• The Group’s estimated Solvency II capital coverage ratio4 post dividend is 165%, above the middle of the Group’s risk appetite range of 140% – 180% (pre-dividend: 174%)
We operate in a dynamic environment, and the way we interact with customers is evolving. Changes inside and outside the industry, including technology and regulation, are shaping customers’ expectations. It is vital that we continue to serve customers and manage claims to the highest standards.
Strategy The Group’s mission is to make insurance much easier and better value for our customers. The Board’s role is to support and challenge the Group’s management to develop and execute a strategy which is aligned with this mission, and positions the business to take advantage of changes in technology affecting vehicles, homes and how our customers communicate with us, as well as delivering operating efficiencies and targeting sustainable income streams. The effective execution of our strategy requires a substantial and continuing change agenda to improve our core systems, digital offering and the agility of the organisation.
Solvency II In June 2016, the Group received approval from the PRA for the use of a Group PIM to calculate its solvency capital requirements (“SCR”). At 31 December 2016, the Group held a capital surplus of approximately £0.92 billion above its SCR. This was equivalent to a Solvency II capital coverage ratio of 165%, post-dividend and taking into account the impact of the new Ogden discount rate. The Board considers the appropriate Group risk appetite range to be 140% to 180% of its SCR, which should enable the Group to meet its operational, regulatory and rating agency requirements.
We have big ambitions for our Green Flag business, and we think technology will continue changing what it means to be good at rescue. So, we have introduced an exciting service called “Green Flag Alert Me”, which tells drivers what’s going on in their cars via an app. And alongside this, the Green Flag app enables people to easily let us know they have broken down, where they are, and track the Green Flag unit coming to help them.
Our objectives for 2017 We will continue to look to improve the performance and cost effectiveness of our existing IT systems and work on developing and building new IT systems.
This has in turn helped the engagement rate to continue to improve through the year from an already improved level in 2015.
Definition The return generated on the capital that shareholders have in the business. This is calculated by dividing adjusted earnings by average tangible equity.
We consider our main emerging risks to be as follows: 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 – MOVE_UK, the Group continues to consider new motor technologies as part of its pricing and underwriting approach.
Potential future changes to the Ogden discount rate The Ogden discount rate has recently been reduced to minus 0.75%, with an imminent consultation announced to consider the methodology for setting this discount rate and therefore potentially leading to further changes to the rate itself. We are monitoring the development of the consultation and analysing the implications on claims costs and the solvency capital requirement.
Volunteering and fundraising We know that participating in fundraising and volunteering is linked to higher engagement levels amongst our people. In order to encourage our people to participate, therefore, we run a network of Community and Social Committees which are made up of local volunteers. These receive central funding and support from the Group to support Group-wide national appeals and create a programme of events and activities based on the interests of employees at their sites.
 Own brands in-force policies increased by 2.3%; overall reduction in in-force policies of 1.2% primarily due to partnerships
The Group‘s partnership with Nationwide Building Society was due to terminate in June 2017. These plans are currently being reviewed which may result in the migration moving to the second half of 2017, whilst the Group works with Nationwide to ensure a smooth transition for customers. If this is the case, the Group will continue to earn premiums written in the second half of 2017 through to the second half of 2018.
Operating profit was therefore £41.8 million, an increase of £21.0 million compared to 2015. The reduction due to the recent change in the Ogden discount rate was £24.7 million, of which £23.1 million relates to 2015 and prior accident years. The current-year attritional loss ratio was 9.2 percentage points lower than 2015 due to lower weather-related claims costs and over 1 percentage point of underlying improvement due to better pricing and risk selection.
– interim (pence) 4.9 4.6 – final (pence) 9.7 9.2 – regular (pence) 14.6 13.8 – first special (pence) 10.0 27.5 – second special (pence) – 8.8 – total (pence) 24.6 50.1
Notes: 1. See glossary on pages 189 and 190 2. See appendix A – Alternative performance measures on page 191 3. See appendix B – Proforma results on page 194 which presents the Group’s results excluding the recent impact of the Ogden discount rate reduction 4. Estimates based on the Group’s Solvency II partial internal model for 31 December 2016 www.directlinegroup.com 39
The COR for Ongoing operations of 97.7% (2015: 94.0%), was 3.7 percentage points higher year on year primarily as a result of the recent Ogden discount rate reduction, partially offset by lower weather losses. The loss ratio was 60.9% (pre-Ogden: 55.0%; 2015: 59.5%) which was higher by 1.4 percentage points compared to 2015. The commission ratio increased by 0.6 percentage points and the expense ratio by 1.7 percentage points. Excluding the impact of the recent reduction in the Ogden discount rate, the COR for Ongoing operations improved to 91.8% in 2016.
The Group’s expense ratio increased to 25.3%, predominantly due to higher intangible asset impairments of £39.3 million and the Flood Re levy of £24.1 million. Excluding the impairment charge and Flood Re levy, the expense ratio would have been 23.2%.
Run-off The Run-off segment generated a profit of £26.6 million in 2016 (pre-Ogden: £68.8 million; 2015: £73.1 million). The reduction in the result followed lower prior-year reserve releases from large bodily injury claims in comparison to the previous year, primarily as a result of the recent reduction in the Ogden discount rate.
In future, the Board has decided that in the normal course of events it will consider whether or not it is appropriate to pay a special dividend only once a year, alongside the full year results. In doing this, the Group will harmonise its major capital management decisions with its planning process and its full-year earnings.
The Group’s leverage continues to be conservative. During 2016, the leverage increased from 16.5% to 17.6% due primarily to the increase in value of the subordinated guaranteed dated notes and a reduction in shareholders’ equity, following the reduction in the Ogden discount rate.
Our commitment to good corporate governance On behalf of the Board, I am pleased to present the Corporate Governance report for the year ended 31 December 2016. A major focus of the Board and mine as Chairman continues to be on maintaining high standards of corporate governance, which we seek to achieve through the Group’s robust governance arrangements.
The UK Corporate Governance Code Direct Line Insurance Group plc (the “Company”) has complied with all of the principles and provisions of the 2014 UK Corporate Governance Code (the “Code”) throughout the financial year.
 Recommends risk appetite and tolerance levels to the Board and supports the Board in promoting a riskaware culture across the Group.
An overview of the role and responsibilities of the Chairman, CEO, SID and the NEDs is set out in the table below: Role Responsibilities
Scheduled Board meeting discussions are focused on four main themes: Strategy & execution, including: setting the Group’s key strategic targets and monitoring the Group’s performance against those targets; reviewing customer experience and monitoring the Group performance against external brand metrics; reviewing and approving key projects aimed at developing the business or rationalising costs; reviewing the approach to mergers and acquisitions; and reviewing the individual strategy of key business lines.
A tailored induction programme has been prepared for Danuta Gray, a recently appointed NED. The programme will focus on the Group’s businesses, strategic and transformational priorities, regulatory and governance frameworks, capital and financial management, and risk framework.
Policy owner approves Minimum standards are approved by policy owners subject to non-objection from the Risk Management Committee.
Approach to diversity The Board carefully considers the diversity of its members from various perspectives. It also seeks to ensure that Directors have the relevant knowledge, skills, experience and, where necessary, independence to help the Group deliver its strategy.
 The Audit Committee reviewed the substantially final draft of the Annual Report & Accounts, before consideration by the Board.
 The PRA approved the Group to use its PIM in June 2016. Following approval, the Group published its Solvency II own funds assessment. In addition, under Solvency II the Group is required to submit Quantitative Reporting Templates to the PRA. The Solvency II related information has been incorporated into the Group’s FRCF and the Committee monitors the integrity of the information.
When considering the Annual Report & Accounts for 2016, the Committee focused on the significant risks and judgements which could be material to the financial statements. These included: Reserve valuation – The Committee reviewed the actuarial best estimates of the level of reserves, including the impact of the reduction in the Ogden discount rate from 2.5% to minus 0.75% following the Lord Chancellor’s review of the discount rate for personal injury claims. External consultants participate independently in the annual review. Further information on reserves is provided in this report.
The Committee reviewed how the Group applied its Minimum Standard on audit and non-audit services in 2016. It is satisfied that the Group has adequate procedures to ensure that the External Auditors are independent and objective.
Effectiveness of the external audit process and reappointing Deloitte as External Auditors In 2016, the Committee assessed the External Auditor’s effectiveness. This was in addition to regularly questioning the External Auditor during its meetings. The Committee assessed the External Auditor through: a detailed questionnaire completed by key stakeholders; discussing matters with the CFO; formally reviewing Deloitte’s independence; and assessing whether it fulfilled the agreed audit plan.
The Committee’s main responsibilities are:  considering and recommending to the Board matters regarding appointment of Directors, membership and chairmanship of Board Committees.
The Committee has actively supported the management team in generating and maintaining a pipeline of potential future leaders who reflect the Group’s diversity and cultural values and who contribute to and develop the capability to evolve the business and drive good outcomes for all our customers and stakeholders.
 During the year the Committee agreed a customer and people measure for the 2017 AIP. The Committee considered the most appropriate mix of customer and people targets, taking into account that the Company had joined the HM Treasury initiative, Women in Finance. This initiative connected certain aspects of remuneration to appropriate targets. To ensure that the targets were challenging, a member of the Committee considered the supporting documentation and underlying processes. The Committee then discussed the targets before approving them.
 We are not proposing any changes to the performance conditions for the 2017 awards under the LTIP. However we will be increasing the level of RoTE required for the March 2017 awards to vest from the current range of 14.5% to 17.5% to a range of 15.0% to 18.0%. This will ensure that awards to Executive Directors will only vest in full if significant value has been delivered to shareholders. Due to the level of uncertainty around the Ogden discount rate review, the Remuneration Committee will further consider the RoTE target to be applied to the August 2017 grant and the outcome of the Committee’s considerations will be confirmed at grant in August 2017.
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 pages 2 to 3 and 10 to 11 respectively.
RoTE test – average of 17.6% for 2013, 2014 and 2015 – 94.0% vesting
Options held arising from vesting in previous periods – – – – – – – – – – 09-Nov-15
The list below sets out the gateway criteria for the AIP for 2017.
 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
 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
Year on Year comparison Direct Line Continuing Operations Emissions from: Tonnes of CO2e
Notes to the consolidated financial statements 1. Accounting policies 127 2. Critical accounting estimates and judgements 134 3. Risk management 136 4. Segmental analysis 149 5. Discontinued operations and disposal group 152 6. Net earned premium 154 7. Investment return 154 8. Other operating income 155 9. Net insurance claims 155 10. Commission expenses 155 11. Operating expenses 155 12. Finance costs 157 13. Tax charge 157 14. Current and deferred tax 158 16. Earnings per share 159 17. Net assets per share and return on equity 160 18. Goodwill and other intangible assets 161 19. Property, plant and equipment 163 20. Investment property 163 22. Reinsurance assets 164 23. Deferred acquisition costs 164 24. Insurance and other receivables 164 25. Derivative financial instruments 165 26. Financial investments 165 27. Cash and cash equivalents and borrowings 166 28. Assets held for sale 166 29. Share capital 166 30. Other reserves 167 31. Subordinated liabilities 167 32. Insurance liabilities 168 33. Unearned premium reserve 169 34. Retirement benefit obligations 170 35. Share-based payments 172 36. Trade and other payables including insurance payables 37. Notes to the consolidated cash flow statement 175 38. Contingent liabilities 175 40. Fair value 176 41. Related parties 178 42. Post balance sheet event 178
These four entities represent the principal business units and account for 99% (2015: 99%) of the Group’s net assets, 100% (2015: 92%) of the Group’s gross earned premium and 98% (2015: 93%) of the Group’s profit before tax. They were also selected to provide an appropriate basis for undertaking audit work to address the risks of material misstatement identified above.
Direct Line Group Annual Report & Accounts 2016 122 £m 2015 £m
Instalment income 107.1 100.1 Other operating income 8 58.2 50.7 Total income 3,337.4 3,269.8
 changes in underwriting and business written so that past trends are not necessarily a predictor of the future.
Direct Line Group Annual Report & Accounts 2016 138 3. Risk management continued  A process is in place to deal with major weather and other catastrophic events, known as the ‘Surge Demand Plan’. A surge is the collective name given to an incident which significantly increases the volume of claims reported to the Group’s claims functions. The plan covers surge demand triggers, stages of incident, operational impact, communication and management information monitoring of the plan.
Certain reinsurance contracts have long durations as a result of bodily injury and PPO claims, and insurance reserves therefore include provisions beyond the levels created for shorter-term reinsurance bad debt.
The Group is mainly exposed to the following market risk factors:  Spread risk;  Interest rate risk;  Property risk; and
Insurance claims recoverable from reinsurers 161.9 (0.3) – 28.7 190.3 (27.9) 162.4
The following table analyses the cash flows relating to the discontinued operations included in the consolidated cash flow statement for the period 1 January to disposal on 29 May 2015.
Net cash generated from operating activities 19.1 Net cash used by investing activities (1.5) Net cash generated from the disposal of discontinued operations1 327.1 Effect of foreign exchange rate changes (9.8) Net increase in cash and cash equivalents 334.9
Reinsurance premium: Premium payable (206.2) (191.7) Movement in reinsurance unearned premium reserve 4.0 2.5
Notes: 1. Results for the year ended 31 December 2015 are based on continuing operations and exclude discontinued operations. 2. The increase in 2016 headcount relates to the acquisition of additional UK accident repair centres and recruitment of additional DLG Legal Services Limited employees.
Wages and salaries 348.1 335.4 Social security costs 38.9 37.8 Pension costs 24.4 23.4 Share-based payments 16.8 12.1 Total 428.2 408.7
(Charge) / credit to the income statement on continuing operations (0.7) (0.4) (1.8) 5.5 0.2 (0.3) – 2.5 Charge to other comprehensive income – 0.7 – – – – (18.0) (17.3) Credit direct to equity – – – – – (1.3) – (1.3)
The effective interest rate on short-term deposits with credit institutions for the year ended 31 December 2016 was 0.45% (2015: 0.56%) and average maturity was 10 days (2015: 10 days).
Rate of increase in pension payment 2.2 2.1 Rate of increase of deferred pensions 2.2 2.1 Discount rate 2.7 3.8 Inflation rate 3.3 3.2
Life expectancy at age 60 in 20 years’ time: Males 90.3 90.1
Due to agents, brokers and intermediaries 15.5 22.5 Due to reinsurers 84.1 78.9 Due to insurance companies 4.4 4.7 Trade creditors and accruals 334.7 295.5 Other creditors 98.4 98.8 Other taxes 93.0 78.9
Assets held at fair value: Investment property (note 20) 347.4 – – 347.4 347.4
Direct Line Group Annual Report & Accounts 2016 178 41. Related parties Transactions between the Group’s subsidiary undertakings, which are related parties, have been eliminated on consolidation and accordingly are not disclosed.
There were no sales and purchases of products and services to or from related parties in the year ended 31 December 2016 (2015: £nil).
Note: 1. This balance relates to an amount recoverable from RBS Group plc, the Group’s former parent company.
Derivative liabilities Designated as hedging instruments: Third parties – – 0.7 0.1
Operating cash flows before movements in working capital (1.3) (5.8) Movements in working capital: Increase in other debtors (1.8) (4.0) Net (decrease) / increase in trade and other payables (0.2) 5.5
Shareholders can arrange to receive their cash dividend payments in a bank or building society account by completing a dividend mandate form. This is available from the Company’s registrar, Computershare Investor Services PLC (“Registrar”), in the UK. You can find the Registrar’s contact details on page 196. Alternatively, shareholders can access their shareholdings online and download a dividend mandate form from the Investor Centre. You can find details of this below.
A forum that represents all employees, including when there is a legal requirement to consult employees.
A Solvency II requirement. It documents the Group’s insurance underwriting entities’ risks and associated capital requirement, both now and projected over the business planning period. It is forward looking, reflecting business strategy and risk appetite.
RoTE is defined in the glossary on page 190 and is reconciled on page 192.