We operate in 27countries and provide insurance products and services in over 130 countries.
Visit www.royalsunalliance.com for more information. This Annual Report & Accounts contains forward looking statements as defined in the US Private Securities Reform Act. For a discussion of factors that could affect future results, reference should be made to the ‘Important disclaimer’ on the inside back cover. The following sections, pages 1 to 25 constitute the Business Review of Royal & SunAlliance and are incorporated by reference into the directors’ report set out on pages 29 to 30. The directors’ report has been drawn up and presented in accordance with, and in reliance upon applicable English Company Law and the liabilities of the directors in connection with that Report shall be subject to the limitations and restrictions provided by such law.
Balance sheet at 31 December Total capital £4,084m £4,229m Shareholders’ funds £2,561m £2,686m Net asset value per share 82p 88p
Dividend Total dividend for the year per ordinary share 5.87p 4.74p
In Personal, we are aiming to strengthen our number three retail position by enhancing our customer focus. By 2010, we plan to grow our Affinity business by more than 50% from 2005 levels.
We will grow organically and will consider acquisitions that strengthen our portfolio.
Our Personal business is ranked third largest in the UK with around four million covers in place. UK Personal primarily provides household, motor and travel insurance through MORE TH>N® our direct business. In Affinity, we provide the retail customers of our corporate partners with a range of insurance products.
Premium growth was strong across the region, with a 26% increase in Latin America, 38% in India and 32% in the Baltics. In Latin America, the increase reflects double digit organic growth as well as the integration of our 2005 acquisition, Cruz del Sur. Asia and the Middle East also delivered double digit premium growth, after adjusting for the disposal of the Japanese business in 2005.
In 2006, International delivered above market premium growth and a COR of 93.1%.
Canada increased net written premiums by 15%, reflecting strong organic growth in Johnson and the successful integration of the Morgex and Shillington acquisitions.
We are targeting 15% growth per annum in Latin America, Asia and the Middle East and the Baltics, in order to double premiums by 2010 from 2005 levels. Over the same period, we intend increasing gross written premiums in India to £200m. All targets are on a local currency basis.
In International, our objective is to drive the business harder. We are targeting sustainable profitable growth ahead of the market and building market share in our target segments.
Our cost reduction and operational improvement programmes are further enhancing profitability across the region.
Emerging Markets is our fastest growing business, covering 20 markets which offer high growth potential.
Latin America is the largest operation accounting for 59% of Emerging Markets’ net written premiums. Our largest operations are based in Chile, where we are the market leader, Brazil and Mexico.
International comprises our businesses in the mature insurance markets of Scandinavia (Sweden, Denmark and Norway), Canada, Ireland and Italy.
I am pleased to report for the fourth successive year further significant achievements in your Company’s operational performance and progress in its realisation of its stated strategic goals. In short we have completed all the goals we set for our restructuring plan and can now accelerate further our plans to both improve and grow profitably our portfolio of businesses. Although much has been achieved over the last four years there is still work to do as we progress our plans to transform all aspects of the Company’s activities and enhance our leadership position in the markets we choose to operate in.
Although a more significant impact of these changes is expected in 2007, there have been continuing business development successes in the year including: • Further expansion of our distribution in the UK and acquisition of new capability set to deliver profitable growth,
The key strategic priority set for 2006 was, however, achieving an acceptable exit from the USA, an objective discussed in some detail in last year’s annual report. I repeat a comment made then that “this outcome requires us to resolve a number of highly complex issues on which we are making good headway in an area which will remain difficult to predict”. If anything, this was an understatement of the challenge. Although we signed the MBO agreement with Arrowpoint Capital (the new company set up by our former US management team to acquire our US operations) in the calendar year 2006, the necessary regulatory approval for the transaction was finally agreed just prior to the disposal being completed and announced on 4 March 2007.
This has been a long and complex project and has required the fullest involvement of the Board. The Board have been resolute in their approach and are confident that the deal represents the 4 Royal & SunAlliance Annual Report & Accounts 2006
A year of significant achievement, which positions us to accelerate further our plans to improve and grow profitably our portfolio of businesses
appropriate deal for both policyholders and shareholders. Whilst it is normal to thank my Board colleagues generally at the end of my report, I would like to specifically thank them on this occasion for their diligence, input and overall contribution into what has proved to be an acceptable exit from our US operation.
Finally, despite the demands of our US exit, other essential and important objectives were also achieved in 2006. This was a significant test of management and a very considerable achievement.
With respect to issues related to continuing operational improvement, and strengthened management control, of particular note has been the launch of a Technical Academy for underwriting and claims. There has also been the continuation of our plans to improve operational effectiveness, reduce costs, improve competitiveness and customer service. Although these involve some further loss of headcount, with an announced reduction of over 1,500 to be effective by June 2008, we continue to positively engage with staff and management at all levels on those key objectives. Our staff understand and support our goal to be the best-in-class. We thank them and appreciate their support, upon which our continued progress depends.
Having noted our success in achieving our strategic aims and core performance objectives, and with confidence in our plans to further improve the business, the Board considered our dividend policy. As a reflection of your Board’s confidence in the future sustainability of the earnings of the Company, we announced at our preliminary results on 8 March a 35% increase in the final dividend for 2006. We plan to increase the 2007 interim dividend level by at least inflation plus 35% and thereafter plan to grow dividends at least in line with inflation.
On Board composition matters two changes have occurred. We welcomed Simon Lee, CEO of our International business, to the Board on 1 January 2007. At the same time, David Paige, Group Risk Director, retired from full-time employment to take up a portfolio career. David made a significant contribution to our risk and regulatory areas and we would like to wish him further success on his new career path. The number of directors who retire by rotation and stand for re-election this year is significant and include Edward Lea, John Maxwell, Noel Harwerth, Malcolm Le May and George Culmer. They form part of a key Board team that I have already warmly commended.
The outlook as seen by the Board is positive. We have firm plans to both improve existing performance and grow and develop our business further. The priorities for the Company are clear and, despite competitive market conditions, particularly in the UK, we aim to make full use of our strategic portfolio. We see ourselves as a Company with a quality set of businesses and strong and effective management, well able, in relative terms, to face with confidence world market uncertainties. At the time of writing, the 2007 pattern in international financial markets has been of some limited instability with market willingness to self-correct and seek reasonable stability. With that comment in mind, I would like to repeat what I said at the beginning; namely as a Company we can now put our restructuring plans behind us and accelerate further our plans to improve and grow profitably our portfolio of businesses.
Last year I also set out our plans to come off risk in the US and bring finality and certainty to our exposure. In line with this strategy, in September, we announced the disposal of our US business to the US management team through a company called Arrowpoint Capital. We’ve now completed the transaction, resolving the last of the Group’s legacy issues and completing the Group restructuring we started in 2003.
Strong financial performance During 2006, we have increased net written premiums by 3% to £5.5bn. In each of our regions there are opportunities to profitably grow the franchise and new business was up 26% on last year.
Net written premiums 5,484 5,300 Underwriting result 310 263 Operating result 780 743 Combined operating ratio (COR) 93.3% 94.1% Underlying return on equity 20.7% 21.6%
We have continued to supplement our organic growth with selective acquisitions in Ireland, the UK, Norway and Canada. The acquisitions along with the distribution deals that we announced in 2006 are expected to contribute premiums of over £400m when at a full run rate.
While we look to profitably grow the business, our commitment is to sustainable profitable performance. In 2006 we’ve continued to deliver against this. We have increased the underwriting profit by 18% to £310m and we’ve improved the operating result by 5% to a profit of £780m. The combined operating ratio of just over 93%, marks the twelfth consecutive quarter of combined ratios in the nineties.
Across the Group, each of the regions has delivered a strong result. The UK combined of 92.3% is in line with last year and the underwriting result is up 4% to £160m. The Commercial combined of 92.6% remains strong, while in Personal we have achieved an excellent result, improving the combined ratio by 4 points to 91.6%.
Scandinavia delivered another good performance with a combined of 93.9% and a 15% improvement in the underwriting result to £75m. This was driven by a positive rating environment and improvements we have made to our claims management.
These results have been achieved against the backdrop of a competitive market and highlight the benefits of our balanced portfolio.
Operational excellence Against this market backdrop, our strong financial performance has been driven by our focus on operational excellence and strong management controls. It covers the work we are doing on underwriting, pricing, claims and expense management as well as the discipline with which we run the business.
Our focus on technical and operational excellence is supported by tight management controls. In underwriting, we have a clearly defined risk appetite and a system of global licensing to ensure that it is enforced. We implement a Group wide technical pricing strategy, backed up by active portfolio management. We hold detailed quarterly reviews with each business and carry out regular audits of business won and business lost.
It is why we are confident that we’re taking on the right business – putting rate through where it is required and walking away when we can’t get the right price, terms or conditions.
Just as we reward superior performance, we take action on underperformance. Of our top 100 management group, we’ve changed out around 10% during the year. We have appointed 12 people from outside the Group into senior roles and we have continued to promote talent from within the business, with 15 of our top managers moving into roles of greater responsibility.
During the year, we have had a real focus on employee development. In addition to the Technical Academy, we have launched a number of new initiatives such as ‘FastTrack’, an accelerated scheme for high potential graduates. Our Executive Development Programme entered its third year and has been highly successful, with 70% of participants in the first two programmes now in more senior roles.
Part of our culture is about listening to our people and taking action on their feedback. We have again completed our annual global employee survey and on the back of actions taken last year the overall satisfaction response improved 3%.
We use the results to build clear action plans to address issues raised and make improvements in each of our businesses. One of the areas we continue to focus on is driving further improvement in the level of employee engagement across the business in order to support the Group’s strategic and financial objectives.
Under the new structure, the Group is organised into three regions – International, Emerging Markets and the UK.
Emerging Markets is our fastest growing region and has enormous potential. We’ve established good positions in Latin America, Asia and the Middle East and the Baltics and our plan is to continue to drive growth of around 15% per annum in order to double premiums by 2010.
Bridget McIntyre continues to lead the UK and is driving the business forward. In Broker, we’re expanding in our target trades and segments such as Marine and Profin. In Retail, we’re growing MORE TH>N® – new business was up nearly 30% in 2006 and we have taken this good momentum into 2007. In Affinity, we entered a major deal with Paymentshield during the year and we are confident we’ll meet our target of over 50% growth by 2010.
customers. Feedback was so positive, that we have now made the service available to all MORE TH>N® customers.
The strength of the portfolio will be evident as we shift capacity to where we see the best opportunities. We expect International to deliver a greater proportion of the Group’s underwriting result, largely driven by an improved Scandinavian performance.
Across the Group, our current expectation is that we will deliver a combined ratio of better than 95% for the full year.
We are focused on driving sustainable profitable performance through technical excellence, continuous operational improvement and performance management. Our technical expertise has driven the delivery of 12 consecutive quarters of sub 100 CORs, and the 0.8 point improvement in the 2006 COR to 93.3%.
We have established a Technical Academy to promote and develop underwriting, claims and actuarial expertise across the Group. The Academy shares best practice and provides a career development framework for those working in technical disciplines. We are also implementing a Groupwide sales effectiveness programme to strengthen the sales tools, infrastructure and reward processes to drive disciplined profitable growth.
Leading technical expertise We have a strong reputation for our technical expertise and work closely with our clients to provide tailored risk management and insurance solutions. We continuously focus on enhancing our capabilities to drive sustainable profitable performance.
Driving profitable performance through technical expertise, operational improvement and performance management
Our increasing customer focus is reflected in our strong new business and retention levels. In the UK, we have customer relationships that go back more than 200 years. In our mature markets, we are using customer segmentation to develop innovative products to attract new customers and widen our target customer base. In the UK, MORE TH>N® has recently launched a number of propositions aimed at increasing customer acquisition and retention, to increase profitability and opportunities for cross selling.
Through these agreements we have access to 27% of the Swedish new car market and around 30% of the Danish new car market.
In the UK we have strong relationships with major manufacturers including Toyota, Land Rover and Volvo. We continue to develop our motor proposition and this year we have signed a new agreement with Kia.
Net written premiums 2,618 2,632 Underwriting result 160 154 Combined operating ratio (COR) 92.3% 93.1%
operational improvements and cost efficiencies. To improve our competitiveness, we are targeting £70m of annualised cost savings by mid 2008 and a sub 15% expense ratio.
In our target segments, we continued to build momentum, increasing new business by 31% to £298m with strong growth in Marine, Profin and Risk Solutions. In November, we acquired Martello Underwriting Limited, a specialist provider of professional indemnity insurance and expect this business to deliver premiums of around £40m in 2007.
Personal UK Personal improved the COR by 4 points to 91.6% and the underwriting result by 67% to £65m. Household performed particularly strongly, delivering a COR of 80.9%, while motor 12 Royal & SunAlliance Annual Report & Accounts 2006
MORE TH>N® ‘DriveTime’ We are increasing the use of sophisticated underwriting tools to tailor our products to our customers and price our risks.
In 2006, MORE TH>N® launched ‘DriveTime’, a telematics product aimed at reducing young driver accidents. An in-car telematics system monitors when a car is driven, rewarding drivers aged between 18-25 with reduced insurance premiums if they don’t drive their cars between 11.00pm and 6.00am, the time when 40% of young driver accidents result in death or serious injury.
Building momentum in target markets and delivering sustainable profitable performance 2006 General Insurer of the Year
MORE TH>N® recorded another impressive performance, improving its COR by 3.7 points to 88.7%. New business sales were up 28% and net written premiums increased 2% to £441m. The expense ratio was 22%, down from 24.1% at the end of 2005 and we are on track to achieve our sub 20% target expense ratio by the end of 2007.
In Personal Intermediated we signed 11 new distribution agreements, including Paymentshield, the UK’s largest independent supplier of mortgage related insurance. We expect this deal to generate premiums of over £200m in 2008.
Technical excellence We continue to build our reputation through our technical excellence and risk solutions. By segmenting our customer base and enhancing our pricing sophistication, we are able to tailor pricing to different customer groups and develop innovative products. In 2006, MORE TH>N® launched ‘DriveTime’, a product aimed at 18-25 year olds which uses GPS technology to reward drivers with reduced premiums if they do not drive at peak times when accidents occur. MORE TH>N® has also used sophisticated risk analysis to broaden its motor customer base, increasing average motor premiums by 10% over 2006.
Our underwriting risk assessment is market leading and our complex flood mapping, arson and crime risk models enable us to accurately price risks. Our technical excellence continues to receive industry recognition. In 2006, our marine business received a British Insurance Award for its Aquaculture insurance solution, and we were awarded ‘Claims Initiative of the Year’ with Marishal Thompson for our work on subsidence risks.
In Commercial, the distribution market is evolving with the emergence of new channels creating new opportunities for insurers with strong customer propositions. Partnership agreements offer growth opportunities in the regional broker market and provide access to high volumes of business within our risk criteria.
The Personal market remains competitive. In Motor, we have consistently put rate through ahead of the market over the last three years, and we are now seeing some evidence of an improvement in rates.
Outlook We are committed to maintaining underwriting discipline and rigorous risk selection to deliver sustainable profitable performance. In Commercial, we will continue to focus on our target trades and segments and use our industry recognised technical skills to maintain strong retention. We will continue to innovate our product offerings and pricing to realise the growth potential of MORE TH>N® and achieve a sub 20% expense ratio. In Affinity, we will continue to target new opportunities and deliver profitable growth from the deals we completed in 2006.
The geographic spread of our International businesses allows us to access markets at different points in the rating cycle. This diversification is a key component in the sustainability of our results.
Business progress against strategies Our business in Scandinavia is the largest in the portfolio accounting for 55% of International premiums. We are the third largest insurer in the region and are driving the business as a pan-Nordic organisation with a portfolio of very strong local brands, principally Codan in Denmark and Trygg-Hansa in Sweden. These brands each have a prompted brand awareness of almost 100%.
The Scandinavian business performed strongly again in 2006, with 4% growth in net written premiums on a local basis and an 18% increase in the underwriting result.
A strong portfolio of businesses focused on maximising opportunities for profitable growth in mature markets
businesses also have a growing presence in Sweden and are expanding into Denmark. In 2007, we expect these businesses to generate premiums of around £50m.
Canada has again delivered excellent results, with a 15% increase in net written premiums reflecting a strong performance by Johnson, our direct Personal business and Commercial. The Canadian business delivered a 2.8 point improvement in the COR to 92% and increased the underwriting result by 85% to £48m.
This reflects the benefits of our disciplined risk selection, claims management and the continued delivery of cost savings.
The Commercial business delivered a 27% increase in net written premiums. Strong new business growth across all regions was supported by the launch of innovative products and quoting tools, including the continued roll out of ‘RapideQuote’ which is now used by over 425 brokers.
In line with our strategy of targeting specific segments, we acquired EGI Holdings Ltd in Ireland during the year. This established business, with strong positions in selected liability and motor lines, extends our range of expertise and product offerings.
By 2010 we expect to double net written premiums from 2005 levels in the Baltics, Latin America and Asia and the Middle East, and to increase gross written premiums in India to £200m.
Net written premiums 531 440 Underwriting result 11 6 Combined operating ratio (COR) 97.3% 96.4%
The additional reinsurance and one-off integration costs noted above, impacted the Latin America result, increasing the COR to 103.7% for the year.
Asia and the Middle East delivered another excellent result with a COR of 83.1%. The business delivered underlying double digit premium growth after adjusting for the disposal of the Japanese business in 2005. Motor was a key driver of growth in the region, particularly in the Middle East, where we have increased volumes after web-enabling our brokers, allowing them to transact more efficiently with us.
Our joint venture in India increased premiums by 38% over the year. We are focused on accelerating the development of this business, and would look to increase our shareholding should the Indian government lift the 26% cap on foreign direct investment.
Santiago, Chile Chile is one of the most vibrant and stable economies in Latin America benefiting from a mineral rich environment, low inflation and high levels of foreign trade. In 2007 GDP growth is forecast to exceed 5% and Chileans spend more per head on insurance than any other Latin American country. We are the clear market leader following our acquisition of Cruz del Sur in 2005, with 17% market share. Our business is headquartered in Santiago which is home to around 40% of the Chilean population.
Market and economic conditions Our Emerging Markets business covers 20 countries with economies at differing stages of development and growth. Premium volumes are growing strongly in the Middle East and Baltics, and in Latin America there are some signs of increasing rates following the hurricanes in 2005. In Asia, increased capacity is creating downward pressure on rates.
Other initiatives We are building a senior team at the centre with specialist technical knowledge to drive product development and growth across the business. This team is supported by key appointments at a regional level including a new CEO for Latin America.
In the Baltics, we have implemented a number of operational efficiency initiatives including automatic renewals on our motor, accident and property portfolios. These actions increase customer retention and free our agent network from administrative tasks allowing them to focus on new business sales.
In the second half of 2007 we will launch our Estonian operation. Leveraging the expertise of our existing Baltic operations, we are confident of building a strong franchise to realise the growth potential we see in this exciting market.
We will continue to leverage the technical expertise and operational efficiency initiatives of the R&SA Group to build competitive advantage and strengthen profitability. In preparation for the Indian detariffication which was implemented on 1 January 2007, we significantly enhanced our pricing capability. Although tariffs were not fully liberalised, our enhanced segmentation and risk selection capability provides us with a real competitive advantage.
+21% ■ Latin America £314m ■ Baltics £114m ■ Asia & Middle East £103m
Discontinued activities Loss after tax from discontinued operations (499) (30) –
3. Other movements Other movements include interest charges on debt, amortisation and reorganisation costs.
Results overview 2006 was another strong year for the Group, with 3% growth in net written premiums and a 5% increase in the operating result.
The 18% increase in the underwriting result to £310m reflects stronger underwriting performances across all of our regions, and our disciplined approach to underwriting and claims and expense management.
The underwriting result includes a £39m strengthening of our UK asbestos reserves following an increase in the frequency of claims notifications during the year.
In Scandinavia, we have strengthened our 2001 and prior Swedish personal accident and motor third party reserves. This strengthening has been offset by positive experience for these lines in more recent years following management actions, and the release of surplus in our Danish Personal and Commercial motor business. Going forward, we do not anticipate any further material strengthening of our Swedish personal reserves.
The Group’s overall reserve position remains strong and our reserves are stronger at the end of the year than at the start of the year.
Other activities predominantly comprise central Group expenses and investment expenses. In 2006, central Group expenses were £74m, 10% lower than 2005, reflecting a small increase in project costs and a 16% reduction in head office expenses.
Interest costs on the Group’s senior and subordinated debt decreased by £15m to £92m, reflecting the repayment of senior debt during the year.
Reorganisation costs of £23m relate to the costs of implementing the Group’s operational improvement programme. This restructuring programme announced at the time of the Rights Issue is now complete and no further restructuring costs will be charged to the income statement in 2007.
Profit before disposals and the pension scheme change is up 11% to £650m, while the tax charge of £170m reflects an effective tax rate of 26%.
Balance sheet The Group’s balance sheet, cashflows and capital position have continued to strengthen during 2006.
We have used these funds to meet our financing and pension funding commitments, and repay a net £169m of senior debt. We also financed £355m of corporate activity, which included funding for acquisitions and new distribution deals, and Codan’s share buy back and buy out of minority interests in the Baltics. After these uses, our cash surplus for the year was £29m.
Net cashflow 639 521 Pension deficit funding (86) (86) Net repayment of debt (169) (86) Corporate activity (355) 97
Funding by: Increase/(decrease) in cash and cash equivalents 443 (127) (Sale)/purchase of other investments (414) 573
Investment policy The Group continues to operate a low risk investment policy. The structure of the investment portfolio remains dominated by high quality fixed income and cash assets which are held to provide a broad match to the duration of our insurance liabilities. The Group also invests in equities and property to provide return whilst ensuring an appropriate diversification of risk.
For the Group’s senior regulated insurance company, Royal & Sun Alliance Insurance plc, we continue to report the capital position under Solvency I.
Our pension funds now show a surplus of £24m, compared with a £239m deficit at the start of the year. This improvement is primarily due to positive market movements and the funding payment made during the year.
Summary 2006 has again been a very successful year for the Group with continued delivery of growth, solid underlying profitability and strong cashflows. The Group has sufficient balance sheet strength to support its strategic objectives of delivering sustainable earnings and targeted profitable growth.
George Culmer Chief Financial Officer 21Royal & SunAlliance Annual Report & Accounts 2006
Risk management The Board is responsible for the Group’s systems of risk management.
This includes the Board Risk Committee, supported by the Group Risk functions, and a Group wide network of regional risk committees,
Risk categories Within the Group the risk elements are viewed under headings that broadly correspond to those used in the Financial Services Authority’s Integrated Prudential Sourcebook (PRU). Additional information is provided in note 28 to the financial statements.
Insurance risk The Group’s general insurance activities are primarily concerned with the pricing, acceptance and management of risks arising from our contracts with customers. The management of the underwriting and claims risks uses a number of key tools, including the review of the performance and management of all the individual insurance portfolios throughout the Group, and the investigation of potential emerging insurance risks.
The reinsurance team monitors and controls reinsurance activity throughout the Group, and has responsibility for the purchase of the Group’s worldwide programme of treaties.
All major treaty purchases are analysed using various sophisticated modelling tools to ensure that the level of cover purchased is capital efficient and aligned with Group risk appetite and strategy.
Operational risk Operational risk exists in every facet of the organisation, including those areas that are not viewed as ‘operating units’. As such, all areas of the Group and its major outsourcing providers, are involved in addressing and controlling operational risk.
Market risk arises from the Group’s investment portfolios. The Global Asset Management Committee is the management committee that oversees the Group’s investment strategy under the oversight of the Investment Committee, and operating within risk limits set by the Board Risk Committee.
Liquidity risk is considered to be a low risk category. Group liquidity is managed by Group Treasury and each operation is required to maintain a minimum level of cash or cash equivalents or highly liquid assets that can be liquidated within a maximum stated period of time. Contingency funding plans are prepared and monitored to ensure that these minimum levels are met even in stress conditions.
• In Canada, we launched ‘ClearSky’, commercial wind energy insurance, and have already captured 20% of the market,
We are dedicated to providing high standards of customer service and continually look for ways to improve our claims and customer service. In Canada, Johnson has been using personal customer managers for a number of years. It has been highly successful and 92% of customers say that they would renew their policies based on the customer service. In the UK, following the successful pilot of this model, we have now extended the service to all our MORE TH>N® customers.
We are committed to resolving complaints promptly. We continue to participate in the annual benchmarking survey on complaints handling by the Association of British Insurers. In 2006, our performance was assessed as upper quartile across all categories.
• We launched ‘FastTrack’, an accelerated scheme for high potential graduates. The programme involves a six month international assignment and development plan to fast track individuals to more senior roles. We had 2,000 applicants and 16 have been selected to participate.
We have also carried out our annual global employee survey. Overall satisfaction improved 3% in 2006 and the results of the survey are used to build clear action plans to address issues raised.
Environment Environmental issues and climate change have received substantial public attention in 2006. We have been taking action on these issues for some time.
• We became the first UK insurer to go ‘Carbon Neutral’ offsetting our emissions against renewable energy projects,
As an insurer, we are driving through a number of initiatives: • We continue to lobby in the UK for increased Government spending on flood defence,
• We make it more affordable for consumers to make environmental choices through our products, such as discounted insurance for hybrid cars,
As a leading motor insurer, we are committed to improving road safety awareness. In Chile, we launched a road safety education programme which has already reached 15,000 children with a further 48,000 to take part in 2007. In Sweden, we’ve donated nearly 300,000 high visibility waistcoats and reflectors for children.
Social exclusion is also an issue across many of the regions in which we operate: • In the UK, we have provided social housing insurance for over 15 years. This year our UK CEO, Bridget McIntyre, took up a post on the Government’s Social Exclusion Taskforce,
• In India, we continue to provide insurance in association with Non Government Organisations for women and tribal groups in rural locations who are living below the poverty line,
• In Canada, we continue to support the United Way, a charity which funds a variety of social services such as children’s development and disadvantaged families.
All targets to be achieved by end of 2007 are based on the levels set out in the 2005 Corporate Responsibility Report. All energy targets are electricity unless otherwise specified. All targets are reductions, except recycling which is an increase in the rates.
Noel Harwerth A, I Age 59. Director of the Group from March 2004. Director of Corus Group plc, Tube Lines Limited, Logica CMG, Corporate Services Group plc, Anglo Irish Bank and Partnership Director, London Underground. Deputy Chairman of Sumitomo Mitsui Banking Corporation Europe Limited (finance). Former Chief Operating Officer of Citibank International plc (finance).
Edward Lea A, R, I Age 65. Director of the Group from July 2003. Chairman of the Group Audit Committee from October 2003. Director Redbourn Group plc (property management and investment). Director of IDC Plugs Limited (electrical services). Director of MacIntyre Care (charity). Previously a director of The British United Provident Association (BUPA).
Malcolm Le May R, I Age 49. Director of the Group from March 2004 and Chairman of the Investment Committee from November 2005. President Europe JER Partners Limited (Europe) (property investment). Non-executive director of Pendragon plc. Former Deputy Chief Executive Morley Fund Management (Investment Fund Manager). Former Deputy CEO of ING-Barings (finance).
Bridget McIntyreE Age 45. UK Chief Executive and director of the Group from November 2005. Previously Executive Director of Norwich Union (insurance).
The directors of Royal & Sun Alliance Insurance Group plc present their report and the audited financial statements of the Company for the year ended 31 December 2006.
Business review An overview of the business performance during the year along with an analysis of its financial position is set out in the financial review on pages 18 to 21. The future developments of the business can be found in the Group CEO’s business review on pages 6 to 9 and in the regional business reviews on pages 12 to 17. The principal risks and uncertainties facing the Group are set out in the estimation techniques, uncertainties and contingencies on pages 50 to 52, and in the risk framework on pages 22 to 23.
Financial KPIs are detailed in the Group CEO review on pages 6 to 9 and the regional business reviews on pages 12 to 17. The employee, customer and the environment and community KPIs are detailed in the regional business reviews on pages 12 to 17, the corporate responsibility report on pages 24 to 25 and the directors’ report on pages 29 to 30.
Post balance sheet events On 4 March 2007 the Group announced the completion of the disposal of its US operation to Arrowpoint Capital Corp.
Dividends The directors recommend a final dividend of 4.12p per share which, if approved by shareholders at the 2007 Annual General Meeting (AGM), will be due for payment on 1 June 2007 to holders of ordinary shares on the register at the close of business on 16 March 2007. This, together with the interim dividend of 1.75p per share, will make a total dividend for the year of 5.87p per share.
The Group is committed to the promotion of equal opportunities for all employees including those with a disability. In order to do this, we will ensure that any reasonable adjustment is made, where it is appropriate to do so, to provide equal opportunities to all in the provision of recruitment, terms and conditions, promotions, transfers, dismissals and vocational training. We are committed, wherever possible, to supporting the rehabilitation and return to work of employees who become disabled during their career with us.
The Group continues to focus on the development of employees in order that they can deliver high levels of performance. We believe we can create real competitive advantage by building and maintaining a high performance culture across the Group. In 2006, the focus has been on developing talent and capability for today’s business needs and those of the future. We have continued to accelerate the development of our in-house executive talent, through the Executive Development Programme which enters its third year in 2007. We have also introduced robust strategies to build capability and performance in the areas of sales, underwriting, claims and actuarial.
A Groupwide programme was introduced looking at sales effectiveness, with the aim of equipping our salesforce with the tools, skills, career pathways, training, reward and recognition that an effective salesforce would expect.
An accelerated career programme, FastTrack, was launched hiring 16 individuals who show potential to swiftly build capability to fulfil leadership positions in the Group. Typically, three or four years post graduate, these individuals follow a structured career acceleration programme involving a six month overseas assignment to help bring increased exposure to cultural and organisational differences.
The third annual web based Global Employee Survey was run in 2006. 91% of eligible employees took the opportunity to contribute. Our aim is to consistently seek feedback on the environment we are creating as an employer and to work constructively towards our objective of becoming an employer of choice. Our intention is to continue to repeat this survey annually, to ensure we have a current picture of employees’ views and also to track year on year movement in particular areas of priority. In this way, by asking our employees, we measure how the culture of our business is changing. For example, in 2006 70% of staff felt that ‘My job provides the opportunity to learn new skills and develop new talents’, an increase of 3% on 2005. As in previous years, we have used the 2006 results to build a Groupwide action plan which requires every manager to identify and work on areas of particular importance to their team.
Our policy is to encourage employee share ownership. Employees from the majority of our global businesses are encouraged to participate in the International Sharesave Plan which is an HM Revenue and Customs approved all employee sharesave scheme.
Share capital During the year, 6,804,499 ordinary shares of 27.5p each were issued in satisfaction of the exercise of employee share options for a total consideration of £6m, and 45,604,849 ordinary shares of 27.5p each were issued under the Company’s scrip dividend scheme for a total consideration of £62m. An authority from the shareholders for the Company to purchase up to 293,567,775 of its own ordinary shares (representing 10% of its issued share capital as at 16 March 2006) remained in force at 31 December 2006.
Substantial share interests As at 7 March 2007, Deutsche Bank AG, Goldman Sachs Asset Management, Legal & General Group plc and Schroder Investment Management had declared an interest in ordinary shares of 27.5p each in the Company representing 3.20%, 8.72%, 3.53% and 4.97% respectively of the issued ordinary share capital, in accordance with Part 22 of the Companies Act 2006 and the Disclosure Rules and Transparency Rules of the UK Listing Authority.
On 12 July 2006, the Company, pursuant to the power conferred by Article 154, executed deed polls for each of the then and all future executive and non-executive directors of the Company. The indemnities granted under these deed polls constitute qualifying third party indemnity provisions (as defined by Section 309B of the Companies Act 1985). The Board believes that it is in the best interests of the Group to provide this indemnity to its directors in order to ensure it attracts and retains high calibre directors through competitive terms of employment in line with the market.
In addition, the Company has arranged appropriate insurance cover in respect of legal action against its directors and officers.
Related party transactions Related party transactions are set out in note 33 on page 102.
Charitable and political contributions The Company and its subsidiaries worldwide made charitable donations of £2,033,711 during the year. The largest contribution of £317,866 was made towards purchasing reflectors and reflective waistcoats for children in Sweden to promote road safety. The Group did not make any donations to European Union (EU) political parties, nor to political parties outside the EU during 2006, and it is not the Group’s policy to do so.
Throughout 2006, the Group has complied with the Principles and Provisions of the Combined Code except that the Group has not appointed a senior independent director nor is there a majority of independent directors on the Nomination Committee. The non-executive directors have a unanimous view that the appointment of a senior independent director is not appropriate at this time. All non-executive directors are encouraged to communicate directly with executive directors outside formal meetings and an active dialogue is maintained by the Board. Notwithstanding the composition of the Nomination Committee, all non-executive directors are involved in any process for the appointment of an additional director.
• Approval of the Group’s financial results and any significant changes to accounting practices or policies.
The separate roles of the Chairman, John Napier, and the Group CEO, Andy Haste, have been clearly defined in written role statements which have been approved by the Board.
The Group operates a Delegated Authority Policy which specifies how executive authority is delegated from the Board to the Group CEO and on to other executives in the Group. Individual executive licences set out specific limits of authority in terms of entering into financial, underwriting and other business commitments. Each executive is responsible for ensuring a similar process of delegation is in place within their area of responsibility.
The Board met 11 times during 2006. Further details on the attendance of directors at Board and Committee meetings are provided on page 34.
The Directors The Board comprises five non-executive directors and four executive directors. Details of the directors can be found on page 26. David Paige resigned as a director on 31 December 2006 and Simon Lee was appointed as a director with effect from 1 January 2007.
and have prepared financial statements for the Company in accordance with IFRS. Company law requires the directors to prepare such financial statements in accordance with IFRS, the Companies Act 1985 and Article 4 of the International Accounting Standards (IAS) Regulations.
In preparing such financial statements the directors are required to: • Select suitable accounting policies and apply them on a consistent basis using reasonable and prudent judgement,
• State whether or not applicable accounting standards have been followed and explain any material departures,
• State whether the Group financial statements have been prepared in accordance with IFRS,
• Use the going concern basis unless it is inappropriate to do so.
Board effectiveness In 2006, the Board undertook an annual evaluation of its performance to assess how well the Board, its committees and the directors are performing. The review included the use of a comprehensive questionnaire.
Further details on the overall risk framework is set out on pages 22 to 23.
The Investment Committee is chaired by Malcolm Le May, meets twice a year and comprises all non-executive directors, Andy Haste and George Culmer. The Committee assists the Board in setting the Group’s investment strategy and monitors the execution of that strategy and the Group’s investment performance.
The Board Risk Committee, which meets quarterly, was chaired during the year by David Paige who resigned from the Board on 31 December 2006. George Culmer has since assumed the role of Committee Chairman. The Committee comprises the Group CEO and the Chief Financial Officer and other members of executive management. The Committee is authorised by the Board under its terms of reference to manage all risks faced by the Group. The Board-approved Group risk appetite is set by reference 32 Royal & SunAlliance Annual Report & Accounts 2006
• Ensuring that risks that are outside the appetite are mitigated in an appropriate manner,
The role of the Group Audit Committee and the Nomination Committee are set out below.
Principal duties The Committee’s principal duties are as follows: • To coordinate and have oversight of the Group’s financial reporting process,
The Group Audit Committee has unrestricted access to Company documents and information, as well as to employees of the Company and the external auditors.
The terms of reference of the Group Audit Committee, which explain its role and the authority delegated to it by the Board of Directors, are available on the Company’s website at www.royalsunalliance.com or on request from the General Counsel and Group Company Secretary.
Report of the Nomination Committee Membership The membership of the Committee and the attendance record of directors in 2006 are shown in the table on page 34. The Committee met twice during 2006.
Principal duties The Committee’s principal duties are to review the structure, size and composition of the Board and to evaluate the directors’ skills, knowledge and experience. It has access to external recruitment consultants in order to help fill any vacancies. The Committee considers the leadership needs and succession planning of the Board when making decisions on new appointments. Resolutions to re-appoint directors at the AGM are not proposed automatically, but are subject to the approval of the Board, taking into account the recommendations of the Committee.
Total number of meetings in the year 1 11 10 6 2 2 8
Bridget McIntyre 10 John Napier 2 11* 2 2* David Paige 11 *Chairman of the Board or board committee
2. John Napier attended one meeting of the Remuneration Committee by invitation.
Going concern The directors have satisfied themselves that the Group has adequate resources to continue in operation for the foreseeable future, having given consideration to the uncertainties and contingencies disclosed in the financial statements, and have therefore prepared the financial statements on a going concern basis.
By order of the Board Mark R Chambers General Counsel and Group Company Secretary 34 Royal & SunAlliance Annual Report & Accounts 2006
In constitution and operation, the Committee complies fully with the Combined Code as appended to the Listing Rules of the UK Listing Authority and as described in the corporate governance section of this report, on page 31.
• Consideration of, and advice to the Board on, the Group’s broader remuneration policy in relation to senior executives reporting to the Group CEO (the Executive Team).
Membership of the Remuneration Committee During the year, the directors who served on the Committee were John Maxwell (Chairman), Edward Lea and Malcolm Le May. All of the non-executive directors on the Committee were determined by the Board to be independent. The attendance of members in 2006 is shown in the table on page 34.
Members of the Committee have no personal financial interest, other than as shareholders, in the Committee’s decisions, and they have no conflict of interest arising from cross directorships. Fees for serving as a committee member and chairing committees of the Board are described in the non-executive directors section of this report on page 40.
Advisors to the Remuneration Committee In developing remuneration strategy during the year, the Committee obtained its principal advice from New Bridge Street Consultants LLP, who were appointed by the Committee and provided no other services to it during 2006.
The terms of engagement for the remuneration consultants are available to shareholders on request and on our website at www.royalsunalliance.com.
The Committee meets as often as necessary throughout the year to ensure that it is able to fully report to the Board and shareholders on all relevant matters. In 2006, the Committee met eight times and the principal business of those meetings included the following activities: • The design and development of the 2006 Long Term Incentive Plan, the key features of which are described later in this report (the Long Term Incentive Plan). As well as discussions of the key features of the Long Term Incentive Plan, the Chairman of the Committee engaged in consultation with major shareholders in order to attain the support of shareholders at the 2006 AGM,
• The determination of performance conditions, and approval of the initial awards, under the Long Term Incentive Plan,
• The review of actual performance of the executive directors in 2005 against agreed goals and objectives,
• The ongoing review and monitoring of performance conditions and reports on performance for awards under the Share Matching Plan and various share option grants,
• The ongoing review of share incentives generally, including the approval of changes of an administrative or regulatory nature,
• The determination of termination arrangements for senior executives who left the Group in 2006, including those of David Paige,
• The drafting of the remuneration report for the 2006 Annual Report and Accounts.
Remuneration policy principles The Committee’s remuneration policy is consistent with the high performance culture across the Group. The key principles which underpin the remuneration policy are: • Total remuneration is set at a level which enables the recruitment, retention and motivation of high quality executive talent,
Elements of remuneration Remuneration for executive directors in 2007 will consist of the four principal elements described below, of which only base salary is pensionable: • Base salary,
For the purposes of the above charts, the bonus value is based on the cash bonus received plus the fair value of the compulsory Deferred Shares. The LTI value is based on the fair value of awards of Performance Shares and half of the maximum potential number of Matching Shares that may vest (subject to performance) relating to voluntary and compulsory Deferred Shares under the Long Term Incentive Plan. Details of how the fair values, referred to above, have been calculated are set out in note 27 on page 85.
Base salaries for executive directors and members of the Executive Team are set on appointment with reference to market data. The strong performance culture within the Group means that it is essential that executive directors are of the highest calibre. To enable the Group to compete for the most talented executives, the Committee relates
Base salaries are reviewed on the basis of market movements and an assessment of the performance of the executive. The 2006 salary review process resulted in the following increases, effective from 1 April 2006, for the continuing executive directors (as at 31 December 2006): Position Increase Base salary
Recognising that base salaries are now generally competitive, as in 2006, increases in 2007 are expected to be broadly in line with movements in boardroom pay.
The following table sets out the base salaries of UK based executives below Board level on a banded basis as at 31 December 2006. No such executive received a base salary in excess of £350,000. Base salary range Number of employees £250,001 and over 6
In relation to the increase in number of employees in the band £150,001 – £200,000, from 2005, there are 12 employees who received pay rises sufficient for them to be included in the above chart. There were also seven new employees throughout 2006 at this level bringing new capabilities to the Group.
The executive directors and the Executive Team participate in an annual bonus plan. If stretching targets are achieved, participants receive a cash bonus of up to 50% of base salary and Deferred Shares worth up to 16.5% of base salary. For outstanding performance, a cash bonus of up to 100% of base salary and Deferred Shares worth up to 33% of base salary are achievable. Deferred Shares are described in the section headed Share based long term incentive awards below.
Policy: Bonus payments are related to stretching performance targets, and are capped at 133% of base salary. For maximum bonuses to be achieved, outstanding performance must be demonstrated.
Bonuses paid to executive directors in respect of the performance year 2006 are included in the table of directors’ emoluments on page 41. The Remuneration Committee is satisfied that the bonus payments made in respect of 2006 reflect the consistently strong COR results across the Group throughout 2006, and the contribution made by each executive director.
Prior to the approval of the Long Term Incentive Plan, two share incentive plans were operated: • The 2004 Share Matching Plan, which was designed to operate for two years. The final awards under this plan were made in 2005,
Deferred Shares As described in the annual performance bonus section on page 37, executive directors, members of the Executive Team and the Top 100 may be granted Deferred Shares as part of the annual bonus. These Deferred Shares may not be withdrawn and will normally vest three years from the date of grant subject to continued employment with the Group.
In addition, executives may invest an additional portion of bonus in Deferred Shares on a voluntary basis. Voluntary Deferred Shares are not at risk of forfeiture and may be withdrawn at any time (but the right to Matching Shares would lapse on those Deferred Shares withdrawn).
Conditional awards of Matching Shares Executives may receive a conditional award of Matching Shares pro rata to the number of Deferred Shares held. The maximum matching ratio for Matching Shares:Deferred Shares will be 2.5:1, calculated on the gross value of the bonus invested in Deferred Shares. At threshold performance the matching ratio will be 0.625:1. Details of the performance condition used for the first grant are described below. Following a review, the Committee resolved to use the same performance conditions in relation to awards proposed in 2007.
Performance conditions The Committee will determine the performance condition for each grant of Performance Shares and Matching Shares, with performance measured over a single period of three years with no provision to retest. In 2007 (as in 2006), grants of Performance Shares and Matching Shares related to non voluntarily Deferred Shares will be subject to a performance condition consisting of a combination of Return on Equity (ROE) and Total Shareholder Return (TSR) targets. These are set out below: • 50% of the shares comprising the award will vest according to ROE performance. If underlying average annual ROE over three years commencing with the financial year of grant is below 10%, no part of the award subject to the ROE performance condition will vest. If underlying average annual ROE over three years is 10%, 25% of the award will vest. If underlying average annual ROE over three years is 16%, 100% of the award will vest. Vesting will be on a straight line basis in between. Underlying ROE will exclude items of an exceptional nature which in the view of the Committee do not reflect the underlying performance of the business,
• 50% of the shares comprising the award will vest according to TSR performance against a comparator group of UK and International Financial Services companies. Below median performance, no part of the award subject to the TSR performance condition will vest. At median performance, 25% of the award will vest. At upper quintile (top 20%), 100% of the award will vest. Vesting will be on a straight line basis in between,
• Additionally, before any shares subject to the TSR condition vests, the Committee must be satisfied that the Company’s TSR performance is reflective of underlying financial performance.
The comparator group will consist of the following companies: Comparator companies
The Company’s TSR will be independently calculated and verified by the Committee for the purposes of awards made under the Long Term Incentive Plan.
Dilution Dilution levels for all schemes are held strictly within limits set by the Association of British Insurers (ABI) (10% over 10 years for all schemes and 5% for discretionary schemes). The dilution levels compared to ABI limits as at 31 December 2006 was: ABI limit Royal & SunAlliance dilution 10% over 10 years for all share schemes 5.83% 5% over 10 years for discretionary schemes 3.63%
The Group CEO is required to build and maintain a minimum shareholding in the Company equivalent to 150% of base salary. The other executive directors have a target of 100% of base salary and other members of the Executive Team have a target of 50% of base salary. In order to ensure that progress is made towards this target, executives are required to retain shares to a value of 50% of the net of tax gain under all executive schemes until the relevant guideline is attained. This requirement will apply to awards under the Long Term Incentive Plan, and will continue to apply to awards under all existing long term incentive plans.
The following table shows the number of shares (including voluntary Deferred Shares held under the Long Term Incentive Plan) held by each continuing executive director at 31 December 2006 and the increase in shareholding over the year.
** All of Bridget McIntyre’s shares were acquired during the year.
Until 31 December 2005, George Culmer participated in a contributory defined contribution occupational pension scheme (the Royal & SunAlliance UK Pension Scheme 2002). From 1 January 2006, this scheme was replaced by the Royal & SunAlliance Stakeholder Pension Plan (the Stakeholder Plan), a contributory defined contribution stakeholder pension scheme. George Culmer became a member of the Stakeholder Plan from 1 January 2006. In 2007, he will receive employer contributions worth 15% of base salary, subject to an employee contribution of 5% of base salary up to the HM Revenue and Customs annual allowance as applicable. Additionally, following a review of the market competitiveness of his pension benefits, the Committee decided to provide George Culmer with a taxable cash allowance of 15% of base salary, in order to bring his overall pension provision closer to the market median.
Service contracts The Committee’s policy on service contracts is that they should be subject to a maximum notice period of one year. Generally, in the event of termination, and in all cases of termination on performance grounds, the Committee’s policy would be to seek and apply mitigation.
George Culmer’s service contract commenced on 1 May 2004 and he was appointed as a director of the Group on the same date. Bridget McIntyre’s service contract commenced on 1 November 2005 and she was appointed as a director of the Group on 2 November 2005. The service contracts for George Culmer and Bridget McIntyre terminate under normal circumstances in October 2024 and July 2023 respectively unless terminated earlier by the Company or by the individual on 12 months’ notice.
David Paige’s service contract commenced on 1 February 2005 and he was appointed as a director of the Group on 16 February 2005. His service contract was due to expire in July 2013, and was subject to a notice period of 12 months. Following the reorganisation of the Group Risk function, David Paige stood down from the Board and left the Group effective 31 December 2006. He received his usual remuneration (including participation in the 2006 annual performance bonus) up to 31 December 2006 and no compensation for loss of office. David Paige was not a member of any Group pension plan and there was no additional cost to the Group.
The Remuneration Committee determines the remuneration of the Chairman of the Board. The fee payable to John Napier in respect of his appointment as Chairman of the Board (effective 17 March 2003) was increased effective 1 January 2006 from £250,000 to £325,000pa in order to reflect market movements and the complexity and challenge of the role. John Napier’s letter of appointment was effective 9 January 2003 and the term of his appointment was initially three years; it has now been extended until 31 December 2008. No further review of John Napier’s fees is anticipated during the current term of his appointment. The appointment may be terminated by John Napier giving three months’ notice to the Company.
Edward Lea and John Maxwell have letters of appointment effective from 10 July 2003; Noel Harwerth and Malcolm Le May have letters of appointment effective from 30 March 2004. These letters of appointment all request one month’s notice should the non-executive director wish to resign. All non-executive directors (including the Chairman) are subject to a three year rolling period of appointment in accordance with the Company’s Articles of Association.
Total shareholder return for Royal & SunAlliance, FTSE World Europe Insurance Index and FTSE 100 Index 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
4. Bridget McIntyre received an annual performance bonus of £360,150 in respect of performance year 2006. Her allowances include 15% of base salary as a retirement allowance, paid monthly. During 2006 the amount paid was £54,000. She also received car benefits worth £14,000 and medical and life assurance benefits worth £3,000.
5. David Paige resigned as director on 31 December 2006. He received an annual performance bonus of £284,012 in respect of performance year 2006. His allowances also included 17.5% of base salary as a retirement allowance, paid monthly. During 2006, the amount paid was £61,000. He also received car benefits worth £14,000 and medical and life assurance benefits worth £7,000. He received no compensation for loss of office.
Pension benefits (audited part) Non-executive directors are not entitled to any pension benefits. The pension benefits earned by the executive directors, as members of Group defined benefit schemes, were as follows: Transfer value Transfer value Difference in Total accrued of total accrued of total accrued transfer values
Change in pension at pension at pension at less members accrued pension 31 December 31 December 31 December contribution
Notes: 1. The difference in transfer values reflects the difference between the two transfer values calculated using relevant information on the respective dates and is not necessarily the actuarial increase of the underlying pension.
4. The benefits shown above in respect of Andy Haste relate to his membership of a defined benefit pension scheme up to the earnings cap. 5. For Andy Haste the increase in his accrued pension during the year, excluding the effects of inflation, was £1,797 and the transfer value in respect of this less his contributions was £14,185 at 31 December 2006.
Shareholdings (non audited part) The interests of directors in ordinary shares of 27.5p each of the Company, as declared and recorded in accordance with the Companies Act 1985, are as follows: Shares held at Shares held at
Non-executive directors Noel Harwerth 2 – 34,000 Edward Lea 302,003 241,128 Malcolm Le May – – John Maxwell 261,011 252,044 John Napier 300,945 290,605
2. Noel Harwerth’s shares were held in the form of 6,800 American Depositary Receipts (ADRs). One ADR represented five ordinary shares. The shares were disposed of as part of the compulsory sale process of ADRs. The ADR programme was terminated on 30 October 2006 .
3. The directors had a beneficial interest as at 31 December 2006 in the voluntary Deferred Shares of 27.5p each held under the Long Term Incentive Plan which are not included in the above table.
Notes 2006 during the year during the year during the year 2006
The official closing middle market price at its highest during the year was 154.75p per share and at its lowest was 118.25p per share; on the last dealing day of the year it was 152.50p per share.
2. All of the above options were granted for nil consideration.
Long term incentive schemes (audited part) Long term incentive scheme interests held during 2006 in respect of the ordinary shares of the Company are as follows: Share Matching Plan Share awards Share awards held at Share awards Share awards Share awards held at 1 January granted during vested during lapsed during 31 December Dates by which qualifying
Notes 2006 the year the year the year 2006 conditions must be fulfilled
George Culmer 1,3 Deferred Share awards 128,938 – – – 128,938 08.04.08 Matching Share awards 386,814 – – – 386,814 08.04.08
Andy Haste 1,3 Deferred Share awards 462,182 – 197,046 – 265,136 14.06.07 – 08.04.08
Bridget McIntyre 1,2 Deferred Share awards – 150,000 – – 150,000 01.11.08 Matching Share awards – 450,000 – – 450,000 01.11.08
David Paige (resigned 1,3 Deferred Share awards 65,100 – – – 65,100 08.04.08
2. Bridget McIntyre’s award of Deferred and Matching shares was approved prior to her appointment on 1 November 2005. Due to dealing restrictions in accordance with the Model Code, these awards could not be granted until 12 June 2006. The number of shares was calculated with reference to the share price on 1 November 2005. Subject to performance as described below, these awards may vest on the third anniversary of her appointment. In all other respects these awards are subject to the same rules as other awards granted in 2005.
3. Matching Share awards are capable of vesting in respect of a maximum of three times the number of Deferred Shares awarded, subject to the achievement of TSR targets over a single two year period. TSR performance is measured relative to other companies specified by the Remuneration Committee. For awards granted in 2004 and 2005, TSR will be measured partly relative to FTSE 100 companies and partly relative to the following financial services comparator group companies: Aegon, Legal & General Group, Allianz Group, Old Mutual, AXA, Prudential, Aviva, RAS, Generali and Zurich Financial Services Group. For 50% of the Matching Share awards, where TSR is measured against the FTSE 100, full vesting will only occur at upper decile performance, vesting will occur in the ratio of shares under Matching Share awards to shares under Deferred Share awards of 2:1 at upper quartile performance and vesting in the ratio 1:1 will occur at median performance. For the other 50% of the Matching Share awards, where TSR is measured against the financial services comparator group, full vesting will occur if TSR is highest in the comparator group, vesting in the ratio 2:1 will occur at upper quartile performance and vesting in the ratio 1:1 will occur at median performance. Matching Share awards will not vest at below median performance. For awards granted in 2004, the targets were measured over the period from 1 April 2004 to 31 March 2006. For awards granted in 2005, the targets will be measured over the period from 1 April 2005 to 31 March 2007. The relevant TSR figures will be averaged over the three months before the beginning and end of this performance period. Additionally, no Matching Shares will vest unless the Committee is satisfied that there has been a sustained improvement in the underlying performance of the Company over the performance period.
Long term incentive plan Share awards Share awards Date by which held at Share awards held at qualifying 1 January granted during 31 December conditions
2. Deferred Shares are inclusive of voluntary Deferred Shares and compulsory Deferred Shares. Voluntary Deferred Shares are purchased by Hill Samuel Trustees on behalf of each participant using part of the net annual bonus paid to them and are held in trust for three years. These Deferred Shares are not at risk of forfeiture and may be withdrawn from the trust at any time, but the related Matching Share awards would lapse if the voluntary Deferred Shares are withdrawn within three years of acquisition. Compulsory Deferred Shares are awarded as part of the annual bonus and are also held in trust and deferred for three years. These Deferred Shares may not be withdrawn and will normally vest in three years from the date of grant subject to continuous employment with the Group.
John Maxwell Chairman of the Remuneration Committee, on behalf of the Board 44 Royal & SunAlliance Annual Report & Accounts 2006
We have audited the consolidated financial statements of Royal & Sun Alliance Insurance Group plc for the year ended 31 December 2006 which comprise the consolidated income statement, the consolidated statement of recognised income and expense, the consolidated balance sheet, the consolidated cashflow statement, estimation techniques, uncertainties and contingencies, significant accounting policies and the related notes. These consolidated financial statements have been prepared under the accounting policies set out therein.
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the Annual Report and the consolidated financial statements in accordance with applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union are set out in the directors’ report.
We report to you our opinion as to whether the consolidated financial statements give a true and fair view and whether the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation. We also report to you whether in our opinion the information given in the directors' report is consistent with the consolidated financial statements. The information given in the financial review, the directors’ report includes that specific information presented in the Group CEO’s business review, the regional business reviews and the estimations techniques, uncertainties and contingencies that are cross referred from the business review section of the directors’ report.
• The consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation,
• The information given in the directors' report is consistent with the consolidated financial statements.
PricewaterhouseCoopers LLP Chartered Accountants and Registered Auditors London 45Royal & SunAlliance Annual Report & Accounts 2006
Continuing operations Income Gross written premiums 6,264 6,237 Less: reinsurance premiums (780) (937)
Net earned premiums 5,292 5,239 Net investment return 2 600 668 Other operating income 4 121 99
Unwind of discount (42) (39) Other operating expenses 4 (151) (176)
Attributable to: Equity holders of the Parent Company (52) 555 Minority interests 32 50
Earnings per share for (loss)/profit attributable to the equity holders of the Parent Company
Ordinary dividends paid and proposed for the year Interim dividend paid (per share) 7 1.75p 1.69p Final dividend proposed (per share) 7 4.12p 3.05p
Net gains/(losses) recognised in equity 34 (2) (Loss)/profit for the year (20) 605
Assets Goodwill and other intangible assets 8 552 450 Property and equipment 9 385 410
Liabilities Loan capital 19 1,192 1,152 Insurance contract liabilities 20 12,790 17,204 Insurance and reinsurance liabilities 21 391 475 Borrowings 22 8 251
Provisions and other liabilities 1,781 2,462 16,162 21,544 Liabilities of discontinued operations 35 3,594 –
The financial statements were approved on 7 March 2007 by the Board of Directors and are signed on its behalf by: George Culmer Chief Financial Officer
Proceeds from sales or maturities of: Available for sale investments 8,166 8,788 Investment property 55 46 Property and equipment 43 13 Intangible assets 1 3 Investments in subsidiaries (net of cash disposed of) – 113 Investments in associates – 5
The insurance liabilities of an insurance company include the provision for unearned premiums and unexpired risks and the provision for outstanding claims. Unearned premiums and unexpired risks represent the amount of income set aside by the company to cover the cost of claims that may arise during the unexpired period of risk of insurance policies in force at the balance sheet date. Outstanding claims represents the company’s estimate of the cost of settlement of claims that have occurred by the balance sheet date but have not yet been finally settled.
Where possible the Group adopts multiple techniques to estimate the required level of provisions. This assists in giving greater understanding of the trends inherent in the data being projected. The Group’s estimates of losses and loss expenses are reached after a review of several commonly accepted actuarial projection methodologies and a number of different bases to determine these provisions. These include methods based upon the following: • The development of previously settled claims, where payments to date are extrapolated for each prior year,
Provisions are calculated gross of any reinsurance recoveries. A separate estimate is made of the amounts that will be recoverable from reinsurers based upon the gross provisions and having due regard to collectability.
• Uncertainty as to the extent of policy coverage and limits applicable, 50 Royal & SunAlliance Annual Report & Accounts 2006
The Group has exposures to risks in each class of business within each operating segment that may develop and that could have a material impact upon the Group’s financial position. The geographical and insurance risk diversity within the Group’s portfolio of issued insurance policies make it not possible to predict whether material development will occur and, if it does occur, the location and the timing of such an occurrence. The estimation of insurance liabilities involves the use of judgements and assumptions that are specific to the insurance risks within each territory and the particular type of insurance risk covered.
Asbestos and environmental claims The estimation of the provisions for the ultimate cost of claims for asbestos and environmental pollution is subject to a range of uncertainties that is generally greater than those encountered for other classes of insurance business. As a result, it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as with other types of claims, particularly in periods when theories of law are in flux. Consequently, traditional techniques for estimating claims provisions cannot wholly be relied upon and the Group employs specialised techniques to determine provisions using the extensive knowledge of both internal asbestos and environmental pollution experts and external legal and professional advisors.
• The tendency for social trends and factors to influence court awards,
The Group may also provide relevant representations, warranties and indemnities to counterparties on any disposal. While such representations, warranties and indemnities are essential components of many contractual relationships, they do not represent the underlying purpose for the transaction. These clauses are customary in such contracts and may from time to time lead to us receiving claims from counterparties.
Regulatory environment The regulatory environment is subject to significant change in many of the jurisdictions in which we operate. We continue to monitor the developments and react accordingly. The directors are confident that the Group will continue to meet all future regulatory capital requirements.
In addition, the Group is continuing to monitor and respond to consultation on the latest Solvency II proposals, which are intended, in the medium term, to achieve greater harmonisation of approach across European member states to assessing capital resources and requirements.
Except where otherwise stated, all figures included in the consolidated financial statements are presented in millions of British pounds sterling (£m), rounded to the nearest million.
Comparative information The comparative information has been restated as follows: • The Group has changed its accounting treatment and recognised the subordinated guaranteed perpetual notes at fair value at the date of conversion. Further information can be found in note 19,
• The US operation is classified as a disposal group at the end of 2006 and accordingly the results of the disposal group are presented as discontinued operations in the income statement. The comparative information in the 2005 results is represented as discontinued information. Further information can be found in note 35,
Consolidation Subsidiaries Subsidiaries are entities over which the Group has the power to govern the financial and operating policies so as to obtain benefits from its activities, generally accompanying a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are deconsolidated from the date that control ceases.
The Group’s shares of its associates’ post acquisition profits or losses are recognised in the income statement, and its share of post acquisition movements in reserves are recognised in reserves. The cumulative post acquisition movements are adjusted in the carrying amount of the investment. When the Group’s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate.
Adjustments are made, where necessary, to conform the accounting policies of associates to ensure consistency with the policies adopted by the Group.
• Income and expenses for each income statement are translated at average exchange rates during each period,
• All resulting exchange differences are recognised as a component of equity.
Goodwill and other intangible assets Goodwill, being the difference between the cost of a business acquisition and the Group’s interest in the net fair value of the identifiable assets and liabilities acquired, is initially capitalised in the balance sheet at cost and is subsequently recognised at cost less accumulated impairment losses.
When calculating the goodwill arising on an acquisition, claims provisions are discounted to present value. Immediately following the acquisition, the claims provisions are valued at full nominal value. This increase in liabilities is matched by the recognition of an intangible asset arising from acquired claims provisions, representing the present value of future investment income implicit in the claims discount. The intangible asset is amortised over the expected run off period and is tested in the context of the liability adequacy test of insurance liabilities where the balances of intangible assets associated with insurance contracts is deducted from the carrying amount of the insurance liabilities.
Other intangible assets comprise renewal rights, customer lists, brands and other acquired identifiable non monetary assets without physical form. Other intangible assets are carried at cost less accumulated amortisation. Amortisation is calculated using the straight line method to allocate the cost over their estimated useful lives which is normally estimated to be between three and five years.
Property and equipment Property and equipment comprise Group occupied land and buildings, fixtures, fittings and equipment (including computer hardware and motor vehicles). These assets are depreciated over their estimated useful life after taking into account residual values.
Increases in the carrying amount arising on the revaluation of Group occupied property are credited to revaluation surplus in equity. Decreases that offset the previous increases of the same asset are charged against revaluation surplus directly in equity, other decreases are charged to the income statement. Each year, the difference between depreciation based on the fair value of the asset charged to the income statement and depreciation based on the assets original cost is transferred from revaluation surplus to retained earnings.
On initial recognition, the financial assets may be categorised into the following categories: financial assets at fair value through the income statement, loans and receivables, held to maturity financial assets and available for sale financial assets. The classification depends on the purpose for which the investments were acquired. Management determines the classification of its investments at initial recognition.
Derivative financial instruments Derivatives are recognised in the balance sheet on a trade date basis and are carried at fair value. Derivatives are carried as assets when fair value is positive and as liabilities when fair value is negative. The method of recognising the resulting gain or loss depends on whether the derivative is designated as a hedging instrument and the nature of the item being hedged. Where a derivative is not designated as a hedging instrument, changes in its fair value are recognised in the income statement.
Hedging Transactions are classified as hedging transactions when the following conditions for hedge accounting are met: • There is a formal designation and documentation of the hedging relationship and the Group’s risk management objective and strategy for undertaking the hedge,
• The hedge is expected to be highly effective in achieving offsetting changes in fair value or cashflows attributable to the hedged risk, consistently with the originally documented risk management strategy for that particular hedging relationship,
• For equity securities fair values are based upon quoted market prices,
• For mortgage loans on real estate and collateral loans, fair values are estimated using discounted cashflow calculations based upon prevailing market rates, 55Royal & SunAlliance Annual Report & Accounts 2006
• For derivatives, fair values are generally based upon quoted market prices.
Recognition of income Premiums written are accounted for in the period in which the contract is entered into and include estimates where the amounts are not determined at the balance sheet date. Premiums written exclude taxes and duties levied on premiums and directly related expenses, eg commissions. Premiums are earned as revenue over the period of the contract and are calculated principally on a daily pro rata basis.
The provisions for claims outstanding, whether reported or not, comprises the estimated cost of claims incurred but not settled at the balance sheet date. It includes related expenses and a deduction for the expected value of salvage and other recoveries. The provision is determined using the best information available of claims settlement patterns, forecast inflation and settlement of claims.
The provisions for claims outstanding, and related reinsurance recoveries, are discounted where there is a particularly long period from incident to claims settlement and where there exists a suitable claims payment pattern from which to calculate the discount. In defining those claims with a long period from incident to claims settlement, those categories of claims where the average period of settlement is six years or more from the balance sheet date, has been used as a guide. The discount rate used is based upon an investment return expected to be earned by assets, which are appropriate in magnitude and nature to cover the provisions for claims outstanding being discounted, during the period necessary for the payment of such claims.
The provisions for claims outstanding relating to long term permanent disability claims in the US, Canada and Scandinavia are determined using recognised actuarial methods.
The reinsurers’ shares of each unexpired risk provision is recognised on the same basis.
Taxation Taxation in the income statement is based on profits and income for the year as determined in accordance with the relevant tax legislation, together with adjustments to provisions for prior years. UK tax in respect of overseas subsidiaries and principal associated undertakings is recognised as an expense in the year in which the profits arise, except where the remittance of earnings can be controlled and it is probable that remittance will not take place in the foreseeable future, in which case UK tax is based on dividends received.
Deferred tax is provided in full using the liability method on temporary differences arising between the tax bases of assets and liabilities and the carrying amounts in the financial statements. However, if the deferred tax arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss, it is not accounted for. Deferred tax is determined using tax rates (and laws) that have been enacted or substantially enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
Actuarial gains and losses arise from changes to actuarial assumptions when revaluing future benefits and from actual experience in respect of scheme liabilities and investment performance of scheme assets being different from previous assumptions. Actuarial gains and losses are recognised as a component of equity.
• Minus the fair value at the balance sheet date of the scheme assets out of which the obligations are to be settled directly.
Vesting conditions, other than those based upon market conditions, are not taken into account when estimating the fair value of such awards but are taken into account by adjusting the number of equity instruments included in the ultimate measurement of the transaction amount. The value of the awards are recognised as an expense on a systematic basis over the period during which the employment services are provided. The proceeds received net of any transaction costs are credited to share capital (nominal value) and share premium when the options are exercised.
Dividends to equity holders The final dividend is recognised as a liability when approved at the AGM. The interim dividend is recognised as a liability when announced.
Leases Rental income from operating leases is recognised on a straight line basis over the term of the lease. Payments made under operating leases are charged on a straight line basis over the term of the lease.
Non current assets and operations held for sale and discontinued operations Non current assets and operations are classified as held for sale if their carrying amount is to be recovered principally through a sale transaction, that is highly probable to complete within one year from the date of classification, rather than through continuing use. Such assets are measured at the lower of carrying amount and fair value less costs to sell and are classified separately from other assets in the balance sheet. Assets and liabilities are not netted. In the period where an operation is presented for the first time as discontinued, the balance sheet for the comparative prior period presented is not restated.
The Group’s consolidated balance sheet is not presented using a current/non current classification. However, the following balances are generally classified as current: cash and cash equivalents; deferred acquisition costs; and insurance and reinsurance debtors.
The remaining balances are of a mixed nature. The current and non current portions of such balances are set out in the respective notes.
(a) Published standards and amendments to published standards that are not yet effective and have not been early adopted by the Group • On 18 August 2005, the International Accounting Standards
Board (IASB) issued IFRS 7, Financial Instruments: Disclosures, and a complementary Amendment to IAS 1, Presentation of Financial Statements – Capital Disclosures. IFRS 7 requires disclosures about the significance of financial instruments for an entity’s financial position and performance. These disclosures incorporate many of the requirements previously in IAS 32. IFRS 7 also requires information about the extent to which the Group is exposed to risks arising from financial instruments, and a description of management’s objectives, policies and processes for managing those risks. The Amendment to IAS 1 introduces requirements for disclosures about an entity’s capital. IFRS 7 and the Amendment to IAS 1 have been adopted by the EU and are effective for periods beginning 1 January 2007,
• On 30 November 2006, IASB issued IFRS 8, Operating Segments, which replaces IAS 14, Segment Reporting. In doing so, IFRS 8 requires: – Identification of operating segments based on internal reports that are regularly reviewed by the entity’s chief operating decision maker in order to allocate resources to the segment and assess its performance. This is because the requirements of IFRS 8 are based on the information about the components of the entity that management uses to make decisions about operating matters,
– An explanation of how segment profit or loss and segment assets are measured for each reportable segment,
IFRS 8 is effective for annual periods beginning on or after 1 January 2009, with earlier application encouraged. IFRS 8 has not yet been adopted by the EU.
(b) Interpretations to published standards that are not yet effective and have not been early adopted by the Group The following new interpretations to existing standards have been published that are mandatory for the Group’s accounting periods beginning on or after 1 May 2006 or later periods, but that the Group has not early adopted: • IFRIC 8, Scope of IFRS 2 (effective from annual periods beginning on or after 1 May 2006). IFRIC 8 requires consideration of transactions involving the issuance of equity instruments – where the identifiable consideration received is less than the fair value of the equity instruments issued – to establish whether or not they fall within the scope of IFRS 2. IFRIC 8 has been adopted by the EU. The Group will apply IFRIC 8 from 1 January 2007,
• IFRIC 10, Interim Financial Reporting and Impairment (effective for annual periods beginning on or after 1 November 2006). IFRIC 10 prohibits the impairment losses recognised in an interim period on goodwill and investments in equity instruments and in financial assets carried at cost to be reversed at a subsequent balance sheet date. IFRIC 10 has been adopted by the EU. The Group will apply IFRIC 10 from 1 January 2007.
1. Segment reporting The Group’s internal reporting is organised into distinguishable components based on the major geographical regions in which it operates. These components represent the primary format for reporting segment information. The secondary segment reporting format is the Group’s business segments: Personal and Commercial.
Unrealised gains/(losses), impairments and foreign exchange 20 8 8 – 36 Unwind of discount (21) – (21) – (42)
Loss on disposal of subsidiaries – – – (1) (1) Share of associates net of tax – – 1 – 1
On 1 January 2007, the Group restructured the segments of the continuing operations. While the UK remained the same, the Group’s overseas business has been reorganised into International (Canada, Ireland, Italy and Scandinavia) and Emerging Markets (Latin America, Asia and the Middle East and the Baltics). Below is a memorandum of the key results for 2006 under the new structure.
1. Segment reporting continued The segment assets and liabilities at 31 December 2006 and capital expenditure for the year then ended are as follows: Central functions Continuing UK International Scandinavia and eliminations operations £m £m £m £m £m
Unrealised gains/(losses), impairments and foreign exchange 7 3 2 – 12 Unwind of discount (21) – (18) – (39)
Reorganisation costs (37) – – – (37) Benefit from change of pension scheme design 180 – – – 180 Profit on disposal of significant shareholding in Rothschilds – – – 61 61 Share of associates – (3) – – (3)
1. Segment reporting continued The restated segment assets and liabilities at 31 December 2005 and capital expenditure for the year then ended are as follows: Central functions Continuing UK International Scandinavia and eliminations operations US Total £m £m £m £m £m £m £m
Central functions Continuing Personal Commercial and eliminations operations £m £m £m £m
Capital expenditure: 62 Royal & SunAlliance Annual Report & Accounts 2006
Net realised Net unrealised Total investment Investment income gains/(losses) gains/(losses) Impairments return
Deposits, cash and cash equivalents 63 55 – – – – – – 63 55
Direct operating expenses (including repairs and maintenance) arising from investment properties were not material in 2006 and 2005.
Unrealised capital gains and losses recognised directly in equity for available for sale assets. Net realised gains/(losses) Impairments Net unrealised transferred to transferred to Net movement gains/(losses) income statement income statement recognised in equity £m £m £m £m £m £m £m £m 3. Net claims and benefits Restated £m £m
Gross claims paid 3,910 3,828 Gross changes in insurance contract liabilities for claims (152) 275 Reinsurance recoveries on loss and loss expenses paid (603) (702) Reinsurers’ share of change in insurance contract liabilities for claims 298 (12)
Other operating income 121 99 63Royal & SunAlliance Annual Report & Accounts 2006
Administration and other expenses 87 102 Reorganisation expenses 23 37 Investment expenses and charges 25 24 Amortisation and impairment of intangible assets 15 11 Foreign exchange losses 1 2
Interest expense on loan capital 80 79 Other loan interest 12 26 Other finance costs – 2
Fees in respect to pension scheme: Auditors’ remuneration in 2006 included amounts relating to the requirements of Section 404 of the Sarbanes Oxley Act.
Directors’ emoluments The aggregate emoluments of the directors, including amounts received from subsidiaries, were as follows: Emoluments of executive directors 4,257 4,056 Fees and other payments to non-executive directors 556 481
Details of directors’ remuneration and pension benefits, including that of the highest paid director (Andy Haste), are included in the directors’ emoluments. Details of directors’ interests in the Parent Company are shown in the directors’ interests.
Pension costs in 2005 included a one-off benefit of £180m due to the change in pension scheme design.
The statutory disclosure relating to discontinued operations is set out in note 35.
5. Income tax expense The tax amounts charged in the income statement are as follows: Restated £m £m
UK corporation tax is calculated at 30% (2005: 30%) of the estimated assessable profit for the year. Since the Group operates around the world, it is subject to income taxes in many different tax jurisdictions. Taxation for other jurisdictions is calculated at the rates prevailing in those jurisdictions. Of the above taxation attributable to the Group £74m (2005: £176m) relates to UK corporation tax and £96m (2005 restated: £83m) to overseas taxation.
Income tax expense 170 259 6. Earnings per share attributable to the equity holders of the Parent Company The earnings per ordinary share is calculated by reference to the profit/(loss) attributable to the equity shareholders and the weighted average of shares in issue during the year.
Profit/(loss) attributable to equity holders of the Parent Company 447 585 (52) 555 Less: Cumulative preference dividends (9) (9) (9) (9)
Weighted average number of ordinary shares in issue (thousands) 2,929,453 2,896,059 2,929,453 2,896,059 Adjustments for share options (thousands) 29,835 17,445 29,835 17,445
Ordinary dividend: Final paid in respect of prior year 3.05 2.96 89 86 Interim paid in respect of current year 1.75 1.69 51 49
8. Goodwill and other intangible assets Intangible asset arising from acquired claims Software
8. Goodwill and other intangible assets continued Intangible asset arising from acquired claims Software
Net book amount at 31 December 2005 152 47 208 43 450
Depreciation on disposals – (13) (13) Revaluation adjustment (4) – (4) Exchange adjustment – (7) (7) Transfer to discontinued operations – (5) (5)
Depreciation on disposals – (69) (69) Disposal of subsidiaries – (1) (1) Revaluation adjustment (5) – (5) Exchange adjustment – 3 3 Transfer to assets held for sale – (12) (12)
The Group occupied property was revalued on 31 December 2006 by independent valuers.
Depreciation and impairment expense of £42m (2005: £37m) has been charged to underwriting and policy acquisition costs.
10. Investment property Investment property consists of the following: £m £m
Land and buildings: Freehold and long leasehold 451 431 Short leasehold 3 4
Investment property at 31 December 454 435 11. Investments in associates The Group has the following investments in associates: Ordinary Country shareholding
Royal & Sun Alliance Insurance (Malaysia) Bhd Malaysia 45.0% Royal Sundaram Alliance Insurance Company Ltd India 26.0% Syn Mun Kong Public Company Ltd Thailand 20.0%
Some associates have been omitted from this statement to avoid providing particulars of excessive length but none materially affects the results or assets of the Group.
At the period end, the Group had pledged £651m (2005: £2,503m) of financial assets as collateral for liabilities or contingent liabilities and had accepted £1,025m (2005: £1,802m) collateral that could be sold or pledged.
Reinsurers’ share of provision for unearned premiums 189 298 Reinsurers’ share of provision for loss and loss adjustment expenses 1,738 4,108
The following changes have occurred in the reinsurers’ share of the provision for unearned premiums during the year: £m £m
Reinsurers’ share of provision for unearned premiums at 1 January 298 266
Changes in reinsurance asset (95) (22) Reinsurers’ share of portfolio transfers and acquisitions 1 35 Exchange adjustment (15) 19
Reinsurers’ share of provisions for loss and loss adjustment expenses at 1 January 4,108 4,158 Reinsurers’ share of total claims incurred 353 856 Total reinsurance recoveries received (998) (1,251) Reinsurers’ share of portfolio transfers and acquisitions (13) 21 Exchange adjustment (341) 318 Other movements 6 6 Transfer to discontinued operations (1,377) –
To be settled within 12 months 724 1,690 To be settled after 12 months 1,014 2,418 14. Insurance and reinsurance debtors £m £m
Insurance debtors comprise: Due from policyholders 950 851 Due from intermediaries 1,046 1,127
Acquisition costs deferred during the year 771 738 Amortisation charged during the year (761) (769)
Derivative assets 17 31 Other debtors 339 332 Pension scheme surplus 188 – Accrued interest and rent 128 155
Cash and cash equivalents and bank overdrafts (as reported within the cashflow statement) 2,040 1,612 Add: bank overdrafts 4 5 Less: transfer to discontinued operations (213) –
The interest bearing financial assets and financial liabilities included in cash and cash equivalents and bank overdrafts had an effective interest rate of 4.45% (2005: 4.09%) and had an average maturity of 34 days (2005: 30 days).
18. Equity and reserves continued Ordinary and preference shares During the year 6,804,499 (2005: 2,137,513) ordinary shares were issued on the exercise of employee share options for a cash consideration of £6m (2005: £2m). The Parent Company also issued 45,604,849 (2005: 20,661,210) ordinary shares during the year under the scrip dividend scheme. The total nominal value of ordinary shares issued during the year was £14m (2005: £6m).
Authorised 3,923,636,364 ordinary shares of 27.5p each (2005: 3,923,636,364 ordinary shares of 27.5p each) 1,079 1,079 300,000,000 preference shares of £1 each (2005: 300,000,000 preference shares of £1 each) 300 300
Issued and fully paid 2,987,526,642 ordinary shares of 27.5p each (2005: 2,935,117,294 ordinary shares of 27.5p each) 821 807 125,000,000 preference shares of £1 each (2005: 125,000,000 preference shares of £1 each) 125 125
The preference shares carry a right to a fixed cumulative preferential dividend of 7.375% per annum, payable in half yearly instalments, and are not redeemable. On a return of capital on a winding up (liquidation), the holders are entitled, in priority to holders of ordinary shares of the Parent Company, to receive out of the surplus assets of the Parent Company any arrears and accruals of the dividend together with the greater of the price at which the gross yield on each preference share is equal to the mean gross yield on 3.5% War Loan or such Government Stock as may be agreed (but not exceeding twice the nominal amount of the preference share) and the nominal amount of the share together with any premium paid on issue.
The holders of preference shares have the right to vote at a general meeting of the Group only if at the date of the notice of the meeting the dividend payable on the share is in arrears or otherwise on a resolution to vary the rights attaching to the preference shares.
The Royal & SunAlliance ESOP Trust No 2 holds ordinary shares in the Parent Company, which may subsequently be transferred to employees including executive directors. At 31 December 2006, the Trust held 4,938,894 ordinary shares (2005: 4,938,894) in the Parent Company with a nominal value of £1m (2005: £1m) and a mid market value, based on the market value of the Parent Company’s shares at the close of business on 29 December 2006 as shown in the Official List of the London Stock Exchange, of £8m (2005: £6m).
Subordinated guaranteed US$ bonds 37 285 Subordinated guaranteed Euro bonds 335 341
Total dated loan capital 372 626 Subordinated Sterling perpetual guaranteed bonds 301 – Subordinated guaranteed perpetual notes 519 526
On 20 April 2006, the Parent Company also announced a tender for any or all of the outstanding $500m Yankee Bonds. Yankee Bonds with a nominal value of $708,000 were tendered for settlement on 22 May 2006.
New Bonds were issued under an offer to exchange any or all of the Yankee Bonds. This exchange improves the regulatory capital position of the Group by replacing the Yankee Bonds, which do not qualify as regulatory capital, with an innovative Tier 1 regulatory capital instrument under the FSA’s General Prudential Sourcebook. This exchange is not accounted for as an extinguishment of the original financial liability (Yankee Bonds) and the recognition of a new financial liability (New Bonds) because the discounted present value of the cashflows under the terms of the New Bonds (including net fees paid) discounted using the effective interest rate of the Yankee Bonds, is less than 10% different from the discounted present value of the remaining cashflows of the Yankee Bonds. The carrying value of the Yankee Bonds exchanged at the date of the exchange became the carrying value of the New Bonds issued in the exchange. After charging expenses directly relating to the exchange of £3m, the carrying value of the New Bonds immediately after the exchange was £222m. The nominal value of the New Bonds issued in the exchange transaction is £297,279,000.
In addition to the New Bonds issued under the exchange, New Bonds with a nominal value of £77,721,000 were issued at par for cash consideration of £77m net of directly related expenses of £1m on the same terms as the New Bonds issued under the exchange. In total, New Bonds with a nominal value of £375,000,000 were issued on 12 May 2006.
During 2005, the terms of the subordinated guaranteed perpetual notes were revised with the effect that their classification under IFRS changed from being equity instruments to debt instruments. In the 2005 financial statements, the reclassification was accounted for as an exchange transaction as the underlying terms of the notes were not substantially impacted by the variation in terms and there were no changes in the holders of the notes immediately before and immediately after the change. During 2006, the International Financial Reporting Interpretations Committee (IFRIC) provided guidance on its understanding of accounting for such a change in terms. The directors have considered the IFRIC’s deliberations and concluded that the Company should change its accounting treatment. The accounting treatment now recognises the impact of the revision of the terms of the notes as if the revision had given rise to a redemption of the equity instrument in exchange for a debt instrument, which is measured at the fair value of the notes at the date of the revision. The carrying value of the notes included in the 2005 results has been increased by £81m and a corresponding deferred tax asset of £24m has been recognised in accordance with this revised accounting treatment. Opening shareholders’ funds have been restated by the net amount of £57m, of which £24m was recognised through the statement of recognised income and expense and £81m was recognised directly in equity.
The bonds and the notes are contractually subordinated to all other creditors of the Parent Company such that in the event of a winding up or of bankruptcy, they are to be repaid only after the claims of all other creditors have been met.
Changes in provision for unearned premiums 79 (4) Gross portfolio transfers and acquisitions 10 41 Exchange adjustment (96) 61 Transfer to discontinued operations (25) –
Provision for losses and loss adjustment expenses at 1 January 14,203 14,288 Claim losses and expenses incurred 3,877 4,451 Total claims payments made in the year, net of recoveries (4,748) (5,225) Gross portfolio transfers and acquisitions 4 (15) Exchange adjustment (773) 637 Other movements 67 67 Transfer to discontinued operations (2,809) –
Assumptions The total value of outstanding claims provisions less related reinsurance recoveries before discounting amounted to £8,655m (2005: £10,843m).
20. Insurance contract liabilities continued Claims development tables The tables below present changes in the historical general insurance provisions that were established in 2001 and the general insurance provisions arising in each subsequent accident year. The tables are presented at current year cumulative average exchange rates and have been adjusted for operations disposed of and discontinued operations.
The top triangle of the tables presents the estimated provision for ultimate incurred losses and loss adjustment expenses at the end of each accident year as at each balance sheet date.
The estimated provision for ultimate incurred losses changes as more information becomes known about the actual losses for which the initial provisions were set up and as the rate of exchange changes. The 2006 redundancy/(deficiency) presents the claims development of earlier accident years incurred in the current accounting period. The redundancy/(deficiency) is equal to the current estimate of cumulative claims less the cumulative claims paid.
Consolidated claims development table gross of reinsurance £m £m £m £m £m £m £m
Three years later 10,184 2,900 2,507 Four years later 10,516 2,814 Five years later 10,968
Three years later 1,213 302 231 Four years later 760 191 Five years later 528
Reconciliation to the balance sheet Current year provision before discounting 4,023 677 840 998 1,437 2,275 10,250 Exchange adjustment to closing rates (154) Discounting (627) Annuities 352
Present value recognised in the balance sheet 9,821 76 Royal & SunAlliance Annual Report & Accounts 2006
Loans from credit institutions of £nil at 31 December 2006 (2005: £233m) under committed credit facilities have been classified by reference to the earliest date on which repayment may be demanded by the lender. At 31 December 2006, total committed credit facilities available to the Group were £500m (2005: £233m), of which £nil (2005: £233m) expire within one year and £500m (2005: £nil) expire within two to five years.
The weighted average interest rate on short term borrowings at 31 December 2006 was 5.81% (2005: 5.79%).
23. Current and deferred tax continued The following are the major deferred tax liabilities and assets recognised by the Group and their movements during the year: Deferred tax assets Retirement Other
Deferred tax liabilities Claims Other equalisation Revaluation of temporary reserves investments differences Total £m £m £m £m
Deferred tax liabilities at 31 December 2006 109 109 101 319
Fair value reserves in shareholders’ equity Available for sale financial assets (2) (28) Group occupied property (2) (5) Retirement benefit obligations (74) 24
At the balance sheet date, the Group had unused tax losses of £653m (2005: £1,812m) available for offset against future profits. A deferred tax asset has been recognised in respect of £14m (2005: £4m) of these losses. No deferred tax asset has been recognised in respect of the remaining £639m (2005: £1,808m) due to the unpredictability of future profit streams. Included in unrecognised tax losses are losses of £39m (2005: £1,086m) which will expire between 2007 and 2024. Other losses may be carried forward indefinitely.
Of the above, £173m is due to be settled outside of 12 months (2005: £468m).
Defined contribution pension schemes Costs of £30m (2005: £28m) were recognised in respect of defined contribution schemes by the Group. The Group’s Swedish subsidiaries are part of a multi employer defined benefit scheme along with other financial institutions in Sweden. As it is not possible to determine the assets and liabilities in respect of any one employer under this plan, it is included in these accounts as a defined contribution plan in accordance with Section 30 of IAS 19. Contributions of £9m were paid to this plan during 2006 and are included in the costs shown above. The latest information regarding the funding of this plan is taken from the interim report for the first half of 2006, when the scheme funding rate was 118%. The Group’s Swedish subsidiaries’ share of the total multi employer plan was less than 15%.
26. Retirement benefit obligations continued Defined benefit pension schemes and other post retirement benefits The major defined benefit pension schemes are located in the UK. The assets of these schemes are held mainly in separate trustee administered funds. The US defined benefit schemes are included in discontinued operations.
The major defined benefit schemes are subject to regular valuation using the projected unit method which is the basis of the pension cost in the consolidated income statement. Independent, qualified actuaries carry out valuations of the major defined benefit schemes for the purposes of assessing pension costs.
Deficit at 1 January (472) (713) Total pension (expense)/credit (34) 121 Employer contribution 203 215 Actuarial gain/(loss) 226 (74) Exchange adjustment 18 (21) Transfer to discontinued operations 91 –
Continuing operations – the amounts recognised are as follows: Restated UK Other Total Total £m £m £m £m
Expected return on scheme assets (255) (13) (268) (238) Past service cost 15 – 15 5 (Gains)/losses on curtailment (4) 1 (3) (182)
The actuarial gains/(losses) recognised in equity is as follows: Continuing Discontinued UK Other operations operation Total Total £m £m £m £m £m £m
Present value of funded obligations 4,560 207 4,767 5,334 Present value of unfunded obligations 6 65 71 105
To be settled within 12 months (86) – (86) (86) To be settled after 12 months 188 (70) 118 (387)
26. Retirement benefit obligations continued The following is a reconciliation of the Group’s retirement benefit obligation: £m £m
Retirement benefit obligation at 1 January 5,439 4,939 Current service costs 60 74 Past service cost/(benefits) 15 (6) Interest costs 255 256 Contributions by scheme participants 3 10 Actuarial (gain)/loss on obligations (234) 508 Gain on curtailments (9) (188) Benefits paid (248) (229) Exchange rate adjustment (82) 75 Transfer to discontinued operations (361) –
Pension scheme assets at 1 January 4,967 4,226 Return on scheme assets 280 691 Contributions by the employer 203 215 Contributions by scheme participants 3 10 Benefits paid (248) (229) Loss on settlement (1) – Exchange rate adjustment (64) 54 Transfer to discontinued operations (270) –
Additional information for the current annual period and previous two annual periods: £m £m £m
At 31 December Present value of defined benefit obligation 4,838 5,439 4,939 Fair value of plan assets 4,870 4,967 4,226
26. Retirement benefit obligations continued Expected return on plan assets The weighted average expected return on assets across the Group for 2006 was 6.0% (2005: 6.1%). The expected return on plan assets is determined by considering best estimates for the expected long term real rates of return from the main asset classes and from rates of return assumed elsewhere within the operation of the business.
Mortality rate The mortality assumptions are set following investigations of the main schemes’ recent experience by the scheme actuaries for their funding valuations. The mortality assumptions adopted for the main UK schemes used the PMA92 and PFA92 mortality tables for males and females respectively, with age ratings to reflect the schemes’ recent experience compared with that expected under these tables.
Commutation Each of the UK defined benefit pension schemes have changed their rules to allow for increased commutation following ‘A day’ in April 2006. The commutation factors are currently under review, but it is expected that the final factors will be cost neutral on the IAS 19 basis (ie when valued on the IAS 19 basis, the amount of cash taken is approximately equal to the value of the pension being given up). For this reason there is no change made to previous practice whereby the accounting valuation makes no allowance for commutation.
Post retirement medical benefits The valuation of liabilities for post retirement liabilities in Canada assumes 9% decreasing to 5% in eight years for drugs (2005: 10% decreasing to 5% in 9 years) and 4% (2005: 4%) for hospitals and 3% (2005: 3%) for other.
Sensitivity analysis The discount rate and the assumed inflation rate both have a significant effect on the IAS 19 accounting valuation. A 0.1% increase in the discount rate would reduce the defined benefit obligation in the UK by £78m. A 0.1% increase in the inflation rate assumption would increase the defined benefit obligation in the UK by £68m.
The effect of an increase of one percentage point and the effect of a decrease of one percentage point in the assumed medical cost trend rates on the following is set out below: 1% increase 1% decrease £m £m £m £m
Aggregate of the current service cost and interest components of net periodic post employment medical costs 0.4 0.3 0.3 0.3
Accumulated post employment benefit obligation for medical costs 2.8 3.1 2.3 2.5 27. Share based compensation The Group has five types of share based payment plans which are settled in the form of ordinary shares: the Executive Share Option; the Equity Incentive Scheme for US Employees; the International Sharesave Plan; the Share Matching Plan; and the 2006 Long Term Incentive Plan. Dilution levels for all schemes are held strictly within ABI limits.
In addition, in the US there are a number of cash settled share based payment plans.
The total employment cost recorded in the income statement for all plans was £13m in 2006 (2005: £9m). These costs include the costs associated with plans which are settled in the form of ordinary shares for awards that have been granted after 7 November 2002. The value of equity settled awards granted prior to this date have been excluded in accordance with the transitional provisions contained in IFRS 2.
Executive Share Option Scheme and Equity Incentive Scheme for US Employees The Group operates an Executive Share Option Scheme and an Equity Incentive Scheme for US Employees, which provide options to purchase ordinary shares to officers and other key employees at prices not less than the fair value of the ordinary shares at the date of grant. The exercise of awards made under the Equity Incentive Scheme for US Employees can be accelerated dependent on the performance of the US subsidiary to between one and three years.
Options exercisable at year end 18,177,779 260.39 17,140,769 336.66 *Price refers to weighted average exercise price in sterling (pence).
Weighted Weighted average average remaining Weighted remaining Weighted Number contractual life average Number contractual life average
Fair values for the options granted under the schemes during 2005 were estimated as of the date of grant using the Black Scholes pricing model with the following weighted average assumptions: dividend yields of 5.0%; expected volatilities of 50%; risk free interest rates of 4.4%; expected terms of five years for Executive Share Option Scheme grants made prior to the 2003 AGM, four years for Executive Share Option Scheme grants made after the 2003 AGM and four years for grants made under the Equity Incentive Scheme for US Employees; and the assumption that all performance criteria are expected to be met. An estimate based on past experience is made of the number of forfeitures during the vesting period due to employees leaving the Group. The actual share price at 31 December 2006 was 152.50p (2005: 125.75p).
27. Share based compensation continued International Sharesave Plan Under the Group’s International Sharesave Plan (savings related) eligible employees can receive options to purchase ordinary shares at a price equal to 80% of the fair value of the ordinary shares on the date of grant. All options vest either three or five years from the grant date and expire six months after vesting. The number of shares available for purchase from the plan by each participant is limited to the whole number of shares purchasable from the aggregate value of the individual’s savings contract upon maturity. An individual’s maximum monthly contribution to all current savings contracts is £250.
Additional information with respect to the Group’s International Sharesave Plan at 31 December is as follows: Shares Price* Shares Price*
The following share options under the International Sharesave Plan are outstanding or exercisable as of 31 December: Options outstanding
Range of exercise prices of shares (years) exercise price* of shares (years) exercise price*
Fair values for the options granted under the International Sharesave Plan were estimated as of the date of grant using the Black Scholes pricing model with the following weighted average assumptions: dividend yields of 3.5% (2005: 5.0%); expected volatilities of 35% (2005: 50%); risk free interest rates of 4.8% (2005: 4.2%); and expected terms equal to the vesting terms of three or five years. An estimate based on past experience is made of the number of forfeitures during the vesting period due to employees leaving the Group. The actual share price at 31 December 2006 was 152.50p (2005: 125.75p).
27. Share based compensation continued Share Matching Plan The Group’s Share Matching Plan for executive directors and other selected executives was adopted following approval obtained at the 2004 AGM. Awards were made during 2004 and 2005 and the awards granted in 2005 were the final awards under the plan.
Additional information with respect to Deferred and Matching Share awards at 31 December is as follows: Shares Shares
Outstanding Deferred Share awards at 31 December 3,433,720 4,075,168 Potential Matching Share awards 8,230,850 12,225,504
Awards of Performance Shares and Matching Shares related to compulsory Deferred Shares are subject to a performance condition consisting of a combination of a return on equity target and a total shareholder return target (with performance measured by comparison against other European insurance companies) over a single three year performance period. Matching Shares related to voluntary Deferred Shares are subject only to the return on equity performance condition. Restricted Shares are not subject to performance conditions. All awards vest on the third anniversary of the date of grant to the extent that the performance conditions have been met.
Further information on the 2006 Long Term Incentive Plan may be found in the remuneration report.
Under the 2006 Long Term Incentive Plan, the weighted average estimated fair value of each Restricted Share award granted by the Company in 2006 was 114.81p. The fair value of each voluntary Deferred Share award was £nil and the fair value of each potential associated Matching Share was 126.00p. The fair value of each compulsory Deferred Share award was 127.00p and the fair value of each potential associated Matching Share was 87.85p. The fair value of each Performance Share award granted was 88.71p. The total fair value of the awards granted under the plan in 2006 was £18m.
Fair values of the awards granted under the 2006 Long Term Incentive Plan during 2006 are taken to be the share price on the day preceding the grant date, except for the Restricted Shares where the share price is reduced by an estimate of the value of dividends that will not be received. A dividend yield of 3.5% was assumed. Market related performance criteria were based on an arithmetic mean estimate of performance against a specified group of 13 competitors; and it is assumed that all non market related performance criteria would be met such that all awards would vest. An estimate based on past experience is made of the number of forfeitures during the vesting period due to employees leaving the Group.
Other share based payments In the US, there are plans under which awards have been granted to certain employees in the form of cash settled share based awards. Under these plans, if the vesting conditions are satisfied, cash awards are made based upon the underlying performance of the Company’s ordinary shares. Awards were made in 1999 and 2001 under old schemes and during 2004 and 2005 on terms that provide the same potential benefits as the Share Matching Plan. The liability in respect of these plans at 31 December 2006 was £2m (2005: £1m). The intrinsic value of awards that had vested at 31 December 2006 was £nil (2005: £nil).
28. Management of risks As an insurance company, the Group is fundamentally concerned with the management of risk. This note, which has been adjusted for the discontinued operations, summarises these risks and the way the Group manages them.
The Group employs a comprehensive risk management framework to identify, assess, manage and monitor the risks arising as a result of operating the business. The framework includes a comprehensive suite of risk policies, procedures, measurement and monitoring techniques and a series of stress tests and scenario analyses to ensure that the Group’s exposures do not exceed risk appetite.
The Group manages its financial assets within a framework that has been developed to seek to ensure the ability to meet its obligations under insurance and investment contracts. A key principle behind this process is to hold assets that provide a broad match against the liabilities arising from insurance and investment contracts.
The Group manages its exposure to insurance risk through the Board Risk Committee (BRC) which considers aggregation of risk and establishes how much risk the Group is willing to assume. The BRC also oversees an emerging risk identification process, including the identification of emerging issues and the setting of these into risk scenarios as part of an overall process of self appraisal.
Further discussion on underwriting risk and pricing, estimation of claims provisions, emerging and legal risks and aggregation of risks is set out below.
• Make appropriate decisions within their area of competence and authority limits,
• Apply suitable terms and conditions in order to manage the portfolio,
All of the Group’s underwriters have specific licenses that set clear parameters for the business they can underwrite, based on the experience of the individual underwriter. Additionally, the Group has a centrally managed forum looking at Group underwriting issues, reviewing and agreeing underwriting direction and setting policy and directives where appropriate. The Group has a quarterly portfolio management process across all its business units, which provides a consistent assessment of each portfolio performance against a set of key performance indicators. Under the portfolio management system, key risk indicators are tracked to monitor emerging trends, opportunities and risks and on an annual basis a review forum of business and underwriting leaders undertake a detailed review of each portfolio utilising data from the quarterly review.
• Provides an emerging risk identification process, including the identification of emerging issues and the setting of these into risk scenarios for consideration by the regions as part of an overall process of self appraisal, 89Royal & SunAlliance Annual Report & Accounts 2006
Specific considerations in relation to casualty insurance risks and property insurance risks are set out below: Casualty insurance risks The Group manages these risks through its underwriting strategy, adequate reinsurance arrangements and proactive claims handling. The underwriting strategy attempts to ensure that the underwritten risks are well diversified in terms of type and amount of risk, industry and geography.
Reinsurance arrangements in place include excess, stop loss and catastrophe coverage. The effect of such reinsurance arrangements is that the Group should not suffer total net insurance losses of more than a specified amount in any one year. In addition to the overall Group reinsurance programme, individual business units are permitted to purchase additional reinsurance protection.
The Group has the right to reprice the risk on renewal. It also has the ability to impose deductibles and reject fraudulent claims. These contracts are underwritten by reference to the commercial replacement value of the properties and contents insured, and claims payment limits are always included to limit the amount payable on occurrence of the insured event. Cost of rebuilding properties, of replacement or indemnity for contents and time taken to restart operations for business interruption are the key factors that influence the level of claims under these policies. The greatest likelihood of significant losses on these contracts arises from storm, flood damage or other weather related incidents. The Group has reinsurance cover for such damage to limit losses.
The Group uses a variety of statistical techniques and a number of different bases to set reserves, depending on the business unit and line of business in question. Our reserving managers consider claims developments separately for each line of business and subdivide certain lines of business by major claim types or sub classifications of business. Large claims impacting each relevant account are also generally assessed separately; either being reserved at the face value of the loss adjusters’ estimates or projected separately in order to allow for the future development of large claims.
In forming its collective judgment, the Committee will consider this information as a whole.
Our reserving managers regularly review reserves for both current and prior accident years using the most current claims data. These reserve reviews incorporate a variety of actuarial methods and judgements and involve extensive analysis. For most lines of business a variety of actuarial methods are reviewed and the reserving managers select methods and specific assumptions appropriate for each line of business based on the current circumstances affecting that line of business. These selections incorporate input from claims personnel, underwriters and operating management on reported claims trends and other factors that could affect the reserve estimates.
Based on the results of the reserve reviews and after consideration of other factors such as the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular line of business, we determine the appropriate level of reserves to book.
The Group is a multi line, multi national property and casualty insurer. It is therefore subject to reserve uncertainty stemming from a number of conditions, including but not limited to those noted above, any of which could be material at any point in time for any line of business. Certain issues may become more or less important over time as conditions change. As various market conditions develop, we must assess whether those conditions constitute a long term trend that should result in a reserving action (ie increasing or decreasing the reserve).
In the UK, asbestos liabilities have emerged most frequently in the employers’ liability line. This coverage indemnifies individuals injured in the workplace. The effect of reinsurance purchased against large individual losses is reduced by the often multi year nature of the liabilities which means a deductible for each year of exposure applies.
28. Management of risks continued UK risks written in the UK The majority of business in this area is employers’ liability (EL) written through our UK Commercial business with a small amount of public and products liability. The underlying method for the estimation of asbestos requirements for UK EL depends critically on establishing a model of all expected deaths from asbestos related disease, which is then adjusted to allow for the delay between claim and death of claimant. Calibration of the resultant model to Group experience of reported claims allows an estimate of future numbers of claims against the Group to be produced.
US risks written in the UK US asbestos exposure arises from a variety of sources including: London market ‘direct’ business written through Marine operations many years ago, inward reinsurance exposures also written through the London market and from participation in UK aviation pools.
The expertise within the Group on catastrophe modelling is shared through the Worldwide Reinsurance Practice Group, which also provides an overview of the company wide catastrophe exposures and reinsurance adequacy. A reinsurance programme is considered to be ‘adequate’ only if it covers at least 199 out of 200 possible events by loss size. This is referred to as the ‘1 in 200 year expected maximum loss’. Since 1999, the Group has set its total retention for a single catastrophic event based on geographic location.
The operations of the Group are responsible for buying reinsurance to protect their results against catastrophes and for determining their own retentions. The Group Corporate Centre reviews the operations’ proposed catastrophe purchases to check that they at least meet the Group’s ‘1 in 200 year’ standard. Group Corporate Centre also checks to see that total Group exposures are within the limits set out above and also are consistent with the required risk based capital. As a result, the Group may decide to purchase further catastrophe coverage at the Group level.
28. Management of risks continued Reinsurance risk The Group reinsures a portion of the risks underwritten to control exposure to losses, to reduce volatility and protect capital. The Group’s reinsurance strategy is to purchase reinsurance in the most effective manner from reinsurers who meet its security standards.
In selecting the reinsurers with whom the Group does business, the Group uses the following principles: • Its strategy is to seek reinsurers with the best combination of credit rating, price and capacity. The Group publishes internally a list of authorised reinsurers who pass its security review process and which its operations may use for new transactions,
• The Group reviews the financial security of each of its reinsurers having regard to the work of rating agencies and specialist advice from other sources, such as the counterparty risk assessment units of its reinsurance brokers,
• As part of this review work, the Group assesses public ratings of its reinsurers. Reinsurers that have a Financial Strength Rating of less than ‘A–’ with Standard & Poor’s, or a comparable rating with AM Best, are removed from the Group’s authorised list unless the Group’s own review discovers exceptional circumstances in favour of the reinsurer. Further, if a rating agency reduces a reinsurer’s rating, the Group carries out its own review of that reinsurer to see whether it should remain on the list of authorised reinsurers,
• The BRC sets targets for the credit profile of reinsurers on the Group’s treaty purchases,
• The Group limits the credit risk exposure to individual captive reinsurers, with whom it deals as part of the commercial lines business, by analysis of their finances and controlling the maximum exposure to each captive each time the reinsurance contract is renewed,
Ceded treaty S&P rating Ceded treaty S&P rating premiums at premiums at
HDI Group 66 AA- 56 AA– Lloyd’s of London 64 A 44 A Munich Re Group 43 AA- 280 A+ Renaissance Re Holdings 25 A+ 37 A+ Swiss Re Group 50 AA- 37 AA
During 2006, over 99% of the Group’s property and casualty treaty cessions by premium were to reinsurers that had a Standard & Poor’s financial strength rating of at least ‘A–’ or better, or equivalent from AM Best, as at the start date of the contract.
Certain of the Group’s subsidiaries are members of government mandated pools in various parts of the world. As of 31 December 2006, the largest pool (by premium volume) was Pool Re operated by the UK Government to provide terrorism cover.
Reinsurance counterparties are subject to a rigorous internal assessment process on an ongoing basis to ensure that their creditworthiness continues to be satisfactory. Collateral is taken to mitigate exposures where appropriate to the size or credit quality of the exposure. Further discussion on credit risk arising from reinsurance ceded is discussed within the section on reinsurance risk.
Insurance operations credit risks are incurred on a devolved basis with regional operations undertaking the responsibility for assessing and monitoring the creditworthiness of their counterparties (eg brokers and policyholders). Local credit committees are responsible for ensuring these exposures are within the risk appetite of the local operations within the overall financial control framework. Exposure monitoring and reporting is embedded throughout the organisation with aggregate credit positions reported at Group level. Invested assets credit risk is discussed in more detail below.
Cash and cash equivalents 1,831 1,617 Debt securities 8,568 11,609 Other financial assets 155 146 Short term investments 114 95 Derivative assets 17 31 Insurance debtors 1,996 1,978 Reinsurance debtors 229 569 Reinsurers’ share of insurance contract liabilities 1,927 4,406 94 Royal & SunAlliance Annual Report & Accounts 2006
28. Management of risks continued The Group’s investments comprise a broad range of financial investments issued principally in the UK, US and Scandinavia. The mix of investments and their carrying values which include fixed maturities and equity securities is set out below.
28. Management of risks continued Less than One to Two to Three to Four to Greater than One year two years three years four years five years five years Total £m £m £m £m £m £m £m
Financial liabilities Borrowings: Amounts owed to credit institutions – unsecured: Under committed credit facilities 233 – – – – – 233
Subordinated guaranteed US$ bonds – – – – – 285 285 Subordinated guaranteed Euro bonds – – – 341 – – 341 Subordinated guaranteed perpetual notes (restated) – – – – – 526 526
The Group Investment Committee (GIC), on behalf of the Group Board, is responsible for reviewing and approving the investment strategy for the Group’s investment portfolios. It provides approval for all major changes of the Group’s investment strategy and, in particular, approves any substantive changes to the balance of the Group’s funds between the major asset classes. Importantly the GIC also approves the terms of reference of the Group’s main operational investment committee, the Group Asset Management Committee (GAMC). The BRC issues GAMC with risk limits.
28. Management of risks continued The Group sets appropriate risk limits to ensure that no significant concentrations to individual companies or sectors arise. The Group takes a long term view in selecting stocks and looks to build value over a sustained period of time rather than churning the portfolio looking for short term gains from its equity holdings.
Property price risk The Group’s portfolio of properties is subject to property price risk arising from changes in the market value of properties. Thus if the value of property falls so will the fair value of the portfolio as set out in the sensitivity analysis.
Foreign currency exchange risk The Group operates in 27 countries. Accordingly, its net assets are subject to foreign currency exchange rate movements. The Group’s primary foreign currency exposures are to the US$, Canadian$, Danish kroner, Swedish krona and Euro. If the value of the British Pound strengthens then the value of non British Pound net assets will decline when translated into British Pounds and consolidated.
The Group incurs exposure to foreign currency exchange risk in two ways: • Operational foreign currency exchange risk – by underwriting liabilities in currencies other than the currency of the primary environment in which the business units operate (non functional currencies),
Derivatives The Group may use derivative financial instruments for the purpose of reducing its exposure to adverse fluctuations in interest rates, foreign exchange rates and equity price risk. The Group does not use derivatives to leverage its exposure to markets and does not hold or issue financial instruments for speculative purposes. Forward contracts are used to reduce the risk of adverse currency movements on certain forecast future cash transactions. The policy on use of derivatives is approved by BRC.
Less than One to More than one year five years five years 2006 2005 2006 2005 £m £m £m £m £m £m £m
Equity/index Asset 12 – – 12 8 see below see below Liability 21 – – 21 17 see below see below
Notes to the financial statements continued 98 Royal & SunAlliance Annual Report & Accounts 2006
28. Management of risks continued At 31 December 2006, there were derivative contracts in place to protect the value of the UK equity portfolios of the Group. These provided limited protection against declines in market levels whilst also capping participation in any appreciation of the market. In total, this strategy covered an underlying equity value of approximately £800m. The impact of these derivatives as of 31 December 2006 if world equity markets decreased by 15% would be to decrease the impact of the decline by £41m (2005: £18m).
Currency markets (note 4): Decrease of major currencies versus British pound of 15% (1,315) (1,154)
2. The sensitivity of the bond assets of the Group has been modelled by reference to a reasonable approximation of the average interest rate sensitivity of the investments held within each of the portfolios.
4. The effect of currency movements on investments is reflected as a one time decrease in the value of major currencies against the British pound on 1 January 2007 and 1 January 2006.
The limits are monitored at a Group level as part of the Group Risk exposure monitoring and BRC reporting process.
United Kingdom Royal Insurance Holdings plc (note 1) Holding company Royal & Sun Alliance Insurance plc General insurance British Aviation Insurance Company Limited (57.1%) General insurance The Globe Insurance Company Limited General insurance The Marine Insurance Company Limited General insurance Martello Underwriting Limited General Insurance Royal International Insurance Holdings Limited General insurance Royal & Sun Alliance Reinsurance Limited General insurance Sun Alliance and London Insurance plc General insurance Sun Insurance Office Limited General insurance
Argentina Royal & Sun Alliance Seguros (Argentina) SA (note 2) General insurance
Chile Royal & Sun Alliance Seguros (Chile) SA (99.4%) (note 3) General insurance
Denmark Codan A/S (71.7%) (note 4) Holding company Codan Forsikring A/S (71.7%) (note 4) General insurance
Norway Duborgh Skadeforsikring AS (71.7%) (note 4) Insurance brokerage White Label Holding AS Group (71.7%) (note 4) Holding company
United States of America Royal & Sun Alliance USA, Inc Holding company Royal Indemnity Company General insurance Royal Surplus Lines Insurance Company General insurance Security Insurance Company of Hartford (note 5) General insurance
Venezuela Royal & Sun Alliance Seguros (Venezuela) SA (99.8%) General insurance
2. Merged with La Republica Compania Argentina de Seguros Generales SA.
3. Merged with Compania de Seguros Generales Cruz del Sur SA.
Investments 45 Intangibles 8 Cash and cash equivalents 11 Other assets 17 Insurance contract liabilities (36) Other liabilities (22)
Goodwill is individually assessed on each acquisition. The goodwill shown above arose from the premium paid for strengthening our market position in targeted business segments and acquiring the skilled workforce to drive future profitability in those segments. Goodwill also represents the future cost saving from expected synergies and economies of scale.
The consideration in regard to EGI Holdings Limited is provisional consideration dependent on the net asset value in the finalised completion accounts.
Net profit for the year before tax on continuing operations 649 894 Adjustments for: Fair value losses (including loss on disposal) on property and equipment 1 – Fair value gains (including gain on disposal) on investments (38) (166) Fair value gains (including gain on disposal) on investment property (53) (51) Impairment charge on available for sale financial assets 3 5 Share of profit from associates (1) (3) Loss/(profit) on disposal of subsidiaries 1 (65) Foreign exchange (gain)/loss (34) 25 Amortisation of available for sale investments 78 62 Other non cash movements 193 28
Movement in working capital (505) (261) Movement in deferred acquisition costs (14) 19
Cash generated from continuing operations 320 376 101Royal & SunAlliance Annual Report & Accounts 2006
Bank loan guarantees In Canada, the Group guarantees outstanding loan repayments in the event of bank loan default by broker subsidiaries and special relationship brokers. The bank loan guarantees amount in total to £7m (2005: £9m) and have a term of up to 10 years. It is not anticipated that any of the brokers will default, and full recourse is available on any default. Scandinavia has financial and performance guarantees totalling £2m (2005: £2m). The fair value of the guarantees did not materially impact the consolidated financial position of the Group.
One year or less 55 58 2 5 Between one and five years 184 179 2 2 After five years 158 162 – –
On 4 March 2007, the Group announced the completion of the disposal of its US operations to Arrowpoint. The disposal will be recognised in the Group’s financial statements for 2007.
An analysis of the result of discontinued operations, and the result recognised on the remeasurement of assets of the disposal group is as follows: £m £m
Assets Goodwill on acquired claims provisions 10 Property and equipment 2 Total investments 1,591 Reinsurers’ share of insurance contract liabilities 1,377 Insurance and reinsurance debtors 250 Deferred acquisition costs 5 Other debtors and other assets 37 Cash and cash equivalents 213
35. Discontinued operations, non current assets and assets and liabilities of operations held for sale continued Employee information Staff costs for employees comprise: £m £m
Taxation There was no deferred income tax charged to equity during the year.
Other disclosures not included elsewhere in these financial statements are as follows: Related party transactions As stated earlier, the Group is selling its US operation to Arrowpoint Capital, a company set up by the US management team. This transaction is undertaken on normal commercial terms and conditions.
Earnings per share attributable to the equity shareholders The earnings per ordinary share is calculated by reference to the profit/(loss) attributable to the equity shareholders and the weighted average of shares in issue during the year. Further details on calculation are set out in note 6, Earnings per share attributable to the equity holders of the Parent Company.
Loss attributable to equity holders of the Parent Company (499) (30) Less: Cumulative preference dividends – –
Weighted average number of ordinary shares in issue (thousands) 2,929,453 2,896,059 Basic earnings per share (p) (17.1)% (1.0)%
Weighted average number of ordinary shares in issue (thousands) 2,929,453 2,896,059 Adjustments for share options (thousands) 29,835 17,445
We have audited the Parent Company financial statements of Royal & Sun Alliance Insurance Group plc for the year ended 31 December 2006 which comprise the Parent Company balance sheet, statement in changes in equity of the Parent Company, the Parent Company cashflow statement and the related notes. These Parent Company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the remuneration report and the directors’ interests that are described as having been audited.
We have reported separately on the consolidated financial statements of Royal & Sun Alliance Insurance Group plc for the year ended 31 December 2006.
Our responsibility is to audit the Parent Company financial statements and the parts of the remuneration report and the directors’ interests to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). This report, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with Section 235 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the Parent Company financial statements and the parts of the remuneration report and the directors’ interests to be audited. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the Parent Company financial statements, and of whether the accounting policies are appropriate to the Company’s circumstances, consistently applied and adequately disclosed.
Opinion In our opinion: • The Parent Company financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union as applied in accordance with the provisions of the Companies Act 1985, of the state of the Company’s affairs as at 31 December 2006 and cashflows for the year then ended,
• The information given in the directors' report is consistent with the Parent Company financial statements.
The separate financial statements were approved on 7 March 2007 by the Board of Directors and are signed on its behalf by: George Culmer Chief Financial Officer 107Royal & SunAlliance Annual Report & Accounts 2006
Ordinary Ordinary Preference Revaluation redemption guaranteed Retained Total share capital share premium shares reserves reserve perpetual debt earnings equity £m £m £m £m £m £m £m £m
Prior year adjustment (note 5) – – – – – – (57) (57)
Changes in equity for the year ended 31 December 2005 (restated) Capital Subordinated
Profit for the year – – – – – – 476 476 Dividends – paid (note 7) – – – – – – (144) (144) Issued by scrip 5 13 – – – – – 18 Issued for cash 1 1 – – – – – 2 Share options – – – – – – 9 9 Fair value gains/(losses) net of tax – – – 974 – – – 974 Reclassification to loan capital (note 5) – – – – – (444) (81) (525) Tax on reclassification to loan capital – – – – – – 24 24
Proceeds from issue of share capital 6 2 Dividends paid (87) (126) Proceeds from issuance of long term borrowings 74 –
Cash and cash equivalents at end of the year 2 –
In accordance with Section 230 of Companies Act 1985, the Company’s income statement and related notes have not been presented in these separate financial statements.
The investments in subsidiaries are recognised in the balance sheet at fair value measured in accordance with the Company’s accounting policies. Fair value of the Company’s significant subsidiary is determined by reference to the market value (derived from relevant indices) of the Company’s ordinary shares and loan capital instruments at the balance sheet date, being the most transparent independent available indicator. The market value is adjusted for the fair value of the Company’s preference shares, assets and liabilities, excluding directly owned subsidiaries. The adjusting items have been fair valued by determining the present value of future cashflow projections, using an appropriate arms length discount rate. The remaining subsidiaries are held at fair value which has been determined to be net asset value.
Other prepayments and accrued income 3 3 Other debtors 3 4
Total other debtors and other assets 6 7 4. Share capital Full details of the share capital of the Company are set out in note 18 to the consolidated financial statements.
The following are the major deferred tax liabilities and assets recognised by the Company and their movements during the year: Deferred tax liabilities Other temporary differences £m
Deferred tax liabilities at 1 January 2005 (14) Transferred to a subsidiary company 14
Other Accelerated temporary Reclassification capital differences of bonds allowances Total £m £m £m £m
At the balance sheet date, the Company has unused tax losses of £4m (2005: £4m) available for offset against future profits. No deferred tax asset has been recognised in respect of the tax losses of £4m (2005: £4m) due to the unpredictability of future profit streams. The losses may be carried forward indefinitely.
The aggregate current tax relating to items that are credited to equity is £2m (2005: £2m).
Net profit for the year before tax 111 450 Realised losses – 2 Foreign exchange (profit)/loss (29) 7 Dividends received – (590) Changes in operating assets/liabilities (19) 19
Receivable from related parties: Receivable from subsidiaries, interest bearing loans 1,009 955 Receivable from subsidiaries, non interest bearing 203 194
Interest is charged on interest bearing loans, which are repayable on 24 hours written notice, at three month LIBOR + 0.6%.
Disabled shareholders Royal & SunAlliance is committed to providing a quality service to all of its shareholders. An induction loop is installed at the AGM venue. Please contact the Company Secretary’s department at the registered office at the address above.
Share price The Company’s share price is shown on Ceefax BBC1 page 230 and on Teletext Ch4 page 519. It is also available on the Company’s website www.royalsunalliance.com.
Share and shareholder analysis Royal & SunAlliance is listed on the London Stock Exchange under the code RSA. The average total daily trading volume during 2006 was approximately 24m shares. The opening market price on 3 January 2006 was 128p and closing market price on 29 December 2006 was 152.5p. The highest daily closing price was 154.75p on 21 November 2006 and lowest daily closing price was 118.25p on 17 January 2006. Further details of the ordinary and preference shares are found in note 18 on page 73.
■ UK 61% ■ Europe 14% ■ USA & Canada 18% ■ Asia & Others 7%
Please quote the company reference number 0059 and your shareholder account number (on your share certificate or dividend tax vouchers) when contacting or corresponding with Lloyds TSB Registrars.
Should you have an enquiry relating to the above please contact the Investor Relations department at Royal & Sun Alliance Insurance Group plc, 9th Floor, 1 Plantation Place, 30 Fenchurch Street, London EC3M 3BD. Telephone: +44 (0)20 7111 7136.
Ex dividend date for the ordinary final dividend for 2006 and the first preference dividend for 2007
Record date for the ordinary final dividend for 2006 and the first preference dividend for 2007
Announcement of the scrip dividend price for the ordinary final dividend for 2006
Deadline for sending scrip dividend mandates to Lloyds TSB Registrars (in relation to ordinary final dividend for 2006)
Announcement of the interim results for the six months ended 30 June 2007, the ordinary interim dividend for 2007 and the second preference dividend for 2007 15 August 2007* Ex dividend date for the ordinary interim dividend for 2007 17 August 2007* Record date for the ordinary interim dividend for 2007 23 August 2007* Announcement of the scrip dividend price for the ordinary interim dividend for 2007 29 August 2007* Ex dividend date for the second preference dividend for 2007 31 August 2007* Record date for the second preference dividend for 2007 2 October 2007* Payment date for the second preference dividend for 2007 2 November 2007* Deadline for sending scrip dividend mandates to Lloyds TSB Registrars (in relation to ordinary interim dividend 2007)
30 November 2007* Payment date for the ordinary interim dividend for 2007 *provisional date
Important disclaimer This document may contain “forward-looking statements” (as defined in the US Private Securities Litigation Reform Act of 1995) with respect to certain of the Company’s plans and its current goals and expectations relating to its future financial condition, performance and results. By their nature, all forward-looking statements involve risk and uncertainty because they relate to future events and circumstances which are beyond the Company’s control, including amongst other things, UK domestic and global economic business conditions, market-related risks such as fluctuations in interest rates and exchange rates, the policies and actions of regulatory authorities, the impact of competition, inflation, deflation, the timing impact and other uncertainties of future acquisitions or combinations within relevant industries, as well as the impact of tax and other legislation and other regulations in the jurisdictions in which the Company and its affiliates operate. As a result, the Company’s actual future financial condition, performance and results may differ materially from the plans, goals and expectations set forth in the Company’s forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, save in respect of any requirement under applicable law or regulation.
Q I have recently moved house – who should I tell? A Please notify Lloyds TSB Registrars in writing at the address given on page 115. Remember to state clearly your old address. If you hold shares in joint names, the letter must be signed by the first named person on the share certificate. If you have previously registered for the Shareview portfolio service, you can log onto www.shareview.co.uk and change your address electronically.
Q My share certificate has been lost/stolen. How do I get a replacement?
Q I would like to receive future communications electronically – how can I arrange this?
Q Why do I receive multiple sets of information whenever you send anything to me?
A If you have acquired shares on more than one occasion, your holdings may have been recorded on the register of shareholders with slightly different details. As a result, two or more accounts may have been set up for you. Sometimes multiple accounts are necessary, eg if you hold shares in your own name and also in joint names with a partner. However, sometimes multiple accounts can be amalgamated. Please contact Lloyds TSB Registrars to discuss whether your accounts can be amalgamated.
A You will need to supply your bank or building society account details to Lloyds TSB Registrars. You can obtain a dividend payment mandate form from Lloyds TSB Registrars. A copy of the form is also attached when dividend cheques are mailed out.
Q Can I receive shares in lieu of cash dividends? A The Company offers a scrip dividend scheme, which allows ordinary shareholders to receive new ordinary shares of 27.5p each instead of cash dividends. The scrip dividend scheme applies to both interim and final dividends, and enables shareholders to increase their holdings in the Company without incurring dealing costs or stamp duty. Please telephone Lloyds TSB Registrars on +44 (0)870 600 3988 for further information.
Q I would like to transfer shares to somebody I know. How do I arrange this?