premium income of £1,435.4 million (2008: £1,147.4 million). The combined ratio was 86.0% (2008: 75.3%). The combined ratio on a like-for-like basis excluding foreign exchange distortions was 82.2% (2008: 91.6%). Earnings per share on profits after tax were 75.2p (2008: 18.8p), and net assets per share increased to 299.2p (2008: 258.1p). The return on equity was 30.1% (2008: 9.2%).
We remain prepared to buy back our shares if the share price drops to an unrealistic level. We are pleased we did not do a Rights Issue
Outlook As I have said, there is more discipline in our industry than at any time in my long career. It is of course not perfect, but the general insurance industry and Lloyd’s in particular have performed excellently through the financial chaos of the last few years. I just hope that the regulators and Government will appreciate the industry’s conservatism and value, and not wound it with some collateral damage from its current bank bashing.
The Hiscox Group has a solid core of profitable businesses which, over the last few years, have enabled us to invest in creating exciting new ventures which will each become core profit earners and bring great value to shareholders. I admire the restless search for new methods of selling our specialist products. The world belongs to the discontented; we will never be satisfied; the profitable growth will continue.
People First I must record our sadness at the recent death of our Senior Independent Non Executive Director, Sir Mervyn Pedelty. He was a huge asset to our business through his knowledge and business acumen, and his warm and humorous personality made him a real pleasure to work with. Life was more fun and interesting when Sir Mervyn was around.
Our inestimable CEO, Bronek Masojada, leads an excellent team at the top, and the talent stretches throughout the Company. Over the years we have steadily been able to attract better talent, and the current frailty of the banks and the political attacks on them will help us by making more talent available. We are acutely aware that we are only as good as the people who work here, and it has been gratifying that our conscious efforts to be an employer of choice for the best people continues to be rewarded. We have great teams throughout the Group and I am deeply grateful to them not only for this great profit but for being so inspirational to work with.
Lo ca l e rro rs an d om iss io ns an d co m m er ci al
The market outlook for 2010 is positive, though with lower expected investment returns and the easing of rates it will probably not be as good a vintage as 2009. We will seek to grow in those specialist areas where margin remains strong and we will maintain our commitment to reinsurance.
Hiscox London Market rating index Index level (%). 12 month rolling period
The dividend has been increased to 15.0p (2008: 12.75p). Over the past five years our dividend has risen by 16.5% compounded, and we have returned £114 million, net of a £176 million capital raising, to investors.
Hiscox London Market Hiscox London Market was again the main profit generator in the Group, contributing £179.9 million (2008: £137.0 million). This was achieved through underwriting £663.0 million of business (2008: £545.9 million).
Marine and energy: This division had a good year. Energy rates rose in 2009 following Hurricane Ike. We were able to take advantage of these rates and better terms to write a larger book of business and have been well rewarded for doing so in 2010.
Property: Our primary focus is on catastrophe exposed property for global companies, homeowners and small businesses. Rates have been under pressure and we expect to reduce the size of this account significantly. In 2010 this reduction will be partially offset by a scheme to underwrite mechanical equipment – a non-cat area which we expect will serve us well.
Casualty: Our London team now focuses on professional indemnity written in Lloyd’s and its results exclude the technology and media book which is now accounted for as part of Hiscox USA. We have shrunk as rates have come under pressure and have taken a cautious reserving approach in view of the economic climate. We have, however, had a net benefit from releases on prior underwriting years.
Insurer of the Year’ for the third year running, and also won the title of ‘General Insurer of the Year’ at the British Insurance Awards.
Hiscox Guernsey: Had another good year. Its focus is on kidnap and ransom, piracy, fine art and terrorism. Premiums grew considerably, particularly in the piracy sector, due to the increased threat around the Horn of Africa. Our success is a reflection of both our risk appetite and our excellent client service. Our team in Guernsey is able to provide a quote, confirm cover, issue a policy and collect the premium in a few hours. This is a testament to the good cooperation between its underwriting and operations teams. Looking forward we see Guernsey continuing to be the leader for the Group in the kidnap and ransom and piracy areas. The Guernsey fine art book saw a small reduction in size due to the reduction in values of insured works.
Investment returns In 2009 we made a tremendous return on our investments. David Astor, our Chief Investment Officer, steered our portfolio very effectively through the financial crisis and kept his nerve when many others panicked. His courage was rewarded with an outstanding investment income result of £182.8 million, a return of 7.2% on invested assets (2008: -£27.6 million; -1.3%). This was achieved by maintaining a well spread portfolio, comprising corporate bonds, quality
Hiscox UK and Europe rating index Index level (%). 12 month rolling period
Claims In 2009 we handled a higher volume of claims than in 2008, reflecting our growing retail business. In addition to this everyday business, the team has also been working harder on recoveries, subrogating against third-parties and making a major contribution to Hiscox UK’s ‘Get Fit’ efficiency programme. They have achieved all of this while maintaining very high levels of customer satisfaction. In 2010 we will make a significant investment in upgrading our claims handling systems for the London Market. Hiscox is a supporter of the move to electronic claims, but current systems require multiple data entry. We will be addressing this obvious inefficiency. A source of deep concern to us is the new Lloyd’s Claims Transformation Project. We support the move to choice of service provider on more complex claims, but we believe strongly that Lloyd’s customers expect a centralised, coordinated approach to enable their non-complex, standard claims to be paid speedily and efficiently. We fear the new scheme has the potential to create a damaging free-for-all in claims that threatens to tarnish the Lloyd’s brand. We have objected to this aspect of the scheme from inception and we hope that sense will prevail before its final implementation.
Capital management The financial crisis has graphically illustrated how success in financial services depends on balancing expected return against perceived risk, while holding sufficient capital to protect against disaster. The challenge for outsiders is that while insurers’ revenue and capital are very visible, the amount of risk they are taking is not. We have tried to make our risk profile clear to shareholders by publishing our expected losses using Realistic Disaster Scenarios promulgated by Lloyd’s and by publishing a ‘box plot and whisker’ chart on our website. The ‘box plot’ chart gives the likely range of possible losses for Hiscox from major industry events.
The individual catastrophic losses are examined alongside an analysis of all the Group’s expected losses, as well as our forecast investment returns and expenses, to arrive at a comprehensive view of our risk profile.
In 2010 we expect our investment returns are likely to be much lower than in 2009. On the underwriting side we expect prices will remain at attractive levels. Therefore, in order to allow us to continue to take the same risk in 2010 as we did in 2009, we need to hold more capital in the business. This means that in 2010 the level of capital we will hold against our premium income will increase.
We have continued to invest in training and development and we are always on the lookout for high quality recruits. In 2009 we relaunched our graduate recruitment programme, and, as a result of the meltdown in other parts of the financial sector, we recruited slightly more graduates than we had expected. The programme is continuing in 2010.
Conclusion and outlook We are optimistic for the year ahead. 2009 was a great year, combining excellent underwriting profits and investment returns. 2010 may not be as memorable a harvest but has good prospects, despite the continuing fallout from the financial markets crisis and the deepest global recession in living memory. We expect to see modest growth thanks to the expansion of our retail activities in Europe, the UK and the US and, provided major losses fall within our expectations, we expect to continue to deliver good returns for our shareholders and staff.
Hiscox London Market Hiscox London Market underwrites insurance and reinsurance business around the world. It uses the Lloyd’s of London broker network and licenses to participate on some of the world’s largest and most complex risks, as well as the simpler and more traditional ones, that come to Lloyd's.
Security Hiscox Syndicate 33 has an A (Excellent) syndicate rating from A.M. Best. It also benefits from Lloyd’s own ratings, A (Excellent) from A.M. Best, A+ (Strong) from Standard & Poor’s and A+ (Strong) from Fitch.
Hiscox USA Hiscox USA opened in 2006 and underwrites a mix of specialty, casualty and property business.
Locations Bermuda, Guernsey, USA – Armonk (New York), Atlanta, Boston, Chicago, Geneva (Illinois), Kansas City (Missouri), Lexington (Kentucky), Los Angeles, Miami, New York City, San Francisco.
Security Hiscox Insurance Company Limited has an A (Excellent) rating from A.M. Best, an A (Strong) rating from Standard and Poor’s, and an A (Strong) rating from Fitch.
Glenn Caton Director of Marketing, Hiscox UK Head of Direct, Hiscox UK
Bruno Ritchie Head of Aerospace and Global Risks Europe, Hiscox London Market
The quality of our people has been a key ingredient in our success in this highly competitive, cyclical market. Hiscox’s reputation for innovation and dynamism has been built in large part on the energy, commitment and expertise of our employees.
Employee engagement survey In September, Hiscox conducted its second global employee engagement survey. The survey, which was open to all permanent members of staff, looked at how committed employees feel to Hiscox, their managers, their teams and their role.
London UK and Corporate London UK and Corporate Market Europe International Centre Total Market Europe International Centre Total *During the year, following a new geographic management structure including new business written through Syndicate 3624, the Group has changed its segmental reporting to provide more effective financial reporting for the evaluation of business segments by the chief operating decision maker to make decisions about future allocation of resources. Accordingly, the 2008 segmental comparatives have been restated in order to enable comparison of results by the user.
Group financial performance continued would result in a 4.3% improvement in the combined ratio (2008: 4.7% decline). The Group also recorded a foreign exchange loss of £69.6 million recognised directly in equity as a result of the retranslation of investments in its US Dollar operations.
Segmental performance During the year, following a new geographic management structure, the Group changed the way it reports its segments. The comparative information has been adjusted accordingly.
The reinsurance outwards spend was comparable to the prior year and reinsurance contracts with commercial reinsurers were renewed during the year with similar terms. The quota share arrangement with the Cougar Syndicate remained in place.
The claims ratio improved significantly to 38.8% compared with 61.2% in the prior year due to a benign year for catastrophe losses and favourable developments in some older years.
The resulting combined ratio excluding the impact of foreign currency movements improved to 71.0% (2008: 94.5%). Profit before tax for the year increased by 31.3% to £179.9 million (2008: £137.0 million).
Gross premiums written increased by million) with growth coming from all core lines especially the direct business and the professional and commercial specialty area. It was aided by the strong Euro exchange rate.
Again, the investment result for the year improved significantly and a total return of £34.9 million, excluding derivatives, was achieved (2008: £11.9 million negative). The claims ratio declined by 11.2% to 53.4% due to a number of large unrelated claims in Europe including the impact of Windstorm Klaus and the ‘freeze’ losses experienced early in the year. The combined ratio, before the impact of foreign exchange, also deteriorated by
The claims ratio improved by 11.6% to 33.0% (2008: 44.6%) reflecting a quiet year for catastrophe losses in Bermuda and recognising good loss experience in Guernsey.
16 Group financial performance Hiscox Ltd Report and Accounts 2009 £320.6m Profit before tax
Cash and liquidity The Group’s primary source of liquidity is generated from premium income and income received on investments. Funds received are used predominantly to pay claims, expenses, reinsurance, increase investments and to pay dividends and taxes.
Net cash outflows from investing activities for the year were £11.7 million (2008: £16.7 million). The cash outflow is primarily as a result of the purchase of tangible and intangible assets. The Group did not acquire any new subsidiaries or associates during the year.
Net cash inflows from financing activities for the year were £1.6 million (2008: outflow £108.5 million). The inflow is due to an increase in the borrowing facility offset by the payment of dividends. The Group did not enter into any share buy-back programmes in the current year. In 2008 the Group spent £62.9 million for the purchase of shares held in treasury and £2.2 million for the purchase of shares held in trust.
The Group maintains relationships with a limited selection of banks who are monitored for their credit status and ability to meet the day-to-day banking requirements of the Group.
There were no impairments recorded against cash or cash equivalents and no recoverability issues have been identified on such assets.
The Group is seeking approval for its own internal models and is in a firm position to ensure that the Solvency II requirements will be implemented successfully, however uncertainty still exists as the full details of the regime are yet to be confirmed.
Group invested assets* £2,660.6m £2,522.4m *excludes derivatives and investment in catastrophe bonds.
High quality and well diversified portfolio Investment portfolio: £2,660.6m 1.9% CAD
Risk assets 19Group financial performance Hiscox Ltd Report and Accounts 2009
With interest rates at low levels and liquidity improving, investors have had more confidence to seek yield. The portfolio, where we continued to increase our exposure to credit during the year, was well positioned for the resulting narrowing of credit spreads. Even modest allocations to high yield and other credit opportunities contributed significantly to our overall returns. Whilst the Group’s allocation to corporate bonds has increased from 20% to 25% during the year, safety and liquidity have remained a high priority and the percentage of the portfolio held in cash and Government supported debt was maintained at around 60%. We are extremely focused on not jeopardising the Group’s capacity to underwrite and pay claims.
Our risk assets performed well and added materially to the Group’s investment return. Given the strength of equities since their lows last March we reduced our exposure in the third quarter, maintaining our allocation at 5% of assets. The pace of the recovery, and hence this year’s strong returns, clearly has an impact on the prospects for our portfolio going into 2010. Whilst strong cashflows provided comfort during the crisis they will serve as a drag on yield as they are reinvested at the rates prevailing in the markets. These low rates in turn have a bearing on our risk appetite given our desire not to lose money in any one year. At current market levels any meaningful increase to equities is unlikely in the short-term. Whilst the best of the rally in risk markets may therefore be behind us, we continue to see value in the corporate bond market, but remain wary of the threat of higher interest rates. Government bonds in particular seem over priced, and there is unlikely to be a shortage of supply any time soon. We are keeping the duration of the main bond portfolios correspondingly short.
We anticipate that volatility will continue and that patience will be required as Governments remove their support and interest rates move to more normal levels. The price of this patience will be lower investment yields in the immediate future.
The risks associated with the core business represent some of the greater exposures, however the Group is exposed to a number of other risks and has systems and procedures to identify and manage them. These procedures are regularly reviewed and improved in the light of the changing risk environment and best practices. Risk appetite is set by the main Board and cascaded down into the Group’s global operations as part of the business planning cycle and through various risk and operational committees. These are: Risk Committees Underwriting Review Group Reinsurance Purchase Review Group Reinsurance Security Committee Cash Flow Review Group Broker Credit Committee Investment Committee Reserving Committees Business Continuity Committee.
These committees are all chaired by either the Chief Executive, Chief Financial Officer or Chief Underwriting Officer and have specific areas of focus, such as underwriting, reinsurance purchase and security, liquidity, broker credit risk, investments, claims reserving and business continuity. Senior management responsibilities are clearly defined together with their reporting lines and the execution of delegated responsibilities is closely monitored by reporting to the Board and its committees. This monitoring, supported by financial and non-financial management information, assesses performance against agreed targets and objectives, as well as the risks to achieving these objectives and the effectiveness of the measures in place to manage these risks. In parallel with these direct risk management processes, there is a dedicated risk management function which, in conjunction with Internal Audit and the Group risk committees, monitors and reviews the effectiveness of risk management activities throughout the organisation and reports to the Board. These functions are organised centrally to assist in the integration of best practice throughout the Group. A range of risk management tools is used to assess and manage risk both at business unit level and on a Group-wide basis.
We adjust our business plan, target products and reinsurance programme to deliver a welldiversified book.
The high quality and short duration of these funds allows the Group to meet its aim of paying valid claims quickly. These funds are maintained in the currency of the insurance policy to reduce foreign exchange risk.
A proportion of the Group’s assets is allocated to riskier assets, principally equities. Here, it is the Group’s philosophy to take a long-term view in search of acceptable risk adjusted returns. The proportion of the Group’s funds invested in risk assets will depend on the outlook for investment and underwriting markets. An allocation within the risk assets is made to less volatile, absolute return strategies. This balances the desire to enhance returns against the need to ensure capital is available to support underwriting throughout any downturn in financial markets.
The majority of the Group’s cash inflows and outflows are routine and can be forecast well in advance. The primary source of inflows is insurance premiums whilst outflows are to policyholders for claims made. Cash flow is forecast on rolling weekly, monthly and quarterly basis depending on the source, and, in the event of a major catastrophe, such forecasting may be up to three years in advance. Free cash is invested according to the Group’s investment policy and cash requirements can normally be met through regular income streams (i.e. premiums or investment income), existing cash balances or realising investments that have reached maturity.
The Group’s liquidity risk arises from large, unplanned cash demands and the principal source of risk is a major catastrophe resulting in a high value of claims. This could be exacerbated if we had to fund claims pending recovery from a reinsurance partner. We plan for this risk through a number of measures.
First, we run stress tests to estimate the size and timing of claims that might have to be paid in the event of a number of major catastrophes all occurring within a short period of time. We also run scenario analyses that consider the impact on liquidity of a range of adverse events happening simultaneously; for example, an economic downturn and declining investment returns combined with unusual levels of insurance losses.
H ur ri ca ne Ik e 7. 5b n m ar ke t lo ss ye ar re tu rn p er io d
at ri na 9b n m ar ke t lo ss ye ar re tu rn p er io d
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nd re w 2b n m ar ke t lo ss ye ar re tu rn p er io d 25Risk management Hiscox Ltd Report and Accounts 2009
“Fundamental to corporate and social responsibility is honest and fair dealing in all activities of the Group. Hiscox has always been extremely conscious of its reputation. Management has always believed that a reputation for integrity and decent behaviour in all dealings, be they within the Group or with those from outside who come in contact with the Group, will be good for morale and for the results of the business.”
Dealing with customers Hiscox is dedicated to advising customers on risk management to prevent burglary and fire in the home and other distressing losses. Should a loss occur, the Hiscox UK philosophy is that insurance is a promise to pay, and the claims service aims to support customers and make them whole as soon as possible.
Rewards and benefits Hiscox encourages employees to identify with the success of the Group through performancerelated pay and bonus savings-related share option schemes and executive share option schemes. Competitive benefits packages contain health, fitness, flexible working and career break opportunities. Salary packages are benchmarked by Watson Wyatt against the financial services industry as a whole and against the Lloyd’s market specifically, where applicable. Packages are also considered on a country-by-country basis.
in essence a non-bureaucratic organisation. An effective and firm system of internal controls ensures that risks are managed within acceptable limits, but not at the expense of innovation or speed of response.
Hiscox has a two-year commitment to support the Whitechapel Art Gallery in London.
The Hiscox Foundation The Hiscox Foundation, a charity funded by an annual donation from Hiscox, has been set up to give donations to deserving causes. It gives priority to any charity in which a member of staff is involved with the aim of encouraging and developing such activity. Hiscox staff continued their eight year long support of the Richard House Hospice, raising over £34,000 during 2009. The foundation has committed to support HART (Humanitarian Aid Relief Trust) over a three year period. The charity helps some of the poorest and most abused people in the world. More details of the charities Hiscox supports can be found on our website www.hiscox.com.
In 2009 Hiscox UK conducted an audit of its impact on the environment and, with Corporate Citizenship, calculated the carbon footprint of the UK business. Hiscox UK aims to be Carbon Neutral by the end of 2010 by reducing greenhouse gas emissions, engaging employees to modify their behaviours and seeking to offset unavoidable carbon emissions.
More detailed information relating to the actions Hiscox is taking to meet each of the Climatewise Principles will be published on www.hiscox.com in June 2010.
The chart to the right shows the gross premiums written of Syndicate 33 for the last nine years.
Cougar Syndicate 6104 Cougar Syndicate 6104 was set up under a limited tenancy agreement for the 2008 year of account with an initial capacity of £34 million. It is wholly backed by external Names and takes a pure year of account quota share of Syndicate 33’s international property catastrophe reinsurance account. The arrangement was extended for the 2009 year of account and Cougar Syndicate 6104’s capacity was increased to £43 million. The Syndicate will continue for the 2010 year of account and the underwriting capacity has been increased to £45 million.
At the end of 2009, net assets exceeded £172 million (2008: £151 million).
Hiscox Insurance Company (Bermuda) Formed by Hiscox in late 2005, Hiscox Insurance Company (Bermuda) Limited was set up as an expansion of the reinsurance operations of Hiscox and as an internal reinsurer of the Group. It recently employed a new team to underwrite healthcare insurance.
Hiscox Bermuda has an A.M. Best rating of A (Excellent). At the end of 2009, net assets were $807 million (2008: $804 million).
Hiscox Insurance Company Inc. is based in Geneva, Illinois and is an admitted insurance company with licences in all 50 US states. Its main business is animal mortality insurance for cattle and horses.
Bronislaw Edmund Masojada Chief Executive (Aged 48) Bronek Masojada joined Hiscox in 1993. From 1989 to 1993 he was employed by McKinsey and Co. Bronek served as a Deputy Chairman of Lloyd’s from 2001 to 2007. He was a Non Executive Director of Ins-sure Holdings Limited from 2002 to 2006 and is a past president of The Insurance Institute of London. He is Chairman of the Lloyd’s Tercentenary Foundation, a charity which supports research in areas of interest to the insurance industry.
Robert Simon Childs Chief Underwriting Officer and Chairman of Hiscox USA (Aged 58) Robert Childs joined Hiscox in 1986, served as the Active Underwriter of the Hiscox Lloyd’s Syndicate 33 between 1993 and 2005, and is the Group’s Chief Underwriting Officer. Robert was Chairman of the Lloyd’s Market Association from January 2003 to May 2005. He is Non Executive Director of HIM Capital Limited and HIM Capital Holdings Limited.
Dr James Austin Charles King Non Executive Director and Chairman of the Conflict Committee (Aged 71) Dr James King joined Hiscox in 2006. He chairs Keytech Limited, The Bermuda Telephone Company Ltd, the Argus Group of Companies, Grotto Bay Properties Ltd and the Establishment Investment Trust, a UK listed company. He was chairman of the Bank of N.T. Butterfield & Son Limited until 19 April 2007. He is a Trustee of the Bermuda Institute of Ocean Sciences and a Director of Castle Harbour Limited. Dr King is a fellow of the Royal College of Surgeons, Canada and the American College of Surgeons.
Andrea Sarah Rosen Acting Senior Independent Director and Acting Chairman of the Remuneration and Nomination Committee (Aged 55) Andrea Rosen joined Hiscox in 2006. She was appointed as a Director of Alberta Investment Management Corporation in October 2007 and is a Director of Emera Inc. She was previously Vice Chair of TD Financial Group and President of TD Canada Trust from 2002 to 2005. Prior to this she held various positions within the TD Financial Group from 1994 to 2002, including Executive Vice President of TD Commercial Banking and Vice Chair of TD Securities. She was Vice President of Varity Corporation from 1991 to 1994 and held various positions with Wood Gundy Inc. from 1981 to 1990.
Dirk Arie Stuurop Non Executive Director (Aged 61) Dirk Stuurop joined Hiscox in 2006. He is managing partner of Lighthouse Holdings LLC. From 2004 to 2009 he was Vice Chairman of the Board of RAM Holdings Limited, a Bermudian domiciled financial guaranty reinsurance operation. From 1999 to 2006, Dirk was President of Stuurop & Company, a privately-owned firm providing strategic advice to executive managements and boards of directors. In 1999 he retired as Chairman of Global Financial Institutions at Merrill Lynch where he worked from 1982. He served as Chairman of Worldinsure Ltd, from 2000 to 2002 and as Senior Executive Director to Banc of America Securities in 2003.
During 2009, and up to the date of this report and accounts, the Group has complied with the provisions of the Combined Code in all material respects.
The Board continues to believe in the need for an Executive Chairman. The roles and activities of the Chairman and Chief Executive are distinct and separate. The Chairman is responsible for running an effective Board including oversight of corporate governance and overall strategy. The Chief Executive has responsibility for running the Group’s business.
The Conflicts Committee The Group has a Conflicts Committee which comprises of independent Non Executive Directors from within the Group, and chaired by Dr James King. It meets as and when required. Conflicts of interest may arise from time to time because Syndicate 33, Syndicate 3624 and
Syndicate 6104 are managed by a Hiscox-owned Lloyd’s Managing Agency. 27.5% of the Names on Syndicate 33 are third parties and 72.5% of Syndicate 33 is owned by a Hiscox Group company. 100% of Syndicate 3624 is owned by a Hiscox Group company. 100% of Syndicate 6104 is owned by third parties. The Conflicts Committee serves to protect the interests of the third-party Syndicate Names. Should such a potential conflict of interest arise, there is a formal procedure to refer the matter to this Committee.
Performance evaluation Periodically the Chairman reviews the performance of the Board as a whole. He meets with the Non Executive Directors separately and as a body to discuss a wide range of issues including the performance of the Executive Directors. In addition the Non Executives periodically meet without the Chairman and Executive Directors to discuss a similarly wide range of issues concerning the company including as appropriate the performance of the Chairman and the Executive Directors. No major issues concerning Board performance have been raised during the year.
The risk management systems are set out in detail in the risk management report on pages
The Board has reviewed the effectiveness of internal controls during 2009, including financial, operational and compliance controls. The Board confirms there is an ongoing process for identifying, evaluating and managing the significant risks faced by the Company, which has been in place throughout the year and up to the date of approval of the Annual Report and Accounts, and accords with the guidance in the document ‘Internal Control: Guidance for Directors on the Combined Code’. The head of each business area is responsible for implementing the risk management programme in their area of operations. The Risk function collates risk management information and works with the risk committees to monitor significant risks and movements, and review the relevant internal controls.
None of the committee has any personal financial interest (other than as a shareholder) or conflicts of interest arising from cross directorships or day-to-day involvement in running the business. No Director plays any part in any discussion about his or her own remuneration.
As a business Hiscox is focused on generating strong pre-tax returns on equity and long-term shareholder returns, therefore our reward structure is aligned with this.
Fixed reward Fixed reward is made up of base salary, benefits and retirement benefits.
Benefits Benefits are set within agreed principles but reflect normal practice for each country. Hiscox benefits include health insurance, life insurance and long-term disability schemes.
Retirement benefits These also vary by local country practice. With the exception of the Netherlands, all Hiscox retirement schemes are based on defined contributions. In the Netherlands, we closed the defined benefit scheme to new members from July 2008 and introduced a defined contribution scheme in 2009 into which all current employees will transition from the beginning of 2010.
Two bonus pools are operated: the Personal Performance Bonus (PPB) and the Profit Related Bonus (PRB). The PPB is only available to junior and mid-level staff and is based entirely on individual performance ratings. It is designed to ensure that employees in these roles continue to be motivated to perform and the benefit is up to 10% of relevant salaries.
All employees, including Executive Directors, are eligible for the Profit Related Bonus. The PRB scheme is triggered when the business profits of the Group, based on the year’s pretax operating result, exceed a return on equity (ROE) linked to the longer-term rate of return (‘Hurdle Rate’). The minimum Hurdle Rate is currently set at a 10% pre-tax return on allocated equity with the bonus pool comprising 15% of profits in excess of that. Bonus pools are then calculated for each major business division based on the performance of that division against the Hurdle Rate of return for the division’s allocated equity.
The Hurdle Rate for the 2009 bonus was reviewed. On balance the conclusion was that the Hurdle Rate should remain unchanged for 2009 but should continue to be reviewed for subsequent years depending on changes in the longer-term rate of return.
The only exception to this is for US-based employees where, due to the implications of the US Internal Revenue Code, employees are not able to receive the deferred element of their bonuses early in order to purchase shares.
Early payment of deferred bonuses for reasons other than the above can only be made with the agreement of the Chief Executive (and the Remuneration and Nomination Committee in the case of Executive Directors).
The Remuneration and Nomination Committee has decided that bonuses earned in respect of performance in financial year 2009 need not be deferred. Employees will, however, be required to repay a proportion of their bonuses in the event that they leave in circumstances in which they would otherwise have forfeited them.
Dividend payments In order to better align senior managers with Total Shareholder Return, the concept which is applied to the Performance Share Plan awards is that the recipient is provided with the equivalent of the dividend either in shares or cash. This specifically works as follows: dividends (or amounts equal to dividends) on shares granted under the Performance Share Plan roll up in the form of shares between the grant and vesting; at the end of the performance period the employee would have options over the proportion of the share grant which vests by reference to the satisfaction of the applicable performance target as well as over the number of shares representing the ‘rolled up’ dividends on those shares; and for UK-based employees only, after vesting but before exercise, the employee would then receive ‘shadow dividends’ (i.e. amounts equal to dividends paid) on the total number of shares remaining under option. Up to a maximum of 200,000 shares under option per individual, these amounts would be paid in cash, twice yearly, at the same time as dividends are paid to shareholders, until the option is exercised (which could be for up to a further seven years, when the option expires). Above 200,000 shares under option, the ‘shadow dividends’ would be re-invested into shares within the trust. Executive Directors, however, would have
Executive Director reward Executive Directors’ reward packages are consistent with the rest of the business. The actual compensation paid to the four Executive Directors in 2009 is outlined in the table below. Details of their contractual notice periods is contained in the table opposite.
Directors’ remuneration report continued the entire ‘shadow dividend’ re-invested in shares within an employee benefit trust.
External Non Executive Directorships No external appointments may be accepted by an Executive Director where such appointment may give rise to a conflict of interest. The consent of the Chairman is required in any event. During the year, RRS Hiscox has been a Non Executive Director of Grainger Trust plc and was paid £35,000 for his services and AGICM Ltd and was paid £10,000. During the year, RS Childs has been a Non Executive Director of HIM Capital Limited and HIM Capital Holdings Limited and did not receive any payment for his services. SJ Bridges and BE Masojada did not hold any Non Executive Director positions during the year.
in accrued Total Transfer value Transfer value Transfer value (decrease) in pension accrued of increase of accrued of accrued transfer value of during the annual pension at in accrued pension at pension at accrued benefit year 31 Dec 09 pension 1 Jan 09 31 Dec 09 during the year
Share options Number of Number of Market price options at Number of Number of Number of options at at date of Date from 1 January options options options 31 December Exercise price exercise which 2009 granted lapsed exercised 2009 £ £ exercisable Expiry date 43Directors’ remuneration report Hiscox Ltd Report and Accounts 2009
Share options The interests of the Directors and employees under the UK and International Sharesave Schemes of the Group are set out below: Number of Number of Market price options at Number of Number of Number of options at at date of Date from 1 January options options options 31 December Exercise price exercise which 2009 granted lapsed exercised 2009 £ £ exercisable Expiry date
by Hiscox Ltd in respect of the year ended 31 December 2009. A second interim dividend of 10.5p (net) per share (2008: final dividend 8.5p (net)) will be paid on 29 March 2010 in respect of the year ended 31 December 2009.
Directors The names and details of the individuals who served as Directors of the Company during the year are set out on pages 32 to 33.
Stuart Bridges and Robert Childs retire by rotation in accordance with the Bye-Laws of the Company and they have each submitted themselves for re-election at the Annual General Meeting of the Company.
Dividends An interim dividend of 4.5p (net) per share (2008: 4.25p (net)) was paid on 6 October 2009
By order of the Board Charles Dupplin, Secretary Wessex House, 45 Reid Street, Hamilton HM12, Bermuda 46 Directors’ report/Directors’ responsibilities statement Hiscox Ltd Report and Accounts 2009
The procedures selected depend on our judgement, including the assessment of the risks of material misstatement of the financial statements and the part of the Directors’ remuneration report to be audited, whether due to fraud or error. In making those risk assessments, we consider internal controls relevant to the entity’s preparation and fair presentation of the consolidated financial statements and the part of the Directors’ remuneration report to be audited in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting principles used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements and the part of the Directors’ remuneration report to be audited.
We also read the other information contained in the Report and Accounts and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information.
Gross premiums earned 1,363,698 1,171,511 – 1,171,511 Premiums ceded to reinsurers (265,596) (243,416) – (243,416)
Expenses Claims and claim adjustment expenses, net of reinsurance 27.2 (463,218) (479,380) – (479,380) Expenses for the acquisition of insurance contracts 18 (256,634) (227,943) – (227,943)
Profit for the year (all attributable to owners of the Company) 280,497 125,928 (55,120) 70,808
Consolidated statement of comprehensive income For the year ended 31 December 2009, after tax
The presentation of the consolidated income statement for the year ended 31 December 2008 has not been adopted in the current year as the current year amounts are insignificant both to the prior year amounts and overall result of the Group.
Deferred acquisition costs 18 141,505 131,130 Financial assets carried at fair value 20 2,413,300 2,081,772
Loans and receivables including insurance receivables 21 488,782 494,315 Current tax – 26,289 Cash and cash equivalents 24 259,647 440,622
The notes on pages 52 to 99 are an integral part of these consolidated financial statements.
Purchase of own shares held in treasury – – – – (62,866) (62,866) Purchase of own shares held in trust – – – – (2,200) (2,200) Deferred tax – – – – 6,370 6,370 Dividends paid to owners of the Company 33 – – (46,756) – – (46,756)
Profit before tax 320,618 105,180 Adjustments for: Interest and equity dividend income (78,298) (92,227) Interest expense 5,293 5,158 Net fair value (gains)/losses on financial investments and derivatives (87,692) 180,085 Depreciation and amortisation 15,16 6,046 5,323 Charges in respect of share based payments 10 5,260 5,269 Other non-cash movements (975) (766) Effect of exchange rate fluctuations on cash presented separately 30,844 (62,086)
Cash flows from operations (211,799) 133,026 Interest received 74,584 89,608 Equity dividends received 3,714 2,619 Interest paid (5,066) (5,327) Current tax paid (1,463) (18,982)
Included within cash and cash equivalents held by the Group are balances totalling £31,607,000 (2008: £47,094,000) not available for immediate use by the Group outside of the Lloyd’s syndicate within which they are held.
in Pounds Sterling and are rounded to the nearest thousand unless otherwise stated. They are compiled on a going concern basis and prepared on the historical cost basis except that pension scheme assets included in the measurement of the employee retirement benefit obligation, and certain financial instruments including derivative instruments are measured at fair value. Employee retirement benefit obligations are determined using actuarial analysis. The balance sheet of the Group is presented in order of increasing liquidity.
The comparative amounts reported herein for the year ended 31 December 2008, are as per those previously reported for that period, but have been adjusted for the reclassification of acquisition costs on the purchase of reinsurance contracts from ‘Outward reinsurance premiums’ to ‘Expenses for the acquisition of insurance contracts’. The effect of the reclassification for the year ended 31 December 2008 is an increase to ‘Outward reinsurance premiums’ of £32,070,000, a decrease in ‘Net premiums earned’ of £24,925,000 and a decrease in ‘Expenses for the acquisition of insurance contracts’ of £24,925,000. The effect on the balance sheet for 31 December 2008 is an increase to ‘Reinsurance assets’ and an increase to ‘Trade and other payables’ of £16,074,000. The presentational adjustment has no impact on the Group’s previously reported profit before tax, shareholders’ equity or result from operating activities. The Directors’ believe that the amended classification of the expense and commissions provides a more appropriate presentation of their operating nature.
The Group also reclassified the prior year comparative for deferred tax assets arising from overseas tax jurisdictions from net deferred tax liabilities to deferred tax assets. The reclassification provides a more appropriate presentation due to the increase of the asset. The effect of the reclassification is an increase to deferred tax assets and deferred tax liabilities of £5,996,000. The presentational adjustment has no impact on the Group’s previously reported profit after tax, shareholders’ equity or results from operating activities.
During the year, following a new geographic management structure including new business written through Syndicate 3624, the Group has changed its segmental reporting to provide more effective financial
Notes to the consolidated financial statements 1 General information The Hiscox Group, which is headquartered in Hamilton, Bermuda, comprises Hiscox Ltd (the parent Company, referred to herein as the ‘Company’) and its subsidiaries (collectively, the ‘Hiscox Group’ or the ‘Group’). For the period under review the Group provided insurance and reinsurance services to its clients worldwide. It has operations in Bermuda, the UK, Europe, and the US and employs over 1,000 people.
The Company is registered and domiciled in Bermuda and on 12 December 2006 its ordinary shares were listed on the London Stock Exchange. As such it is required to prepare its annual audited financial information in accordance with Section 4.1 of the Disclosure and Transparency Rules and the Listing Rules, both issued by the Financial Services Authority (FSA), in addition to the Bermuda Companies Act 1981. The first two pronouncements issued by the FSA require the Group to prepare financial statements which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes 1 to 39 in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union.
The consolidated financial statements for the year ended 31 December 2009 include all of the Group’s subsidiary companies and the Group’s interest in associates. All amounts relate to continuing operations.
2 Significant accounting policies continued 2.2 Basis of preparation continued reporting for the evaluation of business segments by the chief operating decision maker to make decisions about future allocation of resources. The prior year segmental results have been restated accordingly.
A review of the financial performance of the Group is set out on pages 15 to 19. The financial position of the Group, its cash flows and borrowing facilities are included therein. In addition, note 3 to the financial statements provides a detailed discussion on the risks which are inherent to the Group’s business and how those risks are managed.
The Group has considerable financial resources and a well balanced book of business.
The Group early adopted IFRS8 Operating Segments from 1 January 2010.
Adoption of the above had no impact on the financial performance or position of the Group.
Amendments to IFRS 7 Financial Instruments: Disclosure The amendments to the standard enhance the disclosure requirements over fair value measurement and liquidity risk.The standard requires disclosure of those instruments measured at fair value by reference to the source of input used in determining fair value. The instruments are to be categorised using a three-level fair value hierarchy with those instruments with the most reliable method of determining fair value being classified as Level 1. For those instruments which have significant unobservable inputs, Level 3, the amendment requires a reconciliation of the opening and closing balance. In addition, transfers between each level of the hierarchy are to be disclosed. The standard also amends the previous liquidity risk disclosures for non derivative and derivative financial liabilities.
The standard is applicable prospectively and no comparatives are required on transition. However, the Group has voluntarily provided comparatives.
Amendments to IAS 32 Financial Instrument: Presentation and IAS 1 Presentation of Financial StatementsPuttable Financial Instruments and Obligations Arising on Liquidation The amendments were issued in February 2008 and provide a limited scope exception for puttable financial instruments to be classified as equity if certain specified features are fulfilled. The amendments are effective for financial periods beginning on or after 1 January 2009. There is no impact on the Group’s financial performance as it has not issued such instruments.
Amendment to IAS 23 Borrowing Cost The amendment makes it compulsory to capitalise borrowing costs relating to qualifying assets and removes the option to expense such costs. The amendment excludes eligible assets measured at fair value from the revised standard’s scope of application. The amendment had no impact on the Group’s results.
IAS 10 Events After the Reporting Period: clarifies that dividends declared after the end of the reporting period are not obligations. This had no impact on the Group’s accounting policy or financial position as this was already applied.
Standards and interpretations issued but not yet effective or not yet endorsed by the EU IFRS 9 – Financial Instruments (not endorsed) Part I of the three-part project of the new standard for financial instruments was issued by the IASB in November 2009 and is applicable for accounting periods commencing 1 January 2013 although early adoption is permitted. The two remaining parts of the standard are Part II, Amortised Cost and Impairment and Part III, Hedge Accounting, both of which are expected to be issued in 2010.
IFRS 3 (Revised) Business Combinations and IAS 27 (Amended) Consolidated and Separate Financial Statements (endorsed) The revised standards were issued in January 2008 and are applicable for accounting periods commencing on or after 1 July 2009. IFRS 3 incorporates a number of changes in accounting for business combinations which will impact the amount of goodwill recognised and the results reported in the period of the combination and future reporting periods. IAS 27 requires that a change in the ownership interest of a subsidiary, provided that control is maintained, to be accounted for as an equity transaction. As such, a transaction of this nature will no longer give rise to goodwill nor gain or loss.
Hiscox Dedicated Corporate Member Limited underwrites as a corporate member of Lloyd’s on the main Syndicates managed by Hiscox Syndicates Limited (the ‘main managed Syndicates’ numbered 33 and,
The Group uses the acquisition method of accounting to account for the acquisition of subsidiaries. The cost of an acquisition is measured as the fair value of the assets given, together with directly attributable transaction costs, equity instruments issued and liabilities incurred or assumed at the date of exchange. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised directly in the income statement.
(b) Associates Associates are those entities in which the Group has significant influence but not control over the financial and operating policies. Significant influence is generally identified with a shareholding of between 20% and 50% of an entity’s voting rights. The consolidated financial statements include the Group’s share of the total recognised gains and losses of associates on an equity accounted basis from the date that significant influence commences until the date that significant influence ceases. The Group’s share of its associates’ post-acquisition profits or losses after tax is recognised in the income statement each period, and its share of the movement in the associates’ net assets is reflected in the investments’ carrying values in the balance sheet. When the Group’s share of losses equals or exceeds the carrying amount of the associate, the carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred obligations in respect of the associate.
(c) Group companies The results and financial position of all the Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: (i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet; (ii) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the date of the transactions); and (iii) all resulting exchange differences are recognised as a separate component of equity.
2.5 Property, plant and equipment Property, plant and equipment are stated at historical cost less depreciation and any impairment loss. Historical cost includes expenditure that is directly attributable to the acquisition of the items.
2.6 Intangible assets (a) Goodwill Goodwill represents amounts arising on acquisition of subsidiaries and associates. In respect of acquisitions that have occurred since 1 January 2004, goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets and contingent liabilities assured of the acquired subsidiary or associate at the acquisition date.
In respect of acquisitions prior to this date, goodwill is included on the basis of its deemed cost, which represents the amount recorded under previous generally accepted accounting principles.
(b) Syndicate capacity The cost of purchasing the Group’s participation in the Lloyd’s insurance syndicates is not amortised but is tested annually for impairment and is carried at cost less accumulated impairment losses. Having considered the future prospects of the London insurance market, the Board believe that the Group’s ownership of syndicate capacity will provide economic benefits over an indefinite number of future periods.
(d) Rights to customer contractual relationships Costs directly attributable to securing the intangible rights to customer contract relationships are recognised as an intangible asset where they can be identified separately and measured reliably and it is probable that they will be recovered by directly related future profits. These costs are amortised on a straight-line basis over the useful economic life which is deemed to be 20 years and are carried at cost less accumulated amortisation and impairment losses.
(c) Impairment loss An impairment loss is recognised for the amount by which the asset’s carrying
2.12 Revenue Revenue comprises insurance and reinsurance premiums earned on the rendering of insurance protection, net of reinsurance, together with profit commission, investment returns, agency fees and other income inclusive of fair value movements on derivative instruments not formally designated for hedge accounting treatment. The Group’s share of the results of associates is reported separately. The accounting policies for insurance premiums are outlined below. Profit commission, investment income and other sources of income are recognised on an accruals basis net of any discounts and amounts such as sales-based taxes collected on behalf of third-parties.
Claims and associated expenses are charged to profit or loss as incurred based on the estimated liability for compensation owed to contract holders or third-parties damaged by the contract holders. They include direct and indirect claims settlement costs and arise from events that have occurred up to the balance sheet date even if they have not yet been reported to the Group. The Group does not discount its liabilities for unpaid claims. Liabilities for unpaid claims are estimated using the input of assessments for individual cases reported to the Group and statistical analysis for the claims incurred but not reported, and an estimate of the expected ultimate cost of more complex claims that may be affected by external factors e.g. court decisions.
The Group assesses its reinsurance assets on a regular basis and, if there is objective evidence, after initial recognition, of an impairment in value, the Group reduces the
Notes to the consolidated financial statements continued 2 Significant accounting policies continued 2.13 Insurance contracts continued (e) Outwards reinsurance contracts held continued carrying amount of the reinsurance asset to its recoverable amount and recognises the impairment loss in the income statement.
Actuarial gains and losses are only recognised when the net cumulative unrecognised actuarial gains and losses for each individual plan at the end of the previous accounting period exceeds 10% of the higher of the defined benefit obligation and the fair value of the plan assets at that date. Such actuarial gains or losses falling outside of this 10% corridor are charged or credited to income over the employees’ expected average remaining working lives.
The fair value of the employee services received, measured at grant date, in exchange for the grant of the awards is recognised as an expense with the corresponding credit being recorded in retained earnings within equity. The total amount to be expensed over the vesting period is determined by reference to the fair value of the awards granted, excluding the impact of any non-market vesting conditions (e.g. profitability or net asset growth targets). Non-market vesting conditions are included in assumptions about the number of awards that are expected to become exercisable. At each balance sheet date, the Group revises its estimates of the number of awards that are expected to vest. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity, over the remaining vesting period.
When the terms and conditions of an equity settled share based employee
2.16 Financial liabilities All borrowings drawn after 6 May 2008 are now measured at amortised cost at each balance sheet date thereafter using the effective interest method. Any difference between the remeasured amortised cost carrying amount and the ultimate redemption amount is recognised in the income statement over the period of the borrowings.
Up to 6 May 2008 (when all existing borrowings were repaid in full), borrowings were measured at fair value at each balance sheet date using observable market interest rate data for similar instruments, with all changes in value from one accounting period to the next reflected in the income statement unless they formed part of a designated hedge accounting relationship in which case certain changes in value were recognised directly in equity, (see notes 2.17 Net investment hedge accounting In order to qualify for hedge accounting, the Group is required to document in advance the relationship between the item being hedged and the hedging instrument. The Group is also required to document and demonstrate an assessment of the relationship between the hedged item and the hedging instrument, which shows that the hedge will be highly effective on an ongoing basis. This effectiveness testing is re-performed at each period end to ensure that the hedge remains highly effective.
2.18 Finance costs Finance costs consist of interest charges accruing on the Group’s borrowings and bank overdrafts together with commission fees charged in respect of letters of credit. Arrangement fees in respect of financing arrangements are charged over the life of the related facilities.
There are several sources of uncertainty that need to be considered in the estimation of the insurance liabilities that the Group will ultimately pay for valid claims. These include but are not restricted to: inflation; changes in legislation; changes in the Group’s claims handling procedures; and judicial opinions which extend the Group’s coverage
Estimates of insurance liabilities are continually evaluated based on entity specific historical experience and contemporaneous developments observed in the wider industry when relevant, and are also updated for expectations of prospective future developments. Although the possibility exists for material changes in insurance liability estimates to have a critical impact on the Group’s reported performance and financial position, it is anticipated that the scale and diversity of the Group’s portfolio of insurance business considerably lessens the likelihood of this occurring. Note 27 to the consolidated financial statements provides a greater analysis of the main methods used by the Group when formulating estimates of the insurance claims liabilities at each balance sheet date.
3 Management of risk Overview of risk The Group enters into contracts that directly accept and transfer insurance risk, which in turn necessarily creates exposure to financial and other classes of risk. Consequently, Hiscox is fundamentally concerned with the identification and management of all significant risks.
The Board exercises oversight of the development and operational implementation of its risk management policies and procedures, and ongoing compliance therewith, partially through its own enquiries but primarily through a dedicated internal audit function, which has operational independence, clear terms of reference influenced by the Board’s Non Executive Directors and a clear upwards reporting structure back into the Board.
The Group, in common with the non-life insurance industry generally, is fundamentally driven by a desire to originate, retain and service insurance contracts to maturity, rather than engaging in mass distribution of the risks assumed through large scale securitisation. The Group’s business is therefore fundamentally different from other types of financial institutions in that its cash flows are funded mainly through advance premium collections rather than assuming cash deposits, and the timing of such premium inflows is reasonably predictable. In addition, the majority of material cash outflows are typically triggered by the occurrence of insured events noncorrelated to financial markets, and not by the inclination or will of policyholders.
3.1 Insurance risk Insurance risk is transferred to the Group by contract holders through the underwriting process. The Group’s exposure to insurance risk arises from the possibility
3 Management of risk continued 3.1 Insurance risk continued that an insured event occurs, and a claim is subsequently submitted by the insured for payment. Management of insurance risk on a day-to-day basis is the responsibility of the Chief Underwriting Officer, who receives assistance from the management information and risk modelling departments. The Board sets the Group’s underwriting strategy for accepting and managing insurance risk prospectively, seeking to exploit identified opportunities and taking cognisance of other relevant anticipated market conditions. Specific underwriting objectives such as aggregation limits, reinsurance protection thresholds, geographical disaster event risk exposures and line of business diversification parameters are prepared and reviewed by the Chief Underwriting Officer in order to translate the Board’s summarised underwriting strategy into specific measurable actions and targets. These actions and targets are reviewed and approved by the Board in advance of each underwriting year. The Board continually reviews its underwriting strategy throughout each underwriting year in light of the evolving market pricing and loss conditions and as opportunities present themselves.
The Board requires all underwriters to operate within an overall Group appetite for individual events. This defines the maximum exposure that the Group is prepared to retain on its own account for any one potential catastrophe event or disaster. The Group’s underwriting risk appetite seeks to ensure that it should not lose more than one year’s profit plus 15% of core capital as a result of a 1 in 250 year event.
Realistic disaster scenarios are extreme, hypothetical events selected to represent major events occurring in areas with large insured values. They also reflect the areas that represent significant exposures for Hiscox. The Group compiles estimates of losses arising from realistic disaster events using statistical models alongside input from its underwriters. The selection of realistic disaster scenario events is adjusted each year and they are not therefore necessarily directly comparable from one year to the next. The events are extreme and as yet untested, and as such these estimates may prove inadequate as a result of incorrect assumptions, model deficiencies, or losses from unmodelled risks. This means that should a realistic disaster actually eventuate, the Group’s final ultimate losses could materially differ from those estimates modelled by management.
Another tool for managing insurance risk is reinsurance. Reinsurance protection such as excess of loss cover is purchased at an entity level and is also considered at an overall Group level to mitigate the effect of catastrophes and unexpected concentrations of risk. However, the scope and type of reinsurance protection purchased may change depending on the extent and competitiveness of cover available in the market.
Reinsurance Marine and Other Professional Casualty –territory coverage of premium written inwards major assets assets indemnity Other risks Other* Total
Property – Property – Casualty – Reinsurance Marine and Other Professional Casualty –
Marine and major property contracts are normally underwritten by reference to the commercial replacement value of the property covered. The cost of repairing or rebuilding assets, of replacement or indemnity for contents and time taken to restart or resume operations to original levels for business interruption losses are the key factors that influence the level of claims under these policies. The Group’s exposure to commodity price risk in relation to insurance contracts is very limited, given the controlled extent of business interruption cover offered in the areas prone to losses of asset production.
Sources of uncertainty in the estimation of future claim payments The Group’s procedures for estimating the outstanding costs of settling insured losses at the balance sheet date, including those not yet notified by, or apparent to, the insured, are detailed in note 27.
The majority of the Group’s insurance risks are short tail and, based on past history, significant claims are normally notified and settled within 12 to 24 months of the insured event occurring. Those claims taking the longest time to develop and settle typically relate to casualty risks where legal complexities occasionally develop regarding the insured’s alleged omissions or negligence. The length of time required to obtain definitive legal judgements and make eventual settlements exposes the Group to a degree of reserving risk in an inflationary environment.
Notes to the consolidated financial statements continued 3 Management of risk continued 3.1 Insurance risk continued
For the reinsurance lines, there is often a time lag between the establishment and re-estimate of case reserves and reporting to the Group. The Group works closely with clients to ensure timely reporting and also centrally analyses industry loss data to verify the reported reserves.
3.2 Financial risk Overview The Group is exposed to financial risk through its ownership of financial assets including loans and receivables, financial liabilities and reinsurance assets. These items collectively represent a significant element of the Group’s net shareholder funds.
The key financial risk for the Group is that the proceeds from its financial assets are not sufficient to fund the obligations arising from its insurance contracts and financial liabilities. The most important entity and economic variables that could result in such an outcome relate to risk factors such as equity price risk, interest rate risk, the reliability of fair value measures, credit risk, liquidity risk and currency risk. The Group’s policies and procedures for managing exposure to these specific categories of risk are detailed below.
(a) Equity price risk The Group is exposed to equity price risk through its holdings of equity and unit trust investments. This is limited to a small and controlled proportion of the overall investment portfolio and the equity and unit trust holdings involved are well diversified over a number of companies and industries. The fair value of equity assets in the Group’s balance sheet at 31 December 2009 was £134 million (2008: £125 million). These may be analysed as follows: %weighting % weighting
(b) Interest rate risk Fixed income investments represent a significant proportion of the Group’s assets and the Board continually monitors investment strategy to minimise the risk of a fall in the portfolio’s market value which could affect the amount of business that the Group is able to underwrite or its ability to settle claims as they fall due. The fair value of the Group’s investment portfolio of debt and fixed income securities is normally inversely correlated to movements in market interest rates. If market interest rates fall, the fair value of the Group’s debt and fixed income investments would tend to rise and vice versa if credit spreads remained constant.
3 Management of risk continued 3.2 Financial risk continued (b) Interest rate risk continued
One method of assessing interest rate sensitivity is through the examination of duration-convexity factors in the underlying portfolio. Using a duration-convexity based sensitivity analysis, if market interest rates had risen by 100 basis points at the balance sheet date, the fair value might have been expected to decrease by £32 million (2008: decrease of £31 million) assuming that the only balance sheet area impacted was debt and fixed income financial assets.
At 31 December 2009, £138 million was drawn on the Group’s borrowing facility (2008: $130 million). The Group has no
Nature of debt and fixed income holdings other significant borrowings or other assets or liabilities carrying interest rate risk, other than the facilities and Letters of Credit outlined in note 36.
(c) Credit risk The Group has exposure to credit risk, which is the risk that a counterparty will suffer a deterioration in perceived financial strength or be unable to pay amounts in full when due.
The Group’s maximum exposure to credit risk is represented by the carrying values of financial assets and reinsurance assets included in the consolidated balance sheet at any given point in time. The Group does not use credit derivatives or other products to mitigate maximum credit risk exposures on reinsurance assets. The Group structures the levels of credit risk accepted by placing limits on their exposure to a single counterparty, or groups of counterparties, and having regard to geographical locations. Such risks are subject to an annual or more frequent review. There is no significant concentration of credit risk with respect to loans and receivables, as the Group has a large number of internationally dispersed debtors with unrelated operations.
The Committee considers the reputation of its reinsurance partners and also receives details of recent payment history and the status of any ongoing negotiations between Group companies and these third parties. This information is used to update the reinsurance purchasing strategy.
Individual operating units maintain records of the payment history for significant brokers and contract holders with whom they conduct regular business. The exposure to individual counterparties is also managed by other mechanisms, such as the right of offset where counterparties are both debtors and creditors of the Group. Management information reports detail provisions for impairment on loans and receivables and subsequent write-off. Exposures to individual intermediaries and groups of intermediaries are collected within the ongoing monitoring of the controls associated with regulatory solvency.
Debt and fixed income securities 20 1,555,636 198,001 256,120 245,980 2,255,737
The largest counterparty exposure within AAA rating is with the US Treasury. Catastrophe bonds included within ‘other/not rated’ are rated BB or above. A significant proportion of ‘other/not rated’ reinsurance assets at 31 December 2009 and 31 December 2008 are supported by Letter of Credit guarantees issued by financial institutions with Standard & Poor’s or equivalent credit or financial strength ratings of A or better.
At 31 December 2009 the Group held no material debt and fixed income assets that were past due or impaired beyond their reported fair values, either for the current period under review or on a cumulative basis (2008: £nil). For the current period under review, the Group did not experience any defaults on debt securities (2008: one financial instrument).
66 Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2009
Within Between one Between two Over 2009 one year and two years and five years five years Total
At a consolidated level, the Group is exposed to foreign exchange gains or losses on balances held between Group companies where one party to the transaction has a functional currency other than Pound Sterling. To the extent that such gains or losses are considered to relate to economic hedges and intragroup borrowings, they are disclosed separately in order for users of the financial statements to obtain a fuller understanding of the Group’s financial performance (note 14).
Up to 6 May 2008 the Group financed a portion of its net investment in the Bermuda and Guernsey insurance operations using US Dollar borrowings to which hedge accounting was applied (see note 20). There were no items qualifying for hedge accounting in the current year.
Details of all foreign currency derivative contracts entered into with external parties are given in note 22. All foreign currency derivative transactions with external parties are managed centrally. Included in the tables below are net non-monetary liabilities of £240 million (2008: £225 million) which are denominated in foreign currencies.
As a result of the accounting treatment for non monetary items, the Group may also experience volatility in its income statement during a period when movements in foreign exchange rates fluctuate significantly. In accordance with IFRS, non monetary items are recorded at original transaction rates and are not remeasured at the reporting date. These items include unearned premiums, deferred acquisition costs and reinsurers’ share of unearned premiums. Consequently, a mismatch arises in the income statement between the amount of premium recognised at historical transaction rates, and the related claims which are retranslated using currency rates in force at the reporting date. The Group considers this to be a timing issue which can cause significant volatility in the income statements. Further details of the impact of the accounting treatment is provided in note 13.
Financial assets carried at fair value 580,797 1,623,276 166,629 42,598 2,413,300
Employee retirement benefit obligations – – – – – Deferred tax 69,673 – – – 69,673
Financial assets carried at fair value 370,043 1,430,712 236,066 44,951 2,081,772
Employee retirement benefit obligations – – – – – Deferred tax 74,645 – – – 74,645
Sensitivity analysis As at 31 December 2009, the Group used closing rates of exchange of £1:€1.13 and £1:$1.61 (2008: £1:€1.03 and £1:$1.44). The Group performs sensitivity analysis based on a 10% strengthening or weakening of Pound Sterling against the Euro and US Dollar. This analysis assumes that all other variables, in particular interest rates, remain constant and that the underlying valuation of assets and liabilities in their base currency is unchanged. The process of deriving the undernoted estimates takes account of the linear retranslation movements of foreign currency monetary assets and liabilities together with the impact on the retranslation of those Group entities with non-sterling functional currency financial statements. During the year, the Group transacted in a number of over the counter forward currency derivative contracts. The impact of these contracts on the sensitivity analysis is negligible.
Strengthening of US Dollar 94.6 54.2 Weakening of US Dollar (74.8) (41.7) Strengthening of Euro 10.0 13.9 Weakening of Euro (8.2) (11.4)
(f) Limitations of sensitivity analysis The sensitivity information given in notes (a) to (e) above demonstrates the estimated impact of a change in a major input assumption while other assumptions remain unchanged. In reality, there are normally significant levels of correlation between the assumptions and other factors. It should also be noted that these sensitivities are non-linear, and larger or smaller impacts should not be interpolated or extrapolated from these results. The same limitations exist in respect to the retirement benefit scheme sensitivities presented at note 31 to these financial statements. Furthermore, estimates of sensitivity may become less reliable in unusual market conditions such as instances when risk free interest rates fall towards zero.
3.3 Capital risk management The Group’s primary objectives when managing its capital position are: to safeguard its ability to continue as a going concern, so that it can continue to provide long-term growth and progressive dividend returns for shareholders; to provide an adequate return to the Group’s shareholders by pricing its insurance products and services commensurately with the level of risk; to maintain of an efficient cost of capital; to comply with all regulatory requirements by a significant margin; and to maintain financial strength ratings of A in each of its insurance entities.
Syndicate 33 benefits from an A.M. Best rating of A (Excellent). In addition, the Syndicate also benefits from the Lloyd’s ratings of A (Excellent) from A.M. Best and A+ (Strong) from Standard & Poor’s.
As variable remuneration, the vesting of options and longer-term investment plans all relate directly to ROE, this concept is embedded in the workings and culture of
The FGD has been applied in the UK through INSPRU and GENPRU. In accordance with these provisions, the parent company’s solvency margin consideration became a minimum capital requirement for the Group from 31 December 2006 onwards. The Group complied with the requirement for the current and prior year.
4 Operating segments The Group’s operating segments consist of four segments which recognise the differences between products and services, customer groupings and geographical areas. Financial information is used in this format by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The format is representative of the management structure of the segments.
The Group’s four operating segments are: London Market comprises the results of Syndicate 33, excluding the results of the fine art, UK regional events coverage and non US household business which is included within the results of UK and Europe. In addition, it excludes the larger TMT business which is allocated to the International segment and an element of kidnap and ransom and terrorism included in UK and Europe.
Notes to the consolidated financial statements continued 4 Operating segments continued
(a) Profit before tax by segment Year to 31 December 2008
Share of profit of *Interest revenues included total £74,584,000 (2008: £89,608,000).
London UK and Corporate London UK and Corporate 100% ratio analysis Market Europe International Centre Total Market Europe International Centre Total
The claims ratio is calculated as claims and claim adjustment expenses, net of reinsurance, as a proportion of net premiums earned. The expense ratio is calculated as the total of expenses for the acquisition of insurance contracts, administration expenses and other expenses as a proportion of net premiums earned. The foreign exchange impact ratio is calculated as the foreign exchange gains or losses as a proportion of net premiums earned. The combined ratio is the total of the claims, expense and foreign exchange impact ratios. The combined ratio excluding non monetary foreign exchange impact is calculated by adjusting the net premiums earned and the expenses for the acquisition of insurance contracts by the movement arising from retranslating net unearned premiums and net deferred acquisition costs at year end rates of exchange. All ratios are calculated using the 100% results.
Costs allocated to the Corporate Centre are non-underwriting related costs and are not included within the combined ratio. The impact on profit before tax of a 1% change in each component of the segmental combined ratios is: Year to 31 December 2008 Year to 31 December 2009 Restated
London UK and Corporate London UK and Corporate Market Europe International Centre Market Europe International Centre
At Group level 1% change in claims or expense ratio 4,533 3,673 2,775 – 4,278 3,034 1,970 –
London UK and Corporate Intragroup items Market Europe International Centre and eliminations Total
The Group has not reported geographical segmental details of non-current assets excluding financial instruments and including loans and receivables, rights and obligations under insurance and reinsurance contracts, investments in associates and subsidiaries on the grounds of the relevance of these items to the Group’s operations and the usefulness of such information to users.
The net asset value per share is based on 374,819,025 shares (2008: 368,477,595 shares), being the adjusted number of shares in issue at 31 December.
Annualised return on equity (%) 30.1 9.2 7 Investment result The total result for the Group before taxation comprises: Investment income including interest receivable 75,740 94,678 Net realised gains on financial investments at fair value through profit or loss 19,733 4,743 Net fair value gains/(losses) on financial investments at fair value through profit or loss 87,296 (127,053)
Investment result – financial assets 8 182,769 (27,632) Fair value gains/(losses) on derivative financial instruments 22 396 (52,978)
(b) Investment return LondonMarket UK and Europe International Corporate Centre 2009 Total
Fees payable to the Company’s auditors and its associates for other services: The audit of subsidiaries pursuant to legislation 638 519 Other services pursuant to legislation 90 75 All other services* 185 75
Fees in respect of the defined benefit pension scheme: Total auditors’ remuneration expense 1,112 943 *Other fees relate primarily to corporate advisory and financial reporting consulting services. Non-audit services with fees greater than £50,000 must be pre-approved by the Audit Committee which is composed solely of independent Non Executive Directors.
Fees payable to other external auditors in respect of the Company’s subsidiaries in the US pursuant to legislation during 2009 were 13 Net foreign exchange (losses)/gains The net foreign exchange (losses)/gains for the year include the following amounts: Exchange (losses)/gains recognised in the consolidated income statement (25,554) 109,755 Exchange (losses)/gains classified as a separate component of equity (69,589) 150,582
Net unearned premiums and deferred acquisition costs are treated as non monetary items in accordance with IFRS. As a result, a foreign exchange mismatch arises caused by these items being earned at historical rates of exchange prevailing at the original transaction date whereby resulting claims are retranslated at the end of each period. The impact of this mismatch on the income statement is shown below.
Opening balance sheet impact of non retranslation of non monetary items 50,525 14,438 (Loss)/gain included within profit representing the non retranslation of non monetary items (53,732) 36,087
Closing balance sheet impact of non retranslation of non monetary items (3,207) 50,525 14 Foreign currency items on economic hedges and intragroup borrowings In the prior year, the Group highlighted two separate charges on the consolidated income statement to enable readers to obtain a fuller understanding of their impact and that of related amounts recognised directly in other comprehensive income. The current year comparatives are not significant and as such this presentation has not been applied to the consolidated income statement for the year ended 31 December 2009. The current year comparatives are shown below: Consolidated Consolidated other Total income comprehensive impact on statement income equity
Unrealised losses on foreign currency derivative contracts used to manage retranslation risk associated with the net investment in Bermuda and Guernsey insurance operations (42,540) – (42,540)
Foreign exchange losses of £6,058,000 before tax (£4,362,000 after tax) (2008: £8,463,000 and £12,580,000 respectively) have been recorded on certain loan arrangements, denominated in US Dollars, between Group companies. In most cases, as one party to each arrangement has a functional currency other than the US Dollar, foreign exchange losses arise which are not eliminated through the income statement on consolidation. Implicit offsetting gains are reflected instead on retranslation of the counterparty company’s closing balance sheet through other comprehensive income and into the Group’s currency translation reserve within equity.
In the prior year the Group entered into US Dollar currency option collar contracts which were contracted in September and October 2008 to serve as informal hedges of part of the Group’s net investment in its Bermuda and Guernsey insurance operations (note 22).
The Group did not enter into any new economic hedging derivative contracts during the current year.
Other additions – – – 2,775 2,775 Amortisation charges – – – (919) (919)
The Group’s intangible asset relating to Syndicate capacity has been allocated, for impairment testing purposes, to one individual CGU being the active Lloyd’s corporate member entity. The Group has considered the recoverable amount from the active Lloyd’s corporate member entity on a value in use basis. This calculation uses cash flow projections based on financial forecasts approved by management covering a five-year period. Cash flows beyond the five-year period are extrapolated based on an average level of return and annual growth estimated at 2.5% (2008: 2%) consistent with the industry long-term average. A pre-tax discount factor of 1.8% (2008: 7%) has been applied to projected cash flows as part of the exercise. The results of this exercise indicate that the recoverable amount significantly exceeds the intangible’s carrying value and would not be sensitive to reasonably possible changes in assumptions. The Group’s weighted average cost recognised on the balance sheet is significantly below the average open market price witnessed in the recent Lloyd’s of London Syndicate 33 capacity auctions in Autumn 2009.
Assets with a net book value of £398,000 were held under finance leases (2008: £582,000). The total depreciation charge for the year in respect of assets held under finance leases was £56,000 (2008: £116,000) and is included in other expenses.
At 31 December 2009 there were £1,906,000 of assets under development upon which no depreciation has yet been charged (2008: £3,106,000).
Additions during the year – 5,438 Share of post-tax profit recognised for the period 118 260
Total at the end of 2009 12,043 8,236 10,122 264 100% results
During the prior year the Group made equity investments in Senior Wright Indemnity Ltd and Media Insurance Brokers. Cash consideration of £5,438,000 was paid.
The amounts expected to be recovered before and after one year are estimated as follows: Within one year 123,921 110,062 After one year – –
Reinsurers’ share of insurance liabilities 425,572 511,325 Provision for non-recovery and impairment (5,446) (7,531)
The amounts expected to be recovered before and after one year, based on historical experience, are estimated as follows: Within one year 217,278 254,546 After one year 202,848 249,248
20 Financial assets and liabilities Financial assets are measured at their bid price values, with all changes from one accounting period to the next being recorded through the income statement, except in the case of unlisted equity investments, and borrowing instruments that formed part of a designated hedge accounting relationship from 3 January 2007 to 6 May 2008 as provided for by IAS 39.
An analysis of the credit risk and contractual maturity profiles of the Group’s financial instruments is given in notes 3.2(c) and 3.2(d).
The Group’s borrowings from credit institutions at 31 December 2009 are denominated in Pound Sterling (2008: US Dollars). The entire amount from December 2008 was repaid during the year and the amount outstanding at 31 December 2009 is expected to be repaid in full within one year from the balance sheet date. The movement in fair value of derivative instrument liabilities includes settlements totalling £49,838,000, realised gains of £3,234,000 and unrealised losses of £539,000.
From 3 January 2007 until 6 May 2008, the Group designated US$182 million of foreign currency borrowings as hedging instruments in a net investment hedge relationship. The hedging relationship was effective throughout the entire period.
Notes to the consolidated financial statements continued 20 Financial assets and liabilities continued
Total investments 2,400,972 2,081,732 21 Loans and receivables including insurance receivables
There is no significant concentration of credit risk with respect to loans and receivables as the Group has a large number of internationally dispersed debtors. The Group has recognised a loss of £395,000 (2008: gain of £832,000) for the impairment of receivables during the year ended 31 December 2009.
Derivative financial instrument assets included on balance sheet £000 £000 £000 £000
Foreign exchange forward contracts 50,105 180 7 173 Interest rate futures contracts 21,288 906 61 845
Derivative financial instrument liabilities included on balance sheet US$000 £000 £000 £000
Derivative financial instrument assets included on balance sheet US$000 £000 £000 £000
Foreign exchange forward contracts During the current and prior year the Group entered into a series of conventional over the counter forward contracts in order to secure translation gains made on Euro, US Dollar and other non Pound Sterling denominated monetary assets. The contracts require the Group to forward sell a fixed amount of the relevant currency for Pound Sterling at pre-agreed future exchange rates. The Group made a gain on these forward contracts of £769,000 (2008: loss of £10,123,000) as included in note 7. The opposite exchange loss is included within financial investments.
Event linked future contracts In June 2008 the Group commenced trading event linked future contracts which are transacted on the Chicago Climate Futures Exchange. The contracts have fixed maturity dates and are structured such that cash inflows are binary in nature and are triggered by the occurrence of specific natural events in specific geographical zones which cause pre-determined losses to the insurance industry in excess of a specified amount. The Group itself does not have to suffer losses to receive a payment once the industry loss strike amount on each contract has been reached. Consequently the contracts are not accounted for as insurance contracts in accordance with IFRS 4.
Foreign exchange option collar contracts During the fourth quarter of 2008 the Group’s capital benefited from a significant uplift in net asset value due to the appreciation of the US Dollar to Pound Sterling exchange rate which increased the translated values of its net investments in the Bermuda and Guernsey insurance operations. During September and October 2008 the US Dollar fluctuated significantly and in order to protect the majority of the exchange gains earned to date the Group progressively hedged the risk of subsequent US Dollar weakness impacting this capital by entering into a series of currency option collar contracts. These over the counter instruments have no initial purchase cost and consist of covered call and protective put options which essentially protect the Group against material downside movements in US Dollar to Pound Sterling exchange rate whilst at the same time limiting further participation in material US Dollar strengthening beyond an upper cap. These contracts settled in 2009 and the Group made a gain of £314,000 (2008: loss of £42,540,000) as included in notes 7 and 14. The related exchange loss recognised on the retranslation of the hedged portion of underlying net investments concerned was £5,207,000 and is included within the overall loss of £69,589,000 recognised in other comprehensive income (note 13).
Investments in mutual funds comprise a portfolio of stock investments in trading entities which are invested in various quoted investments. The fair value of shares in unit trusts are based on the net asset value of the fund as reported by independent pricing sources or the fund manager.
Level 2 of the hierarchy contains US Government Agencies, Corporate Securities, Asset Backed Securities and Mortgage Backed Securities and Catastrophe bonds. The fair value of these assets are based on the prices obtained from both investment managers and investment custodians as discussed above. The Group records the unadjusted price provided and validates the price through a number of methods including a comparison of the prices provided by the investment managers with the investment custodians and the valuation used by external parties to derive fair value. Quoted prices for US Government Agencies and Corporate Securities are based on a limited number of transactions for those securities and as such the Group considers these instruments to have similar characteristics of those instruments classified as Level 2. Also included within Level 2 are units held in traditional long funds and long and short special funds and over the counter derivatives.
Level 3 contains investments in a limited partnership and unquoted equity securities which have limited observable inputs on which to measure fair value. In the prior year, investments in a mutual fund were included within level 3 as redemptions from the fund were suspended. The fund was redeemed in full in 2009. Unquoted equities are carried at cost, which is deemed to be comparable to fair value. The effect of changing one or more inputs used in the measurement of fair value of these instruments to another reasonably possible assumption would not be significant and no further analysis has been performed.
Derivative instruments included within Level 3 in the prior year represented event linked future contracts which are transacted on the Chicago Climate Futures Exchange. During the current year, the classification of these instruments was reviewed and they have been transferred into Level 2 as the valuation of the derivative is based on observable inputs used by the exchange to determine fair value.
Total gains or losses through profit or loss* 245 – – 245
Closing balance 4,260 – – 4,260 *Total gains/(losses) are included within the investment result in the income statement.
Equities and shares Deposits with Derivative in unit trusts credit institutions Instruments Total
Cash at bank and in hand 166,780 353,542 Short-term bank deposits 92,867 87,080
Cash and cash equivalents include amounts of US$334,000 (2008: US$17,775,000) held in escrow to settle deferred consideration on acquisitions.
The amounts presented in the equity structure of the Group above relate to Hiscox Ltd, the legal parent Company. Ordinary share Share Contributed capital premium surplus
Employee share option scheme – proceeds from shares issued 91 2,413 – Dividends to owners of the Company – – (48,613)
Contributed surplus is a distributable reserve and arose on the reverse acquisition of Hiscox plc on 12 December 2006. Number of Number of 5p ordinary 5p ordinary shares in issue shares in issue (thousands) (thousands)
In accordance with IFRS 2 the Group recognises an expense for the fair value of share option and performance share plan award instruments issued to employees, over their vesting period through the income statement. The expense recognised in the Consolidated Income Statement during the year was £5,260,000 (2008: £5,269,000). This comprises charges of £4,972,000 (2008: £4,960,000) in respect of performance share plan awards and £288,000 (2008: £309,000) in respect of share option awards. The Group has applied the principles outlined in the Black-Scholes option pricing model when determining the fair value of each share option instrument and discounted cash flow methodology in respect of performance share plan awards.
25 Share capital continued Share options and performance share plan awards continued
Net Claims reported and claim adjustment expenses 626,320 705,499 Claims incurred but not reported 594,113 635,926 Unearned premiums 481,792 432,197
The amounts expected to be recovered and settled before and after one year, based on historical experience, are estimated as follows: Within one year 939,565 979,380 After one year 762,660 794,242
Notes to the consolidated financial statements continued 27 Insurance liabilities and reinsurance assets continued
The gross claims reported, the loss adjustment expenses liabilities and the liability for claims incurred but not reported are net of expected recoveries from salvage and subrogation. The amounts for salvage and subrogation at the end of 2009 and 2008 are not material.
The impact of inflation on ultimate claim estimates is therefore significant. In addition a greater level of risk may be inherent in reserving estimates for newer types of insurance products where there is a lack of past historical development experience.
For all risks, the Group uses several statistical methods to incorporate the various assumptions made in order to estimate the ultimate cost of claims. The reserves for outstanding claims are actuarially estimated primarily by using both the Chain Ladder and BornhuetterFerguson methods. There is close communication between the actuaries involved in the estimation process and the Group’s underwriters to ensure that, when applying both estimation techniques, both parties are cognisant of all material factors relating to outstanding claims, and allowance is also made for the rating environment. Catastrophe events which are expected to impact multiple business units in the Group are analysed by the central analysis team. They combine information from underwriters, the claims team and past experience of similar events to produce gross and net estimates of the ultimate loss cost to each part of the Group. These figures are then incorporated by the acturial team into the quarterly reserving exercise. This process ensures that a consistent approach is taken across the Group.
The Chain Ladder method is adopted for mature classes of business where sufficient claims development data is available in order to produce estimates of the ultimate claims and premiums by actuarial reserving group and underwriting year, or year of account for the managed Syndicate. This methodology produces optimal estimates when a large claims development history is available and the claims development patterns throughout the earliest years are stable.
Where losses in the earliest underwriting years or years of account have yet to fully develop, a ‘tail’ arises on the reserving data, i.e. a gap between the current stage of development and the fully developed amount. The Chain Ladder methodology is used to calculate average development factors which, by fitting these development factors to a curve, allows an estimate to be made of the potential claims development expected between the current and the fully developed amount, known as a ‘tail reserve’. This tail reserve is added to the current reserve position to calculate the total reserve required.
In exceptional cases the required provision is calculated with reference to the actual exposures on individual policies. Adjustments are made within the claims reserving methodologies to remove distortions in the historical claims development patterns from large or isolated claims not expected to re-occur in the future. In addition, the reserves determined for the managed Syndicate are converted to annually accounted figures using earnings patterns that are consistent with those for the underlying Syndicate business.
(b) Claims development tables The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The Group analyses actual claims development compared with previous estimates on an accident year basis. This exercise is performed to include the liabilities of Syndicate 33 at the 100% level regardless of the Group’s actual level of ownership, which has increased significantly over the last eight years. Analysis at the 100% level is required in order to avoid distortions arising from reinsurance to close arrangements which subsequently increase the Group’s share of ultimate claims for each accident year, three years after the end of that accident year.
Estimate of ultimate claims costs as adjusted for foreign exchange* at end of seven years later 799,815 392,092 – – – – – – – 1,191,907 eight years later 805,284 – – – – – – – – 805,284 Current estimate of
Total gross liability to external parties at 100% level 1,966,293 *The foreign exchange adjustment arises from the retranslation of the estimates at each date using the exchange rate ruling at 31 December 2009.
Liability recognised in respect of prior accident years at 100% level 42,040
Liability for accident years before 2001 recognised on Group’s balance sheet 32,100
Total Group liability to external parties included in the balance sheet – net** 1,220,433 **This represents the claims element of the Group’s insurance liabilities and reinsurance assets.
27 Insurance liabilities and reinsurance assets continued 27.2 Movements in insurance claims liabilities and reinsurance claims assets
Total at beginning of year (1,767,728) 426,303 (1,341,425) (1,215,887) 222,672 (993,215) Claims and loss adjustment expenses for year (508,238) 45,020 (463,218) (698,471) 219,091 (479,380) Cash paid for claims settled in the year 571,689 (110,924) 460,765 549,106 (117,582) 431,524 Exchange differences and other movements 154,954 (31,509) 123,445 (402,476) 102,122 (300,354)
Current year claims and loss adjustment expenses (725,132) 122,538 (602,594) (828,940) 226,808 (602,132) (Under)/over provision in respect of prior year claims and loss adjustment expenses 216,894 (77,518) 139,376 130,469 (7,717) 122,752
Creditors arising out of direct insurance operations 45,476 35,089 Creditors arising out of reinsurance operations 157,514 175,134
29 Tax expense The Company and its subsidiaries are subject to enacted tax laws in the jurisdictions in which they are incorporated and domiciled.
Notes to the consolidated financial statements continued 29 Tax expense continued
The standard rate of corporation tax in Bermuda is 0% whereas the effective rate of tax for the Group is 12.5% (2008: 32.7%). A reconciliation of the difference is provided below: Profit before tax 320,618 105,180 Tax calculated at the standard corporation tax rate applicable in Bermuda: 0% (2008: 0%) – – Effects of: Tax on profits arising in the UK at 28% 47,770 45,790 Overseas tax losses for which a deferred tax asset is recognised (8,081) (1,681) Other items (99) 466 Other overseas taxes (2,706) – Prior year tax adjustments 3,237 (10,203)
The deferred tax asset relates to losses arising in overseas entities and is subject to overseas relief against future profits. Management consider it probable that taxable profits will arise in future in order to utilise the deferred tax asset.
Trade and other payables 4,050 (4,050) – – Retirement benefit obligations – 1,310 – 1,310 Intangible assets – Syndicate capacity 4,715 (485) – 4,230
(b) Group deferred tax liabilities analysed by balance sheet headings Income statement Transfer to 2008 (charge)/credit equity 2009
Insurance contracts – equalisation provision* (6,703) (10,270) – (16,973) Other items – – – –
*The solvency regulations in the UK require certain entities within the Group to establish an equalisation provision, to be utilised against abnormal levels of future losses in certain lines of business. The regulations prescribe that the provision is increased every year by an amount that is calculated as a percentage of net premiums written for those lines of business during the financial year subject to a maximum percentage. The amount of each annual increase is a deductible expense for tax purposes, and the equalisation provision is taxed when released. Equalisation provisions are not permitted under IFRS which therefore results in the temporary difference for tax purposes. Following a change in the legislation at the end of 2008, Lloyd’s Corporate Members are also entitled to a tax deduction for claims equalisation losses although this is not a solvency requirement for Lloyd’s. The Group has provided for the deferred tax liability on its Corporate Members’ claims equalisation reserve during the year.
The gross amount recognised in the Group balance sheet in respect of the defined benefit scheme is determined as follows: Present value of scheme obligations 140,676 101,615 Fair value of scheme assets (118,391) (115,166)
Deficit/(surplus) for funded plans 22,285 (13,551) Unrecognised net actuarial (losses)/gains (17,648) 9,767 Past service costs recognised in other creditors (11,800) – Unrecognised surplus deemed irrecoverable 7,163 3,784
The scheme assets are invested as follows: Debt and fixed income assets 65,935 71,670
Notes to the consolidated financial statements continued 31 Employee retirement benefit obligations continued
The movement in liability recognised in the Group’s balance sheet is as follows: At beginning of year – – Total expense charged in the income statement of the Group 10 13,300 – Past service costs recognised in other creditors (11,800) – Contributions paid (1,500) –
A reconciliation of the present value of scheme obligations of the scheme is as follows: Opening present value of scheme obligations 101,615 106,793 Current service cost 300 200 Interest cost 5,720 6,135 Actuarial losses/(gains) 23,737 (9,490) Past service costs 11,800 – Benefits paid from scheme (2,496) (2,023) Settlements with scheme members – –
Present value of unfunded obligations/(surplus scheme assets) 22,285 (13,551) (20,783) 3,801 36,124
Gross liability recognised on balance sheet – – – 3,801 16,677
The triennial valuation carried out as at 31 December 2008, resulted in a deficit position of £5.1 million and excludes the impact of the equalisation of scheme obligations. The equalisation of scheme obligations has been included in the valuation as at 31 December 2009 and an amount of £11.8 million has been recognised as past service costs. The Group has agreed to fund the £5.1 million deficit paying equal instalments over four years and to pay the full amount relating to the equalisation of obligations in 2010. During the year the Group made the first instalment of £1.5 million to the defined benefit scheme (2008: £nil). 61% of any scheme surplus or deficit calculated is recharged or refunded to Syndicate 33.
The expected return on scheme assets is based on historical data and management’s expectations of long-term future returns. While management believe that the actuarial assumptions are appropriate, any significant changes to those could affect the balance sheet and income statement. Whilst an additional one year of life expectancy for all scheme members might be expected to reduce the present value of unfunded obligations at 31 December 2009 by approximately £4 million, the Group considers that the most sensitive and judgemental assumptions are the discount rate and inflation.
The Group has estimated the sensitivity of the net obligation recognised in the consolidated balance sheet to isolated changes in these assumptions at 31 December 2009 as follows: Present value (Increase) of unfunded Present value /decrease obligations of unfunded in obligation before change obligations recognised on in assumption after change balance sheet
32 Earnings per share Basic earnings per share are calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of shares in issue during the year, excluding ordinary shares held by the Group and held in treasury as own shares.
Notes to the consolidated financial statements continued 32 Earnings per share continued
Profit for the year attributable to the owners of the Company (£000) 280,497 70,808
Weighted average number of ordinary shares in issue (thousands) 372,848 377,506 Adjustments for share options (thousands) 14,966 13,351
Weighted average number of ordinary shares for diluted earnings per share (thousands) 387,814 390,857
Interim dividend for the year ended: 31 December 2009 of 4.5p (net) per share 16,834 – 31 December 2008 of 4.25p (net) per share – 15,615
Final dividend for the year ended: 31 December 2008 of 8.5p (net) per share 31,779 – 31 December 2007 of 8.0p (net) per share – 31,141
34 Acquisitions The Group did not acquire any associates or subsidiaries during the current year. On 30 September 2008, the Group acquired 100% of the issued share capital of Amershill Limited. Cash consideration of £2,000,000 was paid and goodwill of £1,909,000 was recognised. The fair value of the identifiable net assets acquired was £91,000.
35 Disposals There were no disposals during the current year. The Group disposed of its Hiscox Select A to J Limited subsidiaries on 3 November 2008. The fair value of the net assets were £nil and a cash payment and loss on disposal of £42,000 was incurred. These entities were all non-trading corporate capital vehicles.
(d) The managed syndicate is subject to the New Central Fund annual contribution, which is an annual fee calculated on gross premiums written. This fee was 0.5% for 2009 and 2008. In addition to this fee, the Council of Lloyd’s has the discretion to call a further contribution of up to 3% of capacity if required.
Operating lease commitments The Group acts as both lessee and lessor in relation to various offices in the UK and overseas which are held under non-cancellable operating lease agreements. The leases have varying terms, escalation clauses and renewal rights. The Group also has payment obligations in respect of operating leases for certain items of office equipment. Operating lease rental expenses for the year totalled £5,656,000 (2008: £5,499,000). Operating lease rental income for the year totalled £468,000 (2008: £468,000).
The aggregate minimum lease payments required by the Group under non-cancellable operating leases, over the expected lease terms, are as follows: No later than one year Land and buildings 5,683 5,621 Office equipment 177 144
The total future aggregate minimum lease rentals receivable by the Group as lessor under non-cancellable operating property leases are as follows: No later than one year 468 468 Later than one year and no later than five years 1,053 1,521 Later than five years – –
Obligations under finance leases It is the Group’s policy to lease certain of its motor vehicles under finance lease arrangements. The leases have a typical term of three years and are on a fixed repayment basis with a final lump sum component at the end of each agreement should the Group decide to acquire ownership of the vehicle. Interest rates are fixed at the contract commencement date. The Group’s obligations under leases are secured by the lessors’ charges over the leased assets.
Finance lease interest expense for the year totalled £20,000 (2008: £35,000).
The finance lease obligations to which the Group is committed include the following minimum lease payments: Current liabilities due for settlement no later than one year 226 246 Non-current liabilities due for settlement after one year and no later than five years 177 223
**Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd (2008: 54,560) at 31 December 2009. †Hiscox Trustees Limited is the trustee of the Hiscox Employee Share Ownership Plan (ESOP). The ESOP owned 132,399 shares in Hiscox Ltd (2008: 132,399) at 31 December 2009. The shares have been purchased by the ESOP for future use in employee share option schemes and are held as own shares. None of these shares are currently under option to employees, nor have any been conditionally gifted to them.
39 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 37 to 44. A number of the Group’s key personnel hold insurance contracts with the Group, all of which are on normal commercial terms and are not material in nature.
Value of services provided by Hiscox Syndicates Limited to Syndicate 33 50,845 55,947
Profit for the year after tax 280,497 70,808 191,248 163,846 48,630
Financial assets carried at fair value 2,413,300 2,081,772 1,747,827 1,241,910 1,237,778
Net asset value per share (p) 299.2 258.1 209.5 173.2 147.7
Contents 1 Corporate highlights 2 Why invest in Hiscox? 3 Chairman’s statement 5 Chief Executive’s report 12 Hiscox at a glance 14 People 15 Group financial performance 20 Group investments 21 Risk management 26 Corporate responsibility 28 Insurance carriers 32 Board of Directors 34 Corporate governance 37 Directors’ remuneration report 45 Directors’ report 46 Directors’ responsibilities statement 47 Report of the independent registered public accounting firm 48 Consolidated income statement 48 Consolidated statement of comprehensive income 49 Consolidated balance sheet 50 Consolidated statement of changes in equity 51 Consolidated statement of cash flows 52 Notes to the consolidated financial statements 100 Five year summary