About the Hiscox Group 2 Corporate highlights 3 Why invest in Hiscox? 4 Chairman’s statement 7 Chief Executive’s report 13 Hiscox business structure 14 Actively managed business mix 15 Actively managed key underwriting exposures 16 Capital
Governance and remuneration 23 Risk management 28 Corporate responsibility 30 Insurance carriers 34 Board of Directors 36 Corporate governance 39 Directors’ remuneration report 47 Directors’ report 48 Directors’ responsibilities statement
5% Large property 2% Global errors and omissions 10% Specialty – terrorism, specie, political risks, aerospace 8% Marine and energy 18%Local errors and omissions and commercial 3%Tech and media errors and omissions 14%Art and private client 7%Specialty – kidnap and ransom, contingency, personal accident 5%Small property
Profit before tax (m)Net asset value p per share Dividend p per share
Robert Childs replaces Robert Hiscox as Chairman on 26 February 2013; Richard Watson now Chief Underwriting Officer
UK retail business delivers another good profit of £45.2 million (2011: £49.0 million)
Capital return of £200 million (50.0p per share including final dividend) by way of B share scheme
Additional special distribution of 38.0p per share (approximately £150 million) combined with share consolidation
Our people Specialist expertise that is valued by our customers We are market leaders in many of our specialist areas and our customers value the expertise and cover we provide.
What our UK customers said:* 97% of home insurance customers were satisfied that we answered their questions and provided the information they needed today; 94% of our home insurance customers surveyed were satisfied with the service they received.
Hiscox won Company of the Year at the 2012 London Market Awards, recognising the strength of the business over the previous 18 months. Robert Hiscox was presented with a lifetime achievement award at both the 2012 London Market Awards and the 2012 Insurance Insider awards.
* Results from our monthly customer satisfaction survey for customers telephoning one of our UK-based contact centres. ** Results from a survey of 301 existing household/commercial brokers in Belgium, France, Germany and the Netherlands, 1 January 2012 – 31 December 2012.
We are a leading specialist insurer with: balance that creates opportunity throughout the cycle; strong financial performance; a transparent approach to risk; specialist expertise that is valued by our customers.
Our performance Strong financial performance Hiscox has a strong record of top-line growth with a focus on ROE. Performance highlights between 2008 and 2012 include: increased gross written premiums by 36.5% to over £1.5 billion; healthy combined ratio averaging 87.3%; delivered average ROE of 14.9%; maintained a progressive dividend policy with compound growth of 9.0%; returned additional £150 million of capital.
The quality of our people has been a key ingredient in our success
Hiscox’s reputation for innovation and dynamism has been built in large part on the energy, professionalism, commitment and expertise of our employees.
In September, Hiscox conducted its fifth global employee engagement survey. Open to all permanent members of staff, it looks at how committed employees feel to Hiscox, their managers, their teams and their role. In 2012 our survey shows Hiscox enjoys high employee engagement as we average in the top 85th percentile when compared with 127 companies based around the world. Particularly pleasing was our ‘intent to stay’ score which was in the in the 95th percentile.
profit to shareholders which will have a favourable impact on both the Group premium to capital gearing ratio and return on capital, whilst still providing sufficient headroom above existing internal and external capital needs. This proposed return of capital will be made by way of a B share scheme and will be combined with a share consolidation.
Full details of the proposed return of capital and final dividend equivalent will be set out in a circular expected to be despatched to Hiscox shareholders on or around 26 February 2013.
The basic underwriting strategy When I stopped underwriting for our Lloyd’s Syndicate in 1988, the ‘retail’ account of relatively simple insurance business was 50% of the portfolio, the balance being internationally traded reinsurance and large insurance business. That balance remains roughly the same to this day, albeit over a larger and more diverse Group.
The catastrophe and major loss business currently looks very volatile with international political unrest and more disturbed weather patterns. This is an opportunity for us as it keeps demand up and the weaker competitors away.
It is a nostalgic moment to be writing my last Chairman’s report, and pleasing to be able to announce a solid profit. The year had its catastrophic moments, but as we grow bigger and more balanced, we can absorb Mother Nature’s punches and the vicissitudes of accidents and criminal acts with greater ease.
Dividend, balance sheet and capital management The Board has reviewed the capital requirements of the Group for the coming year and has proposed that a special distribution of 38.0p per share (amounting to approximately £150 million), should be made. This will reduce capital levels close to those of the 2012 opening balance sheet, effectively distributing all of this year’s
Marketing I have always firmly believed that if you are good at what you do you should make every effort to spread that good news to potential clients. I think our marketing has done just that and I must congratulate Steve Langan who heads our UK retail side and masterminds our worldwide marketing. It has made us stand out from the crowd, has given us standards to live up to, has pulled in a great amount of business and has been a very good investment.
IT I bore my colleagues by banging on that we should be an IT company with insurance attached, not an insurance company which uses IT. We are good at underwriting which we have done overall successfully for 112 years, but the next era will be dominated by IT, from an increasing competitive advantage from management information, especially in calculating underwriting rates, to distribution of policies. The company with the best IT and the ability to use it well will win.
Investments Investment income has contributed on average 50% of our profits in the past, but today’s low interest rates make that impossible in the near future without phenomenal risk taking. The low returns from the bulk of our portfolio of Government bonds give little protection against the potential volatility from any risk assets we own. David Astor, our Chief Investment Officer, works tirelessly to eke extra yield without undue risk and has nearly hit that 50% this year despite difficult conditions.
Insurance politics The year has seen us conquer the burden of Solvency ll and I think achieve greater harmony with our regulator, freeing us up to get on with making money. The financial burden of the implementation of Solvency ll on us and the industry has been considerable. After 48 years of assessing risks, which is what underwriting is, it was surreal to have a one size fits all model for assessing the risks in the business inflicted on us in minute detail by actuarially driven regulators, combined with corporate governance diktats imposing huge expectations on nonexecutive directors combined with an extra layer of risk assessment staffing.
The London Market division also writes a successful balancing book of non-catastrophe business in London and through other offices worldwide.
Retail insurance business The accounts that we call ‘retail’ business are very close to my heart as when I underwrote at the box, I built up those accounts leaving the larger risks to my partner Nicholas Thomson. I always thought that the retail accounts were worth building up for their stability. In 1988 we set about widening our distribution to nonLloyd ’s brokers and into Europe, and later in 1996 we bought an insurance company to take the retail account. We paid £28 million for the company (including a £6 million premium over assets) which seemed a high price, and I remember being warned by our investment banker that we were betting the bank. It is highly satisfactory to see the UK and European businesses make a profit of nearly £50 million this year. A pretty good investment.
The growing retail accounts are very important to us as they give stability to our profitability and add real value as steady profits are rated at a greater multiple. We have invested heavily into them both in terms of money and effort as we believe them to be core to our building a balanced and steadily more valuable business.
We are well aware of the graveyard of businesses which have expanded overseas, so having expanded in the sophisticated (but battered) economies of Europe and the US, we will consider any expansion east or to other emerging economies with great caution. It will happen when the right opportunity arises.
Chairman’s statement continued and to help the regulator I wish that all entities involved in general insurance, from the ABI, the International Underwriters Association, the Chartered Insurance Association and Lloyd’s, would form a General Insurance Body to be a strong lobby and, to an extent, a selfregulating body. We in the industry know when a competitor is going to go bust as we trade against them and see the folly; we ought to have a system of warning the regulator. And we desperately need a strong lobby to fight for us in the corridors of power. For instance, when a very senior politician starts attacking the insurance industry for its performance over flood damage, someone needs to hit back very hard with the truth.
The next era I set out to run an honest business, to choose the best people to help me run the business, and to pick honest and careful clients who we would treat with great integrity and efficiency. The ability to pick the right people is to me the most important talent in all of life. My first major delegation was to Nicholas Thomson who was a brilliant underwriter and we owe him a huge debt of gratitude for the strong underwriting discipline he instilled. The next major delegation was to Bronek Masojada who joined in 1993 as Managing Director to help run the company and took the reins as CEO in 2000. Like an Oscar winner I would like to mention a whole host of others who have been indispensable, especially Alec Foster who handled our Lloyd’s members in the early days and invested all our money so wisely, but space does not permit.
Our strategy remains to build balance and diversification within the business. We saw good growth in the London Market, Bermuda and particularly the United States. Profits flowed from our London Market, UK, Bermuda and Guernsey businesses, offsetting the ongoing investment in the United States.
Hiscox London Market Hiscox London Market business remains a powerhouse. Exceptional underwriting and a well-diversified portfolio have delivered a profit of £121.9 million (2011: £57.6 million) with every division contributing. Gross premium income grew by 9.3% to £640.0 million (2011: £585.4 million). The business achieved a combined ratio of 75.5% (2011: 89.1%) despite Superstorm Sandy and some large individual claims such as Costa Concordia. I review each division in turn below.
Property: Our property division delivered a good profit. It grew strongly in US small commercial, personal and onshore energy lines and was only marginally affected by Superstorm Sandy. The fire, theft and collision insurance book performed less well. This business tends to be less catastrophe exposed and so should be a source of stable profits within the division. We will be working hard to achieve this in 2013.
Marine and energy: The team had a good year with profits and growth in offshore energy more than offsetting the Costa Concordia loss which is expected to settle at net $20 million. To the wider industry this loss has deteriorated, mainly due to the rising costs of removing the wreck. As the world becomes more environmentally conscious this type of expense will continue to increase, and we expect this to be reflected in future premiums for marine liability and related risks. In addition our offshore energy team has performed exceptionally well.
Hiscox UK: Our UK business made another excellent profit of £45.2 million (2011: £49.0 million) despite spending more on marketing and paying record flood losses. The business benefited from a good investment return and good underwriting. Growth in commercial product lines offset the cancellation of two high net worth underwriting partnerships, resulting in an increase in revenues of 2.2% to £375.2 million (2011: £367.1 million). The progress in our core lines is set out below: The high net worth business delivered a strong profit despite the largest single loss in its history – a London house fire. Premium income shrank slightly, reflecting the previously announced withdrawal from two partnerships which did not live up to expectations. We also experienced the greatest level of flood activity in our history, paying claims to the value of £14 million in flood and storm losses. You only find out the worth of your insurer when you make a claim so it is pleasing that during this busy year our team lived up to its reputation for excellence, winning ‘The British Insurance Awards Customer Care’ accolade. In the competitive luxury motor market we reached maturity with a second year of profit, our service and brand setting the team apart.
The direct business continues to propel the brand. We increased our marketing spend in the year by £4 million and returned to TV with an advertising campaign that promotes our ethos of trust, honesty and fair customer service. An unexpected outcome has been the strength with which our broker partners have identified with this message, reinforcing our relationships. The direct household products have been held back by challenges within our online platform hampering our flexibility in pricing. We are investing in 2013 and beyond to address this. Our commercial products continue to move ahead despite an increasingly competitive market. Again the brand and our service reputation are real differentiators. Competitors can copy our wordings, but these more intangible elements are real protective moats to our business.
Casualty: The casualty market remains a challenging place and we continue to reduce our lines as the rates on offer remain inadequate. We do, however, believe that ultimately economic sanity will prevail and the market will inevitably harden. In preparation, during the course of 2012 we recruited several senior staff to build on our existing team. The division has performed well at the bottom line, as we have benefited from releases in prior years – demonstrating our prudent approach to reserving.
Hiscox UK and Hiscox Europe In 1987 we took our first step into UK retail business (or local specialty insurance) moving into Continental Europe in 1993. By 2012 our businesses had expanded materially, writing premium income of £507.5 million (2011: £498.0 million) and delivering a profit of £49.1 million (2011: £51.5 million). There is plenty of room to grow in these markets and I remain confident that we have the products, expertise and brand to continue to expand.
gaps in our current model, working direct and in partnership with specialist commercial brokers who don’t have inhouse private client expertise but who want to offer a Hiscox Home Insurance policy to their clients. We also announced our plans to open a multi-function office in York during 2013, with progressive in-sourcing of some of our direct customer service centres. We have had effective relationships with our outsourcing partners for over a decade, but we feel that the next stage in our journey requires greater control over critical aspects of our customer service.
We continue to see opportunity in Europe. Partnerships with major financial institutions have performed well and are expanding from their commercial focus to high net worth personal lines. We also expect in time to see the broader brand benefit from our direct activities. We were on French TV for the first time ever in 2012. This supported our small direct business, and is also, reflecting our UK experience, driving brand recognition and perception in the broker channel. We will be launching a direct business in Germany in 2013, and I am confident that, in time, the German and French business will replicate the success we enjoy in the UK.
Hiscox Bermuda: Our main focus in Bermuda is on reinsurance with an emerging presence in healthcare. Revenues grew by 11.5% to $318.1 million (2011: $285.2 million). Profits grew substantially despite the cost of Superstorm Sandy. This performance reflects strong growth in the reinsurance business with a focus on areas like Japan, Thailand and Australia which were particularly affected by natural catastrophes in 2011. Healthcare made steady progress.
The reinsurance market is evolving and we must change with it. New forms of capital are entering the industry, selling collateralised policies or buying catastrophe bonds issued by cedents like Hiscox, in competition with traditional markets. For a number of years we have invested in a small portfolio of catastrophe bonds issued by cedents. In 2012 we invested in a fund managed by Third Point Reinsurance Investment Management Ltd and took a stake in the firm. After all, a catastrophe bond is no more than a reinsurance contract and a bond investment linked together. We will also be ceding tailored portfolios of catastrophe reinsurance exposure to the fund. We need to adapt as the market adapts and this helps us to do so.
The day-to-day delivery of services to brokers, customers and within the Group is continually improving. As the company grows, we can never be satisfied and will continue to look at ways to improve processes and minimise expenses. We have undertaken various lean management initiatives across the Group in 2012 including: improving how we operate our small commercial insurance lines in Europe, introducing a clientfocused underwriting centre in the US and significantly increasing the amount of time underwriters spend on broker activity in the UK through the creation of virtual teams aligned to each UK region. Each of these steps has progressively improved service reliability and predictability. In 2013 the focus will be on using the momentum of 2012 to maintain service whilst reducing cost.
Investments Hiscox’s focus on property-related insurance means that our invested assets, when measured relative to our premium income, are lower than the industry average. Despite this, investment income has historically accounted for about 50% of our profits. We began the year with cautious expectations, given the low interest rate environment and our view that a lot could have gone wrong during the year. However, our worst fears were not realised and, with a fair wind from central banks, the investment result exceeded our expectations – and accounted for 42.6% of our profits, only just below the longer-term average. We achieved a total return of £92.7 million before derivatives equating to a yield of 3.1% (2011: £25.9 million, 0.9%).
Our asset allocation changed little during the year. In the bond portfolios, duration was kept short and a healthy weighting towards non government bonds was maintained. We made some alterations to the selection of equity and hedge fund managers but our overall exposure remained constant at around 6% of assets. With the words and actions of central bankers reassuring investors that interest rates would be kept low and a financial upheaval, particularly in Europe, would not be tolerated, a ‘risk on’ mentality eventually prevailed. This served us well as non government bonds and equities were much in demand. Our bond portfolios all beat their benchmarks and benefited from the narrowing of credit spreads and, unlike the previous year, there was not much opportunity cost to being short duration. The risk assets portfolio produced particularly strong returns both in absolute terms and relative to market indices.
A lot of detailed analysis has been done to support this decision, but in essence we feel that we started the year in a strong capital position, and looking forward we can see that our prospective profits will generate enough capital to support our growth so that there was no need to retain our after-tax profits for the year.
The Board undertook a thorough selection process in recruiting Robert’s successor. I am delighted that they have chosen Robert Childs, our Chief Underwriter who has been with us for 26 years. This decision has been greeted very warmly within Hiscox and the industry.
Beyond the more visible Chairman’s succession, we have made some other senior executive moves. In June Richard Watson returned from the US, where he served as Chief Executive, to become Deputy Chief Underwriter and he now succeeds Robert Childs as Group Chief Underwriter. Richard made a major contribution to shaping our US business, setting it on a successful path. His experience managing the London Market business and a more retail environment in the US makes him well placed to oversee our underwriting culture. Ben Walter replaced Richard Watson as Chief Executive of Hiscox USA. Ben joined us two years ago as Chief Operating Officer of Hiscox USA from the fund management industry. Gary Head, the Chief Underwriter of Hiscox UK, has moved to the US to serve as its Chief Underwriter. Charles Dupplin returned to the UK from Bermuda where he served as Chief Executive of Hiscox Bermuda, and Group Company Secretary. He will continue as Head of M&A and Special Projects, a role he had in Bermuda, but which received less attention with his other responsibilities. Jeremy Pinchin has succeeded Charles as CEO of Hiscox Bermuda and Company Secretary, whilst remaining Group Head of Claims. All of these moves have entailed personal challenges for the individuals and their families and I am grateful for the sacrifices they have made to help us build our business.
Building a balanced business Gross premiums written at 100% level (£m)
Fine art; high-value household; errors and omissions; directors and officers’ liability; specialty commercial; technology/media; kidnap and ransom; terrorism; direct to customer commercial business
15Actively managed key underwriting exposures Hiscox Ltd Report and Accounts 2012
Realistic disaster scenarios, Hiscox Ltd The table below presents selected realistic disaster scenarios based on our book of business in force at 1 January 2013 and industry data. Given the nature of the risks underwritten, the loss estimates may be materially different than those that arise depending on the size and nature of the event.
This chart shows a modeled range of net loss the Group might expect from any one castastrophe event. The white line between the bars depicts the modeled mean loss.
However, the Group can source additional funding through a revolving credit and Letter of Credit facility. Additional funding from these sources comprised $875 million at 31 December 2012 (2011: $750 million).
The rating agency capital requirements shown in the chart below are based on the Group’s own internal projections of the requirements based upon its 2013 business plan. The A.M. Best capital requirements stated are also consistent with the latest assessment received from A.M. Best in November 2012, which also took into consideration the 2013 business plan.
The BSCR model applies factors to premium, reserves and assets/liabilities to determine the minimum capital required to remain solvent throughout the year.
Internal capital requirements The chief determinant of our capital requirement in 2013 is our own internal risk appetite which is more restrictive than any external measure.
The Group manages the underwriting portfolio so that in a 1 in 250 aggregate bad year it would lose no more than 15% of the Group’s core capital plus assigned buffer capital (currently £100 million). A market loss at this remote return period would be very big indeed and would certainly bring about positive market changes. The Group would be well positioned in the resulting strong market with capital in the order of £1 billion in addition to its LOC facilities and its now well-developed reinsurance partnerships.
Rating agency requirements are an internal projection, by Hiscox, based upon the 2013 business plan. The Hiscox internal risk appetite reflects Hiscox’s goal of maximising its return on capital within accepted levels of risk. All capital requirements have been normalised, with respect to variations in the allowable capital in each assessment, for comparison to a consistent available capital figure.
Net asset value per share increased by 8.1% to 349.7p (2011: 323.5p). The Group continues to maintain a progressive dividend policy and total dividend per share rose by 5.9% to 18.0p (2011: 17.0p), subject to shareholder approval of the final dividend equivalent. Following a review of the Group’s capital position, it is proposed to make a further special distribution, subject to shareholder approval, through the B share scheme of 38.0p per share.
Gross premiums written of £1.56 billion were up 8.0% year-on-year. Strong growth in the property, reinsurance, aviation and local E&O and commercial lines were offset in part by a decline in art and private clients. The Group’s combined ratio including foreign exchange was 85.5% (2011: 99.5%).
This has been a good year for the Group in the investment markets, with the Group’s investments producing a return of 3.1% (2011: 0.9%). All asset classes outstripped their benchmarks.
The net claims ratio improved significantly to 46.0% (2011: 89.9%) with only Superstorm Sandy as a larger event during the year compared to the multiple catastrophe events in 2011. The impact on the combined ratio was an improvement of 44.7% to 89.2% (2011: 133.9%).
Net cash outflows from financing activities for the year were £60.8 million (2011: outflow
£67.3 million). The outflow is due to payment of dividends to shareholders, with less scrip dividends having been taken up in the year.
The Group maintains relationships with a limited number of banks, whose credit status and ability to meet day-to-day banking requirements are monitored by the Group. The bank facility was renegotiated during the year up to $875 million. There was no cash drawn down on the banking facility during the year.
Solvency II Solvency II is the new solvency regime for all European insurers and reinsurers. It aims to create solvency requirements that are consistent across all European member states which better reflect the risks that insurers and reinsurers face.
The Bermuda Monetary Authority (BMA) has begun supervising the Group, under the new Group Supervisory Framework. The new framework places a regulatory capital requirement upon the Group for the first time. Testing of the new standards was undertaken during 2012 in which the Group had sufficient capital to meet requirements. The BMA continues to work towards Solvency II equivalence.
Group investments The Group’s invested assets at 31 December 2012 totaled £3.06 billion (2011: £2.87 billion). Continued positive cash flow accounted for the increase in assets under management during the year. The investment result, excluding derivatives, amounted to £92.7 million (2011: £25.9 million) equating to a return of 3.1% (2011: 0.9%).
We approached 2012 with a good degree of scepticism and in the knowledge that events in the Eurozone, together with concerns over the potential for the US and Chinese economies to disappoint, could lead to a modest and volatile investment return. In the event these fears proved to be unfounded and nearly all asset classes appreciated in value as central bankers rode to the rescue, ensuring there was ample liquidity where necessary and pursuing monetary policy designed to keep interest rates artificially low along much of the yield curve. This support from their central banks enabled politicians to kick various cans down the road. Indeed, when there was a deadline for a political decision to be made, America did its best to alarm markets before averting the worst impact of the much heralded fiscal cliff. The ‘do whatever it takes’ and openended nature of the language accompanying various official statements in the latter half of the year provided fresh impetus to the equity rally and further compressed yields in bond markets. Against this background the Group’s investment return comfortably exceeded initial expectations.
With a healthy allocation to non government bonds, the fixed income portfolios beat their benchmarks and generated much better returns than last year as they benefited from both the marked narrowing of spreads that occurred across a broad credit spectrum and, to a lesser degree, a further small decline in government bond yields. Mortgage backed securities (‘MBS’), mostly concentrated in the US Dollar portfolios, provided the main source of outperformance. The Federal Reserve added agency MBS to the list of bonds that they would purchase in significant quantities, whilst non agency MBS made further gains, given their attractive yields and a background of a generally improving US housing market. The proportion of the portfolio invested in this area has declined steadily in recent years with principal repayments at par. However, following the strong recovery in prices of the underlying bonds, some outright sales were made, further reducing the overall exposure. Corporate bonds, in general, did well but the bank debt, where we remained focused on the national champions and the senior part of their capital structure, outperformed following the reduction in ‘tail risk’ engendered by the central banks. The margin of outperformance in the other currency portfolios was less but all of the managers did well, largely due to their credit exposure.
The allocation to risk assets, which was maintained at approximately 6% of invested assets throughout the year, made a solid contribution to returns. The changes that have been made to the selection of funds that we invest in has borne fruit and the blend of long only and equity based hedge funds returned 14.8%, with both categories exceeding their respective benchmarks.
There were no dramatic tactical shifts during the year, with surplus liquidity being invested in line with the asset allocation that prevailed at the end of 2012. We have not dropped our guard in matters of credit and the quality of our bond portfolios remains high with over 90% of securities rated single A or better. Sovereign bonds whose price depends largely on the prospect of support from the ECB were absent from our portfolio throughout the year. Conservative levels of cash were maintained for the payment of claims and general corporate purposes, with further liquidity being available from lines of credit which remained available and undrawn for cash purposes throughout the year. Cash continues to be invested with a focus on safety rather than yield.
Whilst there are some grounds, looking ahead, to believe that economic activity is set to improve and the risks of a financial mishap are reduced, we still think that, on balance, it is a time for caution. The effects of financial repression have meant that the yields of the bond portfolios have declined over the year and there is little scope for further capital gain. Stretching for yield is an option but there is not much to be gained from taking duration risk and much to be lost when interest rates rise. On credit, we are wary of straying back into below investment grade securities at levels which may look relatively attractive in the short-term, but have limited upside and will perform more like equities when the tide turns. We are however prepared to take a modest amount of selective risk in order to avoid having a portfolio that is condemned to producing little by way of return. This is currently concentrated in the equity allocation where, even after recent gains, they represent a likely source of excess returns over time. Volatility in equity markets remains but so does their reasonable valuation and attraction relative to other assets. Given the above, our sights for the investment return in 2013 are set fairly low.
Group investments Hiscox Ltd Report and Accounts 2012 21 22.0% Cash 71.8% Bonds 6.2% Risk assets
The Group risk management framework The Risk Committee of the Board advises our Directors on how best to manage the Group’s risk profile. Our risk appetite is set by the Board and fed through to our divisions through the risk management framework, which is made up of a number of committees, including: Group Underwriting Review Reserving Committees Cash Flow Review Group Reinsurance Security Committee Broker Credit Committee Investment Committee Operational Risk Committee.
The responsibilities of our senior management are clearly defined, as are our reporting lines, and where responsibilities are delegated the Board and its committees closely monitor their activity, aided by financial and non-financial management information.
Pricing discipline: We are firmly resolved to reject business that is unlikely to generate underwriting profits. Accepting risks below their technical price is detrimental to the industry as it can drive market rates down to a point where underwriting losses mount, insurers’ capital is destroyed causing some businesses to fail, customers to receive poor service and the industry to suffer negative publicity. Remuneration: Hiscox incentivises underwriters on return on equity, rewarding staff for profit not revenue.
Risk management: We believe the likelihood that we may be unable to meet our liabilities, or that we incur excessive costs in doing so, is extremely remote, because of our risk management measures. Forecasting: Most of our cash inflows and outflows are routine and can be forecast well in advance. Our primary source of inflows is insurance premiums while our outflows are largely expenses and payments to policyholders through claims. We forecast our cash flow for the week, month, quarter or up to two years ahead, depending on the source. Cash: Available cash is invested according to the Group’s investment policy and our cash requirements can normally be met through our regular income streams: premiums, investment income, existing cash balances or by realising investments that have reached maturity. Stress tests: We run tests to estimate the impact of a major catastrophe on our cash position in order to identify potential issues. We also run scenario analysis that considers the impact on our liquidity should a number of adverse events occur simultaneously, such as an economic downturn and declining investment returns combined with unusually high insurance losses. Credit: We maintain extensive borrowing facilities. These arrangements have been made with a range of major international banks to minimise the risk of one or more of the institutions being unable to honour their commitments to us. Liquid assets: Our investment policy recognises the demands created by our underwriting strategy, so that some investments may need to be realised before maturity or at short notice. Hence a high proportion of our investments are in liquid assets, which reduces our risk of making losses because we may have to sell assets quickly.
Vetting and auditing: All binding authorities we grant are closely controlled through tight underwriting guidelines. We vet all our agents prior to appointment and monitor and audit them regularly. Agents are frequently audited to ensure they meet our standards.
We buy reinsurance to protect us from large single claims as well as the aggregate effect of many claims resulting from catastrophes. The risk is that our reinsurers are unable to meet their obligations to us, which would put a strain on our earnings and capital.
Our reporting currency is Sterling, but a significant proportion of our underwriting activities is located in the US and Europe. In addition the capital bases of our insurance companies in Bermuda, Guernsey and US are in US Dollars. Therefore, movements in foreign exchange rates may have a material adverse effect on our financial performance and position.
We are an international insurance and reinsurance group that operates in numerous markets around the world.
Currency matching: As the US Dollar is the Group’s largest underwriting currency, our policy is to match our US Dollar insurance liabilities with investments held in that currency to minimise any losses from currency fluctuations. We will hold a percentage of our capital in the matching currency of that part of our underlying business, where it is deemed appropriate. Currency hedging: We closely monitor our net currency positions and will enter into currency hedges if we anticipate adverse movements in exchange rates. Further details of the Group’s investment profile and its management of currency risks are provided in notes 3 and 19 to the consolidated financial statements.
Careful management: We have identified the key aspects of our business that are critical to maintaining our ratings. These are closely managed to minimise the risk of an event, or change in strategy, that might jeopardise our ratings. Communication: Regular and open communication with the major credit rating agencies helps to ensure we continue to meet their expectations.
Disaster recovery planning: A formal disaster recovery plan is in place to deal with workspace recovery and the retrieval of communications, IT systems and data should a major problem occur. These procedures would enable us to move the affected operations to alternative facilities quickly. The plan is tested regularly and includes simulation tests.
Risk assessment: Identifying, planning for and controlling emerging risks is an important part of our risk management activity across all aspects of our business, including underwriting, operations and strategy. We make a significant effort to identify material emerging threats to the Group. It is a core responsibility of each of our risk committees and we believe we take all reasonable steps to minimise the likelihood and impact of emerging risks and to prepare for them in case they occur.
For the third year in a row, Hiscox UK has been carbon neutral. Our carbon footprint has improved by approximately 5% in comparison to the last audited year. The balance of our carbon emissions is offset through an investment in an African Energy Efficient Stove Project in Kenya. Replacing open fires with energy efficient stoves in villages throughout the area results in reduced firewood and therefore carbon emissions. The stoves more than halve the amount of smoke from firewood, benefiting family health. For more information, please go to www.hiscox.com.
Our sustainability efforts have also been recognised by the City of London Corporation. The London office was recently awarded Platinum in the Clean City Award scheme.
The marketplace Hiscox won Company of the Year at the 2012 London Market Awards, recognising the strength of the business over the previous 18 months. Robert Hiscox was presented with a lifetime achievement award at both the London Market Awards and the Insurance Insider awards in 2012.
Dealing with investors In keeping with our policy of open and transparent communication, Hiscox reports both its half and full year results to investors via a series of presentations as well as ensuring all relevant Group financial information is available on the corporate website. In addition, senior management and key employees meet investors and analysts throughout the year to explain and answer questions on the Group financial performance and business strategy.
The workplace Hiscox Spain gained recognition for Best Workplace 2012 as awarded by Great Place to Work.
Culture The Hiscox culture is underpinned by a set of core values that determine a standard
The community Hiscox donated £768,000 to charities in 2012. In 2012 Hiscox Bermuda continued to support Centre Against Abuse which provides shelter, support and tools to those affected by abuse. Hiscox also supports the Women’s Resource Centre providing services related to the empowerment of women. Other charities include YouthNet, a school-based mentoring programme, and The Eliza Dolittle Society Bermuda which helps feed Bermuda’s hungry. Other support was provided to Kaleidoscope Arts Foundation, dedicated to teaching art to children, Friends of Hospice’s Agape House which is Bermuda’s only in-patient palliative care facility and SCARS (Saving Children and Revealing Secrets) whose mission is to reduce the risk of child abuse. Hiscox USA also gives priority to charitable endeavours and staff are actively involved in the San Francisco Make-A-Wish Foundation. Staff also volunteered time and money to aid victims of Superstorm Sandy. Dozens of Hiscox USA employees participated in charity bike rides in California and Pennsylvania, raising over $25,000 for cancer research and prevention as part of the Livestrong initiative. In London, staff supported pupils at the Elizabeth Selby Infants School in Tower Hamlets through the Reading Partners’ Scheme and have volunteered in the gardens of Richard House Children’s Hospice. In Colchester, staff raised £23,000 for Headway.
Syndicate 6104 Syndicate 6104 was set up under a limited tenancy agreement for the 2008 year of account with an initial capacity of £34 million. It is wholly backed by external Names and takes a pure year of account quota share of Syndicate 33’s international property catastrophe reinsurance account. The arrangement has been extended through to the 2013 year of account and Syndicate 6104’s capacity was increased to £66 million, from £39 million. Syndicate 6104 pays an overrider and profit commission to Syndicate 33.
Hiscox Insurance Company Limited has an A.M. Best rating of A (Excellent), a Standard & Poor’s rating of A (Strong) and an A+ (Strong) rating from Fitch.
At the end of 2012, net assets exceeded £240 million (2011: £214 million).
Hiscox Insurance Company (Guernsey) Formed by Hiscox in 1998, Hiscox Insurance Company (Guernsey) Limited writes mainly kidnap and ransom and fine art insurance.
Hiscox Bermuda has an A.M. Best rating of A (Excellent) and an A+ (Strong) rating from Fitch. At the end of 2012, net assets exceeded $1,019 million (2011: $846 million).
Robert Hiscox joined Hiscox in 1965 and has been Chairman of the main holding company of Hiscox since its incorporation in 1973. He was Deputy Chairman of Lloyd’s between 1993 and 1995.
Stuart Bridges joined Hiscox in 1999. He is a Chartered Accountant and has held posts in various financial service companies in the UK and US, including Henderson Global Investors. During the year he was a member of the Prudential Financial and Taxation Committee of the Association of British Insurers, a member of the audit committee of the Institute of Chartered Accountants in England and Wales and Chairman of the Lloyd’s Market Association Finance Committee. He is a Non Executive Director of Caledonia Investments plc.
Caroline Foulger joined Hiscox in January 2013. Until May 2012, Caroline led PricewaterhouseCoopers ’ (PwC) Insurance and Reinsurance team in Bermuda, and was Head of the PwC Bermuda Government and Public Sector Practice. Caroline is a Fellow of the Institute of Chartered Accountants in England and Wales, a member of the Institute of Chartered Accountants of Bermuda and a member of the Institute of Directors.
Auditors KPMG Audit Limited Crown House 4 Par-la-Ville Road Hamilton HM 08 Bermuda
Dr James Austin Charles King Non Executive Director and Chairman of the Conflict Committee (Aged 74)
Robert (Bob) McMillan joined the Hiscox Ltd Board in December 2010. He spent 24 years with the Progressive Insurance Corporation where he served in various positions including National Director of Product Development, then claims before becoming National Director of Marketing. He led Progressive’s initiatives in multi-channel distribution, financial responsibility-based rating, and immediate response claims. He has received two United States patents related to motor insurance pricing. He has lectured on business innovation at the University of Virginia’s Darden School of Business and at the Harvard Business School. He has been a Non Executive Director of Hiscox Inc. since March 2007.
Ernst Jansen joined Hiscox in 2008. He held several Managing Director positions in the European chemical industry between 1980 and 1990. He was an Executive Director then Vice Chairman of Eureko B.V. (now Achmea BV) between 1992 and 2007 and following retirement he became an advisor to the Executive Board and is Director of two investment vehicles of Achmea.
Richard Gillingwater joined Hiscox in December 2010. He is a Non Executive Director and Chairman Designate of Henderson Group plc and a Non Executive Director of Wm Morrison Supermarkets PLC. He is currently Chairman of CDC Group plc. He spent a decade at Kleinwort Benson, before moving to and eventually becoming joint Head of Corporate Finance for BZW, a division of Barclays Bank. When that became Credit Suisse First Boston, he became Chairman of European Investment Banking. In 2003 he became Chief Executive and later Chairman of the Shareholder Executive. In 2007 he became Dean of Cass Business School, retiring at the end of 2012. Richard is a Non Executive Director of SSE plc and Helical Bar plc.
Overview and basis of reporting Hiscox Ltd (‘the Company’) is the Bermudian domiciled holding company for the Group. The Company has a premium listing on the London Stock Exchange. The corporate governance framework for companies registered in Bermuda is established by the Company’s constitution together with Companies Act legislation, and for premium listed companies the UK Corporate Goverance Code applies. During 2012, and up to the date of this Report and Accounts, the Group has complied with the provisions of the UK Corporate Governance Code in all material respects. It was announced during the year that Robert Childs would succeed Robert Hiscox as Chairman. Whilst Mr Hiscox remains Chairman at the date of this report it is clear that Mr Childs will not meet the independence criteria set out in the Code when he is appointed and this is explained below.
Directors’ training was also assessed as part of the annual evaluation described on page 38. The appointment and removal of the Company Secretary is a matter for the Board as a whole. Whilst the Board acknowledges the value that knowledge and experience of the organisation can bring, it also recognises the need to progressively refresh its membership over time. Non Executive Directors will normally be expected to serve for six years. They may be invited to serve for longer, but service beyond nine years is unlikely. Any service beyond six years is subject to particularly rigorous review. All Directors are entitled to seek independent professional advice at the Company’s expense. A copy of the advice is provided to the Company Secretary who will circulate it to all Directors.
The Board meets at least four times a year and operates within established Terms of Reference. It is supplied with appropriate and timely information to enable it to review business strategy, trading performance, business risks and opportunities. The Board of Hiscox Ltd met four times during the year. The Board considers all the Non Executive Directors to be independent within the meaning of the UK Corporate Governance Code as there are no relationships or circumstances which would interfere with the exercise of their independent judgement.
The Board’s Terms of Reference include a Schedule of Matters Reserved for Board Decision, a copy of which can be found on the Group’s website: www.hiscox.com. Aside from the opportunity which the Non Executive Directors have to challenge and contribute to the development of strategy in the regular Board meetings, the Non Executive Directors also attended an annual meeting of senior staff. The Board retains ultimate authority for high-level strategic and management decisions including: setting Group strategy, approving significant mergers or acquisitions, approving the financial statements, declaration of the interim dividend and recommendation of the final dividend, approving Group business plans and budgets, approving major new areas of business, approving capital raising, approving any bonus or rights issues of share capital, setting Group investment guidelines, approving the Directors’ remuneration, approving significant expenditure or projects, and approving the issue of share options. The Board has, however, authorised the boards of the trading entities and business divisions to manage their respective operational affairs, to the extent that Company Board level approval is not required.
The Board’s committees The Board has appointed and authorised a number of committees to manage aspects of the Group’s affairs including financial reporting, internal control and risk management. Each committee operates within established written terms of reference and each committee Chairman reports directly to the Board.
The Committee’s role in remuneration is described in the Directors’ remuneration report presented on pages 39 to 46.
It was announced on 30 July 2012 that Robert Childs would succeed Robert Hiscox as Chairman. A job and person specification was prepared for the Chairman’s role, and a thorough search of both internal and external candidates was conducted by the recruitment consultancy Egon Zehnder under the direction of the Committee. The successful candidate was already a Director of the Company and currently holds the position of Group Chief Underwriting Officer. As at the date of this report Robert Hiscox remains Chairman. However, it is clear that Robert Childs will not meet the independence criteria required by the UK Corporate Governance Code when he is appointed as Non Executive Chairman. Notwithstanding this it was felt that Robert Childs had the strength of character, the commercial experience and the detailed knowledge of the Group’s business to make him an excellent Chairman. The Senior Independent Director represented the Committee throughout the selection process and consulted the Company’s major shareholders prior to any decision being made. As well as Egon Zehnder, the Senior Independent Director, the Chairman of the Remuneration and Nomination Committee and the Chief Executive interviewed all shortlisted internal and external candidates.
The Conflicts Committee The Group has a Conflicts Committee which comprises independent Non Executive Directors from within the Group, and is chaired by Dr James King. It meets as and when required. Conflicts of interest may arise from time-to-time because Syndicate 33, Syndicate 3624 and Syndicate 6104 are managed by a Hiscox-owned Lloyd’s Managing Agency. 27.5% of the Names on Syndicate 33 are third-parties and 72.5% of Syndicate 33 is owned by a Hiscox Group company. 100% of Syndicate 3624 is owned by a Hiscox Group company. 100% of Syndicate 6104 is owned by third-parties. The Conflicts Committee serves to protect the interests of the third-party Syndicate Names. Should such a potential conflict of interest arise, there is a formal procedure to refer the matter to this Committee.
Risk Committees There are a number of committees within the Group which have been established to oversee specific risk areas, including underwriting, reserving, reinsurance credit, liquidity, broker credit, business continuity and investments. A Group risk committee ensures that risk management activities are effective and integrated. These committees comprise Directors of the Company and its subsidiaries and relevant senior employees.
Performance evaluation An internal Board and committee evaluation process was conducted during the year. This followed an externally facilitated review carried out in 2011. This year’s evaluation included a review of Board composition and whether there was an appropriate balance of skills, experience, independence and knowledge. It also considered how diversity, including gender diversity, could be improved. Other areas covered were succession planning, Board meeting content and focus, the support to the Board, the quality and provision of information, the Non Executive Directors’ input into the strategy and shareholder engagement. It was decided that no purpose would be served in assessing the performance of an outgoing Chairman in this year’s evaluation. However, it is intended that the Chairman’s performance will feature in future evaluations. The findings of the evaluation were discussed by the Board as a whole. In addition, the Non Executives periodically meet without the Chairman and Executive Directors to discuss a wide range of issues concerning the Company including, as appropriate, the performance of the Chairman and the Executive Directors. The Chief Executive held one-to-one meetings with each of the Executive Directors to discuss their performance over the year and to set targets for the year ahead.
Shareholder communications The Executive Directors communicate and meet directly with shareholders and analysts throughout each year, and do not limit this to the period following the release of financial results or other significant announcements. All Directors attended the Annual General Meeting in 2012.
The Board has reviewed the effectiveness of its risk management and internal controls during 2012, including financial, operational and compliance controls. The Board confirms there is an ongoing process for identifying, evaluating and managing the significant risks faced by the Company, which has been in place throughout the year and up to the date of approval of the Annual Report and Accounts and accords with the guidance in the document ‘Internal Control: Revised Guidance for Directors on the Combined Code’. The head of each business area is responsible for implementing the risk management programme in their area of operations. The Risk function collates risk management information and works with the risk committees to monitor significant risks and movements, and review the relevant internal controls.
This report sets out the remuneration policy for the Group’s senior executives. This policy is consistent with the overall reward approach across the Group. The sections in this report entitled ‘Annual cash incentives’, ‘Share incentive schemes’, ‘Remuneration of Executive Directors’ and ‘Pensions’ have been audited by KPMG. The remainder of the report is unaudited.
Remuneration and Nomination Committee The Remuneration and Nomination Committee generally meets three times a year. The members of the Committee for 2012 were Andrea Rosen (Chairman), Richard Gillingwater, Daniel Healy, Ernst Jansen, Dr James King, Bob McMillan and Gunnar Stokholm.
The Committee is provided with data and has access to advice from Towers Watson and Deloitte, independent remuneration consultants. The Company also uses the Towers Watson compensation benchmarking reports and other publicly available reports.
Remuneration elements The elements of remuneration at Hiscox are: fixed reward (base salary, benefits and retirement benefits) and variable reward annual cash incentives (bonuses and share incentive schemes).
When approving Executive Directors’ salaries, the Remuneration and Nomination Committee takes into account the size and scope of a role, rates of salary increases elsewhere in the Group, individual and Group performance, and competitive positioning of salaries as informed by Towers Watson data and other publicly available reports.
The Group operates two different types of bonus pools: the Personal Performance Bonus pools (PPB) and the Profit Related Bonus pools. The PPB is only available to junior and mid-level staff and is based entirely on individual performance ratings. It is designed to ensure that employees in these roles continue to be motivated to perform their roles well, irrespective of overall Group performance. The benefit is up to 10% of relevant salaries.
All employees, including Executive Directors, participate in profit related bonus pools. These pools are calculated at a business unit level and for the Group as a whole on the basis of a set percentage of profits in excess of a return on allocated equity hurdle (‘Hurdle Rate’). The Hurdle Rate is reviewed annually by using a benchmark which takes account of the medium-term forward-looking investment returns (specifically the 1–3 year gilt and treasury yields, cash returns and the general investment environment). The Hurdle Rate is set at 5% above this benchmark rate. If the benchmark rate dropped to zero, or exceeded 7.5% (suggesting a Hurdle Rate of 5% or above 12.5%) we would review this approach. Based on the approach described above, the Hurdle Rate for 2012 was set at 7.5% and for 2013 will be set at 7.0%.
Once the bonus pools have been established, individual bonuses are determined based on the results of the relevant business area, individual performance and the size of the relevant bonus pool. The Remuneration and Nomination Committee determines the bonuses to be paid to the Executive Directors based on the performance of the Group has increased considerably over time, but that this was not fully reflected in the base salary progression due to the history described above. To inform the review the Committee undertook analysis of absolute and relative performance over the period. Over the past five years Hiscox has delivered a total shareholder return (TSR) of just under 100%, outperforming the FTSE 250 by just over 60% points and the FTSE non-life by just under 30% points. Over the past ten years Hiscox has delivered a TSR of just over 330%, outperforming the FTSE 250 by over 50% points and the FTSE non-life by 140% points. The Committee believes that this overwhelmingly illustrates that Bronek Masojada and Stuart Bridges have delivered excellent results to shareholders over a significant period of time.
As a result of this review the Committee has decided to increase Bronek Masojada’s salary to £540,000 and Stuart Bridges’ salary to £400,000 effective April 2013. The Committee recognises that these are unusual and significant increases which do not reflect past increases. The changes for 2013 are not intended to form a pattern for future increases.
It is important to note that the Executive Directors and the Remuneration Committee take the issue of pay discipline very seriously and firmly believe that while base pay should be set at a reasonable level, upper quartile total compensation should only be achieved as a result of superior returns to shareholders. This is demonstrated clearly by the fact that in three of the previous 12 years the Executive Directors did not receive any bonus payment because the pre-tax return on equity did not meet the agreed hurdle. The Committee does, however, take equally seriously, the need to retain high-performing executives by ensuring that their pay is competitive. The Committee has considered the costs involved in the event of needing to recruit new executives compared with the costs of increasing compensation to retain successful proven executives. Getting this balance right is clearly in the interests of shareholders.
Directors’ remuneration report continued 40 Directors’ remuneration report Hiscox Ltd Report and Accounts 2012
and an assessment of individual performance. In this way the bonus scheme aligns the interests of Executive Directors and employees with shareholders.
Save as You Earn The sharesave scheme and international sharesave scheme are offered to all employees and currently have a 56% participation.
Shareholding guidelines We strongly believe that senior managers within Hiscox should be aligned with Hiscox shareholders by owning a minimum number of Hiscox shares.
Formal shareholding guidelines are in place which mean that within five years of becoming an Executive Director, Hiscox Partner (the top 5% of employees in the company) or a member of a subsidiary board, the employee will be expected to own Hiscox shares valued at 100% of salary for Hiscox Partners and members of subsidiary boards and 150% of salary for Executive Directors.
The table at the end of the remuneration report details Directors’ interests in the long-term incentive plans.
Non Executive Director remuneration Non Executive Directors receive an annual fee in respect of their Board appointments together with additional compensation for their further duties in relation to Board Committees. The fees paid in 2012 are summarised in the table on page 44.
In 2013 Robert Childs will become Chairman of Hiscox Ltd. His appointment is as Non Executive Chairman and as such he will be paid a fee of £275,000 p.a. but will no longer be entitled to participate in the annual bonus scheme or receive grants under the Performance Share Plan. His outstanding Performance Share Plan grants from 2011 and 2012 will vest, in line with the scheme rules, in 2014 and 2015 respectively.
total shareholder return, the concept which is applied to the Performance Share Plan awards is that the recipient is provided with the equivalent of the dividend either in shares or cash. This specifically works as follows: dividends (or amounts equal to dividends) on shares granted under the Performance Share Plan roll up in the form of shares between the grant and vesting; at the end of the performance period the employee would have options over the proportion of the share grant which vests by reference to the satisfaction of the applicable performance target as well as over the number of shares representing the ‘rolled up’ dividends on those shares; and for UK-based employees only, after vesting but before exercise, the employee would then receive ‘shadow dividends’ (i.e. amounts equal to dividends paid) on the total number of shares that have vested.
Performance conditions Performance conditions for the Performance Share Plan (PSP) are as follows: 25% of the award vests if the Company achieves an average ROE of 10% post-tax for each of the three years; 100% vests if the average three-year return exceeds 17.5% post-tax; and vesting will occur on a straight-line basis between these points.
The performance conditions for the PSP have been unchanged since 2007. For future awards to be made in 2013 and subsequent years the Committee has decided to align the approach to setting the PSP performance conditions with the method of setting the bonus hurdle. The benchmark rate will be set annually as described above under ‘Annual cash incentives’ (taking account of medium-term forward-looking investment returns) and the vesting threshold will be five percentage points above this.
As a result of these proposed changes the threshold rate below which none of the 2013
Remuneration of Non Executive Directors All amounts are denominated in US Dollars. The structure of the fees paid is detailed below. In 2013 Robert Childs will become Chairman of Hiscox Ltd. His appointment is as Non Executive Chairman and as such he will be paid a fee of £275,000 p.a. but will no longer be entitled to participate in the annual bonus scheme or receive grants under the Performance Share Plan. His outstanding Performance Share Plan grants from 2011 and 2012 will vest in line with the scheme rules in 2014 and 2015 respectively.
The fees in relation to Hiscox Ltd for the year were: Hiscox Ltd
Share options The interests of the Directors and employees under the UK and International Sharesave Schemes of the Group are set out below: Number of options at 1 January
Political and charitable contributions The Group made no political contributions during the year (2011: £nil). Charitable donations totaled £768,000 (2011: £533,000) of which £500,000 (2011: £250,000) was donated to the Hiscox Foundation, a UK registered charity. The policy of the Hiscox Foundation is to assist and improve education, the arts and independent living for disabled and disadvantaged members of society. Further information concerning the Group’s charitable activities is contained in the report on corporate responsibility on pages 28 and 29.
*Based on voting rights of 394,387,209 as at 22 February 2013. †Indirect holding.
Principal activity and business review The Company is a holding company for subsidiaries involved in the business of insurance in Bermuda, the US, the UK, Guernsey and Europe. An analysis of the development and performance of the business, its position at the end of the year, and the likely future development can be found within the Chief Executive’s report on pages 7 to 11. A description of the major risks can be found in the risk management section on pages 23 to 27. In addition, note 3 to the consolidated financial statements provides a detailed discussion on the risks which are inherent to the Group’s business and how those risks are managed. Details of the key financial performance indicators are given on page 2. The information that fulfils the requirements of the corporate governance statement as referred to in Disclosure and Transparency Rule 7.2 can be found in the corporate governance statement on pages 36 to 38 and in this report.
Going concern A review of the financial performance of the Group is set out on pages 18 to 19. The financial position of the Group, its cash flows and borrowing facilities are included therein. The Group has considerable financial resources and a well-balanced book of business.
Dividends An interim dividend of 6.0p (net) per share (2011: 5.1p (net)) was paid on 19 September 2012 by Hiscox Ltd in respect of the year ended 31 December 2012. The Directors are recommending the return of capital to shareholders through an issue of B shares and this will be considered at an Extraordinary General Meeting to be held on 28 March 2013. It is proposed that in place of a final dividend, a sum equal to 12.0p per share will be payable to shareholders as part of the return of capital. (The final dividend for 2011 was 11.9p per share.)
We confirm that to the best of our knowledge: the financial statements, prepared in accordance with the applicable set of accounting standards, present fairly, in all material respects, the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and the Directors’ report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
The Directors responsible for authorising the responsibility statement on behalf of the Board are the Chairman, RSS Hiscox and the Chief Financial Officer, SJ Bridges. The statements were approved for issue on 25 February 2013.
Annual General Meeting The notice of the Annual General Meeting, to be held on 16 May 2013 at 10:00am (2:00pm (BST)), will be contained in a separate circular to be sent to shareholders. This will be despatched following the Extraordinary General Meeting to be held on 28 March 2013.
Reserve releases (£m) 152 199 49Financial summary Hiscox Ltd Report and Accounts 2012
We have audited the accompanying consolidated financial statements of Hiscox Ltd (‘the Company’) on pages 51 to 103 which comprise the consolidated balance sheet as at 31 December 2012, and the consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory notes.
Opinion In our opinion: the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as at 31 December 2012, and of its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the EU; and the part of the Directors’ remuneration report which we were engaged to audit has been properly prepared in accordance with Schedule 8 to the UK Companies Act 2006 The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008 No.410), as if those requirements were to apply to the Company.
Income Gross premiums written 4 1,565,819 1,449,219 Outward reinsurance premiums (297,679) (275,208)
Profit for the year (all attributable to owners of the Company) 207,772 21,272
Profit for the year 207,772 21,272 Other comprehensive (loss)/income Currency translation (losses)/gains (net of tax of £nil (2011: £nil)) 12 (35,806) 11,060
The notes on pages 55 to 103 are an integral part of these consolidated financial statements.
Deferred acquisition costs 17 166,041 150,050 Financial assets carried at fair value 19 2,406,269 2,368,636
The consolidated Group financial statements were approved by the Board of Directors on 25 February 2013 and signed on its behalf by: RRS Hiscox Chairman
Dividends paid to owners of the Company 32 – – – – (63,849) (63,849)
Total recognised comprehensive income for the year (all attributable to owners of the Company) – – – (35,806
Changes in operational assets and liabilities: Insurance and reinsurance contracts (8,245) 138,667 Financial assets carried at fair value (49,377) 78,501 Financial liabilities carried at fair value 301 (457) Other assets and liabilities 12,850 (18,888)
Proceeds from the issue of ordinary shares 24 1,701 3,215 Dividends paid to owners of the Company 32 (62,507) (50,512) Net repayments of borrowings – (20,000)
Cash and cash equivalents at 1 January 516,547 336,017 Net increase in cash and cash equivalents 150,596 179,079 Effect of exchange rate fluctuations on cash and cash equivalents (9,481) 1,451
1 General information The Hiscox Group, which is headquartered in Hamilton, Bermuda, comprises Hiscox Ltd (the parent Company, referred to herein as the ‘Company’) and its subsidiaries (collectively, the ‘Hiscox Group’ or the ‘Group’). For the period under review the Group provided insurance and reinsurance services to its clients worldwide. It has operations in Bermuda, the UK, Europe, and the US and employs over 1,400 people.
The Company is registered and domiciled in Bermuda and on 12 December 2006 its ordinary shares were listed on the London Stock Exchange. As such it is required to prepare its annual audited financial information in accordance with Section 4.1 of the Disclosure and Transparency Rules and the Listing Rules, both issued by the Financial Services Authority (FSA), in addition to the Bermuda Companies Act 1981. The first two pronouncements issued by the FSA require the Group to prepare financial statements which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes 1 to 38 in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union.
In March 2004, the IASB issued IFRS 4 Insurance Contracts which specifies the financial reporting for insurance contracts by an insurer. The standard was the first phase in the IASB’s insurance contract project and as such is a stepping stone to Phase II, introducing limited improvements to accounting for insurance contracts. Accordingly, to the extent that IFRS 4 does not specify the recognition or measurement of insurance contracts, transactions reported in these consolidated financial statements have been prepared in accordance with another comprehensive body of accounting principles for insurance contracts, namely accounting principles generally accepted in the UK.
Since the original exposure draft, further amendments have been made to the proposals. As a result, the IASB has committed to re-exposing the draft during the first half of 2013. In addition, the IASB has also stated they will allow at least three full years from the date of any final standard to actual implementation, therefore 2018 is likely to be the earliest date for the adoption of a new standard.
2.2 Basis of preparation The financial statements are presented in Pounds Sterling and are rounded to the nearest thousand unless otherwise stated.
The Group has financial assets and cash of over £3.06 billion. The portfolio is predominantly invested in liquid short-dated bonds and cash to ensure significant liquidity to the Group and to reduce risk from the financial markets. In addition the Group has significant borrowing facilities in place.
A number of new standards, amendments to standards and interpretations are effective for annual periods beginning after 1 January 2012, and have not been applied in preparing these consolidated financial statements.
IAS 1 (amended): Presentation of Financial Statements is effective for annual periods beginning 1 July 2012. The amendment will require a change in the presentation of items of other comprehensive income, requiring companies to group together items within other comprehensive income that may be reclassified to the profit or loss section of the income statement. Upon adoption, the amendment will result in changes to the presentation of the Group’s other comprehensive income.
2.3 Basis of consolidation (a) Subsidiaries Subsidiaries are those entities controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Generally this occurs when the Group obtains a shareholding of more than half of the voting rights of an entity. In assessing control, potential voting rights that are currently exercisable or convertible are taken into account. Management also exercise significant judgement about any actual or perceived control acquired indirectly, through normal commercial dealings with entities of a special purpose nature. The Group does not undertake any such arrangements with such entities where control of that entity would be acquired. The consolidated financial statements include the assets, liabilities and results of the Group up to 31 December each year. The financial statements of subsidiaries are included in the consolidated financial statements only from the date that control commences until the date that control ceases.
Hiscox Dedicated Corporate Member Limited (‘HDCM’) underwrites as a corporate member of Lloyd’s on the main Syndicates managed by Hiscox Syndicates Limited (the ‘main managed Syndicates’ numbered 33 and 3624). As at 31 December 2012, HDCM owned 72.5% of Syndicate 33 (2011: 72.5%). In view of the several but not joint liability of underwriting members at Lloyd’s for the transactions of syndicates in which they participate, the Group’s attributable share of the transactions, assets and liabilities of these Syndicates has been included in the financial statements.
The Group manages the underwriting of, but does not participate as a member of, Syndicate 6104 at Lloyd’s which provides reinsurance to Syndicate 33 on a normal commercial basis. Consequently, aside from the receipt of managing agency fees, defined profit commissions as appropriate and interest arising on effective assets
IFRS 10: Consolidated Financial Statements is effective for annual periods beginning 1 January 2014, with retrospective application. It replaces the portion of IAS 27: Consolidated and Separate Financial Statements that addresses the accounting for consolidated financial statements. IFRS 10 revises the definition of ‘control’, the key factor in determining whether an entity is consolidated. The adoption of IFRS 10 is not expected to have an effect on the Group’s consolidated financial statements.
IFRS 11: Joint Arrangements is effective for annual periods beginning 1 January 2014, with retrospective application. It replaces IAS 31: Interests in Joint Ventures and SIC-13: Jointly-Controlled Entities – Non-Monetary Contributions by Venturers. The standard clarifies the definition of a joint arrangement and uses the principle of control in IFRS 10 to define joint control. The standard is not expected to have a significant impact on the consolidated financial statements of the Group.
IFRS 13: Fair Value Measurement is effective for annual periods beginning 1 January 2013 and is to be applied prospectively. The standard defines fair value, sets out in a single IFRS a framework for measuring fair value, and requires disclosures about fair value measurements. The standard will
2.5 Property, plant and equipment Property, plant and equipment are stated at historical cost less depreciation and any impairment loss. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All other repairs and maintenance items are charged to the income statement during the financial period in which they are incurred.
2.4 Foreign currency translation (a) Functional currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The functional currency of all individual entities in the Group is deemed to be Sterling with the exception of the entities operating in France, Germany, the Netherlands, Spain, Portugal, Ireland and Belgium whose functional currency is Euros, those subsidiary entities operating from the US and Bermuda whose functional currency is US Dollars, Hiscox Insurance Company (Guernsey) Limited and Syndicate 3624 whose functional currency is also US Dollars.
(c) Group companies The results and financial position of all the Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet; income and expenses for each income statement are translated at average included within the experience account, the Group has no share in the assets, liabilities or transactions of Syndicate 6104, nor is it controlled. The position and performance of that Syndicate is therefore not included in the Group’s financial statements.
2.8 Cash and cash equivalents The Group has classified cash deposits and short-term highly liquid investments as cash and cash equivalents. These assets are readily convertible into known amounts of cash and are subject to inconsequential changes in value. Cash equivalents are financial investments with less than three months to maturity at the date of acquisition.
over an indefinite number of future periods due to the stability of the US insurance market. The licenses are tested annually for impairment, and any accumulated impairment losses recognised are deducted from the historical cost amount to produce the net balance sheet carrying amount. This assumption is reviewed annually to determine whether the asset continues to have an indefinite life.
Goodwill on acquisition of subsidiaries is included in intangible assets. Goodwill on acquisition of associates is included in investments in associates. Goodwill is not amortised but is tested at least annually for impairment and carried at cost less accumulated impairment losses.
(c) State authorisation licences State authorisation licences acquired in business combinations are recognised initially at their fair value. The asset is not amortised, as the Board considers that economic benefits will accrue to the Group 2 Significant accounting policies continued
contributions into a separate entity and has no further obligation beyond the agreed contribution rate. A defined benefit plan is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, usually dependent on one or more factors such as age, years of service and compensation.
The amount recognised in the balance sheet in respect of defined benefit pension plans is the present value of the defined benefit obligation at the balance sheet date less the fair value of plan assets, together with adjustments for unrecognised actuarial gains or losses and past service costs. Plan assets exclude any insurance contracts issued by the Group. To the extent that a surplus emerges on the defined benefit obligation, it is only recognisable on the asset side of the balance sheet when it is probable that future economic benefits will be recovered by the scheme sponsor in the form of refunds or reduced future contributions.
Actuarial gains and losses are only recognised when the net cumulative unrecognised actuarial gains and losses for each individual plan at the end of the previous accounting period exceeds 10% of the higher of the defined benefit obligation and the fair value of the plan assets at that date. Such actuarial gains or losses falling outside of this 10% corridor are charged or credited to income over the employees’ expected average remaining working lives. Past service costs are recognised immediately in income, unless the changes to the pension plan are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight-line basis over the vesting period.
A defined contribution plan is a pension plan under which the Group pays fixed by writing-off DAC and by subsequently establishing a provision for losses arising from liability adequacy tests (‘the unexpired risk provision’). Any DAC written-off as a result of this test cannot subsequently be reinstated.
(f) Receivables and payables related to insurance contracts Receivables and payables are recognised when due. These include amounts due to and from agents, brokers and insurance contract holders.
2 Significant accounting policies continued 2.13 Insurance contracts continued (d) Liability adequacy tests continued
2.19 Provisions The Group is subject to various insurancerelated assessments and guarantee fund levies. Provisions are recognised where there is a present obligation (legal or constructive) as a result of a past event that can be measured reliably and it is probable that an outflow of economic benefits will be required to settle that obligation.
The fair value of the employee services received, measured at grant date, in exchange for the grant of the awards is recognised as an expense, with the corresponding credit being recorded in retained earnings within equity. The total amount to be expensed over the vesting period is determined by reference to the fair value of the awards granted, excluding the impact of any non-market vesting conditions (e.g. profitability or net asset growth targets). Non-market vesting conditions are included in assumptions about the number of awards that are expected to become exercisable. At each balance sheet date, the Group revises its estimates of the number of awards that are expected to vest. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity, over the remaining vesting period.
procedures, and ongoing compliance therewith, partially through its own enquiries but primarily through a dedicated internal audit function, which has operational independence, clear terms of reference influenced by the Board’s Non Executive Directors and a clear upwards reporting structure back into the Board. The Group, in common with the non-life insurance industry generally, is fundamentally driven by a desire to originate, retain and service insurance contracts to maturity. The Group’s cash flows are funded mainly through advance premium collections and the timing of such premium inflows is reasonably predictable. In addition, the majority of material cash outflows are typically triggered by the occurrence of insured events noncorrelated to financial markets, and not by the inclination or will of policyholders.
Legislation concerning the determination of taxation assets and liabilities is complex and continually evolving. In preparing the Group’s financial statements, the Directors estimate taxation assets and liabilities after taking appropriate professional advice. To the extent that taxable losses carried forward by the Group exceed taxable temporary differences relating to the same taxation authority and taxable entity, which will result in amounts against which the losses can be utilised, the Group uses estimates of probable future taxable profits available to determine whether recognition of a deferred tax asset is appropriate. The determination and finalisation of agreed taxation assets and liabilities may not occur until several years after the balance sheet date and consequently the final amounts payable or receivable may differ from those presently recorded in these financial statements.
The Board exercises oversight of the development and operational implementation of its risk management policies and is £1,000 million (2011: £964 million) and is included within total insurance liabilities on the balance sheet.
With regard to employee retirement benefit scheme obligations, the amounts disclosed in these consolidated financial statements are sensitive to judgemental assumptions regarding mortality, inflation, investment returns and interest rates on corporate bonds, many of which have been subject to specific recent volatility. This complex set of economic variables may be expected to influence the liability obligation element of the reported net balance amount to a greater extent than the reported value of the scheme assets element. For example, if official UK interest rates are replicated with lower yields emerging in UK corporate bond indices, a significant uplift may occur in the reported net scheme deficit through the reduced effect of discounting outweighing any expected appreciation in asset values. A sensitivity analysis is given at note 30.
payment limits to cap the maximum amount payable from these insured events over the contract period.
The Group compiles estimates of losses arising from realistic disaster events using statistical models alongside input from its underwriters. These require significant management judgement. Realistic disaster scenarios, shown on page 15, are extreme hypothetical events selected to represent major events occurring in areas with large insured values. They also reflect the areas that represent significant exposures for Hiscox. The selection of realistic disaster scenario events is adjusted each year and they are not therefore necessarily directly comparable from one year to the next. The events are extreme and as yet untested, and as such these estimates may prove inadequate as a result of incorrect assumptions, model deficiencies, or losses from unmodeled risks. This means that should a realistic disaster actually eventuate, the Group’s final ultimate losses could materially differ from those estimates modeled by management.
Overleaf is a summary of the gross and net insurance liabilities for each category, split by region of risk.
The estimated liquidity profile to settle these net claims liabilities is given in note 3.2 (e).
The specific insurance risks accepted by the Group fall broadly into the following main categories: reinsurance inwards, marine and major asset property, other property risks, professional indemnity casualty and casualty other insurance risks. These specific categories are defined for risk review purposes only, as each contains risks specific to the nature of the cover provided. They are not exclusively aligned to any specific reportable segment in the Group’s operational structure or the primary internal reports reviewed by the chief operating decision maker. The following describes the policies and procedures used to identify and measure the risks associated with each individual category of business.
Estimated concentration of gross and net insurance liabilities on balance sheet by territory coverage of premium written 31 December 2011
3 Management of risk continued 3.1 Insurance risk continued i) Underwriting risk continued accepted under limited circumstances. Claims typically arise from incidents such as errors and omissions attributed to the insured, professional negligence and specific losses suffered as a result of electronic or technological failure of software products and websites.
The majority of the Group’s insurance risks are short-tail and, based on historical claims experience, significant claims are normally notified and settled within 12- to 24-months of the insured event occurring. Those claims taking the longest time to develop and settle typically relate to casualty risks where legal complexities occasionally develop regarding the insured’s alleged omissions or negligence. The length of time required to obtain definitive legal judgements and make eventual settlements exposes the Group to a degree of reserving risk in an inflationary environment.
Typical property covered by marine and other major property contracts includes fixed and moveable assets such as ships and other vessels, cargo in transit, energy platforms and installations, pipelines, other subsea assets, satellites, commercial buildings and industrial plants and machinery. These assets are typically exposed to a blend of catastrophic and other large loss events and attritional claims arising from conventional hazards such as collision, flooding, fire and theft. Climatic changes may give rise to more frequent and severe extreme weather events (for example earthquakes, windstorms and river flooding etc.) and it may be expected that their frequency will increase over time.
Directly held equity securities 4 3 Units held in funds – traditional long only 69 73 Units held in funds – long and short and special strategies 27 24
The fair value of debt and fixed income assets in the Group’s balance sheet at the assets trade. The fair value of financial assets is measured primarily with reference to their closing bid market prices at the balance sheet date. The ability to obtain quoted bid market prices may be reduced in periods of diminished liquidity. In addition, those quoted prices that may be available may represent an unrealistic proportion of market holdings or individual trade sizes that could not be readily available to the Group. In such instances fair values may be determined or partially supplemented using other observable market inputs such as prices provided by market makers such as dealers and brokers, and prices achieved in the most recent regular transaction of identical or closely related instruments occurring before the balance sheet date but updated for relevant perceived changes in market conditions.
(b) Equity price risk The Group is exposed to equity price risk through its holdings of equity and unit trust investments. This is limited to a small and controlled proportion of the overall investment portfolio and the equity and unit trust holdings involved are well diversified over a number of companies and industries.
The key financial risk for the Group is that the proceeds from its financial assets and investment result generated thereon are not sufficient to fund the obligations. The most important entity and economic variables that could result in such an outcome relate to the reliability of fair value measures, equity price risk, interest rate risk, credit risk, liquidity risk and currency risk. The Group’s policies and procedures for managing exposure to these specific categories of risk are detailed below.
(a) Reliability of fair values The Group has elected to carry all financial investments at fair value through profit or loss as they are managed and evaluated on a fair value basis in accordance with a documented strategy. With the exception of unquoted equity investments and the insurance linked fund, all of the financial investments held by the Group are available to trade in markets and the Group therefore seeks to determine fair value by reference to published prices or as derived by pricing vendors using observable quotations in the most active financial markets in which 3 Management of risk continued 3.1 Insurance risk continued Reserving risk continued
or liabilities carrying interest rate risk, other than the facilities and Letters of Credit outlined in note 35.
Key areas of exposure to credit risk include: reinsurers’ share of insurance liabilities; amounts due from reinsurers in respect of claims already paid; amounts due from insurance contract holders; and counterparty risk with respect to cash and cash equivalents, and investments including deposits, derivative transactions and catastrophe bonds.
Government issued bonds and instruments 34 23 Agency and government supported debt 12 25 Asset backed securities 10 11 Mortgage backed instruments – agency 7 6 Mortgage backed instruments – non-agency 3 5 Mortgage backed instruments – commercial 3 – Corporate bonds 27 27 Lloyd’s deposits and bond funds 4 3
One method of assessing interest rate sensitivity is through the examination of duration-convexity factors in the underlying portfolio. Using a duration-convexity based sensitivity analysis, if market interest rates had risen by 100 basis points at the balance sheet date, the fair value might have been expected to decrease by £39 million (2011: decrease of £38 million) assuming that the only balance sheet area impacted was debt and fixed income financial assets.
The Group also mitigates counterparty credit risk by concentrating debt and fixed income investments in highly liquid instruments, including a particular emphasis on government bonds issued mainly by North American countries and the European Union, excluding those from Portugal, Greece, Ireland, Italy and Spain.
An analysis of the Group’s major exposures to counterparty credit risk excluding loans and receivables, based on Standard & Poor’s or equivalent rating, is presented below: As at 31 December 2012 Note AAA
Debt and fixed income securities 19 816,153 834,671 369,528 174,514 2,194,866 Deposits with credit institutions 19 900 – 12,303 – 13,203 Catastrophe bonds – – – – –
At 31 December 2012 and 2011 the Group held no material debt or fixed income assets that were past due or impaired beyond their reported fair values, either for the current period under review or on a cumulative basis. For the current period and prior period, the Group did not experience any material defaults on debt securities.
Within the fixed income portfolios, which include debt securities, deposits with credit institutions and cash equivalent assets, there are exposures to a range of government borrowers, on either a direct or guaranteed basis, and banking institutions. The Group, together with its investment managers, closely manages its geographical exposures across government issued and supported debt.
Additionally, the geographical location and credit quality of individual bank borrowers are closely monitored. An analysis of the Group’s exposure to bank counterparties by country and credit rating is detailed below. Bank debt held by the Group is mostly senior unsecured and covered bonds. The subordinated bonds are all classed as Lower Tier 2 capital.
Included in the bank debt table above, are £192 million in relation to holdings in debt securities and £3 million held as deposits with credit institutions.
Average contractual maturity analysed by denominational currency of investments as at 31 December
Property – marine and major assets 86,882 41,829 34,942 5,242 168,895
The Group’s exposure to structural foreign exchange risk primarily relates to the US Dollar net investments made in its domestic operation in Bermuda and its overseas operation in Guernsey and the US. Other structural exposures also arise on a smaller scale in relation to net investments made in European operations. The Group’s risk appetite permits the acceptance of structural foreign exchange movements within defined aggregate limits and exchange rate parameters which are monitored centrally. Exchange rate derivatives are used when appropriate to shield the Group against significant movements outside of a defined range.
The currency profile of the Group’s assets and liabilities is as follows: As at 31 December 2012 Sterling
Financial assets carried at fair value 523,212 1,587,848 253,677 41,532 2,406,269
Sensitivity analysis As at 31 December 2012, the Group used closing rates of exchange of £1:€1.23 and £1:$1.63 (2011: £1:€1.19 and £1:$1.54). The Group performs sensitivity analysis based on a 10% strengthening or weakening of Pound Sterling against the Euro and US Dollar. This analysis assumes that all other variables, in particular interest rates, remain constant and that the underlying valuation of assets and liabilities in their base currency is unchanged. The process of deriving the undernoted estimates takes account of the linear retranslation movements of foreign currency monetary assets and liabilities together with the impact on the retranslation of those Group entities with non-Sterling functional currency financial statements. During the year, the Group transacted in a number of over-the-counter forward currency derivative contracts. The impact of these contracts on the sensitivity analysis is negligible.
As at 31 December 2012 Effect on equity after tax £m
requirement and there were no cash drawings (2011: $340 million and £nil million respectively) to support general trading activities; external Names – 27.5% of Syndicate 33’s capacity is capitalised by third-parties paying a profit share of approximately 20%; Syndicate 6104 at Lloyd’s – with a capacity of £39 million for the 2012 year of account (2011 year of account: £37 million). This Syndicate is wholly backed by external members and takes pure years of account quota share of Syndicate 33’s international property catastrophe reinsurance account; gearing quota shares – historically the Group has used reinsurance capital to fund its capital requirement for short-term expansions in the volume of business underwritten by the Syndicate; and qualifying quota shares – these are reinsurance arrangements that allow the Group to increase the amount of premium it writes in hard markets.
The funds raised through Letters of Credit and loan facilities have been applied to support both the 2012 year of account for Syndicates 33 and 3624 and the capital requirements of Hiscox Insurance Company (Bermuda) Limited.
Gearing The Group currently utilises short- to medium-term gearing as an additional source of funds to maximise the opportunities from strong markets and to reduce the risk profile of the business when the rating environment shows a weaker model for the more volatile business. The Group’s gearing is obtained from a number of sources, including: Letter of Credit and revolving credit facility – the Group’s main facility was replaced during 2012 for a total of $875 million which may be drawn as cash (under a revolving credit facility), Letter of Credit or a combination thereof, providing that the cash portion does not exceed $400 million. This facility was secured during 2012 by the Company’s subsidiary Hiscox plc. The Letter of Credit availability period ends on 31 December 2013. This enables the Group to utilise the Letter of Credit as Funds at Lloyd’s to support underwriting on the 2012, 2013 and 2014 years of account. The revolving credit facility has a maximum threeyear contractual period for repayment. At 31 December 2012 US$308 million was drawn by way of Letter of Credit to support the Funds at Lloyd’s
The sensitivity analyses do not take into consideration that the Group’s assets and liabilities are actively managed. Additionally, the financial position of the Group may vary at the time that any actual market movement occurs. For example, the Group’s financial risk management strategy aims to manage the exposure to market fluctuations. As investment markets move past various trigger levels, management actions could include selling investments, changing investment portfolio allocation and taking other protective action.
UK regional events coverage and non US household business, together with the income and expenses arising from the Group’s retail agency activities in the UK and in continental Europe. In addition, it includes the European errors and omissions business from Syndicate 3624. It excludes the results of the larger retail TMT business written by Hiscox Insurance Company Limited. It also includes an element of kidnap and ransom and terrorism written in Syndicate 33.
This modeling takes into account transactional costs and tax, in addition to the necessary capital ratios. It proves the capital efficiency of Lloyd’s, despite a tax disadvantage against offshore entities, and the cost advantage of processing smaller premium business outside of Lloyd’s.
In addition to the ICA modeling process, the EU Insurance Group’s Directive of 1998, as amended by the Financial Group’s Directive (FGD), compels insurance companies that are members of a group to consider the solvency margin of their ultimate parent company. This consideration must refer to the surplus assets of the ultimate parent’s related insurers, reinsurers, intermediate holding companies and other regulated entities.
UK and Europe comprises the results of Hiscox Insurance Company Limited, the results of Syndicate 33’s fine art, of capital levels and its debt to overall equity ratios in line with others in the non-life insurance industry.
For Syndicate 33 and Syndicate 3624, the ICA process produces a result that is uplifted by Lloyd’s to identify the capital required to hold the A rating. The strong control and risk management environment, together with the sophistication of the modeling, have produced a capital ratio below that suggested under the previous risk-based capital regime. Another key area of capital modeling for Hiscox is to identify which insurance vehicle produces the best return on capital employed for the Group, given certain restraints from licences, reinsurance and the regulatory environment.
Share of (loss)/profit of associates *Interest revenues included total £50,811,000 (2011: £48,802,000).
The Group’s wholly owned subsidiary, Hiscox Syndicates Limited, oversees the operation of Syndicate 33 at Lloyd’s. The Group’s percentage participation in Syndicate 33 can fluctuate from year-to-year and, consequently, presentation of the results at the 100% level removes any distortions arising therefrom.
The Group has not reported geographical segmental details of non-current assets excluding financial instruments and including loans and receivables, rights and obligations under insurance and reinsurance contracts, investments in associates and subsidiaries as such details are not used by the chief operating decision maker to evaluate the performance of the Group.
The net asset value per share is based on 394,200,249 shares (2011: 388,233,074 shares), being the adjusted number of shares in issue at 31 December.
Profit for the year (all attributable to owners of the Company) 207,772 21,272 Opening shareholders’ equity 1,255,899 1,266,114 Adjusted for the time-weighted impact of capital distributions and issuance of shares (28,095) (14,025)
Annualised return on equity (%) 16.9 1.7 7 Investment result The total result for the Group before taxation comprises: Note
Investment income including interest receivable 45,699 50,333 Net realised gains on financial investments at fair value through profit or loss 9,071 5,040 Net fair value gains/(losses) on financial investments at fair value through profit or loss 37,920 (29,431)
Debt and fixed income securities 26,813 3.5 8,585 1.9 19,191 2.5 7,990 3.9 62,579 2.8 Equities and shares in unit trusts – – 8,288 13.8 8,580 14.0 10,106 16.6 26,974 14.8 Deposits with credit institutions/
Notes to the consolidated financial statements Hiscox Ltd Report and Accounts 2012 79
8 Analysis of return on financial investments continued (b) Investment return continued
Wages and salaries 88,294 69,185 Social security cost 15,299 12,930 Pension cost – defined contribution 6,117 5,724 Pension cost – defined benefit 1,800 1,700 Share based payments 6,135 8,677 Marketing expenses 26,251 19,955 Investment expenses 3,543 3,360 Depreciation, amortisation and impairment 7,833 8,098 Other expenses 80,930 73,575
Interest and expenses associated with bank borrowings 2,703 1,960 Interest and charges associated with Letters of Credit 35 5,032 3,933 Interest charges on experience account 870 804 Interest charges arising on finance leases 36 – 1 11 Auditors’ remuneration Fees payable to the Group’s main external auditors, KPMG, its member firms and its associates (exclusive of VAT) include the following amounts recorded in the consolidated income statement: Group
Amounts receivable by the auditor and associates in respect of: The auditing of the accounts of any associate of the Group 911 908 All audit-related assurance services 129 132 Taxation compliance services – 8 All non-audit-related assurance services 21 –
12 Net foreign exchange (losses)/gains The net foreign exchange gains for the year include the following amounts: Exchange (losses)/gains recognised in the consolidated income statement (20,173) 7,816 Exchange (losses)/gains classified as a separate component of equity (35,806) 11,060
The Group’s intangible asset relating to Syndicate capacity has been allocated, for impairment testing purposes, to one individual CGU, being the active Lloyd’s corporate member entity. The asset is tested annually for impairment based on its recoverable amount which is considered to be the higher of the asset’s fair value or its value in use. The fair value of Syndicate capacity can be determined from the Lloyd’s of London Syndicate capacity auctions. Based on the average open market price witnessed in the recent Autumn 2012 auction, the carrying value of Syndicate capacity recognised on the balance sheet is significantly below the market price.
The carrying value of customer contractual relationships is tested annually for impairment based on the recoverable amount which is considered to be the higher of the fair value or value in use. The asset’s value in use is considered to be the best indication of its recoverable amount. Value in use is calculated for customer contractual relationships in the same manner as described above for goodwill and the same discount rate used. The results of this testing show that no impairment is due.
The net book value of capitalised internally generated software costs at 31 December 2012 was £23,293,000 (2011: £20,445,000). There are no charges for impairment during the current or prior financial year.
The Group’s land and buildings assets relate to freehold property in the UK and US.
Assets with a net book value of £nil were held under finance leases (2011: £nil).
During the year no expenditure was recognised in the carrying value of property that is under the course of construction (2011: £nil).
On 6 August 2012, the Group acquired a 25% holding in Lark (2012) Ltd, for total consideration of £3,104,000 as referred to in note 33. The company is treated as an associate from this date.
Acquisition costs expensed to the income statement (333,758) 50,143 (283,615) (314,385) 44,593 (269,792)
Debt and fixed income securities 2,194,866 2,170,588 Equities and shares in unit trusts 190,029 173,432 Deposits with credit institutions 13,203 12,848
Total investments 2,398,098 2,356,868 20 Loans and receivables including insurance receivables
All derivatives contracts settle within three months of the year end.
Foreign exchange forward contracts During the current and prior year the Group entered into a series of conventional over-the-counter forward contracts in order to secure translation gains made on Euro, US Dollar and other non-Pound Sterling denominated monetary assets. The contracts require the Group to forward sell a fixed amount of the relevant currency for Pound Sterling at pre-agreed future exchange rates. The Group made a gain on these forward contracts of £71,000 (2011: loss of £84,000) as included in note 7. The opposite exchange loss is included within financial investments.
22 Fair value measurements In accordance with the Amendments to IFRS 7 Financial Instruments: Disclosures, the fair value of financial instruments based on a threelevel fair value hierarchy that reflects the significance of the inputs used in measuring the fair value is provided below.
Financial assets Debt and fixed income securities 718,393 1,476,473 – 2,194,866 Equities and shares in unit trusts – 176,494 13,535 190,029 Deposits with credit institutions 13,203 – – 13,203 Catastrophe bonds – – – – Insurance linked fund – – 8,098 8,098 Derivative instrument assets – 73 – 73
Financial assets Debt and fixed income securities 500,672 1,669,916 – 2,170,588 Equities and shares in unit trusts – 162,806 10,626 173,432 Deposits with credit institutions 12,848 – – 12,848 Catastrophe bonds – 11,639 – 11,639 Insurance linked fund – – – – Derivative instrument assets – 129 – 129
Balance at 1 January 6,926 – – – 6,926 Total gains or losses through profit or loss* 1,242 – – – 1,242
Employee share option scheme – proceeds from shares issued 91 3,124 – Scrip dividends to owners of the Company 32 175 13,162 –
Employee share option scheme – proceeds from shares issued 52 1,649 – Scrip dividends to owners of the Company 32 88 7,578 –
Contributed surplus is a distributable reserve and arose on the reverse acquisition of Hiscox plc on 12 December 2006.
During the year, the Group offered its shareholders the option of receiving a scrip dividend alternative to the cash dividend. This resulted in the Company paying the shareholders, who opted for a scrip dividend, in shares of equal value to the cash dividend at a specified date. The full dividend was distributed from retained earnings and the new shares issued for the scrip dividend were reflected in share capital and share premium.
Annual risk-free rates of return and discount rates (%) 0.27-0.55 0.9-1.9 Long-term dividend yield (%) 3.95-4.31 4.24-4.59 Expected life of options (years) 3.25 3.25 Implied volatility of share price (%) 28 29 Weighted average share price (p) 416.0 397.0
Net Claims reported and claim adjustment expenses 740,293 750,525 Claims incurred but not reported 739,172 739,218 Unearned premiums 576,758 518,002
The choice of selected results for each accident year of each class of business depends on an assessment of the technique that has been most appropriate to observed historical developments. This often means that different techniques or combinations of techniques have been selected for individual accident years or groups of accident years within the same class of business.
The gross claims reported, the claims adjustment expenses liabilities and the liability for claims incurred but not reported are net of expected recoveries from salvage and subrogation. The amounts for salvage and subrogation at the end of 2012 and 2011 are not material.
The Chain Ladder method may be applied to premiums, paid claims or incurred claims (i.e. paid claims plus case estimates). The basic technique involves the analysis of historical claims development factors and the selection of estimated development factors based on this historical pattern. Where losses in the earliest underwriting years or years of account have yet to fully develop, an adjustment is made to the pattern to allow for further expected development. The selected development factors are then applied to cumulative claims data for each accident year to produce an estimated ultimate claims cost for each accident year.
Liability recognised in respect of prior accident years at 100% level *The foreign exchange adjustment arises from the retranslation of the estimates at each date using the exchange rate ruling at 31 December 2012.
Liability for accident years before 2003 recognised on Group’s balance sheet 82,130 **This represents the claims element of the Group’s insurance liabilities.
Estimate of ultimate claims costs as adjusted for foreign exchange* at end of accident year eight years later 316,035 520,847 – – – – – – – – 836,882 nine years later 321,250 – – – – – – – – – 321,250 Current estimate of cumulative claims
26 Insurance liabilities and reinsurance assets continued 26.2 Movements in insurance claims liabilities and reinsurance claims assets
The insurance claims expense reported in the consolidated income statement is comprised as follows: Year ended 31 December Gross
Total claims and claim adjustment expenses (719,792) 180,966 (538,826) (830,368) 132,470 (697,898)
Creditors arising out of direct insurance operations 15,606 58,346 Creditors arising out of reinsurance operations 130,605 152,866
Share of Syndicates’ other creditors’ balances 10,239 4,856 Social security and other taxes payable 8,649 10,640 Other creditors 9,037 14,939
Sch 23 FA 2003 deduction and share based payments (727) (1,867) Non-taxable income (23,723) (10,242) Overseas tax – 380 Prior year tax adjustments 5,885 (17,817)
Trading losses in UK entities 12,959 (12,959) – – Trade and other payables 525 510 – 1,035 Intangible assets – Syndicate capacity 3,344 (468) – 2,876
UK deferred income tax assets and liabilities are calculated at 23% for the year ended 31 December 2012 (2011: 25%). The UK Government has indicated its intention to reduce UK tax rates to 21% by the full year commencing April 2014, however at the balance sheet date, no such measures were substantially enacted.
Movements in deferred and current tax relating to tax deductions arise on employee share options are recognised in the statement of change to equity to the extent that the movement exceeds the corresponding charge to the income statement. The total recognised in the statement of changes in equity is £5,190,000, comprising £4,573,000 deferred tax and £617,000 current tax (2011: £3,927,000 deferred tax).
Deferred tax assets of £25,608,000 (2011: £25,748,000), relating to losses arising in overseas entities, which depend on the availability of future taxable profits in excess of profits arising from the reversal of other temporary differences, are recognised above. Business projections indicate it is probable that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within five years. £23,809,000 (2011: £23,555,000) of the tax losses to which these assets relate will expire after 15 years or later; the balance of tax losses carried forward has no time limit. The Group has not provided for deferred tax assets totalling £13,931,000 (2011: £8,714,000) including £13,841,000 (2011: £8,713,000) in relation to losses in overseas companies of £39,545,000 (2011: £25,408,000). In accordance with IAS 12, all deferred tax assets and liabilities are classified as non-current.
Deficit for funded plans 16,907 15,168 Unrecognised net actuarial losses (32,991) (27,247) Unrecognised surplus deemed irrecoverable 16,084 12,079
Current service cost 347 533 Interest cost 7,548 7,705 Expected return on scheme assets (8,097) (8,988) Recognition of past service credit – (3,037) Amortisation of net actuarial loss 1,034 – Effect of deemed irrecoverability of surplus 968 5,487
A summary of the scheme’s recent experience is shown below: Experience gains/(losses) on scheme obligations 4,372 – – – – 2,783 (3,310) Experience gains/(losses) on scheme assets 9,710 (5,596) 6,075 (3,678) (18,107) 75 6,480
Additional memorandum information at the end of the current and previous six accounting periods is presented below: Present value of scheme obligations 173,420 155,685 146,737 140,676 101,615 106,793 137,461 Fair value of scheme assets (156,513) (140,517) (144,056) (118,391) (115,166) (127,576) (133,660)
Assumptions regarding future mortality experience are set based on professional advice, published statistics and actual experience.
31 Earnings per share Basic earnings per share are calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of shares in issue during the year, excluding ordinary shares held by the Group and held in treasury as own shares.
Diluted Diluted earnings per share is calculated adjusting for the assumed conversion of all dilutive potential ordinary shares. The Company has one category of dilutive potential ordinary shares, share options and awards. For the share options, a calculation is made to determine the number of shares that could have been acquired at fair value (determined as the average annual market share price of the Company’s shares) based on the monetary value of the subscription rights attached to outstanding share options. The number of shares calculated as above is compared with the number of shares that would have been issued assuming the exercise of the share options.
Profit for the year attributable to the owners of the Company (£000) 207,772 21,272
Weighted average number of ordinary shares for diluted earnings per share (thousands) 408,019 399,212
Diluted earnings per share has been calculated after taking account of 15,915,875 (2011: 15,029,986) options and awards under employee share option and performance plan schemes and 510,925 (2011: 579,518) options under SAYE schemes.
34 Disposals The Group disposed of its holding in InsuranceBee, Inc. for no consideration.
(b) During 2012, Hiscox plc entered into a new Letter of Credit and revolving credit facility with Lloyds TSB Bank, for a total $875 million which may be drawn in cash (under a revolving credit facility), Letter of Credit or a combination thereof, providing that the cash portion does not exceed $400 million. In addition, the terms also provide that upon request the facility may be drawn in a currency other than US Dollar. At 31 December 2012 $308 million (2011: $340 million) was drawn by way of Letter of Credit to support the Funds at Lloyd’s requirement and no cash drawings were outstanding (2011: £nil).
(c) Hiscox Insurance Company Limited has arranged a Letter of Credit of £50,000 (2011: £50,000) with NatWest Bank plc to support its consortium activities with Lloyd’s.
Operating lease commitments The Group acts as both lessee and lessor in relation to various offices in the UK and overseas which are held under non-cancellable operating lease agreements. The leases have varying terms, escalation clauses and renewal rights. The Group also has payment obligations in respect of operating leases for certain items of office equipment. Operating lease rental expenses for the year totaled £7,233,000 (2011: £7,256,000). Operating lease rental income for the year totaled £615,000 (2011: £420,000).
The aggregate minimum lease payments required by the Group under non-cancellable operating leases, over the expected lease terms, are as follows: No later than one year Land and buildings 7,482 7,359 Office equipment 194 1
37 Principal subsidiary companies of Hiscox Ltd at 31 December 2012
Hiscox plc* Holding company Great Britain Hiscox Insurance Company Limited General insurance Great Britain Hiscox Insurance Company (Guernsey) Limited* General insurance Guernsey Hiscox Holdings Inc. Insurance holding company USA (Delaware) ALTOHA, Inc. Holding company USA (Delaware) Hiscox Insurance Company Inc. General insurance USA (Illinois) Hiscox Inc. Underwriting agent USA (Delaware) Hiscox Insurance Company (Bermuda) Limited* General insurance and reinsurance Bermuda Hiscox Dedicated Corporate Member Limited Lloyd’s corporate Name Great Britain Hiscox Holdings Limited** Insurance holding company Great Britain Hiscox Insurance Holdings Limited Insurance holding company Great Britain Hiscox Syndicates Limited Lloyd’s managing agent Great Britain Hiscox Underwriting Group Services Limited Service company Great Britain Hiscox Capital Ltd* Reinsurance Bermuda Hiscox Underwriting Ltd Underwriting agent Great Britain Hiscox Europe Underwriting Limited Insurance intermediary Great Britain *Held directly.
**Hiscox Holdings Limited held 54,560 shares in Hiscox Ltd at 31 December 2012 (2011: 54,560).
38 Related-party transactions Details of the remuneration of the Group’s key personnel are shown in the Directors’ remuneration report on pages 39 to 46. A number of the Group’s key personnel hold insurance contracts with the Group, all of which are on normal commercial terms and are not material in nature.
(a) Syndicate 33 at Lloyd’s The following balances were outstanding (payable) at the year end to Syndicate 33 by Group companies.
Hiscox Syndicates Limited 25,840 32,276 Hiscox Group insurance carriers 6,313 3,556 Hiscox Group insurance intermediaries 12,550 14,133
Profit for the year after tax 207,772 21,272 178,800 280,497 70,808
Financial assets carried at fair value 2,406,269 2,368,636 2,459,107 2,413,300 2,081,772
Net asset value per share (p) 349.7 323.5 332.7 299.2 258.1