Trusted brands and direct growth Once again, the growth we achieved across Direct Line, Direct Line for Business and Green Flag demonstrated that by giving customers a reason to come to us direct, they will. Since 2014, our own brand in-force policies have grown by over one million, to over seven million policies.
These systems, which started to go into testing at the end of 2018, are designed to make insurance much easier for our customers by introducing more self-service and customer focused innovations. In addition they are designed also to enable a step change in our ability to use internal and external data more effectively to improve our pricing accuracy and improve our competitiveness. Our new pricing engine is designed to make it much easier and quicker to develop, test and deploy new models. This is intended to allow us to tailor our models better to the price comparison website channel and improve our speed to market. We are also in the process of testing our new digital Travel platform. 2019 is an important year in starting to deliver these systems which we see as a key enabler in transforming our business.
Weather returned to normal levels in 2018 after a benign 2017 and this offset the non-repeat in 2018 of the £57 million non-cash impairment charge incurred in 2017 in relation to IT projects. Normalised for weather and adjusted for the assumed Ogden discount rate change, the combined operating ratio was approximately 93.5%, towards the lower end of our medium-term target range of 93% to 95%.
The pace of technological change and new regulatory requirements demands an agile response, combined with smart investment choices, to deliver what our customers want.
We continued to grow the number of home insurance policies through our partnership with RBS Group, and renewed our Travel agreements with Nationwide and RBS Group for another five years.
Smart and efficient manufacturer Our scale and data allow us the efficiency and flexibility to deliver better customer and claims service and better risk insights.
Connecting with our customers Our people are committed to doing their very best for our customers and our business every day. We are particularly proud of how our people step up to the challenge to get our customers’ lives back on track during severe weather periods such as the freezing weather we saw in Q1 2018. One of our values is to aim higher and we actively encourage everyone to push themselves and learn new strengths. We know that customers have differing needs when it comes to buying insurance, which is why we use our frontline experience to develop new propositions based on customer feedback.
Green Flag We believe our challenger brand has great growth potential and demonstrated this again by achieving another period of double digit growth in policy count and premiums. Our marketing targets the two-thirds of major competitors’ customers who renew without much thought and aims to ‘wake them up’ by dramatising how we match the best things about their service whilst saving half their renewal premium.
See page 90 See page 90 See page 89 See pages 89 and 96 See pages 89 and 90 See pages 89 and 98 See pages 89 and 97 See pages 89 and 97 24 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
Underwriting profit (£ million) 255.1 288.1 Loss ratio 61.8% 56.0% Commission ratio 6.5% 9.1% Expense ratio 23.4% 25.7%
Earnings per share Basic earnings per share increased by 5.3% to 33.5 pence (2017: 31.8 pence). Diluted earnings per share increased by 5.1% to 33.1 pence (2017: 31.5 pence) mainly reflecting an increase in profit after tax.
Cash flow The Group’s cash and cash equivalents decreased by £212.1 million during the year (2017: £193.7 million increase), to £1,092.4 million (31 December 2017: £1,304.5 million).
Scenario and sensitivity analysis The following table shows the impact on the Group’s estimated solvency capital ratio in the event of the following scenarios as at 31 December 2018. The impact on the Group’s solvency capital ratio arises from movements in both the Group’s solvency capital requirement and own funds.
Managing risk in line with our strategy Management, with oversight and challenge 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 per annum delivered while remaining within our risk appetite.
– We set limits on exposure to individual asset classes and the amount of illiquid investments
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.
R eg u la to ry a n d co n d u ct r is k St ra te g ic r is k
– We maintain a constructive and open relationship with our regulators
If Brexit takes place smoothly, for example involving a transition period during which work would take place at the government level to agree a future trading agreement between the UK and the EU, and accordingly without significant disruption to the UK economy and to business generally, then any adverse impact on the Group (if any) would also not be expected to be significant, at least until the end of the transition period and the future trading arrangements between the UK and the EU being clarified. If, however, the UK were to leave the EU in such a way as to involve or lead to significant disruption, as has been conjectured in the event of a ‘hard’ no deal Brexit at the end of March, then the impact on the Group could correspondingly also be disruptive and potentially material.
Sprintathon 422 of our people took part in a Sprintathon this year, where they ran 100m sprints to cover the marathon distance of 26.2 miles. Our aim was to complete a marathon in the shortest possible time and, more importantly, raise money for Stand Up to Cancer.
The Investment Committee’s section of the Annual Report can be found on page 87.
– 17 to 19 year olds are involved in 9% of all fatal and serious crashes, despite representing just 1.5% of all drivers
That’s why we developed our driving app called Shotgun with the aim of cutting the number of young driver deaths to zero in the first 1,000 miles after passing their test, even if they insure their car with someone else.
Recycling coffee cups The popularity of coffee presents a recycling challenge for a company our size.
We know that to remain a successful business we must reflect the customers we serve on a daily basis. We are proud of our diversity and actively encourage people to celebrate the different personalities that make up the Group. It is central to our values and our identity.
When we receive damaged cars I prepare, paint and polish vehicles to the manufacturer’s standard. We have a great working environment here, being part of a team that cares for its customers and employees.
– Up to 12 months unpaid lifestyle break for anyone wishing to pursue something that really matters to them
Idea Lab The Group runs Idea Lab, rewarding employees who generate solutions to improve our customers’ experience and make the business more efficient. This has empowered people to think differently and share their creativity.
The only exception is the recommendation contained in Provision E.1.1 of the Code that the SID should attend sufficient meetings with the major shareholders to listen to their views. Throughout 2018, the Board received regular updates from the Company’s corporate brokers on the views of its institutional shareholders and, in addition, the Investor Relations team provided regular updates to the Board. The Chairman, CEO and CFO met with key shareholders following announcements of results and reported shareholders’ views back to the Board. On this basis the Board is satisfied that it understands the views of shareholders and major shareholders have been invited to meet with the SID should they wish to do so.
The NEDs: – Challenge management in an objective and constructive manner
Board training The Board is committed to the training and development of Directors to improve their knowledge about the business and the regulatory environment in which it operates. The Company Secretary is responsible for helping the Chairman identify and organise training for the Directors which is tailored to individual needs.
When considering the timing of the external audit tender, the Committee took into account the Group’s ongoing change programmes including the implementation of a new general ledger, the use of consultants employed by auditing firms in connection with those programmes, audit partner rotation, the impact of IFRS 17 and the best interests of shareholders. Following an assessment of all the factors, the Committee decided that it was not appropriate to tender the external audit contract at this time. The Committee will review the position on an annual basis, but currently anticipates tendering the audit contract after the implementation of IFRS 17 for the 2023 year end to ensure the broadest choice of firms.
During the year, the Committee approved fees of £0.7 million to Deloitte for services unrelated to audit work. The following is a breakdown of fees paid to Deloitte for the year ended 31 December 2018.
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 capital model; and risk governance.
The Committee has closely monitored developments from the FCA and the Competition and Markets Authority’s work on pricing practices and will remain apprised of the review throughout 2019 as well as of the actions which are being undertaken with the aim of ensuring that the Group continues to maintain fair pricing principles. These actions broadly fall into three categories: governance and accountability; oversight (including data and management information); and vulnerable customers.
The Committee considered, challenged and approved the Annual Risk and Compliance operational plan and the adequacy and objectivity of the Risk function’s resources.
For each of their appointments, the Committee produced a detailed brief setting out the required skills and experience of preferred candidates which included significant financial services, coupled with audit or risk, experience. The brief was shared with executive search agencies and the Committee agreed to engage Egon Zehnder, which is a signatory to the Voluntary Code of Conduct for Executive Search Firms, and has no other connection to the Company, to conduct the searches.
Electing and re-electing Directors Before recommending the proposed election or re-election of Directors at the 2018 AGM, the Committee reviewed the independence of NEDs and concluded that all NEDs met the criteria for independence set out in the Code. Mike Biggs was independent when he was appointed as Chairman.
Additional CSR activities The Committee reviewed and challenged management on key CSR developments and emerging risks throughout 2018. The Committee also monitored and scrutinised the extent and effectiveness of the Group’s external reporting of CSR performance, including through preparation for CSR-related questions at the 2018 AGM and engagement with proxy voting advisers regarding CSR-related feedback. The Committee continues to monitor management’s evaluation of CSR matters in the context of ESG reporting to ensure that the Group’s external CSR position is consistent and appropriate.
Areas of focus in the reporting period – Throughout the year, the Committee kept under review the economic and financial implications of the UK leaving the EU. The implications of an orderly transition and ‘no deal’ exit were considered.
This led to additional payments in March 2019 for Paul Geddes, Mike Holliday-Williams and John Reizenstein for the 2016 AIP. All payments have been made in accordance with the normal policy with 40% deferred into the Group’s shares which will vest on the third anniversary of award (March 2022).
In calculating the RoTE achievement, the reported RoTE for 2018 was adjusted downwards to exclude the favourable impact of the capital management exercises executed in the 2017 financial year on the outcome for these awards. The ongoing enhancement to earnings expected in future years has been explicitly recognised by the Committee in setting higher targets than would otherwise be the case.
Chief Executive Officer On 26 February 2019, Penny James, the current CFO, was appointed to succeed Paul Geddes as Chief Executive Officer and will become the CEO from the conclusion of the AGM on 9 May 2019. Paul will step down from the Board following the AGM on 9 May 2019 and will leave the Group at the end of July 2019.
Your AGM vote I hope that having read the information in this report, and considering the performance of the Group during 2018, you will vote in support of the Remuneration Report at the AGM. Should you have any questions about my Committee’s report please email our AGM email address shareholderenquiries@ directlinegroup.co.uk and I or my team will respond to you.
Target (% of salary) Actual (% of salary) Maximum (% of salary) Actual (£’000)
Notes: 1. Danuta Gray was appointed as Chair of the Remuneration Committee with effect from 10 May 2018. 2. Andrew Palmer stepped down from the Board with effect from 10 May 2018.
Buy-out award The second tranche of Penny James’ buy-out award is due to vest on 1 April 2019, based on the achievement of performance targets that relate partly to the performance of the Company and partly to the performance of her previous employer. The performance conditions for this award are relative TSR (50%) and IFRS profit over 2016, 2017 and 2018 (50%). Relative TSR performance is measured against a peer group based on the prior employer’s TSR performance from 1 January 2016 to 31 October 2017 and Direct Line Group’s TSR performance from 1 November 2017 to 31 December 2018 with a threshold vesting of median (25% vests) and a maximum vesting of upper quartile (100% vests). The peer group is consistent with that used by the prior employer.
Paul Geddes Chief Executive Officer 200% 292% Penny James Chief Financial Officer 200% 101% Mike Holliday-Williams MD Personal Lines 200% 211%
The first tranche of these buy-out awards, which vested in April 2018, was subject to the performance conditions and comparator groups identical to those of the original award, ending in the 2017 performance year. For the second tranche, which will vest in April 2019, the performance conditions differ from the above in that the Group’s TSR performance replaces that of the former employer for the period from 1 November to 31 December 2018 (post-joining).
In considering such factors, and whether to adjust the overall pay-outs and/or operate malus and clawback, the Committee receives appropriate input from the Audit Committee and the Board Risk Committee.
Paul Geddes Chief Executive Officer – Penny James CEO-designate 200% Mike Holliday-Williams MD Personal Lines 200%
Payments to former Directors (Audited) There have been no payments made to a former Director during the year, with the exception of the payments made to John Reizenstein since his cessation as a Director of the Company.
Base salary only for unexpired portion of notice period to be paid in a lump sum or monthly instalments, in which case, instalments are subject to mitigation if an alternative role is found.
– Not performance-related 114 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS
– 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
– Additionally, there is a financial underpin relating to the Committee’s view of the Group’s underlying financial performance for the TSR and RoTE (and any other) elements; 20% of the award vests for threshold performance, with 100% vesting for maximum performance. The Committee reserves the right in respect of future awards to lengthen (but not reduce) any performance period and/or amend the terms of any holding period; however, there is no intention to reduce the length of the holding period
Each of the Directors, whose names and functions are listed on pages 62 to 64, confirms that, to the best of their knowledge: – the financial statements, prepared in accordance with IFRS, give a true and fair view of the assets, liabilities, financial position, and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; – the Strategic report (on pages 1 to 59) and Directors’ report (on pages 118 to 121) include a fair review of: (i) the business’s development and performance; and (ii) the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties they face; and
How the scope of our audit responded to the key audit matter We have gained a detailed understanding over Management’s process for setting 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.
In this context, matters that we are specifically required to report to you as uncorrected material misstatements of the other information include where we conclude that: – fair, balanced and understandable – the statement given by the Directors that they consider the Annual Report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy, is materially inconsistent with our knowledge obtained in the audit; or
Identifying and assessing potential risks related to irregularities In identifying and assessing risks of material misstatement in respect of irregularities, including fraud and non-compliance with laws and regulations, our procedures included the following: – enquiring of management, internal audit, legal counsel, financial reporting, risk, IT, financial crime and the Audit Committee, including obtaining and reviewing supporting documentation, concerning the Group’s policies and procedures relating to: a) identifying, evaluating and complying with laws and regulations and whether they were aware of any instances of non-compliance; b) detecting and responding to the risks of fraud and whether they have knowledge of any actual, suspected or alleged fraud; and c) the internal controls established to mitigate risks related to fraud or non-compliance with laws and regulations.
Profit for the year 473.7 434.0 Other comprehensive income Items that will not be reclassified subsequently to the income statement: Actuarial gain on defined benefit pension scheme 25 2.7 2.1 Tax relating to item that will not be reclassified 13 (0.4) (0.4)
Items that may be reclassified subsequently to the income statement: Cash flow hedges 0.5 (1.1) Fair value (loss) / gain on AFS investments 30 (121.4) 8.8 Less: realised net gains on AFS investments included in income statement 30 (19.5) (23.2) Tax relating to items that may be reclassified 30 23.9 2.5
The consolidated financial statements are prepared on the historical cost basis except for available-for-sale (“AFS”) financial assets, investment property and derivative financial instruments, which are measured at fair value (fair value is defined in note 40).
The IASB amended IFRS 2 ‘Share-based Payment’ to provide further clarity on: the effects of vesting conditions on the measurement of cash-settled share-based payment transactions; the classification of a share-based payment transaction with net settlement features for withholding tax obligations; and accounting where a modification to the terms and conditions of a share-based payment transaction changes its classification from cash-settled to equity-settled.
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.
Intangible assets that are acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to the income statement over the assets’ economic lives using methods that best reflect the pattern of economic benefits and is included in operating expenses. The estimated useful economic lives are as follows: Software development costs Up to 10 years
The following accounting developments are not expected to have a material impact on the Group’s financial statements in future periods: Amendments to IAS 28: Long-term Interests in Associates and Joint Ventures was 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.
144 DIRECT LINE GROUP 2018 ANNUAL REPORT & ACCOUNTS FINANCIALS V6.1 2. Critical accounting judgements and key sources of estimation uncertainty The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underline the preparation of its financial information. The Group’s principal accounting policies are set out on pages 136 to 143. Company law and IFRSs require the Directors, in preparing the Group’s financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent.
The corresponding reinsurance recoveries and impairment provision are calculated on an equivalent basis, with similar estimation uncertainty, as discussed in note 1.6. The reinsurance bad debt provision is mainly for expected recoveries against future PPO payments.
3.3 Principal risks from insurance activities and use of financial instruments There is considerable uncertainty as to the effect of Brexit on the Group and we have proactively considered a variety of possible implications of a disruptive ‘hard’ Brexit, including of a financial and operational nature; these are referred to in the risk management section of the strategic report.
The Group is mainly exposed to the following market risk factors: – spread risk; – interest rate risk; – property risk; and – currency risk.
The main sources of counterparty default risk for the Group are: – investments – this arises from the investment of funds in a range of investment vehicles permitted by the investment policy; – reinsurance recoveries – counterparty exposure to reinsurance counterparties arises in respect of reinsurance claims against which a reinsurance bad debt provision is assessed. PPOs have the potential to increase the ultimate value of a claim and, by their very nature, to increase significantly the length of time to reach final payment. This can increase reinsurance counterparty default risk in terms of both amount and longevity; and
Within the analysis of debt securities above are bank debt securities at 31 December 2018 of £1,125.2 million (2017: £1,197.4 million), that can be further analysed as: secured £63.0 million (2017: £63.5 million); unsecured £949.8 million (2017: £976.3 million); and subordinated £112.4 million (2017: £157.6 million).
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 through partnership brands and through price comparison websites.
The table below analyses the Group’s assets and liabilities by reportable segment at 31 December 2017.
In addition, the Group has an unrecognised deferred tax asset at 31 December 2018 of £4.7 million (2017: £7.4 million) in relation to capital losses of which £4.7 million (2017: £4.1 million) relates to realised losses and £nil (2017: £3.3 million) relates to unrealised losses.
Earnings attributable to owners of the Company 473.7 434.0 Coupon payments in respect of Tier 1 notes (16.6) – Profit for the calculation of return on equity 457.1 434.0 Opening shareholders’ equity 2,715.1 2,521.5 Closing shareholders’ equity 2,573.1 2,715.1 Average shareholders’ equity 2,644.1 2,618.3 Return on equity 17.3% 16.6%
Life expectancy at age 60 in 20 years’ time: Males 89.1 89.3
Loans and receivables Infrastructure debt 289.6 316.4 Commercial real estate loans 201.6 169.0
The subordinated guaranteed dated notes with a nominal value of £500 million were issued on 27 April 2012 at a fixed rate of 9.25%. On the same date, the Group also entered into a 10-year designated hedging instrument to exchange the fixed rate of interest for a floating rate of 3-month LIBOR plus a spread of 706 basis points which was credit value adjusted to 707 basis points with effect from 29 July 2013.
Restricted Shares Plan The purpose of the Restricted Shares Plan is to facilitate the wider participation in Group share-based awards to eligible employees. These awards can be granted at any time during the year, generally have no performance criteria, and vest over periods ranging between one and three years from the date of the grant, subject to continued employment. During the year awards were made over 0.5 million Ordinary Shares (2017: 1.1 million Ordinary Shares) with an estimated fair value of £1.6 million (2017: £3.9 million) using the market value at the date of grant.
Movement in total share awards Number of share awards millions 2017 millions
plus a spread of 706 basis points which was credit value adjusted to 707 basis points with effect from 29 July 2013. 2. This includes £2.7 million of accrued interest settled in relation to the £250 million of repayment of subordinated guaranteed notes in 2017.
Derivative financial instruments 5 1.4 1.0 Trade and other payables 12 1.7 1.4 Deferred tax liabilities 4 0.6 0.6 Current tax liabilities 4 0.2 – Total liabilities 357.6 340.2 Total equity and liabilities 3,909.9 3,944.2
AFS debt securities AFS Fair value through other comprehensive income 5.1 5.1 – Loan to subsidiary undertakings Amortised cost Amortised cost 531.8 531.8 – Derivative financial instruments Fair value through profit or loss Fair value through profit or loss 1.4 1.4 – Cash and cash equivalents Amortised cost Amortised cost 236.1 236.1 –
Farmweb Limited1 United Kingdom Non-trading company Green Flag Group Limited2 United Kingdom Intermediate holding company Green Flag Holdings Limited1 United Kingdom Intermediate holding company Green Flag Limited2 United Kingdom Breakdown recovery services Intergroup Assistance Services Limited1 United Kingdom Non-trading company National Breakdown Recovery Club Limited1 United Kingdom Dormant7
The subordinated guaranteed dated notes with a nominal value of £500 million were issued on 27 April 2012 at a fixed rate of 9.25% and have a redemption date of 27 April 2042. The Company has the option to repay the notes on specific dates from 27 April 2022. If the notes are not repaid on 27 April 2022, the rate of interest will be reset at a rate of 6-month LIBOR plus 7.91%.
Financial assets that are classified as available-for-sale. Please refer to the accounting policy note 1.12 on page 139.
Direct own brands Direct own brands include Home and Motor under the Direct Line, Churchill and Privilege brands, Rescue under the Green Flag brand and Commercial under the Direct Line for Business brand.
Current-year attritional loss ratio is defined in the glossary on page 191 and is reconciled to loss ratio (discussed below) on page 158.
Tangible equity Equity Tangible equity is defined as equity (excluding Tier 1 notes) less intangible assets within the balance sheet and is reconciled on page 165.
Tangible net assets per share is defined as tangible equity (as above) expressed as a value per share and is reconciled in note 16 on page 165.