Financial statements 104 Contents 105 Independent Auditor’s report financial statements 117 Notes to the consolidated financial statements 164 Parent Company financial statements 167 Notes to the Parent Company financial statements
A year of strong progress Paul Geddes, CEO of Direct Line Group, commented: “2017 is the fifth successive year in which we have delivered a strong financial performance. We have seen significant growth in our direct own brand policies as more customers respond positively to the many improvements we have made to the business. This success has resulted in our proposing an increase in the final dividend by 40.2% to 13.6 pence, bringing the total ordinary dividend to 20.4 pence and declaring a special dividend of 15.0 pence. This amounts to a cash return of £486 million to shareholders.
See glossary on page174 for definitions. 3. Estimates based on the Group’s Solvency II partial internal model.
• Operating profit from Ongoing operations of £610.9 million (2016: £403.5 million), primarily due to the non-repeat of the Ogden discount rate change which was reflected in 2016’s results. Profit before tax of £539.0 million (2016: £353.0 million)
• Combined operating ratio2 from Ongoing operations of 91.8% (2016: 97.7%) reflecting strong Motor and Commercial performance, including from prior-year reserve releases. Adjusted for normal weather, combined operating ratio towards the lower end of the target range 93% to 95%
RoTE1 at least 15% Grow our dividend in line with business growth
The way customers buy, the risks they face and the assets they use are changing at a rapid pace – our philosophy is to embrace those changes and help shape the future. Our digital capabilities mean we can open up new markets; Direct Line for Business has done this with small and medium-sized enterprises (“SMEs”). It also enables us to work with leading car manufacturers, such as Tesla, Peugeot and Citroën and Volkswagen Insurance Service (Great Britain) Limited so together we can learn from technology and develop the right solutions to support their customers.
Five years after the Group’s initial public offering we have consistently achieved profitable growth and returned £2.4 billion to shareholders including the ordinary and special dividends for 2017 of £486 million. Our successful strategy, built around our “rocket” (see page 14), has enabled us to launch new medium-term financial targets: Notes: 1. Return on tangible equity. See glossary on pages 174 to 176 for definition.
Churchill is one of Britain’s most recognisable brands. Our products are available by phone and online, including PCWs. Our customers are looking for a dependable partner who is reliable, trustworthy, and happy to spend time making sure they are happy. Those values are at the heart of the brand.
NIG is our commercial insurance brand dedicated to the broker market and is focused on a number of specialisms including SMEs, Agriculture and Real Estate. We sell our products through over 2,000 brokers, including an in-house intermediary that arranges commercial insurance for partnerships, such as RBS and NatWest.
We are one of the leading providers of rescue and other personal lines insurance in the UK2, 3 with 7.7 million in-force policies. This includes providing roadside assistance and recovery for customers through Green Flag, the UK’s third largest roadside recovery provider2. We also offer customers protection for their holidays and pets and are the second largest travel and the fourth largest pet insurer respectively3.
Customer focus We put our customers at the heart of everything we do. Our brands, products and distribution channels aim to make insurance much easier to access and better value for our customers. Our fast and efficient claims service gives our customers the help they need, when it is needed.
Talented people We invest in our people, encouraging everyone to aim higher. We do this so that our talented people across all parts of our business strive to improve and innovate, so that we can continue to deliver the products and services which meet the needs of current and future customers.
Data and technology We are harnessing the power of technology to make life easier for both our customers and our people. Continuing our history of disrupting the insurance market, we aim to use technology to become even more customer-centric, learning from the wealth of data we possess as a result of being a leading insurer.
Capital and financial strength We have a simple but highly cash-generative business model. Our proven underwriting discipline, claims excellence and cost control helps us meet our customers’ needs whilst targeting sustainable returns for our shareholders.
We strive to make sure our business is well-governed and controlled. We manage our finances carefully and balance this with targeting sustainable returns for our shareholders.
Customers We give customers products that best suit their needs and exceptional service throughout their relationship with us.
Communities We are committed to supporting our employees’ charitable work, reducing our environmental impact, and inspiring a generation of safer young drivers.
See page 34 for finance review See page 14 for our strategy 2. See page 21 for explanation on NPS. 3. See page 28 for details on employee engagement.
In 2017, the Group delivered profit before tax of £539.0 million (2016: £353.0 million). Continuing underwriting discipline, increasing operating efficiency, favourable claims results in the year and releases from prior year reserves have helped us achieve this commendable result.
Dividends In August 2017, the Group announced that the regular dividend would be rebased upwards to reflect the Board’s confidence in the Group’s earnings capability, its potential to generate strong cash flows, and the progress the business has made since the initial public offering (“IPO”) five years ago when the Group’s dividend policy was previously set. In line with this, the Board is recommending a final dividend of 13.6 pence per share. If approved, the total regular dividend of 20.4 pence per share will represent 39.7% growth on 2016’s regular dividend (14.6 pence per share). In addition, the Board has resolved to pay a further special interim dividend of 15.0 pence per share to reflect the Group’s strong performance in the year.
This is intended to enable the Group to meet all of its operational, regulatory and rating agency requirements.
IT infrastructure The Board continues to provide oversight of the programme of activity to upgrade and better integrate the major IT systems within the Group’s technology infrastructure aimed at improving the digital offering, customer experience and operational efficiency. Whilst progress has been made in each of the three areas, implementation and integration of a range of new IT systems is inherently complex and challenging. The Group remains focused on building the right capabilities and will take the time necessary to do so. The Board’s ongoing areas of focus include developing future capability for both customers and colleagues, and monitoring risks around the internal control environment, part of which is focused on the stability and security of the Group’s IT systems.
Culture, conduct and regulation The Group maintains active relationships with its insurance regulators through constructive dialogue. The Board promotes an open and collaborative culture, and provides oversight of the Group’s conduct with customers. It oversees the Group’s culture and the conduct policy, which aims to ensure that fair customer outcomes are achieved and that employees behave with integrity. The Group also has a Code of Business Conduct which sets out standards that our employees are required to adhere to (see page 60). The Board recognises that opportunities will arise to improve further the services offered to customers; and it has therefore encouraged a range of customer experience initiatives which are designed to deliver increased levels of customer satisfaction.
John Reizenstein was appointed as a member of the Investment Committee in July 2017. In November 2017, the Group welcomed Penny James to the Board as an Executive Director and CFO-designate, following the announcement that Penny will become CFO with effect from 1 March 2018 and that John Reizenstein will retire from the Board at the conclusion of the Annual General Meeting (“AGM”) on 10 May 2018. I thank John very much for his outstanding achievements as CFO over the last seven years; his contribution to the success of the Group to date has been significant and I wish him the very best for the future.
Andrew Palmer, independent NED and Chair of the Audit and Investment Committees, has decided to step down from the Board on 10 May 2018, having served as a Director since 2011. His tireless work before and after the IPO has been invaluable to the Board and to the Group’s senior management. He leaves us with our deepest gratitude and our best wishes for the future.
My introduction to the Corporate Governance report and the Nomination Committee report provide further information on these changes.
I would like to thank each member of the Board for their significant contribution, commitment and service; and look forward to working with them in 2018 as the Group continues to build on its success to date.
Leadership Your Board seeks to ensure that decisions are of the highest standard. It challenges strategic proposals, performance delivery and management responsibilities. See page 49.
Effectiveness The effectiveness of your Board’s and its Committees’ performance is considered annually in an effectiveness review. See page 52.
Remuneration Your Remuneration Committee ensures a close correlation between creating value for shareholders, and remunerating Executive Directors and senior executives appropriately. See pages 57 and 74.
Relations with shareholders and stakeholders Your Board maintains strong relationships and regular interaction with shareholders. Their continued support for the strategic aims is important. See page 57. Your Board also has regard to the interests of stakeholders. See page 59.
This year’s progress reflects the hard work of our people and our continued customer focus.
Q: How would you describe the Group’s financial performance? A: 2017 is the fifth successive year in which we’ve delivered a strong financial performance. The Group has a great track record of meeting the targets we publish and this gave us the confidence to extend some of our targets into the medium term. Investors I meet acknowledge that since going public in 2012 we have demonstrated consistently strong results, coupled in recent years with growth in the business – though of course they encourage us to not only sustain this but do better.
Q: What has driven the Group’s dividends? A: As announced in the 2017 half year results, the Board has rebased the regular dividend upwards, increasing the final dividend by 3.9 pence to 13.6 pence per share (2016: 9.7 pence). This reflects our confidence in our earnings and the progress we have made since the IPO in 2012.
Q: What do you see as the greatest market opportunities and challenges? A: I’ve already mentioned Direct Line for Business and Green Flag. There are other exciting opportunities ahead for NIG, where we are providing a great service to brokers serving the SME sector, and where we are investing in pricing capability as well as technology. In our Home business, we are doing innovative work with our NatWest partner to serve their retail customers better, and in Travel we are building a new operating platform as a foundation for developing both our direct and partner business. Of course the markets we operate in are extremely competitive and 2017 saw significant industry-wide challenges in the form of Insurance Premium Tax (“IPT”) and changes to the personal injury discount rate. These challenges, coupled with the growing popularity of PCWs, have created a shoppers’ market and I’m delighted with the success that our brands have enjoyed across the direct and PCW channels.
Q: It has been five years since the IPO. Can you describe the journey you have been on as an organisation? What have been the most significant changes over the last five years? A: In many ways it seems like no time at all! I think that the fifth birthday has given us cause to reflect on not just a one year view but on a five year view of our progress. We have achieved a huge amount over that period. We are a people business and these achievements are the result of the efforts of our entire DLG team, all of whom have played a part in a fundamental change in our culture from that of a division of a large global bank to our own unique identity.
Key steps in this change have been our focus on the customer and on individual behaviours, our performance management system, investing in our leadership, our colleague share ownership scheme, and initiatives such as Idea Lab, which enable colleagues to be rewarded for saving the Company money.
One of the proudest moments for all of us in the last five years has been to write over four million Direct Line policies in 2017. This is the result of an alignment of our strategy, our insurance and marketing expertise and the customer focus of our employees.
• Technologies including artificial intelligence and machine learning will enable better risk modelling, improved personalisation and enhanced customer experience
Our response • We continued to invest and partner with innovative FinTech and InsureTech companies
• We continued to invest in our systems, digital and data capabilities including appointing a new Chief Data Officer
• We developed a custom-built digital platform to provide a seamless journey for our RBS and NatWest partnership customers
Claims and premium inflation Rising cost pressures for insurers and customers • Motor insurance premiums continued to rise with pressure from increasing costs, regulatory changes and macroeconomic pressures
• Increased vehicle complexity, exchange rate impacts and inflation have contributed to rising repair costs
• Regulatory changes including those to the Ogden discount rate and the rise in IPT have added upwards pressure to the costs of insurance
Our response • We continued to add to our accident and repair network and rebranded the network to DLG Auto Services
Changing customer needs SMEs represent a growing customer base with distinct needs • The SME segment in the UK continued to grow, having grown by over 2 million businesses since 2002
• Technology and digital trends are enabling small businesses to reach a wider customer base and operate for longer hours, with fewer staff
• Small and micro businesses are behaving increasingly like consumers – looking for simplicity, speed and personalisation
Car technology and automation Opportunities and challenges in an evolving sector • The automotive industry is undergoing dramatic change with improvements in in-car technology and the advent of electric, connected and autonomous vehicles
Brand strength Brand is a key differentiator in a competitive environment • Retention is a key driver of profitability for insurers, as the cost of acquisition is often higher than that of retention
• It is a critical enabler for selling direct which typically has better retention and profitability
Regulation and legislation A dynamic and complex regulatory environment • The insurance regulatory and legislative environment continues to change at a rapid pace, with changes including: – new rules to promote price transparency by requiring disclosure of the previous year’s premium on renewal
– increase in the IPT rate – reduction in the personal injury discount rate
Our response • We continue to keep abreast of regulatory changes and engage continuously with regulators
We aim to make it easy for our customers to access our products and services at every stage of their journey. This includes increasing online policy servicing options for our customers including claims, enhancing the customer experience from purchase through to claims and evolving telephone sales and servicing by investing in next-generation customer systems.
Our response • The investment in our brands and propositions continues to deliver benefits, with the Direct Line brand in-force policy count passing four million customers this year
Putting customers first We have revitalised our Green Flag brand. We are the industry challengers providing a smarter breakdown service. By leveraging a nationwide network, instead of maintaining an expensive branded fleet, it is our customers who reap the rewards.
We aim to improve efficiency and effectiveness across the organisation. To do this we continue to deliver transformation initiatives, while also investing in capabilities to enhance the quality and effectiveness of our claims operations.
• We continue to monitor and control our costs carefully as part of the day-to-day running of the business, to help enable our expense ratio to reduce as the business grows
Lead & disrupt the market We seek to maximise existing growth opportunities while creating and driving future areas of value
We aim to remain a leading competitor in our chosen sectors by providing quality propositions and value for money. Where there are opportunities, we will look to launch new and exciting products and services with the aim of putting us at the forefront of disruptive changes.
Our response • When Direct Line was first launched, we disrupted a broker-led personal lines market – now we are looking to do the same for the Commercial small and micro business segment. This year, under the Direct Line for Business brand, we successfully launched the first two of our new, fully personalised insurance products for the Hair & Beauty and the Bed & Breakfast trades. Products can be tailored by the customer, allowing them to create a policy that’s just right for them and only paying for what they need. Next year we will continue our expansion with the launch of further personalised insurance products for different types of business
• We continue to build on our industry-leading position in understanding the impact of in-car technology on our industry. In 2017, we joined the StreetWise project, with the UK Government and Artificial Intelligence developers, which aims to use artificial intelligence to put autonomous vehicles on Britain’s roads by 2019. Our Shotgun app was launched with the aim of saving lives and making Britain safer. The app, aimed at under-25s, uses telematics and gamification to reward safer drivers
• In Home, we took an equity stake in Canopy, a rental market disruptor offering an alternative to costly security deposits that are hindering ‘Generation Rent’
Data & technology Harness the power of technology and the scale of our data
We aim to harness the power of technology to make things easier for our customers and our people. By implementing integrated systems that are flexible and efficient, over time we aim to reduce our expense ratio while improving customer interactions such as self-service. We also enjoy a wealth of data from being a major insurer with a large number of policies, which we can use to make our business better for our customers.
• We continue to deliver our ambitious IT transformation programme by improving our digital offering for our customers through self-service options and enhancing the customer experience
• In 2017 a new Direct Line brand initiative – Fleetlights partnered with the Caister Volunteer Lifeboat Service, making them the first search and rescue team in the world to use our high-performance, pioneering semi-autonomous drone technology to save lives at sea. We also launched Smarter Crossings – the world’s first responsive road – using lightemitting diodes that can react to the traffic, the people around it and the time of day, helping to keep road users safe
Driverless cars We positively embrace technology and welcome developments in automated driving. Driverless technology will impact all road users and bring new insurable risks to the market. As the UK’s largest motor insurer, we play a crucial role in this innovation and are backing projects that aim to bring this technology safely to the market. By embracing these technologies early on, we will be able to deliver the motor insurance our customers truly need.
• We’re improving the quality of career conversations by implementing simplified performance and development processes and increasing our people managers’ ownership of performance conversations and outturns
• We are also focussed on investing in our future at all levels of the organisation. We made a series of appointments and promotions to the Strategic Leadership Team with the dual purpose of capability and succession planning
• Early talent continues to be a significant focus for us with the second year of our Graduate and Apprentice Schemes – bringing the number of graduates in the business to over 100, and apprentices to over 200. The graduate scheme gives a broad understanding of our business to our graduates in preparation for their advancement towards leadership roles
• We will continue to embed diversity and inclusion in our culture and talent processes, enabling our staff to “bring all of themselves to work” and continuing the good progress made on gender mix at senior levels
“This course was unlike any leadership course I have ever been on, with a fresh, different approach.” Sheila Brudenell, Counter-Fraud Operations, Bromley
Our approach to capital and risk management is to maintain an appropriate level of capital and solvency in line with the risk appetite agreed by the Board to support our business, while aiming to grow dividends in line with our overall business growth.
• We also announced refreshed medium-term targets in our half-year results, including targeting around the middle of our 140% to 180% solvency capital ratio range
• We proposed a major Solvency II model change, which was subsequently accepted by the Prudential Regulation Authority (“PRA”)
• We recognise the strategic value and competitive advantage that strong risk management can provide and continue to work to drive ownership of risk management across the Group
Read more about our rewards for performance on page 74. For definitions, see the glossary on pages 174 to 176
We aim to make an underwriting profit. For 2018, we expect to achieve a COR in the range of 93% to 95% for Ongoing operations, assuming a normal level of claims from major weather events and no further change to the Ogden discount rate.
We base LTIP awards partly on relative TSR performance, which includes dividends. Directors also receive dividends on their beneficial shareholdings and accrue these on unvested LTIP awards.
A measure of the cost of doing business, including paying our people, marketing expenses, and spending on infrastructure and IT. This includes the costs we incur handling claims and any commissions we pay to brokers or partners.
We target a solvency capital ratio in the range of 140% to 180%.
See Finance review page 37 See Finance review page 42 Customer claims experience programmes and improved propositions have contributed to an increase in our overall brand score.
Notes: 1. See glossary on pages 174 to 176 and Appendix A - APM from page 177. 2. Estimates based on the Group’s Solvency II partial internal model. 3. On an aggregated 12-months rolling basis, with 2013 rebased to 100. 4. FCA complaints reporting requirements have changed for periods after 29 June 2016. Before 29 June 2016, only complaints resolved after 2 business days were classed as FCA reportable. From July 2016 all complaints resolved are classed as FCA reportable. 5. For the Group’s principal underwriter, U K Insurance Limited. 6. See page 91 of Directors’ Remuneration Report for explanation of gateway measures.
Risk appetite Our risk appetite statements define the risks we are prepared to accept to achieve our business objectives. The processes for setting risk appetite; particularly the cascade, assessment, mitigation and reporting of risk exposures against risk appetite; are documented in the Group’s policies and underlying minimum standards. To monitor whether the business remains within risk appetite, we use key risk indicators (“KRIs”).
We derive the KRIs from the risk appetite statements which are used to drive and monitor risk-aware decision-making.
These KRIs are qualitative and quantitative, and forward and backward-looking. We review our risk appetite statements and KRIs annually.
Managing risk in line with our strategy Management, with oversight from the Board, is responsible for developing our strategy. Our strategic planning process aims to ensure we have developed clear objectives and targets, and identified the actions needed to deliver them, including the management of risk. The delivery of a strategic plan will, by its very nature, result in risks and therefore understanding and managing those risks appropriately is a key aspect of the strategic planning process. The Group’s risk strategy is aligned with the Group strategy and supports business decision-making through the proactive identification, assessment and management of risks. The Group’s risk strategy is consistent with our overall long-term ambition of sustainable growth and at least a 15% RoTE delivered while remaining within our risk appetite.
Our risk governance framework The Board sets and monitors adherence to the risk strategy, risk appetite, and risk framework. The Board approves our strategy, risk appetite and policies, and the Board Risk Committee (“BRC”) approves the Enterprise Risk Management Strategy and Framework (“ERMF”). The Board has established a risk management model that separates responsibilities into ‘Three Lines of Defence’.
1. Maintain capital adequacy The Group seeks to hold own funds in the range of 140% to 180% of the internal model solvency capital requirement. The Group also seeks to maintain sufficient economic capital consistent with its strategic aim of maintaining a credit rating in the ‘A’ range.
The Group aims to meet planned and unexpected cash outflow requirements, including those requirements that arise following a 1-in-200 years insurance, market or credit risk event.
We need to have a strong understanding of the nature and extent of the risks involved in pursuing the Group strategy; and, to enable our strategy’s success, we must manage risk effectively and efficiently.
Every year, the Board considers a five-year strategic plan and an Own Risk and Solvency Assessment (“ORSA”) for the Group. The plan makes certain assumptions in respect of the competitive markets in which the Group operates, and the delivery and implementation of the new customer systems. Appropriate aspects of the strategic plan are stress-tested to understand and help set capital and other requirements.
When reviewing the strategic plan, the Board considered the Group’s prospects over the five-year period that the plan covered and the conclusions of the ORSA, based on the Group’s anticipated activities as set out in the strategic plan. This review included reviews of solvency, liquidity, assessment of principal risks, and risk management over a three year period, with a further two years of indicative planning. The one-year planning period has greater certainty, so it was used to set detailed budgets across the Group. Outcomes for the four-year period are less certain. However, the plan provides a robust planning tool for strategic decisions. The Board recognises that, in a strategic plan, uncertainty increases over time and, therefore, future outcomes cannot be guaranteed or accurately predicted.
Considering the Group’s current capital and trading position, its principal risks, and the remaining four years of the strategic plan, the Board has a reasonable expectation that the Company and the Group can continue in operation, and provide the appropriate degree of protection to those who are, or may become, policyholders or claimants in the period to 31 December 2021.
Our Enterprise Risk Management Strategy and Framework This section sets out, at a high level, our approach to setting risk strategy and the ERMF for managing risks. It documents the high-level principles and practices to achieve appropriate risk management standards and demonstrates the inter-relationships between components of the ERMF – see diagram.
Our risk culture Our risk culture underpins our business and decision-making, and helps us embed a robust approach to managing risk. Our risk culture is demonstrated in the understanding and business-wide use of the risk management systems and processes and through risk-aware decision-making. The Board is committed to promoting a culture of high standards of corporate governance, business integrity, ethics and professionalism in all our activities. An annual assessment of risk behaviours and attitudes is undertaken jointly by the Risk function and Group Audit and considers a range of factors influencing risk culture.
Principal risks and uncertainties We assess robustly the principal risks facing us. Principal risks are defined as having a residual risk impact of £40 million or more on a 1-in-200 years basis, taking into account customer, financial and reputational impacts. There have been movements in our risk profile during 2017 primarily driven by the Ogden discount rate change and enhanced technology controls. There have been no material breaches of risk appetite.
Insurance risk • Underwriting risk • Reserve risk • Distribution risk • Pricing risk
The risk of loss due to fluctuations in the timings, amount, frequency and severity of an insured event relative to the expectations at the time of underwriting. See pages 127 to 129.
The risk of loss resulting from fluctuations in the level and volatility of market prices of assets, liabilities and financial instruments. See pages 129 to 131.
Chief Financial Officer • We ensure compliance with an investment strategy approved by the Board
• We carefully diversify asset classes • We set limits on exposure to individual asset classes and the amount of illiquid investments • We tightly control individual credit exposures • We use risk-reduction techniques, such as hedging foreign currency exposures with forward contracts, and hedging exposure to US interest rates with swap contracts
Chief Financial Officer • Credit limits are set for each counterparty and we actively monitor credit exposures
• We have well-defined criteria to determine which customers are offered and granted credit
• We monitor operational risk activity in line with a Board-approved operational risk appetite
• We are continuing to work to improve performance of our IT systems while focussing on developing future systems capability. With significant change underway, we are continuing to monitor risks associated with our IT systems’ stability, cyber security, and the internal control environment
• We have a strong culture of delivering on our commitments to our customers
• Our conduct risk management framework is designed to deliver fair outcomes to customers and minimise our risk exposure
• We carry out planned risk-based monitoring of customer processes as well as more targeted thematic reviews which consider strategic or regulatory projects
The risk of direct or indirect adverse impact on the earnings, capital, or value of our business, resulting from the strategies not being optimally chosen, implemented or adapted to changing conditions.
• The Boards lead an annual strategy and five-year planning process which considers our performance, competitor positioning and strategic opportunities
We consider our main emerging risks to be: Technological change in driving habits reduces consumer need for motor insurance New car technologies, such as crash-prevention technologies and driverless cars, could significantly affect the size and nature of the insurance market, and the role of insurers.
In addition to our partnership with the Government on automated driving systems, the Group continues to build strong collaborative relationships, including with key manufacturers of driverless cars.
Protecting Britain’s young drivers As Britain’s leading car insurer, our Corporate Social Responsibility strategy is focussed on road safety. In particular, we are using our insight and expertise to make a measurable difference to young drivers in the UK.
We believe we can use our expertise and experience to help reduce the number of deaths and life-changing injuries on Britain’s roads.
17 to 19-year olds are involved in 9% of all fatal and serious crashes, despite representing just 1.5% of all drivers. It’s less well-known that, young drivers are more dangerous in their first 1,000 miles of driving after passing their test, before then improving. This is because young drivers are often over confident straight after passing their test. In addition, they are less experienced at spotting dangers or hazards on the road and often take more risks.
To keep drivers engaged, we have put in place attractive rewards and created a leader board to allow people to see how their driving measures up against other drivers on the app. These leader boards can be personalised to allow people to compete with their friends.
We partner with leading CSR organisations to ensure that we understand, prioritise, and respond to the sometimes competing needs of our different stakeholders across society.
You can find more details of our approach on the Group’s website at www.directlinegroup.com, including our CSR Charter, policy framework, performance against last year’s targets and targets for 2018.
Shotgun With over downloads, our Shotgun app is helping raise awareness of safer driving among 17 to 25-year olds
We are really proud to say that the app is already helping to make a real difference by improving road safety for young drivers. Our analysis of drivers using the app so far shows that for key areas such as speeding and braking, there has been a great improvement. Early indicators are that around one in three drivers have improved their smoothness, which means less hard breaking or tailgating is happening and one in four have improved their safe driving skills by reducing their speed. We know that these metrics have a high degree of correlation to overall safety and accident statistics, and so we are confident that Shotgun has already helped save people from death or serious injury.
Road safety partners During 2017, we worked with various partners to highlight a range of road safety issues.
Diversity, inclusion and human rights We continue to work towards an environment based on meritocracy and inclusion, creating a work place where we celebrate differences and we value our people for always being themselves.
Our diversity and inclusion practices are in line with the Universal Declaration of Human Rights. Our Ethical Code for Suppliers requires that all our suppliers adhere to the core International Labour Organization standards. We support the aims of the Modern Slavery Act 2015 and are committed to ensuring that modern slavery is not present in our supply chain. In accordance with the Act, we publish an annual statement on slavery and human trafficking on the Group website at www.directlinegroup.com.
In 2016, the Group signed up to the Women in Finance Charter. The Charter is a commitment by HM Treasury and signatory firms to work together to build a more balanced and fairer industry. Our pledge to the Charter reinforces our other initiatives such as our Diversity Network Alliance in promoting diversity and inclusion in our business. We report our progress against this commitment annually on the Group website www. directlinegroup.com.
Living wage We comply with the principles of the Living Wage Foundation relating to our employees.
Examples of activities include employees manning our call centres to take pledges for appeals such as Children in Need, supporting national appeals such as the World’s Biggest Coffee Morning in aid of Macmillan and organising quiz nights, fun runs, masquerade balls, festivals, cake sales, charity football matches and more to raise thousands of pounds for local causes.
Matched giving and grants We believe that our people’s feelings about working for the Group are linked to our reputation in the community and we therefore try to align our approach to giving more generally with their interests. In 2017, our employees donated £151,000 through our payroll giving scheme and we donated a further £104,000 in matched giving. We also provided £66,000 in grants to organisations for which our employees fundraise or volunteer.
Energy use is the main cause of our emissions. In absolute terms, we have reduced our emissions significantly after rationalising and implementing an energy-savings plan across our estate over the last five years. This covered building management, air-conditioning, heating and lighting, for instance. We are targeting a 30% like-for-like reduction in the Group’s energy use by 2020 against a 2013 baseline.
Throughout 2017, we have maintained our commitment to sourcing 100% of the Group’s electricity from renewable sources.
Waste We continually seek opportunities to improve our systems for managing waste. In 2017, the Group recycled 72% of its waste (80% in 2016). This year-on-year fall is due to a 58% reduction in paper waste, which is 100% recycled. Excluding paper, the Group recycled 60% of its waste (54% in 2016). 98% of our waste, including recycling is diverted from landfill.
• Operating profit improved by £215.4 million to £364.5 million, due to the non-repeat of the £150.3 million Ogden charge in 2016. Other prior-year releases were lower year on year, albeit large bodily injury claims developed favourably
In-force policies (thousands) 4,019 3,873 Of which own brands 3,845 3,642
Performance Motor in-force policies increased by 3.8% to 4.0 million during 2017, primarily due to growth in own brands. This was supported by higher levels of new business and higher levels of customer retention. Investment in brand differentiation continued in 2017, and helped drive the strong performance in Direct Line. Motor gross written premium increased by 8.5% to £1,670.4 million as a result of higher volumes and higher average premiums.
The COR was 91.9% (2016: 106.3%), a significant improvement due to the non-repeat of £150.3 million of the Ogden charge incurred in 2016. Excluding the impact of Ogden in 2016, the COR improved due to strong growth at improved margins. Motor also benefitted from a £49 million reserve release after a detailed review in H1 of the Group’s Ogden provision within case reserves. Other prior-year releases were lower year on year, albeit large bodily injury claims developed favourably. The expense ratio increased slightly due to a higher intangible asset impairment of £56.9 million (2016: £39.3 million). The commission ratio improved 0.7 percentage points compared with 2016.
While bodily injury claims frequency was better than expected in 2017, claims severity inflation, particularly in relation to damage perils, remained a headwind. Overall, claims inflation in 2017, excluding Ogden, was below the Group’s expected long-term average of 3% to 5% per annum.
The Group already has a partnership with PSA Finance UK (part of Groupe PSA; owners of the Peugeot and Citroën brands) and an introducer relationship with Tesla, and the Group has recently signed a letter of intent for a partnership arrangement intended to be for five or more years with Volkswagen Insurance Service (Great Britain) Limited covering five well-known brands – Volkswagen, Audi, SEAT, Škoda and Volkswagen Commercial Vehicles.
• Gross written premium was 4.2% lower primarily due to partnerships, while own brands increased by 1.2%
• COR increased by 4.4 percentage points to 89.4% • Operating profit was £128.8 million, compared with £166.7 million in 2016. The reduction reflected substantially lower prior-year reserve releases and higher costs from escape of water (“EoW”) claims
Gross written premium £799.1m £834.4m Loss ratio 50.6% 40.7% Commission ratio 17.7% 22.6% Expense ratio 21.1% 21.7% Combined operating ratio 89.4% 85.0% Operating profit £128.8m £166.7m
The change in distribution of Home’s insurance business from partners to PCWs continued in 2017, increasing market price competitiveness and commoditisation. The Group remained competitive across all channels and successfully grew its PCW policies in 2017 at attractive margins, helping to support the strong profitability of the category.
Home own brands maintained competitiveness in 2017. The Group was quick to adjust new business prices to reflect claims inflation, and due to its strong propositions and improved competitiveness, wrote higher new business volumes. Total own brands risk adjusted prices were 2.6% ahead of prior year. Higher new business growth, particularly through PCWs led to a reduction of 1.3% in Home own brands average written premium1. As expected, renewal premiums continue to experience some reduction year on year due to channel mix moving towards lower premium PCW and web channels, whilst strong retention enabled policy renewals to grow year on year.
The Group’s Home partnership with Nationwide ended in December 2017 when new business ceased to be written. Existing in-force polices will run off during 2018.
The COR increased by 4.4 percentage points primarily as a result of a higher loss ratio, partially offset by a reduced commission ratio. The loss ratio increased 9.9 percentage points compared with 2016, mainly as prior-year reserve releases were lower than for 2016 at £23.7 million (2016: £75.9 million), as 2016 benefitted from significant releases from the reserves established following the storms of late 2015. The impact of major weather events in 2017 was slightly lower at approximately £13 million (2016: £18 million), lower than the normal annual level of claims costs expected from major weather events of approximately £65 million. Based on planned volumes for 2018, the Group's current assumption of a normal annual level of claims costs from major weather events is approximately £55 million.
The current-year attritional loss ratio, excluding claims costs from major weather events, was 4.2 percentage points higher than in 2016. This was predominantly driven by elevated EoW claims inflation costs and a change in channel mix. Claims, pricing and underwriting actions taken since Q1 2017 have been on track to reduce claims inflation to a more normal level.
The decrease in the commission ratio of 4.9 percentage points to 17.7% primarily reflected lower profit share payments to partners, as a result of lower prior-year reserve releases, a higher current-year attritional loss ratio and changes to partnership arrangements business mix.
Operating profit of £128.8 million decreased by £37.9 million due to elevated EoW claims inflation and lower prior-year reserve releases, partially offset by a reduced commission ratio.
• COR increased by 1.0 percentage point to 94.3% • Operating profit reduced slightly to £43.6 million
Total in-force policies 7,739 7,880 Of which Green Flag direct 802 729
Gross written premium £421.1m £400.8m Loss ratio 65.4% 61.6% Commission ratio 5.5% 7.2% Expense ratio 23.4% 24.5% Combined operating ratio 94.3% 93.3%
Performance Rescue and other personal lines in-force policies reduced 1.8% to 7.7 million compared with 2016, primarily due to lower partner volumes. Green Flag direct in-force policies increased by 10.0% in the year from 729k to 802k. Gross written premium increased 5.1% compared with 2016, primarily due to price increases in Travel and strong growth in Green Flag direct which increased 11.5% compared with 2016.
The COR for Rescue and other personal lines was 1.0 percentage point higher at 94.3% (2016: 93.3%) primarily due to an increase in the loss ratio as a result of lower prior-year reserve releases in Travel. The commission ratio improved 1.7 percentage points due to lower payments to partners while the expense ratio improved 1.1 percentage points primarily due to improved marketing efficiency for Rescue. The COR for Rescue was 82.8% (2016: 83.4%).
Green Flag has a strong focus for 2018 to seek to further enhance customer experience and build in its 2017 NPS performance.
Commercial Highlights • Commercial in-force policies grew by 4.9% with Direct Line for Business growth of 8.1% • Gross written premium increased by 0.3% to £501.5 million.
• COR reduced by 5.3 percentage points and operating profit increased by £32.2 million, benefitting from lower weatherrelated claims costs and higher prior-year reserve releases
The Commercial COR of 93.4% benefitted from low weatherrelated claims costs. The COR was 5.3 percentage points lower than 2016, primarily due to higher prior-year reserve releases following favourable development on liability classes and the non-repeat of the Ogden charge of £24.8 million incurred in 2016. The current-year attritional loss ratio was 2.5 percentage points higher in 2017 as the Group continued to set current accident year reserves conservatively. Based on planned volumes for 2018, the Group's current assumption of a normal annual level of claims costs from major weather events is approximately £20 million.
Operating profit of £74.0 million increased £32.2 million primarily due to the loss ratio improvement.
In line with the Group’s strategic pillar to ‘lead and disrupt’, Direct Line for Business made significant strides in its strategy to disrupt the small and micro commercial insurance industry, launching its new direct insurance platform for UK businesses in April 2017. Hair and Beauty was the first product launched and in December this was followed up by Direct Line for Business’s Bed & Breakfast proposition. Management aims to have 75% of its targeted trades launched by the end of 2018.
Financial highlights • Strong growth in direct own brands1 premiums and in-force policies up 9.3% and 5.3% respectively, driven again by continued Direct Line momentum in Motor
• Reported expense ratio in line with 2016. Excluding non-cash intangible assets impairments of £56.9 million (2016: £39.3 million), underlying expense ratio improved 0.5 percentage points to 23.5%
• COR from Ongoing operations of 91.8% (2016: 97.7%) reflecting strong Motor and Commercial performance, including from prior-year reserve releases. Adjusted for normal weather, COR towards the lower end of the target range of 93% to 95%
Ongoing operations In-force policies (thousands) 15,714 15,806 In-force policies – direct own brands1 (thousands) 6,909 6,563 Gross written premium 3,392.1 3,274.1 Net earned premium 3,135.0 3,000.6 Underwriting profit 256.9 70.1 Instalment and other operating income 179.3 165.3
Key metrics Loss ratio3 57.4% 60.9% Commission ratio3 9.1% 11.5% Expense ratio3 25.3% 25.3% Combined operating ratio3 91.8% 97.7% Adjusted diluted earnings per share1 (pence) 33.6 21.2 Return on tangible equity1 21.7% 14.2% Investment income yield1 2.5% 2.5% Net investment income yield1 2.1% 2.2% Investment return yield1 2.6% 2.6% Basic earnings per share1 (pence) 31.8 20.4 Return on equity 16.6% 10.8% Net asset value per share (pence) 198.9 184.7 Tangible net asset value per share (pence) 164.4 147.4 Dividend per share • interim (pence) 6.8 4.9 • final (pence) 13.6 9.7 • total ordinary (pence) 20.4 14.6 • special (pence) 15.0 10.0 • total (pence) 35.4 24.6 Solvency capital ratio4 – estimated 162% 165%
Underwriting profit 256.9 70.1 Instalment and other operating income 179.3 165.3 Investment return 174.7 168.1
Of which Green Flag direct 60.9 54.6 Direct Line for Business 122.6 109.6
Gross written premium increased by 3.6% to £3,392.1 million (2016: £3,274.1 million) primarily relating to an increase in Motor and Home own brands and other personal lines partially offset by a reduction in Motor and Home partnerships.
Net earned premium (£m) 4 1,470.6 790.5 417.6 456.3 3,135.0 Net insurance claims (£m) 4 896.0 400.5 273.3 227.5 1,797.3 Prior-year reserve releases (£m) 33 275.5 23.7 6.8 86.3 392.3 Major weather events (£m) n/a (13.0) n/a n/a (13.0)
Instalment income 116.4 107.1 Other operating income: Vehicle replacement referral income 16.9 14.1 Revenue from vehicle recovery and repair services 11.3 19.3 Legal services income 11.0 11.2 Other income 23.7 13.6
Investment income 167.1 167.9 Hedging to a sterling floating rate basis (27.0) (17.1) Net investment income 140.1 150.8 Net realised and unrealised gains excluding hedging 35.3 20.7
Investment income yield1 2.5% 2.5% Net investment income yield1 2.1% 2.2% Investment return yield1 2.6% 2.6%
The Group’s investment strategy is to seek to match the duration of its UK liabilities and protect the Group’s capital. To avoid over-concentration in the limited credit market the Group invests in US and some global investment-grade credit. The Group uses derivatives to hedge the currency and interest rate risk back to a sterling floating rate basis, and as a result benefits from credit diversification while hedging to a UK interest rate exposure.
Assets under management increased by £128.3 million reflecting lower capital distributions in 2017 as a result of the Ogden discount rate change, strong investment performance and business growth offset by continued reduction in the Group’s net liabilities.
The total investment return increased to £175.4 million (2016: £171.5 million) to give a total yield of 2.6% (2016: 2.6%). Whilst investment income has benefitted from an increase in US interest rates, this has been offset by an increase in the cost of hedging to a sterling floating rate, resulting in a hedging cost of £27.0 million. This was more than offset by other realised and unrealised gains, including on the property portfolio.
Investment income remained broadly stable at £167.1 million (2016: £167.9 million) and the investment income yield was in line with management guidance at 2.5% (2016: 2.5%). Investment income net of hedging costs was £140.1 million (2016: £150.8 million) and the investment income yield net of the hedging result was 2.1% (2016: 2.2%).
Operating profit – Ongoing operations 610.9 403.5 Run-off 43.8 26.6 Restructuring costs (11.9) (39.9)
Run-off costs The Run-off segment generated a profit of £43.8 million in 2017 (2016: £26.6 million). This increase over 2016 was largely due to the non-repeat of the Ogden charge in 2016.
Going forward, the coupon payment for the recently issued Tier 1 notes will be accounted for directly through equity. As a result of the repurchase, reported finance costs are expected to reduce by approximately half.
RoTE increased to 21.7% predominantly due to an improvement in profit after tax (2016: 14.2%). The profit after tax in 2017 included in the RoTE calculation includes an adjustment to remove the one-off costs in relation to the buy-back of the £250 million subordinated guaranteed dated notes (£66.1 million before tax). See appendix A – APM from page 177.
Following a review of the approach to the Group’s Executive Remuneration policy, the Remuneration Committee is proposing that the level of RoTE required for the March 2018 long-term incentive plan awards to vest be increased from the current range of 15.0% to 18.0% to a range of 17.5% to 20.5%, partly reflecting the issue of the Tier 1 notes.
Adjusted diluted earnings per share from Ongoing operations were 33.6 pence (2016: 21.2 pence) reflecting the increase in operating profit.
Dividends The Board is proposing a final dividend of 13.6 pence per share making a total ordinary dividend of 20.4 pence per share (2016: 14.6 pence). This represents 39.7% growth over the 2016 ordinary dividend in line with the increase in interim dividend announced with the H1 results.
Net cash used in financing activities of £256.9 million (2016: £528.4 million) reduced £271.5 million as a result of lower dividends paid in 2017 and a net cash generation of £19.7 million from Tier 1 and Tier 2 debt restructuring transactions.
Tangible net assets 2,244.0 2,012.6 Closing number of shares 1,365.1 1,365.1 Net asset value per share (pence) 198.9 184.7 Tangible net asset value per share (pence) 164.4 147.4
The Group considers the class of business, the length of time to notify a claim, the validity of the claim against a policy, and the claim value. Claims reserves could settle across a range of outcomes, and settlement certainty increases over time. However, for bodily injury claims the uncertainty is greater due to the length of time taken to settle these claims. Annuity payments for injured parties also increase this uncertainty.
The Lord Chancellor changed the Ogden discount rate from 2.5% to minus 0.75% with effect from 20 March 2017 based on a three year average of yields on index-linked government securities and the rate may be sensitive to future movements in these instruments. The Government is currently planning to review the Ogden discount rate again based on ‘low risk’ investments rather than ‘very low risk’ investments, however, there is considerable uncertainty if, when and how a change might be made.
The Group’s prior-year reserve releases were £435.4 million (2016: £290.1 million) with good experience in large bodily injury claims being a key contributor. The releases in 2017 include a £49 million Ogden specific release where the claims file review performed in H1 following the Ogden discount rate change indicated a lower ultimate cost at the new rate than was assumed at the year end 2016. In addition, large bodily injury claims developed favourably. Home prior-year reserve releases of £23.7 million (2016: £75.9 million) were affected by EoW experience, whilst in 2016 Home benefitted from favourable development on the December 2015 weather events.
Looking forward, the Group expects to set its initial MBE for future accident years conservatively. Over time, the proportion of the Group’s underwriting profit attributable to the current- year is expected to increase, including due to targeted improvements in the expense and commission ratios. Assuming current claims trends continue, the contribution from prior-year reserve releases is expected to remain significant, albeit it is expected to reduce over time.
• Commercial property risk reinsurance to protect against large individual claims with a retained deductible of £4 million which renews annually on 1 July.
Investment portfolio The investment strategy is designed to deliver several objectives, which are summarised below: • to ensure there is sufficient liquidity available within the investment portfolio to meet stressed liquidity scenarios determined by the Risk function
2. Securitised credit was disposed of during 2016. 3. Net of bank overdrafts: includes cash at bank and in hand and money market funds with no notice period for withdrawal.
Asset and liability management The following table summarises the Group’s high--level approach to asset and liability management.
Commercial real estate loans 3.0% 2.5% 3.0% 1.2% Cash and cash equivalents 9.0% 19.4% 9.0% 16.9%
At 31 December 2017, total net investment holdings of £6,709.3 million were 1.9% higher than at 31 December 2016, reflecting operating cash flows offset by dividends paid. Total debt securities were £4,610.1 million (31 December 2016: £4,724.5 million), of which 4.8% were rated as ‘AAA’ and a further 61.9% were rated as ‘AA’ or ‘A’. The average duration at 31 December 2017 of total debt securities was 2.3 years (31 December 2016: 2.3 years). At 31 December 2017, total net unrealised gains, net of tax, on AFS investments were £80.2 million (31 December 2016: £92.1 million).
Allocation (£m) Income (£m) Yield (%) Allocation (£m) Income (£m) Yield (%)
Capital management Capital management policy The Group aims to manage its capital efficiently and generate long-term sustainable value for shareholders, while balancing operational, regulatory, rating agency and policyholder requirements.
The Group aims to grow its regular dividend in line with business growth.
Where the Board believes that the Group has capital which is expected to be surplus to the Group’s requirements for a prolonged period, it would intend to return any surplus to shareholders. In normal circumstances, the Board expects that a solvency capital ratio around the middle of its risk appetite range of 140% to 180% of the Group’s SCR would be appropriate and it will therefore take this into account when considering the potential for special distributions.
Solvency II In its results, the Group has estimated its Solvency II own funds, SCR and solvency capital ratio as at 31 December 2017. The Group will formally submit its final Solvency and Financial Condition Report in May 2018 to the PRA, and expects to continue to update the assumptions and implement minor model changes until then. Therefore, the final solvency position may differ from those included in these results.
Sensitivity analysis The following table shows the Group’s estimated solvency capital ratio sensitivities based on the assessed impact of scenarios as at 31 December 2017.
Tier 1 capital 1.94 1.74 Tier 2 capital – sub debt 0.26 0.54 Tier 3 capital – deferred tax 0.05 0.03
At 31 December 2017, the Group held a Solvency II capital surplus of approximately £0.86 billion above its regulatory capital requirements and was equivalent to an estimated solvency capital ratio of 162%, post-dividend.
Tier 1 capital after foreseeable dividends represents 86% of own funds and 139% of the estimated SCR. Tier 2 capital relates solely to the Group’s £0.26 billion subordinated debt. The amount of Tier 2 and Tier 3 capital permitted under the Solvency II regulations is 50% of the Group’s SCR and of Tier 3 it is less than 15%. Therefore, the Group has no ineligible capital.
The Group has issued Tier 1 notes to mitigate the risk of a single refinancing date. In addition, under Solvency II eligibility restrictions the Group previously had limited options to raise additional subordinated debt (Tier 2) capital to recover solvency. As a result of raising the Tier 1 notes and repaying half of the Tier 2 capital the Group has the ability to raise further Tier 2 capital should this be required.
Capital generation 0.49 0.31 Change in solvency capital requirement 0.01 0.27
Surplus generation 0.50 0.58 Capital expenditure (0.10) (0.11) Management capital action 0.03 --- Capital distribution – ordinary dividends1 (0.28) (0.20) Capital distribution – special dividends1 (0.20) (0.14)
During 2017, the Group’s own funds reduced from £2.31 billion to £2.25 billion. The Group generated £0.49 billion of Solvency II capital offset by £0.10 billion of capital expenditure and capital distribution of £0.48 billion, including the 2017 interim and final ordinary dividends and special interim dividends. The capital management action refers to the debt refinancing activity mentioned above.
Regulatory update Throughout 2017, the FCA’s focus has been on value measures and pricing practices as well as the publication of its business plan. The PRA focus has been on the pillars of its financial risk framework, namely reserving, pricing, reinsurance and investments. The Group is exposed to the risk of changes to regulatory rules, policy or interpretation, and to supervisory expectations or approach by regulators or other bodies or authorities; and of changes to law, tax, monetary or fiscal policies or their interpretation by government or government authorities, any of which may have adverse operational and financial impact.
For 2018, the Group targets net investment income yield to be around 2.1%, with overall investment return in the region of £150 million.
Statement of the Directors in respect of the Strategic report The Board reviewed and approved the Strategic report on pages 1 to 43 on 26 February 2018.
Effectiveness and evaluation As Chairman, my principal objective is to develop and lead an effective Board for the benefit of our shareholders. The Board undertakes a review of its effectiveness each year and appoints an external evaluator every third year, as recommended by the UK Corporate Governance Code. Having benefitted from an external review in 2016, the Board and its Committees carried out their 2017 effectiveness review in-house with the assistance of the Company Secretary. Respondents agreed that strengths identified in earlier reviews, including the Board’s culture, the openness of its debate and the quality of information received, remained strengths. In the interests of continuous improvement, some suggestions for fine-tuning were raised during the review process and taken into consideration by the Board. You can find further details on page 53.
On behalf of the Board, I am pleased to present the Corporate Governance report for the year ended 31 December 2017. The Board continues to focus on maintaining high standards of corporate governance, which we seek to achieve through the Group’s robust governance framework.
The Board recognises the importance of succession planning and understands the need to have leaders who live the Group’s culture and values.
See page 60 for our full Code of Business Conduct. See page 57 for relations with shareholders.
Bring all of yourself to work Be the best you can be, the real and whole you; celebrate our diversity of skills, experiences and personalities; be a role model to others, demonstrate a ‘can do’ spirit, have fun and make this a great place to be; be excited about our Company and our future; believe in yourself, feel confident and empowered.
Your Board maintains strong relationships and regular interaction with our shareholders. Their continued support for our strategic aims is important.
Biography Jane is Chair of the Board Risk Committee. She has extensive experience of risk management, corporate governance and internal control. She also has wide experience in developing and monitoring customer and conduct risk frameworks. She spent her early career with KPMG, working in the financial sector, later becoming responsible for delivering corporate governance, internal audit and risk-management services in the north of England. Jane has also held a number of executive roles, including Director of Audit, and Risk and Governance Director at Aviva’s UK Life business. She is a Fellow of the Institute of Chartered Accountants in England and Wales.
Current external appointments Danuta is interim Chairman of Aldermore Group plc, a Non-Executive Director and Chairman of the Remuneration Committee of PageGroup plc, a Non-Executive Director and Chairman of the Remuneration Committee of Old Mutual plc, and a Non-Executive Member of the Defence Board of the UK Ministry of Defence.
Current external appointments Richard is Executive Chairman of Cunningham Lindsey and Non-Executive Chairman of Brit Syndicates Ltd. He also serves as a member of the PRA Practitioner Panel, Bank of England.
Current external appointments Clare is a Non-Executive Director of British United Provident Association (“Bupa”) and Retail Charity Bonds plc. She is also a Non-Executive member of the partnership board of Miller Insurance Services LLP, and Treasurer of the Disasters Emergency Committee.
Biography Sebastian is Chair of the Corporate Social Responsibility (“CSR”) Committee. He has extensive experience in retail and consumer practice at large groups; and has a detailed understanding of the UK consumer markets, products and brands. Sebastian was previously CEO of Synergy Insurance Services Limited and subsequently gained wide retail experience as Strategy Director responsible for developing and implementing the turnaround strategy at Mothercare.
Biography Andrew is Chair of the Audit and Investment Committees. He has performed various senior roles in the financial services and insurance industries. Additionally, he has insight into corporate governance developments and best practice in financial reporting. In 2009, Andrew retired from Legal & General Group plc, where he was the Group Finance Director. He is a Fellow of the Institute of Chartered Accountants in England and Wales.
Biography John was CFO throughout 2017 and will be succeeded by Penny James on 1 March 2018. He joined the Group in 2010 as CFO and led the IPO in 2012. Under John’s financial stewardship, the Group has achieved and upgraded its financial targets, sold its International division at an attractive price, and undertaken multiple actions to return capital to shareholders. He has also been focused on the sustainability of the Group’s strong financial track record through targeted reductions in the Group’s expense and commission ratios, as well as actions to underpin the Group’s planned loss ratio. John has extensive City and financial services experience, spending more than 20 years in investment banking with UBS and Goldman Sachs. He was previously an Executive Director at the Co-operative Insurance Society, CIS General Insurance and The Co-operative Bank. He was CFO of these organisations between 2003 and 2007, and subsequently Managing Director, Corporate and Markets.
Current external appointments John is a Trustee and Director of Farm Africa. He has been appointed to the Panel on Takeovers and Mergers (the “Panel”) with effect from 1 May 2018, having been an alternate representative of the ABI on the Panel since 2015.
Experience and qualifications Simon is Group Human Resources Director. He joined the Group in 2014 and is responsible for leading the Group’s HR function, Internal & External Communications and Public Affairs. He is also responsible for delivering the Group’s People and CSR strategies. Simon is a Fellow of the Chartered Institute of Personnel and Development. Under Simon’s leadership, the Group has achieved significant improvements in employee engagement, people development, succession planning and diversity & inclusion. Simon’s achievements include the Group becoming a signatory to the Women in Finance Charter, and the successful implementation of the Group’s Graduate and Apprenticeship schemes. Simon has spent the majority of his career as a leader in customer-centric businesses. Before moving into HR, Simon held several commercial business roles in the fast-moving consumer goods and financial services sectors. Simon is also a trustee of the KidsOut UK charity.
Experience and qualifications José is Chief Risk Officer. He joined the Group in 2012 and has over 25 years’ experience of the insurance industry. José is responsible for the Group’s Risk Management and Compliance function and is a Fellow of the Institute of Actuaries. During José’s leadership of the Risk and Compliance function, the Group has achieved separation from RBS Group, delivered its IPO and sold its International division. José successfully led the programme to implement Solvency II and to design, build and obtain approval from the PRA for the Group’s Internal Model. Under his stewardship, the Group’s approach to risk management has developed and matured. This has been achieved by enhancing and embedding greater ownership of risk management in the business and driving improvements in risk behaviours and attitudes across the Group. José was previously Global Chief Risk Officer and Group Chief Actuary at HSBC Insurance. Before joining HSBC, José worked for Zurich Insurance, first in its London Market Operations, then as Chief Actuary International Business Division (Asia, Latin America and Africa) and lastly as Chief Actuary in the UK.
Experience and qualifications Steve is Chief Operating Officer. He joined Direct Line Group in 2010 and has nearly 30 years’ experience of the insurance industry. Steve is responsible for leading the Group’s Claims, Information Technology (“IT”), Information Security, Procurement and Business Services functions. Under Steve’s leadership, the Group has realised significant benefits and efficiencies through delivering the claims transformation programme, rationalising the Group’s property footprint, enhancing the procurement and contract management processes, and implementing the IT transformation programmes. Steve’s previous roles include Director of Strategic and Technical Claims at RSA, Director of Claims and Customer Service at Capita, and Director of Operations at AMP. Steve is also Chairman of the Motor Insurers’ Bureau.
Leadership The Board The Board has a collective objective of promoting the long-term success of the Company for its shareholders and provides leadership of the Company.
Board composition As at the date of this report, the Board comprised the Chairman, who was independent when appointed to the Board; four Executive Directors; and six independent NEDs, including the SID. The current Directors served throughout all of 2017, except for Danuta Gray and Mike Holliday-Williams who were appointed on 1 February 2017 and Penny James who was appointed on 1 November 2017.
• Interacts with the Audit Committee and BRC when considering setting targets and pay-outs
• Engages its independent adviser, FIT Remuneration Consultants LLP (“FIT”) on market practice, corporate governance, incentive plan design and target-setting, regulations and other remuneration matters when necessary
Structure of the Board, Board Committees and executive management The diagrams on pages 50 and 51 summarise the role of the Board, its Committees and the responsibilities of the Chairman, the CEO and executive management. The Board and Board Committees have unrestricted access to management and external advisers to help discharge their responsibilities. The Board and Board Committees are satisfied that, in 2017, sufficient, reliable and timely information was received to perform their responsibilities effectively. Each Committee plays a vital role in helping the Board to operate efficiently and consider matters appropriately.
The Board Risk Committee: • Oversees and advises the Board on the Group’s current and potential future risk exposures, and its strategic approach to managing risk • Recommends risk appetite and tolerance levels to the Board and supports the Board in promoting a risk-aware culture across the Group • Meets privately with the CRO without the presence of management • The chair of the BRC has monthly one-to-one meetings with the CRO
The Investment Committee: • Provides oversight of the Group’s investment strategy • Oversees the management and performance of the Group’s investment portfolio
Board Leadership The Board has clear divisions of responsibility and seeks the long-term success of the Group.
Biographical details of the Executive Directors and Executive Committee members are shown on pages 46 to 48.
The SID: • Acts as a sounding board for the Chairman and an intermediary for the other Directors when necessary
• Depending on the needs of the business, the NEDs and the Chairman commit at least three days a month and three days a week respectively to discharging their duties effectively as contained in their letters of appointment. The letters are available for inspection at the Company’s registered office and AGM.
Board and executive management roles Each Director brings different skills, experience and knowledge to the Company, with the NEDs bringing additional independent thought and judgement.
Risk management, regulatory and other related governance, including: considering the impact of the Ogden discount rate review on the Group; reviewing and agreeing the Group’s Policies; setting risk appetites; approving the ORSA; approving major changes to the Group’s partial internal model and seeking to ensure that the Group complies with all regulatory requirements.
The co-ordination of the Board meeting content is managed by the Chairman, and supported by the CEO and Company Secretary.
Building on positive responses to the 2016 effectiveness review, the 2017 questionnaire focused on further opportunities for improvement, including making the best use of the experience and expertise of NEDs in the Board’s strategic thinking, the preservation of the Board’s culture at a time of changes to its composition and how the supportive and challenging relationship between the Board and the Group’s senior management can be preserved and enhanced.
The Committee questionnaire focused on the clarity of each Committee’s role and scope, its composition, the resources available to it and the effectiveness of communicating the Committee’s proceedings to stakeholders.
Based on the responses to the questionnaire and resulting reports, the Directors are satisfied that the Board and each of its Committees operated effectively in 2017. The Directors are also satisfied that they made significant progress in areas identified for potential improvement in 2016.
The Group’s governance framework is detailed in the Group’s High Level Control and System of Governance Framework document. This document, together with the Regulatory Governance Map, details how the Group meets Solvency II and PRA requirements to identify Key Functions, to have and maintain a Governance Map and the requirements in respect of the PRA Senior Insurance Managers Regime and the FCA Approved Persons regime. The Board reviews these documents annually.
The core elements of the Governance Framework are the: • Matters Reserved for the Board and the Board Committees’ Terms of Reference; • High Level Control and System of Governance Framework document; • Regulatory Governance Map; • risk appetite statements, which are described on page 22; • Enterprise Risk Management Strategy and Framework
The BRC approves the ERMF, following review by the Risk Management Committee (a committee comprised of Executives).
The Risk Management Committee approves the Executive Governance Framework which is developed by Executives.
The Board has authorised certain potential conflicts of interest in this way. However, the Board still deals with any actual conflict of interest or duty that might arise. This usually would involve making sure a Director does not participate in a relevant Board or Committee discussion or decision.
To do this, the Company Secretary maintains a register of conflicts, and any conflicts that the Board has authorised.
Approach to diversity The Board and Executive management are committed to ensuring that diversity is promoted across all areas of the Group and that everyone is treated fairly irrespective of their racial or ethnic origin, gender, age, disability, belief or sexual orientation, religion, or educational or professional background. There is a Board approved diversity policy and progress has been made in embedding principles and practices to promote diversity across the Group and to champion the benefits of a diverse and inclusive workforce.
The principles and practices set by the Board and the progress made in broadening the diversity of the Board include: 1. Maintaining at least 30% female representation on the Board The Board is committed to seeking to maintain at least 30% female representation and at the same time to ensure that diversity as a whole remains a central feature. However the Board will continue to appoint the most appropriate candidates based on knowledge, skills, experience and, where necessary, independence.
The Board appointed two female Directors during 2017 (Danuta Gray and Penny James). As at 26 February 2018, being the date of this report, Board female representation was 36%. The Board’s female representation exceeds the target set in Lord Davies’ Women on Boards Review Five Year Summary to be achieved by 2020 and remains on target with the Hampton-Alexander Review’s recommendations for a minimum of 33% of women’s representation on boards by 2020.
2. Only engaging executive search firms who have signed up to the Voluntary Code of Conduct for Executive Search Firms on gender diversity and best practice. In its search for candidates, the Board aims to only engage with executive search firms who are signatories to the Voluntary Code of Conduct for Executive Search Firms. During the year, the Nomination Committee worked closely with Egon Zehnder and Heidrick and Struggles, which culminated in the appointment of Danuta Gray and Penny James respectively. Both of these executive search firms are signatories to the Voluntary Code and neither has any other connection with the Company.
The Group is a signatory to the Women in Finance Charter which aspires to see gender balance at all levels across financial services firms. The Group is committed to seeking to increase female representation at senior management level to 30% by the end of 2019. As at 31 December 2017, women represented 25% of the Group’s senior management. The charts on page 28 of the CSR report provide a clearer picture of the diversity of the Board, senior managers and employees.
During the year, the Group introduced new initiatives, including succession planning programmes, to broaden and strengthen female talent at middle management level. Other key 2017 gender diversity initiatives included: the promotion of flexible working; a partnership with the EveryWoman network which helps organisations enhance the potential of female talent; and mentoring schemes and associated development programmes for high-potential female candidates.
The Directors confirm that they consider that the Annual Report & Accounts, taken as a whole, are fair, balanced and understandable, and provide the information that shareholders and stakeholders need to assess the Group’s position and performance, business model and strategy. In arriving at this conclusion, the Board was supported by a number of processes, including the following: • management drafted the Annual Report & Accounts to ensure consistency across sections, and a steering group comprising a team of cross-functional senior management provided overall governance and co-ordination; • a verification process, to ensure the content was factually accurate; • members of the Executive Committee reviewed drafts of the Annual Report & Accounts; • the Company’s Disclosure Committee reviewed an advanced draft of the Annual Report & Accounts; and
Jane Hanson, Mike Biggs and Clare Thompson have served on the Board since December 2011, April 2012 and September 2012 respectively. At the Board’s request, they have agreed to continue serving as NEDs and resolutions for their re-election as Directors will be proposed to the 2018 AGM. In accordance with the Code, the extension of their terms of appointment beyond six years has been the subject of a particularly rigorous review. The Board is satisfied that Jane, Mike and Clare continue to make a significant contribution to the proceedings of the Board and its Committees and that the extension of their terms of appointment will provide valuable continuity as work on refreshing the Board progresses.
The Nomination Committee’s work during the year led to the appointment of Danuta Gray as an additional NED, Mike Holliday-Williams, MD Personal Lines, as an Executive Director, both with effect from 1 February 2017 and Penny James as an Executive Director with effect from 1 November 2017. You can find out more about these activities and the Nomination Committee’s work during the year on pages 70 to 71.
• how the Board has assessed the Group’s longer-term viability and the adoption of the going concern basis in the financial statements is on pages 23 and 103.
The Group Audit function supports the Board by providing an independent and objective assurance of the adequacy and effectiveness of the Group’s controls. It brings a systematic and disciplined approach to evaluating and improving the effectiveness of its risk management, control and governance frameworks, and processes.
This confirmation is based on the BRC’s twice-yearly review and challenge of the Group’s Material Risk Assessment (“MRA”), and the Board’s review and approval of the Group’s risk appetite statements. The MRA identifies risks quantified as having a residual risk impact of £40 million or more based on a 1-in-200 years likelihood. The quantifications are produced through stress and scenario analysis, and the IECM. Each directorate’s bottom-up risk identification and assessment supplements the MRA. The MRA also plays a key role in developing the ORSA and assessing the Group’s strategic plan.
Remuneration The Board has delegated responsibility to the Remuneration Committee for the remuneration arrangements of the Group’s Executive Directors and Chairman. It recommends and monitors the remuneration level and structure for senior executives. You can find out more about this in the Directors’ remuneration report starting on page 74.
During 2017, the Board received regular updates from the Executive Directors, the Investor Relations team and the Company’s corporate brokers on the views of its shareholders and other investors.
During 2017, the CEO and the CFO met with key shareholders following announcements of results and reported shareholders’ views back to the Board. They discussed a range of matters including the Group’s growth, Home and Motor strategies, price comparison website competitiveness, profitability, IT investment and reserving policy.
The CEO and CFO hosted conference calls for the Group’s quarterly results briefings and presentations for its 2016 full year results in March 2017 and its 2017 half year results in August 2017. In addition, the CEO and CFO provided a short video summarising the key messages of the Group’s 2016 full year results which is available on the Company’s website.
We communicate with our debt investors through regular announcements and the debt investor section of our website which contains bond information, credit ratings and materials relating to the Group’s year-end reports, and information about our long-term debt maturity profile so investors can see the related future refinancing needs of the Group.
Q1 2017 • Full Year 2016 results roadshow – London/ Edinburgh/USA
Q3 2017 • Half Year 2017 results roadshow – London/ Edinburgh/USA
• Bank of America Merrill Lynch annual CEO conference – London
Motor Insurance conference • Tier 1 notes issue roadshow – London/ Edinburgh
The diagram below sets out some examples of activities undertaken by the Board and its Committees during the 2017 financial year to illustrate how the Board’s decisions are informed by an understanding of, and have regard to, the interests and views of its shareholders and other stakeholders.
• During 2017 the Non-Executive Directors collaborated with Customer Assurance and Operations teams to understand the impact of recent training programmes on customer telephone calls and how this links to creating industry leading conversations and a better experience for the Group’s customers.
• As part of a Board visit to the Group’s call centre in Doncaster, the Board awarded recognition prizes to employees for creating great customer experience and presented employees with accreditations from the Institute of Customer Service.
• The Remuneration Committee has incorporated people metrics into its decision making process for the award of bonuses to management as part of the Group’s AIP.
• The CSR Committee believes in the positive benefits from employee participation in fundraising and volunteering and has monitored and challenged progress against CSR KPIs including those relating to energy use, CO2 emissions and waste. Further details are included in the CSR report on page 29 and are available at www.directlinegroup.com.
Investing in our people Doing the right thing for the community and the environment
• The Group’s investment case is detailed on page 2 and incorporates the medium-term financial targets announced in the Company’s 2017 Half Year report relating to: a COR of 93% to 95%; RoTE above 15%; growing the dividend in line with business growth; and maintaining solvency capital around the middle of the 140% to 180% Solvency II target range.
• The Group’s dividend policy states the expectation that one-third of the annual dividend will generally be paid in the third quarter as an interim dividend and two-thirds will be paid as a final dividend in the second quarter of the following year. The Group aims to grow its regular dividend in line with business growth. In the normal course of events the Board will consider whether or not it is appropriate to distribute any surplus capital to shareholders once a year, alongside the full year results. Further details on the dividend policy are contained in the Directors’ report on page 100.
31 Dec 12 31 Dec 13 31 Dec14 31 Dec15 31 Dec016
• The Committee reviews and monitors the reserving process. The Committee challenged the key reserving assumptions and judgements, emerging trends, movements and analysis of uncertainties underlying the ABE and MBE of technical provisions.
Financial reporting The Committee monitors the integrity of the financial statements of the Group and any other formal announcement relating to its financial performance. The Group’s financial reporting and control framework has been expanded to include Solvency II-related information.
The Committee also advised the Board whether the Annual Report & Accounts, taken as a whole, were fair, balanced and understandable and provided sufficient information to enable the reader to assess the Group’s position and performance, business model and strategy.
When considering the Annual Report & Accounts for 2017, the Committee focused on the significant judgements and issues which could be material to the financial statements. These included the matters set out in the table on the next page.
It is expected that the Ogden discount rate will change more frequently in future and the Committee will monitor the processes for the implementation of a change.
The Committee reviews and challenges the ABE and MBE on a six-monthly basis. In addition, it monitors developing trends in risks that could impact the reserves in a positive or negative way. On an ongoing basis deep dives are carried out on different risks.
The Committee considered reports on the judgements applied to the carrying value of the Group’s investments that are not held at fair value and the basis for the valuation. These assets are principally comprised of infrastructure loans, commercial real estate loans and private placement bonds held within the investment portfolio and information was provided to the Committee on a regular basis to support the value recognised in the accounts. During the year an impairment loss was recognised on the portfolio of £9.5 million and the Committee considered the explanation presented to support the impairment.
The Committee will monitor the carrying value of investments and the basis for that valuation.
As part of this process, the Committee considered the valuation of intangible assets. These mainly related to investment in the Group’s IT systems and capabilities in respect of projects which are aimed at improving the digital offering, customer experience and operational efficiency. Reports were presented to the Committee covering the assumptions and judgements made in coming to a valuation of these assets. As a result, the Committee recommended that an impairment charge of £56.9 million was made in the year.
The Committee approves the annual plan for reviews of reserves, informed by emerging internal and external issues. At the other two scheduled meetings, the Committee considers developing trends in reserving and discusses and challenges the underlying assumptions that are used in setting the ABE reserves.
The Group’s Financial Reporting Control Framework (“FRCF”) is part of its wider internal controls system. It addresses financial reporting risks. The Board delegates supervision of the FRCF to the Audit Committee and the CFO is responsible for the FRCF on a day-to-day basis.
During the year, the Chair of the Committee attended the Group Audit function’s offsite day to aid the Committee in assessing whether the function was effective. This was in addition to regular interaction between the Chair of the Committee and the Group Head of Audit and the wider audit team. Following feedback from the Chair, and having reviewed a report from Company Secretariat, the Committee concluded that the function was effective and that it had the appropriate resources.
The Committee decided that it was not appropriate to tender the external audit contract for the 2019 year end and, subject to continued effective performance by Deloitte, would review the position again in 2018 in relation to the 2020 year end. At that point a decision will be made whether to tender the external audit contract for the year ended 31 December 2020 or defer until a later date. A number of factors were taken into account, including anticipated business changes, regulatory developments such as the new insurance accounting standard for implementation in 2021 and the appointment of a new audit partner by Deloitte during 2016, following the normal audit partner rotation process. The current audit partner is Colin Rawlings who was first appointed for the 2016 audit. The Committee has reviewed the latest public report on Deloitte, issued by the Financial Reporting Council’s Audit Quality Review Team, and has discussed the findings with Colin Rawlings and made enquiries as to how those findings relevant to the audit of Direct Line Group have been addressed.
There are no contractual obligations restricting the Company’s choice of external auditor and no auditor liability agreement has been entered into. Equally, any recommendation to re-appoint Deloitte as auditor of the Company depends on continued satisfactory performance.
Auditor independence and non-audit services policy The Group has an Independence of External Auditors Minimum Standard. This establishes parameters for preventing or mitigating anything that compromises the External Auditor’s independence or objectivity. The Minimum Standard covers: (i) the provision of audit and non-audit services; (ii) employment of audit employees by the Group and of Group employees by the external audit firm; and (iii) rotation of key audit employees. The Committee reviews and refreshes the standard annually to make sure it remains appropriate. The standard is compliant with the FRC’s implementation of the EU Audit Regulation and Directive in adopting the list of prohibited non-audit services which cannot be provided to the Group.
The non-audit fee of £0.2 million related to: (i) audit-related assurance services; (ii) services provided in reviewing the Group’s executive crisis management advice and training; (iii) supporting the Group HR Director on remuneration matters; and (iv) assurance services in relation to the issuance of Restricted Tier 1 notes.
The Committee reviewed how the Group applied its Minimum Standard on audit and non-audit services in 2017. It is satisfied that the Group has adequate procedures to ensure that the External Auditors are independent and objective.
The Committee, after taking into account all of the information available, concluded that Deloitte had performed its obligations effectively and appropriately as External Auditor to the Group.
Main activities during the year Risk monitoring and oversight At each scheduled meeting, the Committee received a report from the CRO detailing the Group’s current and forward-looking solvency position, and providing outputs of regular risk monitoring and details of specific risks and issues. The report was enhanced during the year to set out more clearly the Group’s current risk profile, the areas of management focus and the key activities being undertaken by the risk management function to drive forward the embedding of risk management across the Group.
The Committee received regular reports regarding the three strategic risk appetite statements: maintain capital adequacy; stable and efficient access to funding and liquidity; and maintain stakeholder confidence.
The Committee monitored the Group’s risk management and internal control systems, and reviewed their effectiveness. This covered all material risks, including financial, operational and compliance. The Committee reviewed the residual risk position after the operation of controls and considered the effectiveness of any associated mitigating actions and compensating controls. The monitoring and review by the Committee involved examining an assessment of the control environment and material controls at Group level, based on directorate-level risk and control self-assessments. These assessments were subject to challenge by the Risk and Group Audit functions.
On behalf of the Board, the Committee also monitored the Group’s risk management systems, and reviewed their effectiveness. This included Horizon, the Group’s risk management software, on which the Committee took part in a deep dive workshop to gain a more insightful understanding of the scope and application of the system.
• In October 2017, the Group received approval from the PRA following a ‘Major’ change to the IECM. The ‘Major’ change was due to the accumulation of ‘Minor’ model changes since the IECM had previously been approved by the PRA. The Committee reviewed and challenged the application to the PRA, including the details of and rationale for all model changes, together with the impacts on the SCR and the governance process for the model changes. The Committee also scrutinised reports from the Risk Function and Group Audit on IECM validation and the control environment respectively.
The Committee reviewed the third annual Assessment of Risk Behaviours and Attitudes undertaken jointly by the Risk function and Group Audit, which covered areas including: tone from the top; decision-making; and risk management. The Committee challenged the outputs of the assessment, as well as areas for further improvement, and ensured the appropriateness of the actions identified. The Committee also considered the activities of the Risk function in driving a good risk culture across the Group through mechanisms such as training and its internal communication strategy. The Committee commended the continued progress made in embedding risk management and demonstrating positive culture and behaviours in risk management.
The Committee undertook a deep dive on the Commercial division, focusing on its governance processes, control environment and risk profile. Challenges from the Committee included assessing the enhancements of controls relating to pricing and budgeting as well as the improvements to reinsurance data collection processes.
Additionally, the Committee considered other subjects in more detail at each scheduled meeting. These included: compliance and regulatory risk including oversight of the Group’s regulatory relationships; operational risk; financial risk, Solvency II and IECM; emerging risks; and risk governance.
Compliance and regulatory risk During the year, the Committee considered the Group’s compliance with regulatory requirements including conduct and financial crime. The Committee approved the annual Compliance Plan which sets out the compliance activities which will be undertaken in the upcoming year with the objectives of: (i) ensuring compliance; (ii) maintaining an open and co-operative relationship with regulators; and (iii) ensuring the Board and employees understand their regulatory responsibilities.
Operational risk The Committee continued to review and challenge IT controls, including risks relating to IT systems’ stability, cyber security, technology resilience and the internal control environment. The Committee assessed the level of prevention, protection and detection in relation to cyber risk and the residual risk for each of the IT control areas, taking into account any compensating controls and/or mitigating actions. The Committee questioned the impact of system stability issues in relation to customer and conduct metrics, including call abandonment rates. The Committee also reviewed IT risk appetite statements to gain assurance that these were appropriate and in line with the overarching Group risk appetite.
As detailed in the areas of focus on page 65, the Committee received regular updates on the Group’s multi-year transformation programmes, including the development of the next generation of customer systems for Personal Lines and Commercial. The Committee monitored and examined the oversight and challenge of major change initiatives by the Risk function and reviewed the outputs of the assurance work undertaken by the Risk function and Group Audit.
Financial risk At each meeting, the Committee monitored the Group’s performance against capital risk appetite through the CRO’s report. Committee members considered financial risks in the strategic plan against risk appetite. Committee members also reviewed and challenged the ORSA report and subsequently recommended the report for approval to the Board. Challenges on the ORSA included those in relation to stress testing of the strategic plan, distribution risk, internal model validation activity and contingent management actions.
The Committee reviewed and challenged the stress and scenario testing plan prioritising the importance of certain scenarios. The Committee also examined the outputs of the budget stress tests and the associated management actions, where necessary, required to keep the Group within risk appetite.
The Committee also reviewed the application to the PRA regarding the ‘Major’ model change, which included the impact it would have on the SCR. For more information on the ‘Major’ model change please see the areas of focus section on page 65.
Emerging risks During the year, the Committee held a strategy day where it considered management’s response to the emerging risks to the business, and challenged the assumption that management had identified all possible emerging risks. The Committee also challenged the Risk function’s role in ensuring that these risks were being monitored and managed appropriately. The Committee undertook a deep dive into risks arising from autonomous car technology and from potential new market entrants. The Committee also challenged the possible opportunities in emerging risks, particularly regarding the use of data in pricing.
Anti-Bribery and Corruption Annually, the Committee considers an anti-bribery and corruption (“ABC”) report, which includes an annual risk assessment of the level of ABC risk to the Group. Following review and challenge, the Committee was satisfied that the Group’s policies and procedures on ABC were fit for purpose and ABC risks were managed appropriately.
Main activities during the year The Committee monitors the implementation of the CSR strategy through regular updates on the different focus areas and challenges the robustness of, and progress against, targets relating to each strand of the CSR strategy. The Committee also ensures that best practice and thinking across the market is considered as part of the Group’s own CSR approach.
CSR strategy The Group’s CSR strategy for the year focused on four areas. They are: (i) Helping to make our society safer (Shotgun); (ii) Proud to be here; (iii) Being recognised as part of our communities; and (iv) Reduce, Reuse and Recycle. A member of the Executive Committee sponsored each area.
• The Committee challenged management on the future CSR strategy and in particular the need to create a clearer focus on one or two key themes.
Proud to be here The objective of this area of focus is to improve employee engagement as a key enabler of the Group’s 2017 strategy. The KPIs for this element are linked to the People Strategy and focus on employee engagement, diversity and inclusion. The Committee also reviewed the Group’s policy on compliance with the Modern Slavery Act 2015. This included reviewing internal compliance and how third-party suppliers complied with the requirements under the Act.
CSR activities The Committee was kept up to date with the Group’s external positioning, including the Group’s stakeholders and its approach to managing external relationships, which included the use of the corporate website and the AGM. The Committee continues to challenge management’s approach to ensure that it is both authentic and strategic, and that it continues to focus on initiatives with real potential to improve lives. The Committee monitored the Group’s performance against the targets set in relation to CSR KPIs.
• At the request of the Committee, a study was received examining the efficiency and effectiveness of the present hedging strategy employed to mitigate currency and non-Sterling interest rate risk, as well as considering alternative instruments to achieve the same hedging objectives. The Committee concluded that the present hedging strategy remained appropriate in terms of efficiency and effectiveness.
• The Committee chose to use two external search consultants during the year; Egon Zehnder for the Non-Executive position and Heidrick & Struggles for the CFO position. For both consultants, the Committee set the profile and criteria to be used in the search. Mike Holliday-Williams was appointed as Executive Director through the internal talent pipeline.
Main activities during the year Board composition During the year, the Committee: considered the Board’s skills and experience; reviewed the structure, size and composition of the Board; reviewed the membership and chairmanship of the Board’s Committees; and reviewed NEDs’ letters of appointment, terms of appointment and time commitment. The letters of appointment for the Chairman and NEDs set out the time the Group anticipates that they will commit to their roles. This is at least three days a week for the Chairman and an average of three days a month for the other NEDs depending on business needs.
Board changes There were a number of Board changes during the year. The Company appointed: • Danuta Gray as a NED with effect from 1 February 2017; • Mike Holliday-Williams as an Executive Director with effect from 1 February 2017; and • Penny James as an Executive Director and CFO-designate with effect from 1 November 2017.
Heidrick & Struggles is a signatory to the Voluntary Code of Conduct for executive search firms. The firm is not connected in any way to the Company.
As Penny James was appointed since the last AGM, she will submit herself for election at the Company’s 2018 AGM.
Following regulatory approval, the Committee also recommended the appointment of Mike Holliday-Williams to the Board in recognition of his leadership of the Personal Lines business and to leverage his expertise for the benefit of all of the Group’s businesses.
The Board is satisfied that Jane and Clare remain independent and that all three continue to make a significant contribution to the Board and its Committees, and provide valuable continuity to the Board. Mike Biggs was independent when appointed as Chairman. The Committee recommended to the Board and shareholders to elect or re-elect all serving Directors at the Company’s 2017 AGM.
Diversity The Group celebrates the diversity of its workforce. The Group seeks to recruit the best candidates for all positions throughout the business. At the date of this report, four of the Group’s 11 Directors are women, which equates to 36% of the Board. This meets the target set in Lord Davies’ Women on Boards Review Five-Year Summary published in October 2015, to be achieved by 2020. The Group is also aiming to meet the executive-level target set in the Hampton-Alexander Review to be achieved by 2020. The Board acknowledges the benefits of diversity in all respects.
You can find out more about the Group’s approach to diversity in the CSR report on page 28 and the Corporate Governance report on page 55.
Impact of capital management exercises on incentive schemes When considering the impact of the capital management exercises on the incentive schemes, the Committee concluded, taking into consideration the Board’s view that these transactions were in the best interests of the Group and its shareholders, that it was not appropriate that management be penalised for them in the incentive scheme outcomes. The Committee therefore determined that the AIP outturn for 2017 should be adjusted for the one-off cost to IFRS profit.
Membership, attendance and responsibilities of the Committee can be found on pages 49 and 50. FIT Remuneration Consultants LLP, who act as independent advisers to the Committee, also attend Committee meetings.
In addition, the Committee concluded that the favourable impact on RoTE should be excluded from the RoTE performance for the in-flight LTIP awards. Therefore, the 2017 RoTE outcome for the awards granted in 2015 was adjusted downwards. Similarly, the reported RoTE in 2018 and 2019 will be adjusted downwards for the remaining in-flight LTIP awards. The ongoing enhancement to earnings expected in future years has been recognised by the Committee in setting higher RoTE targets than would otherwise be the case for the LTIP for awards to be granted in 2018.
Directors and other senior executives Mike Holliday-Williams, Managing Director, Personal Lines, joined the Board on 1 February 2017. He did not receive a salary increase as a result of the promotion and his AIP and LTIP opportunity were set at the same level as John Reizenstein, the CFO. During the year the Committee approved the vesting of the final tranche of his buy-out shares awarded when he initially joined the Group in 2014.
Remuneration strategy As part of the remuneration policy review, the Committee reaffirmed the remuneration strategy to provide a clear and simple framework for remunerating the Company’s Executive Directors, and aligning their variable pay opportunity to the business strategy and the Company’s demonstrable success.
Interaction with other Board Committees The Committee believes that it is important to have clear lines of communication with other key Board committees. To this end the Chair of the Audit Committee is currently a member of the Committee and the Chair of the Board Risk Committee attends Committee meetings at relevant times during the year. Generally, this is: when the Committee is discussing the performance of senior executives or regulated employees; during the discussions on the outcomes of the incentive arrangements; or when there are new legislative or regulatory requirements. At these times the Committee considers it important to take into account factors that the Chairs of the Audit and Board Risk Committees consider appropriate in relation to risk management and the control environment.
If it is felt necessary, the Remuneration Committee and the Board Risk Committee can hold joint sessions to discuss relevant regulatory developments that are best dealt with by the Committees operating and discussing the issues together.
Remuneration at a glance – summarising the remuneration arrangements for Executive Directors 76 to 77
Annual report on remuneration – detailing pay outcomes for 2017 and covering how the Group will implement its remuneration policy in 2018 78 to 93
Pay outcomes for 2017 Helped by focusing on the value, service and brand propositions we offer to our customers, and maintaining underwriting discipline, 2017 was another strong year for the Group with PBT of £539m. This outturn was ahead of the target thereby leading to a maximum payout for this element under the Annual Incentive Plan (“AIP”).
Overall, performance on both the customer and people metrics under the strategic measures was also strong, resulting in an achievement of 84%, with an on-target achievement for the personal objective (60%).
The only adjustment from the statutory IFRS basis was to exclude the exceptional in-year costs of the capital management exercises. It is considered best practice to neutralise such transactions and the Committee concluded this was appropriate given the Board’s view that this unbudgeted finance cost was in the interests of the Company and shareholders, and that management should not be penalised for it. Given the level of outperformance of the target, this in fact had no impact on the outturn.
For the 2018 AIP we will continue with the balanced scorecard of financial and strategic measures. No change will be made to the current weightings and assessment approach.
The Remuneration Committee is committed to aligning Executive Directors’ pay to the Group’s business strategy and demonstrable success, and the interests of our shareholders.
Overall, 85.6% of the total awards vested in March 2017 and 79.2% in August 2017.
Awards under the LTIP granted in March and August 2015 are due to vest during 2018. This is subject to the Committee’s satisfaction that the financial and risk underpins have been met at the end of the vesting period. The RoTE performance period for these awards ended on 31 December 2017. The threeyear average RoTE performance for 2015, 2016 and 2017 was 18.1% against a maximum target of 17.5%. Awards under the RoTE element are, therefore, due to vest at 100% of the maximum potential.
No further change to the overall approach to pay is anticipated for 2018: • The CEO and MD Personal Lines will be awarded a salary increase of 2.5% from 1 April 2018, in line with the average rate for staff generally. No increase will be awarded to the CFO-designate or the CFO in light of the former’s package having just been set and the latter’s pending retirement.
• No change will be made to either the weighting or the approach to assessment of the financial metric under the AIP.
• We are not proposing any changes to the performance conditions for the 2018 awards under the LTIP. However, the RoTE scale will be increased from the current range of 15% to 18% to a range of 17.5% to 20.5%. This increased range reflects both the beneficial impact of the capital management exercises and the Group’s planned underlying RoTE performance.
The Committee is monitoring potential changes to the Corporate Governance Code, including regarding publishing a ratio of CEO to all-employee pay, and will adopt such practices once the preferred methodology has been confirmed.
Chief Financial Officer During the year Penny James was appointed to succeed John Reizenstein as Chief Financial Officer and will become the CFO on 1 March 2018. Mr Reizenstein will step down from the Board at the AGM and leave the Group in the autumn.
In setting Ms James’ remuneration, the principle we followed was to replicate the value of her previous total remuneration package, including compensating her for awards forfeited on leaving her previous employer. The details are fully set out on page 92 of the report.
For Mr Reizenstein, the Committee noted that he was retiring and, on that basis, confirmed his “good leaver” status without the exercise of any discretion.
Your AGM vote I hope that, having read the information in this report and considering the performance of the Group during 2017, you will vote in support of the Remuneration resolution at the AGM.
Remuneration at a glance Implementing the policy in 2018 Key feature Implementation in 2018
• Reviewed annually with any increases taking effect on 1 April
• 2.5% salary increase for the CEO to £830,754 • 2.5% salary increase for the MD Personal Lines to £562,584 • No increase was awarded to either the CFO or
• Any payment is subject to an additional gateway assessment, including assessing risk factors
• Awards typically granted as nil-cost options • Awards typically granted every six months at half the annual level • The Plan allows for awards with a maximum value of 200% of base salary per financial year • Performance is measured over three years and determined by RoTE and relative TSR measures • Awards vest subject to financial underpin and payment gateway • Malus and clawback conditions apply • Awards are subject to an additional two-year holding period following the end of the three-year performance period
Executive Directors’ total pay This chart illustrates the total remuneration components received in 2017.
Statutory remuneration report Introduction We have prepared this remuneration report in accordance with the requirements of the Companies Act 2006 and the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended) (the “Regulations”). The report also meets the relevant requirements of the Listing Rules of the Financial Conduct Authority, and describes how the Board has complied with the principles and provisions of the UK Corporate Governance Code relating to remuneration matters. Remuneration tables subject to audit in accordance with the relevant statutory requirements are contained in the annual remuneration report and stated to be audited. Unless otherwise stated, the information within this Directors’ remuneration report is unaudited.
Notes: 1. Salary – the Company operates a flexible benefits policy, and salary is reported before any personal elections are made. 2. Benefits – includes a company car or allowance, private medical insurance, life assurance, income protection, health screening and discounted insurance. 3. Annual bonus – includes amounts earned for performance during the year, but deferred for three years under the DAIP. For more information, see page 87.
5. 2015 LTIP awards RoTE – the expected levels of vesting are set out on page 82. The corresponding values under long-term incentives, including the estimated value of dividends accrued to 31 December 2017, are £1,135,614 for Paul Geddes, £687,341 for John Reizenstein and £582,738 for Mike HollidayWilliams, based on a three-month average Company share price to 31 December 2017 of £3.65557. Any shares vesting under the LTIP granted in 2015 will not be delivered until the end of the applicable vesting periods in March and August 2018.
6. 2014 LTIP awards TSR – the level of vesting is set out on page 82. The corresponding values under long-term incentives, including the value of dividends on vesting, are £927,109 for Paul Geddes, £561,141 for John Reizenstein and £418,193 for Mike Holliday-Williams, using the share prices on 26 March 2017 and 29 August 2017 of £3.376 and £3.819 respectively.
7. SIP – includes the value of matching shares under the SIP. 8. Mike Holliday-Williams was appointed to the Board on 1 February 2017. His salary, benefits and pension for the purposes of this table have been pro-rated accordingly.
9. Penny James was appointed to the Board on 1 November 2017 and also became employed on that date. 10. The annual bonus figure for Penny James consists of two elements: £173,250 relates to the pro-rated annual bonus for 2017 determined on the same basis as other Executive Directors, £840,841 relates to an estimated payment in lieu of the bonus forfeited at her previous employer as detailed on page 93. The actual payment will be confirmed in next year's report.
11. The long-term incentive figure for Penny James relates to an estimated amount in respect of the first tranche of her buy-out awards disclosed on page 90 which vests in April 2018, and is subject to performance conditions ending in the 2017 performance year. The value is based on an expected level of vesting of 100% and a three-month average share price to 31 December 2017 of £3.65557. The actual vesting will be confirmed in next year’s report.
The Committee established target performance levels at the start of the year. The Committee’s approach to setting and assessing PBT targets under the AIP is to set a target level of profit performance and then, at the year end, to assess over- or underperformance by judging overall corporate performance both on an absolute and relative basis. While the Committee does not set a formal threshold to maximum profit range against which performance is formulaically assessed, the Committee’s starting point each year has been to look at a range of 10% either side of the targets when discussing the achievement. The Committee again felt this an appropriate basis for its discussions and concluded that the indicative outturn should apply without further adjustment.
The bar chart illustrates the Committee’s assessment of the level of achievement under the AIP. The outcomes reflect continuing strong performance during the year as discussed in the Group highlights and Chairman’s statement on page 1 and pages 8 to 9 respectively.
Strategic element (25% weighting) The Group’s strategy is to make insurance much easier and better value for our customers. We have continued to invest in improving the customer experience and removing the reasons for customer problems. Overall, performance on the customer agenda against our 11 key customer metrics remains very strong, with the Direct Line and Churchill brands performing well in independent customer experience benchmarking studies and good progress on key Net Promoter Score measures and customer journeys.
The Committee considered that the Group has made good progress in continuing to improve the customer experience against an already solid performance, as well as advancements in its key people measures against a background of high employee engagement. Having considered performance against targets and an assessment of the quality of performance achieved, the Committee agreed an outturn of 84% under this element for this good performance.
Personal element (20% weighting) This element relates to an objective that is shared with other Executive Committee members and set by the Committee. The Committee considers the performance against this element together with the Executive’s personal performance and leadership over the year.
The Group remains focused on improving its digital offering, customer experience and operational efficiency, and a key focus of management continues to be the level of change the Group is making to its IT infrastructure. 2017 saw the Group make good progress on these plans, executing key planned changes on schedule, increasing confidence in future plans and managing costs, with a significant focus on the stability and security of the IT environment. Whilst there was significant progress on these initiatives, the impact on intangible assets due to a reworking of some elements of capital expenditure resulted in an impairment charge at the year end (and which is included in the outcome under the Financial element).
LTIP outcomes for 2017 (Audited) The following summarises the outcome against performance targets set for the 2014 and 2015 LTIP awards: Awards under the LTIP granted in March and August 2014 vested during 2017. They were subject to TSR performance over the three-year vesting period, and RoTE performance in 2014, 2015 and 2016. The Group achieved an average RoTE of 16.2% over the three-year performance period. This resulted in 76% of the maximum potential vesting of the RoTE element (45.6% of the total award). The TSR element comprises the other 40% of the total award. For the March 2014 awards, the Company’s TSR was positioned above upper quintile against its comparator group; for the August 2014 awards, TSR was slightly below the upper quintile. This resulted in 100% and 83.9% respectively of the maximum potential vesting under the TSR element (40% and 33.6% of the total award). Overall, 85.6% of the total awards vested in March 2017 and 79.2% in August 2017 as the Committee was satisfied that the financial and risk underpins were met at the end of the vesting period.
Dec 2013 Dec 2014 Dec 2015 Dec 2016 Dec 2017 Dec 2018
RoTE test – average of 18.1% for 2015, 2016 and 2017 – 100% vesting
Relative TSR test – To be tested based on performance to 25 August 2018
Value in single figure 2016 – revised 2017 – final 2017 – final 2016 – revised 2017 – estimated 2017 – estimated
3. Danuta Gray was appointed to the Board from 1 February 2017. She was appointed to the Remuneration Committee with effect from 6 March 2017.
Percentage change in Chief Executive Officer’s pay for 2016 to 2017 The table below shows the Chief Executive’s year-on-year percentage change in salary, taxable benefits and bonus, compared to the average pay for all other UK employees.
Notes: 1. Based on the change in average pay for UK employees employed in the year ended 31 December 2017 and the year ended 31 December 2016. Salaries are not adjusted for the number of working hours, therefore the increase partly reflects the increase in working hours for some employees during the year. 2. There were no changes in benefits provision between 2016 and 2017. 3. For employees other than the Chief Executive Officer, this includes average amounts earned under the AIP, and other variable incentive schemes, including monthly and quarterly incentive schemes operated in certain parts of the Group.
Chief Executive Officer’s pay between 2012 and 2017 The table below shows historical levels of the Chief Executive Officer’s pay between 2012 and 2017. It also shows vesting of annual and long-term incentive pay awards as a percentage of the maximum available opportunity.
Notes: 1. Based on actual vesting under the 2010, 2011 and 2012 RBS Group LTIP. The value included in the single figures in respect of these awards is £205,000 2. The 2017 single figure reflects the estimated vesting of the RoTE portion of the LTIP granted in March and August 2015. Any shares under the LTIP granted in 2015 will not be delivered until the end of the applicable vesting periods in March and August 2018. However, they have been included in the single figure, as the performance period in respect of the RoTE portion has now been completed.
31 December 2012 31 December 2013 31 December 2014 31 December 2015 31 December 2016
Note: There were no special dividends paid in 2017 which reflected the Group’s capital position following the implementation of the new Ogden Discount Rate at the beginning of the year. Furthermore, the Group implemented a new policy with regards to capital distributions in 2017 whereby the Board will consider whether or not it is appropriate to pay a special dividend once a year, alongside the full-year results. There have been no share buy-backs since the IPO. The overall expenditure on pay has been taken from note 10 to the consolidated financial statements. Therefore, consistent with market practice, it has not been calculated in a manner consistent with the single figure in this report.
Distribution statement This chart shows the overall pay expenditure across all Group employees compared with the total dividend value paid to shareholders for 2016 and 2017.
AGM voting outcomes The table shows the percentage of shareholders voting for or against, and the percentage of votes withheld, relating to the resolutions to approve the Directors’ annual remuneration report and remuneration policy, both of which were put to shareholders at the 2017 AGM.
Approval of Directors’ remuneration policy (2017 AGM) 881,046,703 98.29% 15,349,348 1.71% 32,669,059 3.52%
Note: The percentages of votes for and against are expressed as a percentage of votes cast, excluding votes withheld. The percentage of votes withheld is expressed as a percentage of total votes cast, including votes withheld. The Committee is grateful for the strong vote in favour of the Directors’ annual remuneration report and remuneration policy in 2017. The Committee makes itself available to investors to discuss developments in the remuneration aspects of corporate governance generally, and, in particular, changes to the Company’s executive pay arrangements.
Notes: 1. Executive Directors are expected to retain all the Ordinary Shares they obtain from any of the Company’s share incentive plans until they achieve a shareholding level that is equal to 200% of base salary. This is calculated after any disposals necessary to pay personal taxes on acquiring such Ordinary Shares. 2. For these purposes, holdings of Ordinary Shares will be treated as including all vested but unexercised awards, or awards unvested but after the performance period in the holding period, valued on a basis that is net of applicable personal taxes.
Using shares In receiving an award under the LTIP or DAIP, Executive Directors commit not to hedge their exposure to outstanding awards under these plans or in respect of shares they are reporting to the Company within their ownership for the purposes of any Share Ownership Guidelines. They also agree not to pledge as collateral their participation under any of the plans or any shares which they are required to hold in the Company for any purposes, including for Share Ownership Guidelines.
2. Includes matching shares held under the SIP which are subject to forfeiture and deferred shares under the Direct Line Group DAIP. For more information, see pages 87 and 90.
3. On 27 March 2017 Paul Geddes exercised a DAIP and an LTIP award granted on 26 March 2014, and on 29 August 2017 exercised an LTIP award granted on 29 August 2014. Following these exercises, 1,044 DAIP shares remain vested but unexercised.
4. On 27 March 2017 John Reizenstein exercised a DAIP and an LTIP award granted on 26 March 2014, and on 29 August 2017 exercised an LTIP award granted on 29 August 2014. Following these exercises, 94,009 DAIP shares and 878,527 LTIP shares remain vested but unexercised.
The table shows the Non-Executive Directors’ beneficial interests in the Company’s shares.
Notes: 1. There were no changes to the number of shares held by Directors between the year end and the date of this report. 2. Includes holdings of connected persons, as defined in section 96B(2) of the Financial Services and Markets Act 2000.
Direct Line Group share awards Direct Line Group Deferred Annual Incentive Plan (“DAIP”) awards (Audited) This table details the awards made to the CEO, the CFO and the MD Personal Lines under the Direct Line Group DAIP
Notes: The Company’s share price on 29 December 2017 was £3.817, and the range of prices in the year was £3.338 to £4.113.
1. These awards take the form of nil-cost options over the Company’s shares and are subject to performance conditions to be assessed by the Committee. Awards granted before 2014 accrue dividend entitlements until the date of transfer of shares. Awards granted from 2014 accrue dividend entitlement from the grant date to the date on which an award vests.
3. The closing market price on the dates of the vesting of the awards was £3.368 on 27 March 2017 and 3.819 on 29 August 2017. 4. Awards under the LTIP vested at 85.6% of the maximum potential on 27 March 2017 and 79.2% of the maximum potential on 29 August 2017. 5. Dividends added post-vesting are shown to 31 December 2017, although these are not realised until exercise. 6. Paul Geddes exercised on 27 March 2017 at £3.3412 resulting in an aggregate gain of £1,108,777, and on 29 August 2017 at £3.8019 resulting in an aggregate gain of £947,065.
Awards made in August and November 2017 also include an additional two-year holding period before awards may be released. The Company’s normal policy is to grant awards twice a year, after the Group announces its full and half-year results. The value of each grant of awards is set at 50% of the annual policy level. This means the total combined face value of awards to each of the Executive Directors equates to 200% of base salary.
Buy-out awards (Audited) The table below details the last tranche of the award made to Mike Holliday-Williams under the Direct Line Group Restricted Shares Plan (RSP) that vested in 2017. This award was made to the MD Personal Lines on recruitment in May 2014 as compensation for the forfeiture of legacy awards granted by his previous employer. Executive Directors do not participate in the RSP and Mike Holliday-Williams will not receive any subsequent grants under this plan.
No. of share options held at 31 December 2017 Vesting date
For the details of the performance conditions for each award see page 92.
Director Position 2018 base salary £’000 2017 base salary £’000 Annual change in base salary
Strategic Based on a basket of: • customer measures, including Net Promoter
As in previous years, all AIP outcomes will be determined after the Committee establishes a payment gateway. To do this, the Committee must be satisfied that it is appropriate to permit a bonus award at all, or at a given level. The gateway involves some subjectivity about performance. This may result in positive or negative moderation of each AIP performance measure or the overall bonus outcome. The targets are commercially sensitive and will be reported in next year’s report.
In considering such factors, and whether to adjust the overall payouts and/or operate malus and clawback, the Committee receives appropriate input from the Audit Committee and the Board Risk Committee.
Performance conditions for LTIP awards LTIP awards to be granted in 2018 will continue to be subject to performance against these performance conditions: • 60% based on RoTE over a three-year performance period (2018, 2019 and 2020) • 40% based on relative TSR performance against the constituents of the FTSE 350 (excluding investment trusts) over a three-year performance period, starting on the date of grant. The starting and closing TSR will be averaged over a three-month period
For the RoTE element, 20% of the award will vest for threshold RoTE and 40% for a RoTE of 18.5% for awards to be made in 2018. Otherwise, vesting is similar to TSR: a straight-line interpolation occurs from threshold to target, then from target to maximum performance.
New Executive Director On 1 November 2017, Penny James joined the Board as an Executive Director and was appointed CFO-designate to succeed John Reizenstein. Penny’s annual salary is £675,000 with a pension allowance of 25% of salary. She also participates in the Company’s Annual Incentive Plan up to a maximum of 175% of salary and the Long-Term Incentive Plan up to 200% of salary.
As explained in the letter from the Committee Chairman, this did not reflect any increase on her package from her previous employer.
On joining she received an LTIP award over 200% of salary on the same terms as the August 2017 grant (except that the vesting dates will run from the date of grant). This was granted at the annual award level as no separate buy-out was made to compensate her for the loss of her 2017 award at her previous employer.
Full details of the awards bought out are set out in the relevant section above.
Penny James will also receive an amount in lieu of forfeited bonus opportunity at her previous employer for the period 1 January 2017 to 31 October 2017 and the single figure disclosures on page 79 have included an estimated amount of £840,841. This will only be paid once the Committee has finally determined the amount due. Any change to the estimated amount will be reported in next year’s report. The award will be subject to deferral in line with the Group's deferral schedule which is the same as that of the original award.
Change of Executive Director John Reizenstein, the current CFO, will be retiring in September 2018. He will not seek re-election at the Company’s 2018 Annual General Meeting and will accordingly step down from the Board as an Executive Director at that time. The Committee confirmed his “good leaver” status without the use of any discretion. He will, therefore, retain awards granted to him up to the date on which his planned retirement was announced in September 2017 (for details of all awards see pages 87 and 88). John will also be eligible for an award under the AIP for the period to the AGM in May 2018 and will thereafter receive base salary and benefits only until the date of his actual retirement. No salary increase has been given for 2018.
External directorships Paul Geddes is a Non-Executive Director for Channel 4 for which he receives an annual fee of £22,177. John Reizenstein is a trustee and Director of Farm Africa, for which he receives no fees. Otherwise, the Executive Directors do not currently hold any further external directorships.
Service contracts Subject to the discretion set out in the recruitment remuneration policy, it is the Company's policy to set notice periods for Executive Directors of no more than 12 months (both by the Director or Company). The Executive Directors’ service agreements summary is as follows: Director Effective date of contract Notice period (by Director or Company) Exit payment policy
• This is the core element of pay that reflects the individual’s role and position within the Group. It is payable for doing the expected day-to-day job
• Staying competitive in the market allows us to attract, retain and motivate high-calibre executives with the skills to achieve our key aims while managing costs
• When reviewing base salaries, the Committee typically takes the following into account: – level of skill, experience and scope of responsibilities, individual and business performance, economic climate, and market conditions; – the median market pay in the context of companies of a similar size, particularly FTSE 31-100 companies, as they are considered to reflect the size and complexity of the Group; – the practice of insurance peers such as Admiral Group, Aviva, esure Group, Hastings Group, Legal & General, Old Mutual, Phoenix Group, Prudential, RSA Insurance Group, Standard Life and companies of a similar size to DLG as appropriate; and
• The principles for setting base salary are similar to those applied to other employees in the Group. However, the specific benchmarking groups used to review external market relativities may differ across employee groups
• Pension contributions are paid only in respect of base salary • Executive Directors are eligible to participate in the defined contribution pension arrangement or alternatively they may choose to receive a cash allowance in lieu of pension
Benefits • A comprehensive and flexible benefits package is offered, emphasising individuals being able to choose the combination of cash and benefits that suits them
• The costs of benefits provided may fluctuate from year to year, even if the level of provision has remained unchanged. An annual limit of 10% of base salary per Executive Director has been set for the duration of this policy (plus an additional amount of up to 100% of salary in respect of relocation expenses). The Committee will monitor the costs in practice and ensure the overall costs do not increase by more than the Committee considers to be appropriate in all the circumstances
• Additionally, the limit for any employee share plans in which the Executive Directors participate will be in line with the caps permitted by HMRC from time to time
• Similarly, while not benefits in the normal usage of that term, certain other items such as hospitality or retirement gifts may also be provided
– general base salary movements across the Group • The Committee does not follow market data strictly. However, it uses it as a reference point in considering, in its judgement, the appropriate salary level, while regarding other relevant factors, including corporate and individual performance, and any changes in an individual’s role and responsibilities
• The Committee may periodically amend the benefits available to some or all employees. The Executive Directors are eligible to receive such additional benefits as the Committee considers appropriate having regard to market norms
• Where an Executive Director is required to relocate to perform their role, they may be offered appropriate relocation benefits. The level of such benefits would be determined based on the circumstances of the individual and typical market practice
• The Committee sets targets at the beginning of each financial year • No more than 10% of the bonus is paid for threshold performance
• The AIP remains a discretionary arrangement. The Committee reserves discretion to adjust the outturn (from zero to the cap), should it consider it appropriate
• Vested options will remain exercisable up to the tenth anniversary of grant • Malus and clawback provisions apply to the LTIP. These are explained in the notes to the policy table • Awards under the LTIP may be made at various times during the financial year.
While the Committee reserves the right to do otherwise, the Committee’s practice has been to make awards twice in each financial year, following the announcement of the Group’s annual and half-year results
• The Committee will determine the performance conditions for each award made under the LTIP, measuring performance over a period of at least three years with no provision to retest
• Executive Directors are expected to retain all the ordinary shares vesting under any of the Company’s share incentive plans, after any disposals for paying applicable taxes, until they have achieved the required shareholding level unless such earlier sale, in exceptional circumstances, is permitted by the Chairman
AIP • To motivate executives and incentivise delivery of performance over a one-year operating cycle, focusing on the short- to mediumterm elements of our strategic aims
• For Executive Directors, at least 40% of the award is deferred into shares under the Deferred Annual Incentive Plan (the “DAIP”). This typically vests three years after grant (with deferred awards also capable of being settled in cash at the discretion of the Committee, for example, when it gives rise to legal difficulties to settle in shares). The remainder of the award is paid in cash following the year end
• The maximum bonus opportunity under the AIP is 175% of base salary per annum. The current maximum bonus opportunity applying for each individual Executive Director is shown in the statement of implementation of policy
(30% of the bonus for the individual performance element). No more than 60% of the maximum opportunity pays out for target performance. However, the Committee retains flexibility to amend the payout level at different levels of performance for future bonus cycles. This is based on its assessment of the level of stretch inherent in the set targets, and the Committee will disclose any such determinations appropriately
• For awards to be granted in 2017, vesting will continue to be determined based on two measures: RoTE and relative TSR performance against the FTSE 350 (excluding investment trusts). The Committee may apply different performance measures and targets for future awards, provided not less than 50% of the award shall be subject to one or more financial measures, and not less than 25% shall be subject to a relative TSR measure
Updated performance scenarios The Directors’ remuneration policy has been designed to ensure that a significant proportion of total remuneration is delivered as variable pay and, therefore, depends on performance against our strategic objectives.
The following charts show the potential remuneration which Executive Directors may earn under four performance scenarios as set out below.
On-target Based on what the Director would receive if performance was on-target (excluding share price appreciation and dividends): • Fixed remuneration as above • AIP – consists of the on-target bonus of 60% of maximum bonus opportunity • LTIP – consists of the threshold level of vesting (20% vesting)
Maximum Based on the maximum remuneration receivable (excluding share price appreciation and dividends): • Fixed remuneration as above • AIP – consists of the maximum bonus (175% of base salary for the CEO and CFO-designate, and 150%
for the MD Personal Lines) • LTIP – consists of the face value of awards (200% of base salary for all Executive Directors)
The Directors present their report for the financial year ended 31 December 2017.
Strategic report The Company’s Strategic report is on pages 1 to 43. It includes the following information that would otherwise need to be disclosed in this Directors’ report: Subject Pages
Interest capitalised by the Group None Unaudited financial information None Long-term incentive plan involving one Director only
Dividends The Group aims to manage its capital efficiently and generate long-term sustainable value for shareholders, while balancing operational, regulatory, rating agency and policyholder requirements.
The Board recommends a final dividend of 13.6 pence per share to shareholders. Subject to shareholder approval at the Company’s 2018 AGM, this will become payable on 17 May 2018 to all holders of Ordinary Shares on the Register of members at close of business on 6 April 2018. A special interim dividend has been declared of 15.0 pence per share and will have the same record and payment dates as the final dividend for 2017.
You can find further details regarding dividends paid during 2016 and 2017 in the Finance review on page 39 and in note 14 to the consolidated financial statements on page 146. You can also find information on dividend capital management in the Finance review on page 42.
The Company’s Articles of Association set out the Directors’ powers. You can view these on the Company’s website at www.directlinegroup.com. The Directors’ powers are also subject to relevant legislation and, in certain circumstances, authority from the Company’s shareholders. You can find details of the Directors’ remuneration, service contracts, employment contracts and interests in the shares of the Company in the Directors’ remuneration report on pages 74 to 99.
The Articles of Association of the Company permit it to indemnify the Company’s officers, and officers of any associated company, against liabilities arising from conducting Company business, to the extent permitted by law. As such, the Company has executed deeds of indemnity for each Director’s benefit, regarding liabilities that may attach to them in their capacity as Directors of the Company or associated companies. These indemnities are qualifying third-party indemnities as defined by section 234 of the Companies Act 2006. No amount was paid under any of these indemnities during the year. The Company maintains directors’ and officers’ liability insurance. This provides appropriate cover for legal actions brought against its Directors. The Company has also provided the directors of DLG Pension Trustee Limited with qualifying pension scheme indemnities. This is in accordance with section 235 of the Companies Act 2006. DLG Pension Trustee Limited acts as trustee for two of the Company’s occupational pension schemes.
At the Company’s 2017 AGM, the Directors were authorised to: • allot shares in the Company or grant rights to subscribe for, or convert, any security into shares up to an aggregate nominal amount of £50,000,000; • allot shares up to an aggregate nominal amount of £100,000,000, for the purpose of a rights issue; • allot shares having a normal amount not exceeding in aggregate £15,000,000 for cash without offering the shares first to existing shareholders in proportion to their holdings; and
• make market purchases of up to 137,500,000 shares in the Company, representing 10% of the Company’s issued share capital at the time.
Substantial shareholdings In accordance with the provisions of chapter 5 of the FCA’s Disclosure Guidance and Transparency Rules, the Company has been notified of the following indirect interests in the Company’s voting rights. The Company has not been notified of any direct interests. Information provided by the Company pursuant to the FCA’s Disclosure Guidance and Transparency Rules is publicly available via the regulatory information services and on the Company’s website.
Scope 2 – indirect emissions resulting from generating electricity purchased for office buildings and accident repair centres.
Electricity, heat, steam and cooling purchased for own use (Scope 2) 9,371 10,476
T&D losses from electricity, commuting, paper and business travel (Scope 3) 18,072 18,072
Intensity metric: tonnes CO2e/Million GBP net earned premium (£m) 11.3 11.6
Year on Year Comparison (Scope 2 Location-based methodology) Tonnes of CO2e
Intensity metric: tonnes CO2e/million GBP net earned premium (£m) 8.5 6.4 5.5 35%
Scope 3 (Only T&D losses from electricity) 1,774 1,079 876 51%
The Finance review on pages 42 and 43 describes the Group’s capital management strategy, which covers how it measures its regulatory and economic capital needs, and deploys capital.
Disclosing information to the Auditor Each Director at the date of approving these Annual Report & Accounts confirms that: as far as they are aware, there is no relevant audit information of which Deloitte LLP, the Company’s External Auditor, is unaware; and they have taken all the steps they ought to have taken as a Director to make themselves aware of any relevant audit information, and establish that Deloitte LLP is aware of that information.
Auditor Deloitte LLP has expressed its willingness to continue in office as the External Auditor. A resolution to reappoint Deloitte LLP will be proposed at the forthcoming AGM. You can find an assessment of the effectiveness and recommendation for reappointing Deloitte LLP in the Audit Committee report on page 64.
Company law requires the Directors to prepare such financial statements for each financial year. Under that law, the Directors must prepare the Group financial statements in accordance with IFRS, as adopted by the EU and Article 4 of the International Accounting Standard (“IAS”) regulation. The Directors have also chosen to prepare the Parent Company financial statements under IFRS, as adopted by the EU. Under company law, the Directors must not approve the accounts unless they are satisfied that they give a true and fair view of the Company’s state of affairs and profit or loss for that period.
• the annual report and the financial statements, taken as a whole, are fair, balanced and understandable, and provide the information necessary for shareholders to assess the company’s position and performance, business model and strategy.
Notes to the Parent Company financial statements 1. Accounting policies 167 2. Investment in subsidiary undertakings 167 3. Other receivables 168 4. Current and deferred tax 168 5. Derivative financial instruments 169 6. Financial investments 169 7. Cash and cash equivalents 169 8. Share capital and capital reserves 169 10. Subordinated liabilities 170 12. Trade and other payables 170 14. Cash used by operations 170 15. Related parties 171 16. Share-based payments 171 17. Risk management 171 18. Directors and key management remuneration 171
Opinion In our opinion: • The financial statements give a true and fair view of the Group’s and Parent Company’s affairs as at 31 December 2017, and of the Group’s profit for the year then ended
• The Group financial statements have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and IFRSs as issued by the International Accounting Standards Board (IASB)
• The Parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and IFRSs as issued by the IASB and as applied in accordance with the provisions of the Companies Act 2006; and
The financial statements, included within the Annual Report and Accounts, comprise of: • the Consolidated Income Statement
• the related notes 1 to 41 on the Consolidated financial statements, and the related notes 1 to 18 on the Parent Company financial statements
Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) and applicable law. Our responsibilities under those standards are further described in the auditor’s responsibilities for the audit of the financial statements section of our report.
Summary of our audit approach Key audit matters The key audit matters that we identified in the current year were: • Valuation of insurance reserves 1) The frequency and severity of bodily injury excess claims 2) The inflation and discount rate assumptions for valuing PPOs
Last year our report included key audit matters relating to Change and IT and the setting of propensity and severity assumptions when valuing PPO liabilities. We determined that the scale of offshoring and outsourcing has not materially changed in the year, and the processes and controls that had been offshored or outsourced and the Group’s oversight thereof were now embedded in the organisation. Following the Ogden discount rate change, the propensity and severity assumptions represented a reduced risk in comparison to previous audits. Through performing our detailed risk assessment for the 2017 audit, we refined our key audit matters to focus on inflation and discount rate assumptions when valuing PPOs and on the valuation of intangible assets.
Based solely on reading the Directors’ statements and considering whether they were consistent with the knowledge we obtained in the course of the audit, including the knowledge obtained in the evaluation of the Directors’ assessment of the Group’s and Parent Company’s ability to continue as a going concern, we are required to state whether we have anything material to add or draw attention to in relation to: • the disclosures on pages 24 and 25 that describe the principal risks and explain how they are being managed or mitigated
• the Directors’ confirmation on page 57 that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity; or
• the Directors’ explanation on page 23 as to how they have assessed the prospects of the Group, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions
Furthermore, the reduction in the Ogden discount rate to minus 0.75% in February 2017 has impacted on the historical consistency of bodily injury excess data by causing a “step-change” in incurred claims and potentially affecting claimant reporting behaviour. As typical actuarial techniques rely on the projection of historical data, this rate change increases the level of uncertainty in the Group’s modelled reserves for bodily injury excess claims which increases the susceptibility of the balance to material misstatement due to error and fraud.
How the scope of our audit responded to the key audit matter We have gained a detailed understanding of the end to end claims and reserving process, and assessed the design and implementation of selected controls. We have also tested the operating effectiveness for actuarial data reconciliations and key management review controls over the reserving process. Our work included attendance at the January Reserve Review Committee in order to observe a key management review control.
We have tested the completeness and accuracy of the underlying data used in the Group’s actuarial calculations and the actuarial data used by Deloitte actuarial specialists by performing reconciliations on the data back to the financial ledger.
Having done this, we worked with those specialists to: • assess and challenge the methodologies and key assumptions, and their underlying rationale, adopted by the Group
Key observations We have determined the estimate for the ultimate value of large bodily claims to be reasonable. In making this determination we observed that the frequency and severity assumptions used in determining this ultimate value are reasonable, albeit slightly prudent.
How the scope of our audit responded to the key audit matter We have gained a detailed understanding over the setting of these assumptions and assessed the design and implementation of key governance controls surrounding the setting of the PPO inflation rate and discount rate. In addition, we tested the operating effectiveness of a direct and precise business control, performed weekly, over the completeness of the PPO listing; this is a key data input which has a material impact on the PPO assumptions and hence the valuation.
We have worked with our actuarial specialists to: • review and challenge the Group’s PPO inflation assumption through inquiries with the Actuarial Director, reviewing relevant supporting documentation and benchmarking against market economic data
• review and challenge the selected discount rate with reference to current and future performance of the assets backing the PPO liabilities; and
Refer to page 62 (Audit Committee Report), page 119 (accounting policies) and page 147 (financial disclosures).
How the scope of our audit responded to the key audit matter We tested the design and implementation of key controls over the impairment of intangible assets. This included senior management review and approval of the impairment review and year end impairment charge.
• we challenged management’s forecasted future cash flows for each CGU through assessing historical forecasting accuracy, holding inquiries with management, inspecting the Group’s five year strategic plan and benchmarking key assumptions against market data where applicable. We then engaged our valuation specialists to assess the appropriateness of the discount rate used in the value in use calculation
While we observed that there is still uncertainty in the final end-state architecture design, based on the information available to date we deem the feasibility of successful project delivery and the expected benefits thereof to be reasonable.
We concurred with management that the asset’s future cash flows will not be generated independently and the recoverable amount should therefore be tested as part of those CGUs. We observed that the forecasted future cash flows and the discount rate were reasonable and that no further impairment is required.
Refer to page 62 (Audit Committee Report), page 120 (accounting policies) and page 153 (financial disclosures).
• challenged management on credit assets of interest where indicators could point to issuer financial difficulty, obtaining evidence to assess whether the position taken by management is reasonable
We also considered this measure to be suitable having compared to other benchmarks: our materiality equates to 5.1% (2016: 7.9%) of statutory profit before tax, 0.8% (2016: 0.9%) of gross earned premium and 1.1% (2016: 1.1%) of equity.
Responsibilities of Directors As explained more fully in the Directors’ responsibilities statement, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view, and for such internal control as the Directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
Report on other legal and regulatory requirements Opinion on other matters prescribed by the Companies Act 2006 In our opinion the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.
In our opinion, based on the work undertaken in the course of the audit: • the information given in the strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements; and
Other matters Audit tenure Following the recommendation of the audit committee, we were appointed by the Board of Directors of the Royal Bank of Scotland Group plc on 21 March 2000 to audit the financial statements for the year ending 31 December 2000 and subsequent financial periods. The period of total uninterrupted engagement including previous renewals and reappointments of the firm is 18 years, covering the years ending 31 December 2000 to 31 December 2017.
Consistency of the audit report with the additional report to the audit committee Our audit opinion is consistent with the additional report to the audit committee we are required to provide in accordance with ISAs (UK).
Consolidated income statement For the year ended 31 December 2017 £m 2016 £m
Instalment income 116.4 107.1 Other operating income 7 62.9 58.2 Total income 3,489.7 3,337.4
Insurance claims (payable to) / recoverable from reinsurers 8 (183.1) 375.2 Net insurance claims 8 (1,754.2) (1,803.8)
Profit for the year attributable to owners of the Company 434.0 278.8
Profit for the year 434.0 278.8 Other comprehensive (loss) / income Items that will not be reclassified subsequently to the income statement: Actuarial gain / (loss) on defined benefit pension scheme 25 2.1 (4.4) Tax relating to item that will not be reclassified 13 (0.4) 0.7
Other comprehensive (loss) / income for the year net of tax (11.3) 84.5 Total comprehensive income for the year attributable to owners of the Company 422.7 363.3
The attached notes on pages 117 to 163 form an integral part of these consolidated financial statements.
Consolidated balance sheet As at 31 December 2017 £m 2016 £m
Assets Goodwill and other intangible assets 17 471.1 508.9 Property, plant and equipment 18 174.4 180.9
Cash and cash equivalents 27 1,358.6 1,166.1 Assets held for sale 28 4.2 3.8 Total assets 9,948.2 10,121.7
Derivative financial instruments 24 12.0 45.1 Trade and other payables, including insurance payables 36 658.0 699.2 Deferred tax liabilities 13 31.1 46.0 Current tax liabilities 13 40.7 0.5 Total liabilities 6,886.6 7,600.2 Total equity and liabilities 9,948.2 10,121.7
Profit for the year – – – – – – 278.8 278.8 – 278.8
Transfer from non-distributable reserve – – – – (152.9) – 152.9 – – – Shares acquired by employee trusts – (39.5) – – – – – (39.5) – (39.5) Credit to equity for equity-settled share-
Profit for the year – – – – – – 434.0 434.0 – 434.0
Shares acquired by employee trusts – (19.6) – – – – – (19.6) – (19.6) Credit to equity for equity-settled share-
Shares distributed by employee trusts – 19.8 – – – – (19.8) – – – Tax on share-based payments – – – – – – 1.0 1.0 – 1.0 Issue of Tier 1 notes (note 31) – – – – – – – – 346.5 346.5
1. Accounting policies Basis of preparation As required by the Companies Act 2006 and Article 4 of the IAS Regulation, the consolidated financial statements are prepared in accordance with IFRSs as adopted by the EU and as issued by the IASB. The Company’s financial statements have been prepared in accordance with and full compliance with IFRSs as issued by the IASB.
The consolidated financial statements are prepared on the historical cost basis except for AFS financial assets, investment property and derivative financial instruments, which are measured at fair value.
Adoption of new and revised standards The Group has adopted the following new amendments to IFRSs and the IASs that became mandatorily effective for the Group for the first time during 2017 however these have no impact on the consolidated financial statements or performance.
Amendments to IAS 7 ‘Statement of Cash Flows’ require an entity to provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non-cash changes. On initial application of the amendment, entities are not required to provide comparative information.
The IASB amended IAS 12 ‘Income Taxes’ – Recognition of Deferred Tax Assets for Unrealised Losses to clarify how to account for deferred tax assets related to debt instruments measured at fair value, particularly where changes in the market interest rate decrease the fair value of a debt instrument below cost. The amendments clarify that an entity needs to consider whether tax law restricts the sources of taxable profits against which it may make deductions on the reversal of that deductible temporary difference. Furthermore, the amendments provide guidance on how an entity should determine future taxable profits and explain the circumstances in which taxable profit may include the recovery of some assets for more than their carrying amount.
Where necessary, adjustments have been made to the financial statements of subsidiaries to bring the accounting policies used into line with those used by the Group. The policies set out below have been applied consistently throughout the years ended 31 December 2017 and 31 December 2016 to items considered material to the consolidated financial statements.
All intercompany transactions, balances, income and expenses between Group entities are eliminated on consolidation.
1.5 Insurance claims Insurance claims are recognised in the accounting period in which the loss occurs. Provision is made for the full cost of settling outstanding claims at the balance sheet date, including claims incurred but not yet reported at that date, net of salvage and subrogation recoveries. Outstanding claims provisions are not discounted for the time value of money except for claims to be settled by PPOs established under the Courts Act 2003. A court can award damages for future pecuniary loss in respect of personal injury or for other damages in respect of personal injury and may order that the damages are wholly or partly to take the form of PPOs. These are covered in more detail in note 2.4. Costs for both direct and indirect claims handling expenses are also included.
A liability adequacy provision is made for unexpired risks arising where the expected value of claims and expenses attributable to the unexpired periods of policies in force at the balance sheet date exceeds the unearned premium reserve in relation to such policies after the deduction of any acquisition costs deferred and other prepaid amounts (for example, reinsurance). The expected value is determined by reference to recent experience and allowing for changes to the premium rates. The provision for unexpired risks is calculated separately by reference to classes of business that are managed together after taking account of relevant investment returns.
1.9 Property, plant and equipment Items of property, plant and equipment (except investment property – note 1.11) are stated at cost less accumulated depreciation and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately.
AFS Financial assets can be designated as AFS on initial recognition. AFS financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Impairment losses and exchange differences resulting from translating the amortised cost of foreign currency monetary AFS financial assets are recognised in the income statement, together with interest calculated using the effective interest rate method. Other changes in the fair value of AFS financial assets are reported in a separate component of shareholders’ equity until disposal, when the cumulative gain or loss is recognised in the income statement.
Insurance receivables Insurance receivables comprise outstanding insurance premiums where the policyholders have elected to pay in instalments, or amounts due from third parties where they have collected or are due to collect the money from the policyholder.
Gains and losses arising from changes in the fair value of a derivative are recognised as they arise in the income statement unless the derivative is the hedging instrument in a qualifying hedge. The Group enters into fair value hedge relationships and a small amount of cash flow hedges.
Provision for taxation is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date, and is allocated over profits before taxation and amounts charged or credited to components of other comprehensive income and equity, as appropriate.
Deferred tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and the Group intends to settle its current assets and liabilities on a net basis.
1.21 Capital instruments The Group classifies a financial instrument that it issues as a financial liability or an equity instrument in accordance with the substance of the contractual arrangement. An instrument is classified as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms, or as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities.
The Tier 1 notes are classified as equity as they have a perpetual maturity and the Group has full discretion over interest payments, including ability to defer or cancel interest payments indefinitely.
1.23 Accounting developments New IFRSs and amendments that are issued, but not yet effective for the 31 December 2017 reporting period and have not been early adopted by the Group are disclosed below. The Group intends to adopt these standards, if applicable, when they become effective, except for IFRS 9 as explained below.
IFRS 15 was endorsed by the EU in 2016 and either a full retrospective application or a modified retrospective application is required for annual periods beginning on or after 1 January 2018. During 2017 the Group reviewed all non-insurance revenue and expects to apply IFRS 15 fully retrospectively. Insurance contracts are out of the scope of IFRS 15 and therefore the Group does not expect the impact on other operating income to be material.
In 2018, the Group will continue to assess the potential effect of IFRS 16 on its consolidated financial statements; the undiscounted value of the Group’s lease obligations is disclosed in note 39. The Group does not expect the impact on operating expenses or finance costs to be material.
In December 2016 the IASB issued ‘Annual Improvements to IFRS Standards 2014-2016 Cycle’ that included the two following improvements: IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ – the amendment deletes certain short-term exemptions for first-time adopters (IASB effective date of 1 January 2018); IAS 28 ‘Investments in Associations and Joint Ventures’ – the amendment provides clarification that measuring investees at fair value through profit or loss is an investment-by-investment choice; it is effective from 1 January 2018.
The core of IFRS 17 is the general model, supplemented by an optional simplified premium allocation approach which is permitted for the liability for the remaining coverage for shortduration contracts. The general model measures insurance contracts using the building blocks of: discounted probabilityweighted cash flows; an explicit risk adjustment; and a contractual service margin representing the unearned profit of the contract which is recognised as revenue over the coverage period.
An assessment will be undertaken during 2018 of the impact of IFRS 17 on the Group’s financial statements. The Group expects to be able to apply the simplified premium allocation approach to most of its insurance and reinsurance contracts.
Amendments to IAS 28 ‘Investments in Associates and Joint Ventures’– Long-term Interests in Associates and Joint Ventures were issued in October 2017 to clarify that an entity applies IFRS 9 to long-term interests in associates or joint ventures that form part of the net investment in the associate or joint venture but to which the equity method is not applied. The amendments are effective from 1 January 2019.
Amendments to IFRS 9 ‘Financial Instruments’ – Prepayment Features with Negative Compensation was issued in October 2017 to allow instruments with symmetric prepayment options to qualify for amortised cost or fair value through other comprehensive income measurement because they would otherwise fail the ‘solely payments of principal and interest on the principal amount’ condition. The amendments are effective from 1 January 2019.
IAS 23 ‘Borrowing Costs’– the amendments clarify that if any specific borrowing remains outstanding after the related asset is ready for its intended use or sale, that borrowing becomes part of the funds that an entity borrows generally when calculating the capitalisation rate on general borrowings.
There was £9.5 million impairment within loans and receivables of the Group’s financial assets in the year ended 31 December 2017 (2016: £nil).
2.2 Fair value The Group has made the judgement that level 1 of the Group’s fair value hierarchy set out in note 40 will include only sovereign debt securities issued by members of the G1O group of countries within the Group’s AFS debt securities portfolio, with all other financial assets and liabilities carried at fair value included in level 2 as they are not considered to be quoted in a deeply liquid market.
Impairment testing of software development costs involves estimation uncertainty in a number of areas including: the projection of the economic benefits associated with each asset; subsequent re-measurement of these benefits through the development cycle and into use; and the projected ultimate cost of each asset at each point through the development cycle due to specification changes.
2.4 General insurance: outstanding claims provisions and related reinsurance recoveries The Group makes provision for the full cost of outstanding claims from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling. Outstanding claims provisions net of related reinsurance recoveries at 31 December 2017 amounted to £3,144.5 million (2016: £3,388.3 million).
The Lord Chancellor changed the Ogden discount rate from 2.5% to minus 0.75% in March 2017 based on a 3-year average of yields on index-linked government securities which will be sensitive to future movements in these instruments. The Government is currently planning to review the Ogden discount rate again based on ‘low risk’ investments rather than ‘very low risk’ investments, however, there is considerable uncertainty if, when and how a change might be made.
The Group will continue to exercise judgement around the Ogden rate used in its reserves allowing for the possibility for it to change in the future. It considers the uncertainties around the legal framework and its implementation as being significant and therefore provisions at the current proposed rate of minus 0.75%. An allowance for further movements in the Ogden rate is made within the Group’s Solvency II balance sheet and capital requirements. Details of the IFRS sensitivity analysis to the assumed Ogden discount rate are shown in note 3.3.1. However, it should be noted that the Government is considering not only the appropriate level for the rate but also the methodology of how it is applied, so any sensitivity has considerable limitations.
3.3.1 Insurance risk The Group is exposed to insurance risk as a primary consequence of its business. Key insurance risks focus on the risk of loss due to fluctuations in the timings, amount, frequency and severity of an insured event relative to the expectations at the time of underwriting.
• changes in underwriting and business written so that past trends are not necessarily a predictor of the future.
The Group’s reserves are subject to the risk of retrospective changes in judicial conditions such as the change in the Ogden discount rate announced on 27 February 2017. This is the discount rate set by the Lord Chancellor and used by courts to calculate lump sum awards in bodily injury cases. The rate had been 2.5% since 2001 but was changed to minus 0.75% from 20 March 2017. The Group subsequently revised its reserve estimation to be based on the new rate, although this rate may change again in future, depending on the outcome of the Government’s consultation on the framework for setting the rate and on the frequency and timing of future changes.
Notes to the consolidated financial statements continued 3. Risk management continued The tables below provide a sensitivity analysis of the potential impact of a change in a single factor (discount rate used for PPOs, Ogden discount rate) with all other assumptions left unchanged. Other potential risks beyond the ones described could have an additional financial impact on the Group.
Increase / (decrease) in profit before tax and equity3,4 £m 2016 £m
Ogden discount rate² Impact of the Group reserving at a discount rate of 0% compared to minus 0.75% 68.4 102.1 Impact of the Group reserving at a discount rate of minus 1.5% compared to minus 0.75% (102.9) (156.4)
The Group will consider the statutory discount rate when setting its reserves but not necessarily provide on this basis. This is to ensure that reserves are appropriate for current and potential future developments.
3. These sensitivities exclude the impact of taxation. 4. These sensitivities reflect one-off impacts at 31 December and should not be interpreted as predictions.
The sensitivity above is calculated on the basis of a permanent change in the rate on the actuarial best estimate reserves as at 31 December 2017. It does not take into account a change in the Ogden discount rate setting regime, nor any second order impacts such as those on the Group’s PPO assumptions or reinsurance bad debt assumptions. The year on year reduction in sensitivity to a change in the Ogden discount rate reflects a £49 million reserve release arising after a detailed case review of the Group’s 2016 Ogden provision as well as the overall reduction in bodily injury exposures. This is due to continued positive prior-year development of claims reserves for large bodily injury claims, particularly for accident years where the reinsurance retention level was higher than the current level of £1 million.
There is the risk that claims are reserved or paid inappropriately, including the timing of such activity. However, there are claims management controls in place to mitigate this risk, as outlined below: • claims are managed utilising a range of IT system-driven controls coupled with manual processes outlined in detailed policies and procedures to ensure claims are handled in an appropriate, timely and accurate manner; • each member of staff has a specified handling authority, with controls preventing them handling or paying claims outside their authority, as well as controls to mitigate the risk of paying invalid claims. In addition, there are various outsourced claims handling arrangements, all of which are monitored closely by management, with similar principles applying in terms of the controls and procedures; • loss adjustors are used in certain circumstances to handle claims to conclusion. This involves liaison with the policyholder, third parties, suppliers and the claims function; • specialist bodily injury claims teams are responsible for handling these types of losses with the nature of handling dependent on the level and type of claim. Claims exceeding a certain threshold are referred to the technical and large loss teams who also deal with all other claim types above defined limits or within specific criteria; and
When underwriting policies, the Group is subject to concentration risk in a variety of forms, including: • geographic concentration risk – the Group purchases a catastrophe reinsurance programme to protect against a modelled one in 200-years catastrophe loss. The retained deductible is 13.99% of the gross earned premium of the preceding 12 months and at 31 December 2017 was £147 million (2016: £150 million)
• product concentration risk – the Group’s business is heavily concentrated in the UK general insurance market. However, the Group offers a diversified portfolio of products and a variety of brands sold through a range of distribution channels to its customers; and
Distribution risk This is the risk that material change in the volume of policies written may result in losses or reduced profitability.
The Group uses reinsurance to: • protect the underwriting result against low-frequency, high-severity losses through the transfer of catastrophe claims volatility to reinsurers; • protect the underwriting result against unforeseen volumes of, or adverse trends in, large individual claims in order to reduce volatility and to improve stability of earnings; • reduce the Group’s capital requirements; and / or
The remaining notes, with a nominal value of £250 million, have a redemption date of 27 April 2042 with the option to repay the notes on 27 April 2022. If the notes are not repaid on that date, the rate of interest will be reset at a rate of the six-month LIBOR plus 7.91%.
Property risk This is the risk of loss arising from sensitivity of assets and financial investments to the level or volatility of market prices, rental yields, or occupancy rates of properties. At 31 December 2017, the value of these property investments was £309.3 million (2016: £329.0 million). The property investments are located in the UK.
Spread Impact of a 100 basis points increase in spreads on financial investments1,2,4 – – (183.5) (183.1) Interest rate Impact of a 100 basis points increase in interest rates on financial investments and derivatives1,2,3,4 17.3 21.5 (98.3) (101.5) Investment property Impact of a 15% decrease in property markets (46.4) (49.4) (46.4) (49.4)
4. The subordinated liabilities and associated interest rate swap are excluded from the sensitivity analysis. 5. These sensitivities exclude the impact of taxation. 6. The sensitivities set out above have not considered the impact of the general market changes on the value of the Group’s insurance liabilities or retirement benefit obligations. They reflect one-off impacts at 31 December and should not be interpreted as predictions.
The Group has a number of open interest rate and foreign exchange derivative positions. Collateral management arrangements are in place for significant counterparty exposures. At 31 December 2017, the Group has pledged £28.2 million in cash (2016: £23.7 million) and £0.3 million in UK Gilts (2016: £3.4 million) to cover initial margins and out-of-the-money derivative positions. At 31 December 2017, counterparties have pledged £25.1 million in cash and £15.5 million in UK Gilts (2016: £19.1 million in cash and £39.4 million in UK Gilts) to the Group to cover in-the-money derivative positions.
The terms and conditions of collateral pledged for both assets and liabilities are market standard. When securities are pledged they are required to be readily convertible to cash, and as such no policy has been established for the disposal of assets not readily convertible into cash.
3.3.3 Credit risk This is the risk of loss resulting from default in cash inflows and / or changes in market value of issuers of securities, counterparties and any debtors to which the Group is exposed. The Group is mainly exposed to the following credit risk factors: • counterparty default risk; and
Counterparty default risk This is the risk of loss from unexpected default of the counterparties and debtors of Group undertakings. This risk is monitored by three forums: the Investment risk forum monitors credit spreads as indicators of potential losses on investments incurred but not yet realised; the Credit risk forum monitors reinsurance and corporate insurance counterparty default risk; and the NIG credit committee is responsible for monitoring broker credit risk. The main responsibility of these forums is to ensure that all material aspects of counterparty default risk within the Group are identified, monitored and measured.
• consumer credit – exposure from offering monthly instalments on annual insurance contracts
Within the analysis of debt securities above are bank debt securities at 31 December 2017 of £1,197.4 million (2016: £1,199.5 million), that can be further analysed as: secured £63.5 million (2016: £62.2 million); unsecured £976.3 million (2016: £973.8 million); and subordinated £157.6 million (2016: £163.5 million).
• large exposures to different credits where movements in values and ratings are closely correlated.
The table below analyses the distribution of debt securities, by geographical area (commercial real estate loans and infrastructure debt are all within the UK).
The tables below analyse the credit quality of financial and insurance assets that are neither past due nor impaired (excluding debt securities analysed above). The tables include reinsurance exposure, after provision. Note 3.3.1 details the Group’s approach to reinsurance counterparty default risk management.
At fair value through the income statement: Foreign exchange contracts (forwards) 2,735.3 51.1 – – 51.1 Designated as hedging instruments: Foreign exchange contracts (forwards) 17.3 1.0 – – 1.0
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 579.9 11.3 – – 11.3 Designated as hedging instruments: Interest rate swaps 113.1 0.5 (0.1) 0.3 0.7
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 1,110.0 21.4 – – 21.4 Designated as hedging instruments: Foreign exchange contracts (forwards) 14.8 1.6 0.1 – 1.7
The tables below analyse financial investments, cash and cash equivalents, insurance and financial liabilities by remaining duration, in proportion to the cash flows expected to arise during that period, for each category.
Commercial real estate loans 169.0 4.3 56.6 108.1 – – Cash and cash equivalents1 1,358.6 1,358.6 – – – –
Trade and other payables, including insurance payables 658.0 648.8 8.0 0.4 0.8 –
Trade and other payables, including insurance payables 699.2 688.9 9.8 0.2 0.3 –
Notes: 1. This represents money market funds with no notice period for withdrawal and cash at bank and in hand. 2. Insurance liabilities exclude unearned premium reserves as there are no liquidity risks inherent in them.
The Group’s regulatory capital position is assessed against the Solvency II framework. From 1 July 2016, the Group gained approval to assess its SCR using a partial internal model, including a full internal economic capital model for the UKI underwriting entity. The model is calibrated to a 99.5% confidence interval and considers business written to date and one year of future written business over a one year time horizon, in line with Solvency II requirements.
4. Segmental analysis The Directors manage the Group primarily by product type and present the segmental analysis on that basis. The segments, which are all UK based, reflect the management structure whereby a member of the Executive Committee is accountable to the Chief Executive Officer for each of the operating segments: Motor This segment consists of personal motor insurance together with the associated legal protection cover. The Group sells motor insurance direct to customers through its own brands, Direct Line, Churchill and Privilege, and also through partnership brands such as vehicle manufacturers and through PCWs.
Rescue and other personal lines This segment consists of rescue products which are sold direct through the Group’s own brand, Green Flag, and other personal lines insurance, including travel, pet and creditor sold through its own brands, Direct Line, Churchill and Privilege, and also through partnership brands and through PCWs.
During 2018 the Group does not expect to incur material restructuring costs and run-off profits are expected to decrease over time. From 2018 these items will be included within operating profit with any future material restructuring activities or other one-off items highlighted separately as they occur.
Underwriting profit 119.0 83.7 24.0 30.2 256.9 Loss ratio 60.9% 50.6% 65.4% 49.9% 57.4% Commission ratio 2.5% 17.7% 5.5% 19.1% 9.1% Expense ratio 28.5% 21.1% 23.4% 24.4% 25.3% COR 91.9% 89.4% 94.3% 93.4% 91.8%
Gross earned premium: Gross written premium 3,392.1 3,274.1 Movement in unearned premium reserve (52.4) (71.3)
Net unrealised (losses) / gains: Impairment of loans and receivables (9.5) –
Derivative gains / (losses): Foreign exchange forward contracts1 107.8 62.5 (425.7) 19.1 Associated foreign exchange risk 68.4 (259.1) 151.0 253.0 Net gains / (losses) on foreign exchange forward contracts 176.2 (196.6) (274.7) 272.1
Note: 1. Foreign exchange forward contracts are at fair value through the income statement and interest rate swaps are designated as hedging instruments.
Vehicle replacement referral income 16.9 14.1 Revenue from vehicle recovery and repair services 11.3 19.3 Legal services income 11.0 11.2 Other income1 23.7 13.6
Note: 1. Other income includes salvage income and fee income from insurance intermediary services.
Ongoing operations 175.0 164.4 Run-off (0.2) 1.2 9. Commission expenses £m 2016 £m
Total Ongoing Restructuring costs Run-off Total Group £m £m 2017 £m
Amortisation and impairment of other intangible assets 111.0 – – 111.0
Total Ongoing Restructuring costs Run-off Total Group £m £m 2016 £m
Amortisation and impairment of other intangible assets 96.7 – – 96.7
Notes: 1. Staff costs and other operating expenses attributable to claims handling activities are allocated to the cost of insurance claims. 2. Other operating expenses include IT costs, insurance levies, professional fees and property costs. 3. A property site in Bristol comprising of freehold property and fixtures and fittings was transferred from freehold property to assets held for sale in 2016.
The property with a carrying value of £23.5 million was remeasured on transfer to its fair value of £3.8 million resulting in a charge to other operating expenses in restructuring of £19.7 million.
Fees payable for the audit of: The Company’s annual accounts 0.3 0.3 The Company’s subsidiaries 1.6 1.5
Total audit fees 1.9 1.8 Fees payable for non-audit services: Audit-related assurance services 0.1 0.2 Other services 0.1 0.2
Note: 1. The prior year current tax credit for the year ended 31 December 2016 included £5.6 million relating to retrospective claims for research and development tax relief.
Profit before tax 539.0 353.0 Expected tax charge 103.8 70.6 Effects of: Disallowable expenses 5.4 10.6 Non-taxable items (0.3) (0.9) Effect of change in corporation taxation rate (0.2) (1.0) Over provision in respect of prior year (3.7) (5.1)
Tax charge for the year 105.0 74.2 Effective income tax rate 19.5% 21.0%
Note: 1. In the Finance (No 2) Act 2015 the UK Government enacted a reduction in the UK corporation tax rate from 20% to 19% effective from 1 April 2017, and then the Finance Act 2016 enacted a further reduction to 17% effective from 1 April 2020. As a consequence, the closing deferred tax assets and liabilities have been recognised at the tax rates expected to apply when the assets or liabilities are settled. The impact of these changes on the tax charge for the year is set out in the table above.
The table below analyses the major deferred tax assets and liabilities recognised by the Group and movements thereon.
Note: 1. The non-distributable reserve was a statutory claims equalisation reserve calculated in accordance with the rules of the PRA. With the introduction of Solvency II on 1 January 2016, the requirement to maintain this reserve ceased and the balance at 31 December 2015 was released to retained earnings. The taxation of this release is spread over six years from the change in regulation. This is provided for in deferred tax above as it represents the future unwind of previously claimed tax deductions for transfers into this reserve.
Amounts recognised as distributions to equity holders in the period: 2016 final dividend of 9.7 pence per share paid on 18 May 2017 132.4 – 2015 final dividend of 9.2 pence per share paid on 19 May 2016 – 126.0 2017 first interim dividend of 6.8 pence per share paid on 8 September 2017 92.9 – 2016 first interim dividend of 4.9 pence per share paid on 9 September 2016 – 67.1 2016 first special interim dividend of 10.0 pence per share paid on 9 September 2016 – 136.9 2015 second special interim dividend of 8.8 pence per share paid on 19 May 2016 – 120.6
The proposed final and special dividends for 2017 have not been included as a liability in these financial statements.
15. Earnings per share Earnings per share is calculated by dividing earnings attributable to the owners of the Company by the weighted average number of Ordinary Shares during the year.
Basic Basic earnings per share is calculated by dividing the earnings attributable to the owners of the Company by the weighted average number of Ordinary Shares for the purposes of basic earnings per share during the period, excluding Ordinary Shares held as employee trust shares.
Diluted Diluted earnings per share is calculated by dividing the earnings attributable to the owners of the Company by the weighted average number of Ordinary Shares during the period adjusted for dilutive potential Ordinary Shares. The Company has share options and contingently issuable shares as categories of dilutive potential Ordinary Shares.
Earnings attributable to owners of the Company 434.0 278.8 Opening shareholders’ equity 2,521.5 2,630.0 Closing shareholders’ equity 2,715.1 2,521.5 Average shareholders’ equity 2,618.3 2,575.8 Return on equity 16.6% 10.8%
There have been no impairments in goodwill for the year ended 31 December 2017 (2016: £nil).
WWW.DIRECTL INEGROUP.COM 149 18. Property, plant and equipment Freehold land and buildings £m
Additions at cost – 1.4 Increase in fair value during the year 21.6 5.4
Note: 1. The cost included in carrying value at 31 December 2017 is £252.4 million (2016: £275.3 million).
Notes to the consolidated financial statements continued 20. Subsidiaries The principal subsidiary undertakings of the Group, over which it exercises 100% voting power, are shown below. Their capital consists of Ordinary Shares which are unlisted. All subsidiaries (a full list of which is included in note 2 of the Parent Company’s financial statements) are included in the Group’s consolidated financial statements.
Reinsurers’ share of general insurance liabilities 1,141.1 1,329.0 Impairment provision1 (59.9) (50.7)
Derivative assets At fair value through the income statement: Foreign exchange contracts (forwards) 51.1 21.4 Designated as hedging instruments: Foreign exchange contracts (forwards)1 1.0 1.7 Interest rate swaps 32.3 56.6
Derivative liabilities At fair value through the income statement: Foreign exchange contracts (forwards) 11.3 43.5 Designated as hedging instruments: Interest rate swaps 0.7 1.6
25. Retirement benefit obligations Defined contribution scheme The pension charge in respect of the defined contribution scheme for the year ended 31 December 2017 was £25.5 million (2016: £24.9 million).
Rate of increase in pension payment 2.2 2.2 Rate of increase of deferred pensions 2.2 2.2 Discount rate 2.5 2.7 Inflation rate 3.3 3.3
Life expectancy at age 60 in 20 years’ time: Males 89.3 90.3
Index-linked bonds 28.7 28.6 Government bonds 17.7 16.9 Liquidity fund1 52.7 56.3
Income statement: Net interest income / (cost)1 3.2 (2.7) 0.5 Statement of comprehensive income: Actuarial gains arising from experience adjustments 13.7 1.2 14.9 Actuarial losses arising from changes in financial assumptions – (19.3) (19.3)
Income statement: Net interest income / (cost)1 2.7 (2.4) 0.3 Statement of comprehensive income: Actuarial gains arising from experience adjustments 1.0 1.5 2.5 Actuarial gains arising from changes in demographic assumptions – 3.1 3.1 Actuarial losses arising from changes in financial assumptions – (3.5) (3.5)
Sensitivity analysis The table below provides a sensitivity analysis of the potential impact of a change in a single factor with all other assumptions left unchanged. Other potential risks beyond the ones described in the table could have an additional financial impact on the Group. This sensitivity analysis has been selected to reflect the changes to discounted cash flows as a result of changes to the discount rate, inflation rate and mortality assumptions. The methodology adopted involves actuarial techniques.
Inflation rate 0.25% increase in inflation rate – – 2.2 2.3 0.25% decrease in inflation rate – – (2.2) (2.3) Life expectancy 1 year increase in life expectancy 0.1 0.1 3.1 2.7 1 year decrease in life expectancy (0.1) (0.1) (3.1) (2.7)
The effective interest rate on short-term deposits with credit institutions for the year ended 31 December 2017 was 0.29% (2016: 0.45%) and average maturity was 10 days (2016: 10 days).
Notes: 1. Arose on the cancellation of a debt payable to a shareholder. 2. Arose on the reduction of nominal value of each share in issue with a corresponding transfer to capital redemption reserve.
The Tier1 notes are treated as a separate category within equity and the coupon payments are recognised outside of the profit after tax result and directly in shareholders’ equity.
The Group has the option to cancel the coupon payment which becomes mandatory upon breach or non-compliance with the Group SCR, a breach of the minimum capital requirement or where the Group has insufficient distributable reserves.
Proceeds of this issuance have primarily been used to fund the repurchase of £250 million subordinated guaranteed dated notes which had a market value of £326.8 million (see note 32).
Estimate of ultimate gross claims costs: At end of accident year 3,393.4 3,823.3 3,941.7 2,698.1 2,372.7 2,184.0 2,094.5 2,118.1 2,157.7 2,217.3 One year later 50.8 121.6 (117.1) (99.3) (163.3) (117.6) 20.7 (30.0) (86.7) Two years later 51.7 (37.0) (99.1) (94.6) (118.9) (153.0) (38.4) (143.5) Three years later (36.7) (14.0) (50.3) (89.3) (49.3) (21.0) (144.9) Four years later (16.7) (101.5) (105.5) (60.9) (9.9) (102.1) Five years later (55.5) (38.8) (57.7) (21.2) (79.2) Six years later (45.7) (80.8) (25.9) (60.3) Seven years later (29.9) (27.3) (50.0) Eight years later (16.2) (14.0) Nine years later (24.3)
Gross liability recognised in balance sheet 89.4 162.0 132.4 118.6 109.1 180.3 405.2 474.9 628.6 1,166.7 3,467.2 2007 and prior 679.2 Claims handling provision 79.3 Total 4,225.7
Current estimate of cumulative claims 3,200.7 3,579.3 3,397.8 2,231.3 1,915.9 1,743.8 1,798.6 1,781.9 1,903.3 2,016.9
Incurred but not reported 1,697.9 (546.9) 1,151.0 Claims handling provision 94.4 – 94.4
Incurred but not reported 2,002.8 (890.0) 1,112.8 Claims handling provision 79.3 – 79.3
Cash paid for claims settled in the year (2,012.0) 14.0 (1,998.0) Increase / (decrease) in liabilities: Arising from current-year claims 2,389.9 (200.3) 2,189.6 Arising from prior-year claims (818.8) 383.4 (435.4)
Movement in prior-year net claims liabilities by operating segment £m 2016 £m
Notes to the consolidated financial statements continued 35. Share-based payments The Group operates equity-settled, share-based compensation plans in the form of an LTIP, a Restricted Shares Plan, a DAIP and Direct Line Group Share Incentive Plans, including both the Free Share awards and a Buy-As-You-Earn Plan, details of which are set out below. All awards are to be satisfied using market purchased shares.
Long-Term Incentive Plan Executive Directors and certain members of senior management are eligible to participate in the LTIP with awards granted in the form of nil-cost options. Under the plan, the shares vest at the end of a three-year period dependent upon the continued employment by the Group and also the Group achieving predefined performance conditions associated with TSR and RoTE. For awards made after the 2017 AGM, the Directors will be subject to an additional two-year holding period following the three-year vesting period.
Awards were made in the year ended 31 December 2017 over 4.2 million Ordinary Shares with an estimated fair value of £15.2 million at the 2017 grant dates (2016: 3.3 million Ordinary Shares with an estimated fair value of £12.4 million).
Expected volatility was determined by considering the actual volatility of the Group’s share price since its IPO and that of a group of listed UK insurance companies.
Deferred Annual Incentive Plan To incentivise delivery of performance over a one-year operating cycle, Executive Directors and certain members of senior management are eligible for awards under the AIP, of which at least 40% is granted in the form of a nil-cost option under the DAIP with the remainder being settled in cash following year end. During the year awards were made over 0.9 million Ordinary Shares (2016: 1.0 million Ordinary Shares) under this plan with an estimated fair value of £2.9 million (2016: £3.7 million) using the market value at the date of grant.
Granted during the year1 9.6 7.7 Forfeited during the year (1.3) (0.8) Exercised during the year (6.2) (6.0)
Note: 1. In accordance with the rules of the LTIP and DAIP award plans, additional awards of 3.0 million shares were granted during the year ended 31 December 2017
The weighted average share price for awards exercised during the year ended 31 December 2017 was £3.61 (2016: £3.68).
The Group recognised total expenses in the year ended 31 December 2017 of £14.8 million (2016: £16.8 million) relating to equity-settled share-based compensation plans.
36. Trade and other payables, including insurance payables £m 2016 £m
Due to agents, brokers and intermediaries 18.2 15.5 Due to reinsurers 74.2 84.1 Due to insurance companies 4.0 4.4 Trade creditors and accruals 282.8 334.7 Other creditors 95.9 98.4 Other taxes 103.9 93.0
The table below details changes in liabilities arising from the Group’s financing activities.
Within one year 19.2 17.4 In the second to fifth years inclusive 58.1 54.2 After five years 154.8 159.7
Notes to the consolidated financial statements continued 40. Fair value Fair value hierarchy For disclosure purposes, fair value measurements are classified as level 1, 2 or 3 based on the degree to which fair value is observable: • level 1 financial assets are measured in whole or in part by reference to published quotes in an active market. In an active market quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency and those prices represent actual and regularly occurring market transactions on an arm’s length basis.
• level 2 financial assets and liabilities are measured using a valuation technique based on assumptions that are supported by prices from observable current market transactions. These are assets for which pricing is obtained via pricing services, but where prices have not been determined in an active market, or financial assets with fair values based on broker quotes or assets that are valued using the Group’s own models whereby the majority of assumptions are market-observable.
• level 3 fair value measurements used for investment properties, HTM debt securities, infrastructure debt and commercial real estate loans are those derived from a valuation technique that includes inputs for the asset that are unobservable.
At 31 December 2016 Carrying value £m Level 1 £m £m Fair value £m
Liabilities held at fair value: Derivative liabilities (note 24) 45.1 – 45.1 – 45.1 Other financial liabilities: Subordinated liabilities (note 32) 539.6 – 625.0 – 625.0
Differences arise between carrying value and fair value where the measurement basis of the asset or liability is not fair value (e.g. assets and liabilities carried at amortised cost). Fair values of the following assets and liabilities approximate their carrying values: • insurance and other receivables; • cash and cash equivalents; • borrowings; and