Strategic report 1 Group highlights 2 Our investment case 4 Group at a glance 6 Business model 8 Chairman’s statement 10 Chief Executive Officer’s review 12 Market overview 14 Our strategy 20 Our key performance indicators 22 Risk management 26 Corporate social responsibility 30 Operating review 34 Finance review
Green Flag is our roadside rescue and recovery service. It is a standalone service and an optional product alongside motor insurance across all of our brands. Green Flag offers an award-winning breakdown service at a much cheaper price than its two biggest rivals.
January 2018, 14,063 adults interviewed for motor insurance and 12,214 for home insurance. 2. Mintel Vehicle Recovery – UK, September 2017. 3. Mintel Pet Insurance – UK, August 2017 and Mintel Travel Insurance – UK, February 2017.
Strategy The Group’s mission is to make insurance much easier and better value for our customers. The Board supports and challenges the Group’s management to develop and execute a strategy which is aligned with this mission and positions the business to address the evolution of customers’ needs, including taking advantage of significant changes in technology. The effective execution of our strategy requires a substantial and continuing change agenda to improve our digital offering and the agility of the organisation.
• These same trends are changing how these businesses interact with financial services providers
Small businesses accounted for of all private sector businesses at the start of 20173
• We continue to grow in Commercial through our business brands NIG and Direct Line for Business. Direct Line for Business continued to grow throughout the year in all product areas. In particular, we’ve expanded our business to offer better value, personalised insurance products to different types of small businesses
Costs are considered and form part of the gateway measures6 for the AIP awards.
Our First Line of Defence is management who are responsible for owning and managing risks to achieve our business objectives on a day-to-day basis. The Second Line of Defence is the Risk function and is responsible for the design and implementation of the ERMF, and for providing proportionate oversight of and challenge to the business’s management of risks, events and management actions. Group Audit is the Third Line of Defence, providing an independent and objective view of the adequacy and effectiveness of the Group’s risk management, governance and internal control framework.
• We monitor how risks are managed in the performance of outsourced and offshored activities
UK economy The UK could enter a prolonged period of reduced growth due to the exit from the EU, potentially reducing insurance sales and the value of our investment portfolio. Whilst our operations are based mainly in the UK, we continue to monitor implications surrounding Brexit negotiations, and their uncertain outcomes, including: changes to the value of sterling which impact claims and non-claims supplier costs; inflation; recruitment and retention of people; potential changes to direct and indirect tax; and the regulatory impact on our capital position.
We gauge employee engagement through our Employee Opinion Survey. In 2017 we again significantly improved our engagement score from 73% in 2016 to 78%. The percentage of our employees who are proud to work for the Group also increased from 87% in 2016 to 91%, while 85% tell others that the Group is a great place to work (81% in 2016).
In response to the terror attacks in London and Manchester last summer, the Group donated to the British Red Cross UK Solidarity Fund.
Regulatory The Group has continued to operate within a highly dynamic and evolving regulatory landscape, particularly in the UK motor insurance market where a number of reviews and initiatives, including those that have been announced, by the UK Government, the Ministry of Justice (“MoJ”), the Financial Conduct Authority (“FCA”) and the PRA. On 23 February 2017, the Government announced measures to reduce the volume and cost of soft tissue damage ‘whiplash’ claims and stated its expectation that this will see a reduction in motor insurance premiums of £40 on average. On 27 February 2017 the Lord Chancellor announced a reduction in the Ogden discount rate to minus 0.75% with effect from 20 March 2017. The Group has also been engaged in the consultation to consider options for reform concerning the discount rate.
In-force policies for Home own brands increased by 2.0% to 1.8 million over 2017, and gross written premium grew by 1.2%. Partnership in-force policies and premiums continued to fall in line with previous years.
The Group’s focus on capital and risk management led to a successful renewal of its catastrophe reinsurance programme in July 2017, for the first time with a fixed rate three year arrangement for approximately 60% of its programme, providing more certainty over the costs it will incur on the majority of its programme until 2020.
Note: 1. Average incepted written premium excluding IPT for Home own brands for year ended 31 December 2017.
Total in-force policies for Ongoing operations during 2017 reduced by 0.6% to 15.7 million (31 December 2016: 15.8 million). The fall primarily related to lower partner volumes in Home and Rescue and other personal lines partially offset by increases in more profitable Motor and Home direct own brands business. Motor in-force policies grew by 3.8% and Commercial by 4.9% across the period. Own brands direct in-force policies in 2017 grew by 5.3% including a 5.6% increase in Motor, 2.0% increase in Home, 10.0% increase in Green Flag direct and a 8.1% increase in Direct Line for Business.
For details relating to the sensitivity analysis for the potential impact of a change in the discount rate used in relation to periodic payment orders (“PPOs”) and changes in assumed Ogden discount rate see note 3.3.1 of the consolidated financial statements.
• Motor reinsurance to protect against a single or an accumulation of large claims which renews on 1 January. The retained deductible is at an indexed level of £1 million per claim, providing a substantial level of protection against large motor bodily injury claims. This programme was renewed on 1 January 2018 with a partial 90.50% placement on the first layer of reinsurance £2 million excess £1 million. All other layers are placed 100%.
Tier 1 capital before foreseeable dividends 1.98 1.87 Foreseeable dividends (0.39) (0.13)
Credit ratings Standard & Poor’s and Moody’s Investors Service provide insurance financial-strength ratings for U K Insurance Limited, the Group’s principal underwriter. U K Insurance Limited is currently rated ‘A’ (strong) with a stable outlook by Standard & Poor’s, and ‘A2’ (good) with a positive outlook by Moody’s.
Current external appointments Sebastian is Group Chief Executive of Dixons Carphone plc and is also a trustee of the charities, Save the Children and The DSG International Foundation.
Experience and qualifications Jonathan is Managing Director, Commercial. He joined the Group in 2000 and has over 30 years’ experience of the insurance industry. Jonathan is responsible for delivering the Commercial strategy, developing customer propositions, enhancing the Commercial brands and delivering efficiencies within the Commercial businesses. Under Jonathan’s leadership, the Commercial division has returned to profit, delivered strong growth within Direct Line for Business, improved its pricing capabilities and strengthened NIG’s competitive position. He has also delivered enhanced customer propositions and improved digital capabilities. Jonathan was previously Managing Director of the Group’s household and life businesses. He joined the Group as Product and Pricing Director for UK Partnerships. Before joining the Group, Jonathan held roles at HBOS, MBNA and Pinnacle.
The Board and Board Committees held a number of scheduled meetings in 2017 at which senior executives, external advisers and independent advisers were invited to attend and present on business developments and governance matters. The Company Secretary attended all Board meetings and he or his nominated deputy attended all Board Committee meetings. The table below sets out attendance at the scheduled meetings1 in 2017. Additional Board and Committee meetings were convened during the year to discuss ad hoc business development, governance and regulatory matters.
Shareholder benefit The Board organises and directs the Group’s affairs in a way that it believes will help the Group succeed for the benefit of shareholders as a whole. More information on the Board’s approach towards the Group’s wider stakeholders’ interests can be found on page 59.
Matters Reserved for the Board and Board Committees’ Terms of Reference
The Board approves the High Level Control and System of Governance Framework, risk appetite, Group policies and Regulatory Governance Map, following review by the BRC.
The Directors, in conjunction with senior management and the Investor Relations team, met with debt investors in the course of the Group’s normal investor conferences and roadshows throughout 2017.
During 2017, the Committee received regular reports on the FRCF and the testing of it. Part of those reports focused on control deficiencies, compensating controls and the mitigating actions taken by management.
Before each financial year, the Committee formally approves a list of audit-related services that the External Auditor can provide. This is in accordance with the Minimum Standard.
The Group has delegated authority to the Audit Committee’s Chair to approve any non-audit services provided by the External Auditor costing up to £100,000. Non-audit services costing over £100,000 require the Committee’s approval. Each year, the Committee receives and reviews a report on expenditure on non-audit services.
At the Committee’s meeting in November 2017, and as detailed in the areas of focus on page 65, the Committee undertook a deep dive on customer complaints and reviewed and challenged the action plans designed by management to reduce customer complaints and improve customer experience.
• The Committee invited the managers of the UK property and US dollar high-yield portfolios to present updates on their respective portfolios, current investing strategy and market outlooks. In the case of the presentation given by the manager of the property portfolio, the Committee requested a report on cladding and fire risk matters. The Committee was satisfied with the performance of both portfolios, current strategy and responses received to questions raised at both presentations.
• As part of its focus on Executive succession planning, and to improve gender and other diversity in the Group’s senior management, the Committee continued to encourage management to grow its talent pipeline, both by developing existing employees and by hiring new talent. This is being achieved by: (i) the systematic assessment of potential; (ii) bespoke personal coaching; and (iii) development plans for high-potential employees. The Committee also continued to encourage the targeted recruitment of new senior executives to strengthen general management, leadership and capability in disciplines including strategic development, change management, IT, claims management, data, finance and procurement. In 2017, the Group made 16 external appointments to senior management, 50% of whom were female.
• The Committee ensured that John Reizenstein and Penny James would work alongside one another to support an orderly transition until John steps down as an Executive Director at the conclusion of the AGM on 10 May 2018. Penny will take over as CFO on 1 March 2018. Her appointment reflects the commitment to seek to attract diverse and effective leadership to drive and deliver the Group’s strategy.
Summary of policy approved at the 2017 AGM 94 to 99
• CEO, CFO and CFO-designate contribution rate of 25% of salary
RoTE test – average of 16.2% for 2014, 2015 and 2016 – 76.0% vesting
Notes: 1. This relates to awards under the Direct Line Group LTIP made to date. As described on page 82, awards made under the Direct Line Group LTIP in March and
5. On 4 May 2017 Mike Holliday-Williams exercised an RSP award granted on 27 May 2014, and on 29 August 2017 exercised an LTIP award granted on 29 August 2014.
Performance measure Vesting for threshold performance Awards in 2018 Awards in 2017 Awards in 2015 and 2016 Awards in 2018 Awards in 2017 Awards in 2015 and 2016
• Before any payment can be made, the Committee will perform an additional gateway assessment (including in respect of any risk concerns). This will determine whether the amount of any bonus is appropriate in view of facts or circumstances which the Committee considers relevant. This assessment may result in moderating (positively or negatively) each AIP performance measure, subject to the individual maximum bonus levels
Likely future developments in the business 11 and 43 Employee involvement 28 and 29
Disclosure of information under Listing Rule 9.8.4C In accordance with Listing Rule 9.8.4C, the table below sets out the location of the information required to be disclosed, where applicable.
Employees with disabilities The Group is committed to promoting diversity and inclusion across every area of the business through initiatives such as the Diversity Network Alliance. At recruitment, we adjust and enhance our application and selection process, and guide and provide additional training for interviewers, where necessary.
Scope 1 – direct emissions including fuels used in office buildings, accident repair centres and owned vehicles.
Valuation of insurance reserve Refer to page 62 (Audit Committee Report), page 118 (accounting policies) and page 156 (financial disclosures).
• review the estimated impact on reserves of recent paid and incurred claim developments using our in-house reserve software
Other information The Directors are responsible for the other information. The other information comprises the information included in the annual report, other than the financial statements and our auditor’s report thereon.
In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated.
IFRIC 22 ‘Foreign Currency Transactions and Advance Consideration’ was issued in December 2016 and the interpretation clarifies how to determine the date of transaction for the exchange rate to be used on initial recognition of a related asset, expense or income (or part of it) where an entity pays or receives consideration in advance for foreign currency-denominated contracts and has an effective date of 1 January 2018.
2.1 Impairment provisions – financial assets The Group determines that financial assets are impaired when there is objective evidence that an event or events since initial recognition of the assets have adversely affected the amount or timing of future cash flows from the asset. The determination of which events could have adversely affected the amount or timing of future cash flows from the asset requires judgement. In making this judgement, the Group evaluates, among other factors, the normal price volatility of the financial asset, the financial health of the investee, industry and sector performance, changes in technology and operational and financing cash flow or whether there has been a significant or prolonged decline in the fair value of the asset below its cost. Impairment may be appropriate when there is evidence of deterioration in these factors.
2.3 Goodwill and other intangible assets Goodwill impairment testing inherently involves estimation uncertainty in a number of areas including: the preparation of the five-year strategic plan and the extrapolation of cash flow forecasts beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the CGUs; estimation of market values of CGUs; and the valuation of the separable assets of each business whose goodwill is being reviewed. Details of a sensitivity analysis on the recoverable amount in excess of carrying value are shown in note 17.
The provisions for PPOs have been categorised as either claims which have already been determined by the courts as PPOs (approved PPO claims provisions) or those expected to settle as PPOs in the future (anticipated PPOs). The Group is subject to estimation uncertainty on the propensity of large bodily injury claims to move from Ogden settled values to PPOs. The estimates in the table above are based on historically observed propensity and the recent change in the Ogden discount rate. They do not allow for any future changes in PPO propensity. Anticipated PPOs consist of both existing large loss case reserves including allowances for development and claims yet to be reported to the Group. Reinsurance is applied at claim level and the net cash flows are discounted for the time value of money. The discount rate is consistent with the long duration of the claims payments and the assumed future indexation of the claims payments.
3.2 Risk and capital management modelling The Board has ultimate responsibility for ensuring that the Group has sufficient funds to meet its liabilities as they fall due. The Group carries out detailed modelling of its assets, liabilities and the key risks to which these are exposed. This modelling includes the Group’s own assessment of its SCR. In 2015, this SCR assessment was submitted to the PRA as part of the Group’s Internal Model Approval Process for which approval was subsequently granted in June 2016. The SCR quantifies the insurance, market, credit and operational risks that the regulated entities are undertaking.
Notes: 1. The sensitivities relating to an increase or decrease in the real discount rate used for PPOs illustrate a movement in the time value of money from the assumed level of 0.0%. The PPO sensitivity has been calculated on the direct impact on the change in the real discount rate with all other factors remaining unchanged. 2. Ogden discount rate sensitivity has been calculated on the direct impact of a permanent change in the discount rate with all other factors remaining unchanged.
Notes to the consolidated financial statements continued 3. Risk management continued 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
The measurement and management of liquidity risk within the Group is undertaken within the limits and other policy parameters of the Group’s liquidity risk appetite and is detailed within the liquidity risk minimum standard. As part of this process the Investment and Treasury team are required to put in place a liquidity plan which must consider expected and stressed scenarios for cash in-flows and out-flows that is reviewed at least annually by the Investment risk Committee. Compliance is monitored in respect of both the minimum standard and the regulatory requirements of the PRA.
3.4 Capital adequacy (unaudited) The Group manages capital in accordance with the Group's capital management minimum standard, the aims of which are to manage capital efficiently and generate long-term sustainable value for shareholders, while balancing operational, regulatory, rating agency and policyholder requirements. The Group seeks to hold capital resources such that in the normal course of business, the Solvency II capital coverage ratio is around the middle of the target range of 140% to 180%.
Certain income and charges are not allocated to the specific operating segments above as they are considered by management to be outside underlying business activities by virtue of their one-off incidence, size or nature. Such income and charges are categorised as either run-off or restructuring costs; run-off costs are described below.
The table below analyses the realised and unrealised gains and losses on derivative instruments included in investment return.
The table below analyses the claims handling expenses included in the net insurance claims.
Wages and salaries 363.6 348.1 Social security costs 40.4 38.9 Pension costs 25.5 24.4 Share-based payments 14.8 16.8
Proposed dividends: 2017 final dividend of 13.6 pence per share 187.0 – 2017 special dividend of 15.0 pence per share 206.3 2016 final dividend of 9.7 pence per share – 133.4
The weighted average duration of the defined benefit obligations at 31 December 2017 is 20 years (2016: 20 years) using accounting assumptions.
Loans and receivables Infrastructure debt 316.4 337.0 Commercial real estate loans 169.0 79.7
Issued and fully paid: equity shares Ordinary Shares of 10 10/11 pence each1 1,375 1,375 150.0 150.0
Note: 1. The shares have attached to them full voting dividend and capital distribution rights (including wind-up); they do not confer any rights of redemption.
38. Contingent liabilities The Group did not have any material contingent liabilities at 31 December 2017 (2016: none).
Other financial assets: HTM debt securities (note 26) 85.1 – 13.6 74.6 88.2
Shares distributed by employee trusts – – (25.6) – – (25.6) – (25.6)
Shares distributed by employee trusts – – (19.8) – – (19.8) – (19.8) Issue of Tier 1 notes (note 9) – – – – – – 346.5 346.5
Clawback The ability of the Company to claim repayment of paid amounts for equity settled share-based payments.
Express claims performance in the current accident year in relation to net earned premium.