Bridgemarq Real Estate Services Inc.
Annual Report 2016

Plain-text annual report

Brit Limited Annual Report 2016 B r i t i L m i t e d A n n u a l R e p o r t 2 0 1 6 SEEING THE DIFFERENCE MAKES THE DIFFERENCE 2 Brit Limited Annual Report 2015 SEEING THE DIFFERENCE AT BRIT WE BELIEVE THAT SEEING THE DIFFERENCE MAKES THE DIFFERENCE. WE ARE A LLOYD’S INSURER BUILT AROUND DEEP SPECIALISMS THAT WE DEPLOY TO PROVIDE DIFFERENTIATED PRODUCTS AND SOLUTIONS FOR OUR CLIENTS. WE ARE SUCCESSFUL WHEN OUR CLIENTS SEE THE DIFFERENCE WE MAKE TO THEIR COMPLEX CHALLENGES, WHICH IN TURN ALLOWS US TO GENERATE SUSTAINABLE, LONG- TERM VALUE. AS A BUSINESS OUR CORE VALUES ARE TO DELIVER ON OUR COMMITMENTS AND ACTIVELY MANAGE RISK TO MAXIMISE RESULTS. THESE VALUES UNDERPIN WHAT WE DO, HOW WE OPERATE AND FORM THE BASIS OF OUR KEY OBJECTIVE OF DELIVERING LONG-TERM VALUE CREATION. STRATEGIC REPORT The Strategic Report contains information about the Group, how we make money and how we run the business. It gives an insight into our markets, approach to governance, sustainability and risk management. It provides context for our financial statements, sets out our key performance indicators and analyses our financial performance. GOVERNANCE This report sets out other information of interest to our stakeholders. It includes our Directors’ responsibility statement and our Directors’ statement on going concern. It also explains our governance framework and contains our Modern Slavery and Human Trafficking Statement. FINANCIAL STATEMENTS This section presents the financial position, performance and development in accordance with generally accepted accounting practice for both the Group and the Company. It also contains the Auditor’s Report. ADDITIONAL INFORMATION This section explains how we calculate our KPIs with reference to data contained within the financial statements. We also summarise other information relating to the Company useful to stakeholders. GLOSSARY In this section we include definitions of the terms used in this Annual Report, focusing on terms specific to the insurance industry and to Brit. Brit Limited Annual Report 2016 1 STRATEGIC REPORT OFFICER STATEMENTS BRIT AT A GLANCE KEY PERFORMANCE INDICATORS UNDERWRITING REVIEW INVESTMENT MANAGEMENT REVIEW 4 6 8 10 19 FINANCIAL POSITION AND CAPITAL STRENGTH 23 FINANCIAL PERFORMANCE REVIEW PRINCIPAL RISKS AND UNCERTAINTIES OUR PEOPLE, CULTURE, SOCIAL, COMMUNITY AND ENVIRONMENTAL MATTERS GOVERNANCE DIRECTORS’ REPORT CORPORATE GOVERNANCE REPORT MODERN SLAVERY AND HUMAN TRAFFICKING STATEMENT FINANCIAL STATEMENTS INDEPENDENT AUDITOR’S REPORT CONSOLIDATED INCOME STATEMENT CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME CONSOLIDATED STATEMENT OF FINANCIAL POSITION 26 38 42 45 48 50 54 58 59 60 CONSOLIDATED STATEMENT OF CASH FLOWS 61 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 62 64 PARENT COMPANY FINANCIAL STATEMENTS 135 ADDITIONAL INFORMATION RECONCILIATION OF KEY PERFORMANCE INDICATORS TO THE FINANCIAL STATEMENTS 144 COMPANY INFORMATION GLOSSARY TITLE 148 149 00 Disclaimer This document does not constitute or form part of, and should not be construed as, an offer for sale or subscription of, or solicitation of any offer or invitation or advice or recommendation to subscribe for, underwrite or otherwise acquire or dispose of any securities (including share options and debt instruments) of the Company nor any other body corporate nor should it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever which may at any time be entered into by the recipient or any other person, nor does it constitute an invitation or inducement to engage in investment activity under Section 21 of the Financial Services and Markets Act 2000 (FSMA). This document does not constitute an invitation to effect any transaction with the Company or to make use of any services provided by the Company. Past performance cannot be relied on as a guide to future performance. STRATEGIC REPORT 2 Brit Limited Annual Report 2016 STRATEGIC REPORT THIS STRATEGIC REPORT CONTAINS INFORMATION ABOUT OUR BUSINESS AND PROVIDES AN INSIGHT INTO HOW WE OPERATE AND OUR APPROACH TO SUSTAINABILITY AND RISK MANAGEMENT. IT PROVIDES CONTEXT FOR OUR FINANCIAL STATEMENTS, SETS OUT OUR KEY PERFORMANCE INDICATORS AND ANALYSES OUR FINANCIAL PERFORMANCE. 4 OFFICER STATEMENTS Mark Cloutier, our Group Executive Chairman, and Matthew Wilson, our Group CEO, comment on the Group’s performance and business development during 2016 and look ahead to 2017. 10 UNDERWRITING REVIEW We discuss our underwriting performance and developments during the year. 26 FINANCIAL PERFORMANCE REVIEW We provide an analysis of the performance of our business during 2016. 6 BRIT AT A GLANCE We introduce the Brit Group, explain who we are and what we do. We examine our track record, financial strength and look ahead to 2017. 19 INVESTMENT MANAGEMENT REVIEW We explore current investment market conditions and explain our performance and our portfolio. 38 PRINCIPAL RISKS AND UNCERTAINTIES We set out our risk management framework and explain how we managed the principal risks facing our business in 2016 to ensure we deliver our strategic priorities. 8 KEY PERFORMANCE INDICATORS We set out our key performance indicators (KPIs). We explain how we use them to monitor our performance and outline their performance from 2012 to 2016. 23 FINANCIAL POSITION AND CAPITAL STRENGTH We review our financial position at 31 December 2016 and our balance sheet strength. 42 OUR PEOPLE, CULTURE, SOCIAL, COMMUNITY AND ENVIRONMENTAL MATTERS We provide information on our people, social, community and environmental matters, to the extent necessary to understand our business. This Strategic Report was approved by the Board on 15 February 2017. Matthew Wilson Group Chief Executive Officer Mark Allan Chief Financial Officer Brit Limited Annual Report 2016 3 STRATEGIC REPORT4 Brit Limited Annual Report 2016 OFFICER STATEMENTS with our new Singapore service company starting to write business in the period and with a significant strategic investment in Camargue Underwriting Managers, a Lloyd’s coverholder and one of South Africa’s leading providers of specialised insurance products. We also launched Syndicate 2988 for the 2017 underwriting year, supported by third party capital. Our investment strategy takes a long term view of markets and we are pleased this strategy has resulted in a return of 2.6% in the year, primarily driven by contraction in the US yield curve, giving rise to mark to market gains on our long dated treasuries. In November, we sold the majority of our fixed income positions locking in a solid result for the year and leaving the portfolio defensively positioned with a 25.9% allocation to cash and cash equivalents. In December 2016, we announced appointment of Matthew Wilson to Group Chief Executive Officer, and my appointment as Group Executive Chairman, effective 1 January 2017. I have worked with Matthew since 2010 and there is no one who knows the business better. He has the skill-set, market experience and leadership qualities to successfully take the business forward on the next stage of its journey. I look forward to continuing to work closely with Matthew and the entire Brit team in my new role, and to build upon the market-leading platform we have created at Brit, through what are likely to be challenging, but interesting times.’ Mark Cloutier Group Executive Chairman 15 February 2017 ‘Brit has delivered a strong performance in 2016. Our return on adjusted net tangible assets before FX, which we see as a key indicator of our performance, increased to 11.8%, giving a five year average of 16.9%. This was driven by the combination of a continuing contribution from underwriting results, under difficult circumstances, and a strong performance from our investment portfolio. Our RoNTA, after including foreign exchange movements, increased significantly to 15.8%. Market conditions remain challenging as competition from new entrants and additional capacity from existing competitors with appetite to grow has put continuing downward pressure on rates across several major classes of business. We do not believe these conditions are sustainable over the longer term and certainly call for a cautious approach to growth. In this climate, we are determined to maintain underwriting discipline and have adopted a defensive stance to protect our business and preserve capital. Our strategy is to remain well diversified and to focus on retaining quality business, while contracting the areas of our book experiencing the most rating pressure. We also continue to assess cautiously new business and manage our portfolio mix to target areas of our book with less rating pressure. We believe that such an approach will enable us to weather the current environment and position us well for the future when the ill-discipline reads through to results and market conditions improve. This focused and disciplined strategy has resulted in a combined ratio for 2016 of 96.4%, including 4.5 percentage points attributable to major losses. Pleasingly, our attritional ratio remained relatively constant at 55.5%. This is a solid result in today’s challenging environment and increasingly complex marketplace. During 2016, we have maintained our strategy of building our platform through the addition of specialty underwriting talent in targeted areas. We have also launched a number of initiatives, demonstrating our commitment to innovating new products that address real client needs, both in terms of the cover we offer and the claims service we provide. Our international distribution capabilities also continue to expand, Brit Limited Annual Report 2016 5 demonstration of this objective, and we look forward with excitement to the resulting expansion of Brit’s presence at Lloyd’s. Lastly, I am honoured and excited to lead Brit going forward and would like to thank Mark who has been instrumental in the transformation of Brit over the last few years. Today we are a highly successful business with a clear strategy, a strong culture and a hugely supportive parent in Fairfax. I am pleased that Mark will continue to play a crucial role as Group Executive Chairman, supporting myself and the senior management team as we look forward to 2017 and beyond with confidence.’ Matthew Wilson Group Chief Executive Officer 15 February 2017 ‘Market conditions have, as expected, remained difficult during 2016, with the industry experiencing continued pressure on premium rates. Against this backdrop with increased catastrophe activity, we delivered a respectable combined ratio of 96.4%, including 4.5 percentage points attributable to major losses. Brit experienced an expected overall rate reduction of 3.3%, lower than the 4.1% reduction experienced in 2015. This reduction was seen across both reinsurance business, which experienced rate reductions of 4.8%, and direct business, which experienced rate reductions of 2.9%. We have looked to balance our portfolio by actively defending our core business, ensuring rigorous risk selection in the classes experiencing pressure and modestly expanding in areas where profitable opportunities exist, while contracting in areas where it is felt that profit margins are thinner. We are also managing our net position through the selective use of additional reinsurance protections, such as increased cessions on quota shares. It is pleasing to have seen a number of initiatives successfully launched during the year, and to see those initiated in recent years delivering profitable premium growth for the Group. In the current environment, we believe this proactive approach and emphasis on innovation is an important complement to our disciplined underwriting. Looking ahead, we believe our clearly defined underwriting approach and opportunity driven growth strategy will allow us to navigate the ongoing challenging conditions, while leaving us strongly positioned for any improvements over the longer term. In September 2016 we announced the launch of Syndicate 2988 which has a capacity of £52m (US$82m) for its first year of trading. Syndicate 2988 reaffirms our commitment to the Lloyd’s market and will help us further position Brit as the specialist underwriter of choice, building on our existing strength across underwriting, claims and capital management and track record of delivering attractive returns for capital providers. Delivering new products, solutions and perspectives for brokers and clients is at the very heart of our strategy. The launch of Syndicate 2988 is a powerful STRATEGIC REPORT6 Brit Limited Annual Report 2016 BRIT AT A GLANCE WE ARE A MARKET-LEADING GLOBAL SPECIALTY (RE)INSURER AND THE LARGEST BUSINESS THAT TRADES SOLELY ON THE LLOYD’S OF LONDON PLATFORM, THE WORLD’S LEADING SPECIALIST COMMERCIAL INSURANCE MARKET. Overview We provide highly specialised insurance products to support our clients across a broad range of complex risks, with a strong focus on property, energy and casualty business. We operate globally via a combination of our own international distribution network that benefits from Lloyd’s global licences and our broker partners. Our underwriting capabilities are underpinned by a strong financial position and our commitment to deliver superior returns to our shareholders. A full history of Brit can be found at www.britinsurance.com. The Fairfax Group FFHL Group Limited (FFHL), a member of the Fairfax Financial Holdings Limited group (Fairfax), completed the acquisition of 97.0% of the then LSE listed Brit PLC on 5 June 2015 and acquired the remaining 3.0% on 8 July 2015. Fairfax (www.fairfax.ca) is a Canadian company whose shares are listed on the Toronto Stock Exchange. On 29 June 2015, Fairfax completed the sale of 29.9% of Brit to Ontario Municipal Employees Retirement System (OMERS), the pension plan manager for government employees in the Canadian province of Ontario. Brit’s ordinary shares’ listing on the London Stock Exchange was cancelled with effect from 23 June 2015 and Brit PLC was renamed Brit Limited. FFHL will have the ability to repurchase the shares owned by OMERS over time and on 3 August 2016, FFHL acquired an additional 2.4% of Brit from OMERS, bringing its ownership to 72.5%. We believe that the Fairfax Group is an excellent partner for Brit, enabling us to enhance our global product offering. It provides us with expanded underwriting opportunities and distribution channels and supports the delivery of our strategy to become a leading global specialty (re)insurer. Underwriting Brit predominantly underwrites complex, high value insurance and reinsurance risks. Insurance represents in excess of 80% of our GWP while treaty reinsurance represents the balance. Our largest source of business is the US excess and surplus lines market and the majority of our premium income is denominated in US dollars, although the risks underwritten are distributed globally. We complement our core classes with highly specialised niche lines which provide both diversification and the potential for high returns. We source our business through trading relationships with Lloyd’s brokers, wholesale brokers, retail agents and reinsurance intermediaries including the three largest brokers and from a wide range of middle tier intermediaries. The majority of reinsurance business is sourced through the global reinsurance brokers. We underwrite primarily in London, but have developed an extensive network of local offices in the US, Bermuda, Japan, China and Singapore to access business that does not usually reach Lloyd’s. We lead or are second agreement party on approximately 70% of the business we write, underlining our underwriting strength and expertise. Our platform and operations Our strong and efficient capital model results from our focus on the Lloyd’s platform. As part of the Fairfax group we also benefit from the group’s financial strength. We believe that our efficient, flexible and scalable operating platform provides a stable foundation that enables us to pursue our strategy of focusing on maximising profitability of the underwriting business and extending our global distribution network. Investment Management At Brit we have a significant investment portfolio comprising financial investments, investments in associates, investment related derivatives and cash. The value of our invested assets at 31 December 2016 was US$3,971.5m. During the fourth quarter of 2016 we undertook a portfolio rebalancing exercise. Our concerns around rising rates resulted in the longer dated, interest rate sensitive fixed income instruments being sold and the proceeds being invested into short dated Treasury bills. Following this exercise, the portfolio ended the year defensively positioned with an increased allocation to cash and cash equivalents (US$1,027.3m), a reduced holding in fixed income securities (US$2,439.4m) and an equity allocation of US$492.0m. The investment portfolio is managed for the most part by Hamblin Watsa Investment Counsel Limited, a Fairfax subsidiary with an excellent long-term track record, whose sole business is managing investment portfolios of Fairfax group companies. Our culture and values We are passionate about our business, our people and our customers and we Brit Limited Annual Report 2016 7 Outlook Despite the challenging rating environment and increased catastrophe activity, we have returned both a solid underwriting result and investment performance in 2016. However, this profitable underwriting environment being experienced by the market is likely to result in further rate softening in 2017, albeit at reduced rates, and a continued challenging environment when combined with exceptionally low interest rates, geopolitical uncertainty, global growth concerns and market volatility. Capital availability continues to increase from both traditional and non- traditional sources and we expect this to create further competition during 2017. We continue to focus on our core fundamentals of underwriting discipline, risk selection and capital management and are making good progress with the selective expansion of our global distribution capability, capitalising on our initiatives of recent years. Our position as the largest Lloyd’s-only insurance business with the right platform and business mix continues to position us well in the depressed rating and low yield environment. Joining the Fairfax group supports the delivery of our strategy, enabling us to enhance our global product offering, opening new distribution channels while providing us with additional new business opportunities. RoNTA1 Combined ratio Attritional ratio % % % 11.8 9.1 20.7 24.2 18.7 8.5 14.4 17.4 96.4 91.7 89.5 85.4 93.2 98.0 97.1 94.0 55.5 55.2 51.0 51.3 51.8 55.4 58.1 64.2 Investment return (net of fees) % 2.6 0.1 2.9 2.1 2.9 2.4 3.2 4.2 have focused on cultivating a franchise that is built on delivering exceptional service. Our culture is centred on achievement and we have established a framework that identifies and rewards strong performance. Each part of our business has objectives aligned with the overall Group strategy, so that all of our employees understand the vital part they play in our success and value our culture which we consider to be collaborative, hardworking, smart, friendly and fun. Our track record Over the past eight years, we have successfully transformed Brit into a simpler, more focused, more profitable, more efficient and more dynamic business, driven by some of the industry’s best talent. We have been proactive in delivering the best service for our clients and attractive returns to shareholders. Over this period Brit has demonstrated a strong track record of profitable underwriting, competitive net investment returns, growth in core business lines and disciplined capital management. In 2016, we continued to build on our underwriting track record with a combined ratio of 96.4% and an underwriting profit of US$54.6m, bringing our five year average combined ratio to 91.2%. Our overall 2016 result was impacted by underwriting market conditions and an increased incidence of major losses. Despite this backdrop, we achieved a profit after tax of US$157.6m and a return on adjusted net tangible assets before foreign exchange movements (RoNTA) of 11.8%. RoNTA for 2016 after including foreign exchange movements was 15.8% (2015: 3.8%). Our financial strength Our capabilities and ambition are underpinned by our strong financial position. Our business is underwritten exclusively through our wholly-aligned Lloyd’s Syndicate 2987, which benefits from Lloyd’s ratings of A (Excellent) from A.M. Best, AA- (Very Strong) from Fitch and A+ (Strong) from Standard & Poor’s. At 31 December 2016 we had capital resources equal to 125.6% of the management capital requirements needed to support our business. Our capital strength provides the flexibility to allow us to cope with major losses while not deviating from our commitment to fund profitable expansion and to provide attractive returns. Result of the UK referendum on EU membership On 23 June 2016, the United Kingdom voted to leave the EU. While the medium and long-term ramifications of Brexit will take time to assess, the country is now likely to enter a long phase of negotiation with the EU on the terms of the country’s exit. Brit’s focus remains on putting our clients first. Their needs will remain at the core of everything we do, and we will continue to manage our business with this in mind. Contingency planning on the potential impact of this outcome was performed prior to 23 June, and we will continue to monitor developments to work to minimise the impact on Brit and our clients and to take advantage of opportunities as they arise. Year 2016 2015 2014 2013 2012 2011 2010 2009 Note 1: Before FX and corporate activity costs STRATEGIC REPORT 8 Brit Limited Annual Report 2016 KEY PERFORMANCE INDICATORS AT BRIT WE MONITOR AND MEASURE OUR PERFORMANCE BY REFERENCE TO CERTAIN KEY PERFORMANCE INDICATORS (KPIS). THESE KPIS ARE USED BY US TO MANAGE OUR BUSINESS AND ALLOW US TO SEE AT A GLANCE HOW WE ARE PERFORMING. Introduction Our six KPIs show the returns that we are generating, the performance of our underwriting activities, the performance of our investment portfolio, our financial strength and our efficient, flexible and scalable platform. The development of our KPIs over the five years set out below reflects our successful major transformation programme and the repositioning of our business focusing on a simpler and more efficient model. A reconciliation of each KPI to the amounts presented in the financial statements, where relevant, is included in the Annual Report and Accounts starting on page 144. Definitions of each of our KPIs are included in the Glossary starting on page 149. RETURN ON NET TANGIBLE ASSETS BEFORE FX MOVEMENTS AND CORPORATE ACTIVITY COSTS (RoNTA) Return on net tangible assets before foreign exchange movements and corporate activity costs (RoNTA) shows the return being generated by our operations compared to the adjusted net tangible assets deployed in our business. Our track record over the past five years has been very strong with significant outperformance of our global peers in both severe and benign catastrophe years. In 2016, we delivered a RoNTA of 11.8% in challenging insurance and investment market conditions driven by a strong underwriting performance, resulting in a five year average RoNTA of 16.9%. RoNTA for 2016 after including foreign exchange movements was 15.8% (2015: 3.8%). Track record % 25 20 15 10 5 0 24.2 20.7 18.7 11.8 9.1 2012 2013 2014 2015 2016 TOTAL VALUE CREATED The total value created measures the increase in adjusted NTA (including distributions) in a year. It reflects the after tax result recorded in the income statement and all other value movements. In 2016, value creation was US$139.0m or 12.9% of opening adjusted NTA. The company has generated a total value of US$719.0m over the past five years, an average of US$143.8m per annum. Track record US$m 150 200 100 100 50 0 217.2 192.0 151.6 139.0 19.2 2012 2013 2014 2015 2016 COMBINED RATIO The combined ratio is our key underwriting metric and measures the profitability of our underwriting. It shows how much of every US$1 of premium is spent in the total costs of sourcing and underwriting the business and settling claims. A combined ratio under 100% indicates underwriting profitability. Our combined ratio in 2016 was 96.4%, reflecting a solid underwriting performance in difficult market conditions. We have consistently delivered combined ratios below 100% over the past five years and an average ratio of 91.2% over that period. INVESTMENT RETURN We assess the performance of our investment portfolio by comparing the return generated by our invested assets, net of external investment related expenses, against the value of those invested assets. Our investment strategy takes a long-term view of markets, which can lead to significant variations in our year-on-year return figures. CAPITAL RATIO The capital ratio measures the strength of our balance sheet by comparing our available capital resources to the capital we need to hold to meet our management entity capital requirements. Our balance sheet remains strong. At 31 December 2016, after dividends paid and share buy-back during the year of US$148.9m, Group capital resources totalled US$1,457.3m which equated to 125.6% of our Group capital requirement of US$1,160.2m. Brit Limited Annual Report 2016 9 Track record % 100 80 60 40 20 0 93.2 85.4 89.5 91.7 96.4 2012 2013 2014 2015 2016 Track record % 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2.9 2.9 2.6 2.1 2012 2013 2014 2015 2016 0.1 Track record % 200 150 100 50 141.0 150.4 125.0 128.2 125.6 0 2012 2013 2014 2015 2016 RATIO OF FRONT OFFICE EMPLOYEES TO BACK OFFICE EMPLOYEES This measure monitors the efficiency of our business model by comparing the number of front office client- facing revenue generators and service providers to the number of back office employees. An increase in the ratio would suggest that the back office is becoming more efficient in supporting the client-facing activities of the front office. We have monitored this ratio since 2013 following the restructuring of the Group. At 31 December 2016, the ratio was 180.7%, reflecting that we had approximately 1.8 front office employees for every back office employee. Track record % 200 150 149.7 159.8 178.5 180.7 100 50 0 2013 2014 2015 2016 STRATEGIC REPORT 10 Brit Limited Annual Report 2016 UNDERWRITING REVIEW UNDERWRITING PHILOSOPHY Our underwriting philosophy is simple: we have developed a best in class specialty underwriting team wholly focused on writing a broad mix of profitable business. Our Lloyd’s platform gives us a significant advantage as the Lloyd’s market is a specialist in and leader of complex, short- tail property and energy business. We have also maintained our position in a broad mix of casualty lines and our casualty treaty account has consistently outperformed those of our peers. In addition, we have continued to enhance our global distribution channel, launched a number of innovative products and developed our professional, customer focused claims function. CLAIMS MANAGEMENT Our claims function is one of the key ‘market facing’ parts of our business, with its professionalism and complex claims handling experience building a leading reputation. The way in which claims are handled by an insurer or reinsurer will often determine whether business will be renewed and the reputation of the claims function often assists in the underwriting of new business. A professional claims function will also drive value for the business in its handling of claims which in the specialty business will often be complex. Business developments during 2016 During 2016 we have continued to focus on our underwriting strategy. Key developments have included: • Syndicate 2988 In November, Brit received approval from Lloyd’s to launch a new syndicate, Syndicate 2988, to underwrite risks attaching on or after 1 January 2017. Syndicate 2988, which is managed by Brit Syndicates Limited, has a capacity of £52m (US$82m) for its first year of trading and is supported by private Lloyd’s members. Underwriting is undertaken by Brit’s existing teams and the syndicate will write a well-balanced global portfolio of both insurance and reinsurance across a broad range of specialty lines in which Brit already has well established product offerings. The launch of Syndicate 2988 reinforces Brit’s long-term commitment to the Lloyd’s market and ambition to use its infrastructure to expand our current position as the largest Lloyd’s only insurer. It will also help us further position Brit as the specialist underwriter of choice, building on our existing strength across underwriting, claims and capital management and track record of delivering attractive returns for capital providers. • Camargue On 31 August 2016, following the receipt of all regulatory approvals, Brit acquired a 50% interest in the South African company, Camargue Underwriting Managers Proprietary Limited. Founded in 2001 and with a strong track record of growth since inception, Camargue writes a range of specialised insurance products across the South African market. A Lloyd’s coverholder, Camargue has a longstanding relationship with, and is an important trading partner for, Brit. Camargue is the largest independent provider of specialist liability solutions in South Africa with gross written premiums of ZAR215.0m (US$14.4m) for the year to 31 December 2015. Brit Limited Annual Report 2016 11 The investment builds on Brit’s strategy of selective international expansion into niche specialty businesses that offer well-established distribution networks underpinned by underwriting expertise. Under the agreement, Camargue will retain its independence, underwriting on behalf of Lloyd’s syndicates, international insurers and local capacity. • Singapore office In February we announced the opening of an office in Singapore. The new office, which operates on the Lloyd’s Singapore platform, began operations on 1 March 2016, after receiving approval from both Lloyd’s and MAS (Monetary Authority of Singapore). We believe that local markets such as Singapore are becoming increasingly important as we see both capacity and insurance penetration continue to grow. By opening an office in Singapore we’ll be able to offer both on the ground expertise and local access to decision makers. • ‘Pay or Explain’ claims initiative At the Miami Boat Show in February 2016, Brit launched ‘Pay or Explain’, the first product to offer a definitive timescale to respond to an insurance claim. Aimed at those buying Marine Yacht insurance cover, the Pay or Explain policy is a guarantee that, for insurance cover of up to US$/€150m, we will provide a roadmap to managing the claim within 30 days of being notified of a loss. As part of the new product, we have put in place an infrastructure, which includes on-the-ground consultants, surveyors and specialist lawyers, dedicated to improving the speed of managing the claim and, where appropriate, payment of the claim. This initiative offers peace of mind and removes the significant uncertainty often faced by yacht owners around the time it will take for a claim to be paid. It is also a clear demonstration of Brit’s commitment to innovating new products that address real customer needs. • Conexus In March, Brit launched a new product targeting the fine art and specie sector. The product, ‘Conexus’, has been designed to combine cover for fine art and specie, property business interruption and general liability into a single policy. Traditionally, these three elements of cover would need to have been bought separately, resulting in an increased level of administration for brokers and clients. Initially targeting business in North America, we believe that this combined product offers a far more appealing and convenient unified product, and demonstrates our ability to use the wealth of expertise across our business and willingness to innovate to respond to a market need. • Aviation consortium In March, Brit successfully launched a Lloyd’s consortium for commercial general aviation, the only Lloyd’s consortium for commercial general aviation. The consortium, which Brit leads, writes hull risks of up to US$10.0m and provides liabilities cover of up to US$150.0m. The commercial general aviation class covers a wide range of specialty business, from firefighting helicopters to regional aircraft carriers. Formed in response to market demands for increasing efficiency, the facility allows brokers to bind fully through just one underwriter. It demonstrates not only our strong capabilities within aviation, but also our willingness to work with the market to develop offerings that truly add value in a changing and competitive landscape. • Ambridge Partners LLC For 2016, Brit has acted as lead partner for Ambridge Partners LLC (Ambridge) as it increased capacity of its transactional liability facility to US$175.0m. This increase in capacity follows Brit’s investment in Ambridge in September 2015, and provides attractive exposure to the fast-growing managing general underwriter and continues Brit’s selective international expansion into niche specialty businesses with a strong track record in distribution and underwriting capabilities. This increased capacity will enable Ambridge to further cement its position as a leading managing general underwriter in the transactional liability space and allows Brit to build on its investment. STRATEGIC REPORT 12 Brit Limited Annual Report 2016 • US Marine In May, BGSU appointed a New York based Senior Vice President Marine to build its presence in the Hull, Liability, Cargo and Yacht lines. The appointment marked the strategic evolution of our US based P&C platform into the Marine market, a space where the wider Brit Group enjoys a long pedigree and presents us with the opportunity to deliver dedicated expertise and local service whilst enhancing our existing appetite in the class. In October, BGSU announced two appointments to its newly formed Marine business. First, the appointment of a Vice President Cargo based in New York and responsible for building our presence in the US cargo market. Second, a Vice President Yacht based in Annapolis, Maryland responsible for developing our presence in the US recreational marine market. These appointments reflect our strategy of expanding our regional footprint in the Americas by building on the agility of the Lloyd’s service company model with a focus on specialty products that deliver sustainable and profitable growth. • Launch of Latin American engineering team In May, BGSU appointed a Miami based Vice President Engineering, with responsibility for Latin America and the Caribbean. This appointment is part of our strategy to expand our footprint in the Americas, focusing on specialist areas where we can deliver sustainable and profitable growth. • Diamond Processing consortium In November, Brit announced the launch of a Lloyd’s consortium for diamond processing. The consortium, led by Brit and brings additional capacity of up to $50m to the London market, is Lloyd’s first dedicated to diamond processing and affirms Brit’s position as market leader in this class of business. The Diamond Processing consortium further demonstrates Brit’s market leading capability in this specialty sub-class, providing it with a strong strategic position to take advantage of recent improvements in diamond cutting technology and risk assessment techniques. • Brit head office In February, we completed our move to The Leadenhall Building on Leadenhall Street, London EC3V. The lease is for approximately 60,000 sq ft of office space over the 16th, 17th, 18th, 39th and 40th floors. The five floors include a dedicated broker area, extensive facilities for employees and client meeting rooms. The office has been designed to foster conditions for collaboration, between both employees and clients, through the creation of various break-out areas and the construction of two state-of-the-art staircases connecting different floors. Brit hopes the new office, opposite the home of the UK insurance market, Lloyd’s, will bring brokers and underwriters closer together in a modern yet inviting environment, with unrivalled views of the City. • Brit’s Lloyd’s underwriting box In March, we unveiled a new design for our underwriting box at Lloyd’s. The space has been designed by us to update and modernise the traditional Lloyd’s box, creating a more practical and welcoming environment for both brokers, clients and visitors. Through the introduction of a broker lounge area and improved use of technology, we hope to bring brokers and our underwriters closer together in the heart of the London insurance market. We were also delighted with the support we had from Lloyd’s on this project. Brit Limited Annual Report 2016 13 STRATEGIC REPORT14 Brit Limited Annual Report 2016 UNDERWRITING REVIEW MARKET CONDITIONS HAVE, AS EXPECTED, REMAINED CHALLENGING DURING 2016. THE INSURANCE INDUSTRY HAS EXPERIENCED CONTINUED PRESSURE ON PREMIUM RATES, INFLUENCED BY LOW INSTANCES OF CATASTROPHE LOSSES IN RECENT YEARS, COMPETITION FROM NEW ENTRANTS AND ADDITIONAL CAPACITY FROM EXISTING COMPETITORS WITH AN APPETITE TO GROW DESPITE RATING PRESSURE. 2016 Review Premium rates continued to experience reductions in 2016, albeit at a lower rate than in 2015. Overall risk adjusted premium rates reduced by 3.3% (2015: 4.1%), with reductions in our direct business of 2.9% (2015: 3.4%) and reductions in our reinsurance portfolio of 4.8% (2015: 6.9%). Rating pressure was most severe in our direct energy (10.6% reduction), aviation (5.7% reduction) and property PRV (8.8% reduction) divisions, partly offset by improved experience in the specialist liability and accident and health divisions. Property treaty reinsurance rates reduced by 5.6% (2015: 9.3%), and casualty treaty rates reduced by 4.8% (2015: 4.9%). Critically, we continue to see rating adequacy in many lines. In response to these conditions, we have continued to take a defensive position. We have looked to balance the portfolio by actively defending our core business and modestly expanding in areas where profitable opportunities exist, while contracting in areas where it is felt that profit margins are thinner. Our retention rate for the year was 84.3% (2015: 82.4%) which reflects our focus on retaining core accounts and pro-active management of broker relationships. GWP for 2016 totalled US$1,912.2m, a 2.3% decrease at constant exchange rates over 2015, reflecting the market environment and the discipline displayed by our underwriters. It is pleasing to see that our business initiatives launched over the last few years continue to make a positive contribution to GWP, resulting in a US$39.1m increase over 2015. Our distribution strategy remains key, especially during a period of intense market competition, and we continue to build and leverage our network. Continued improvement in relationships with the broker and coverholder community, with a clear articulation of our strategy and risk appetite, is a key area of focus. This is evidenced by the continued contribution from our overseas offices, allowing us to see business not generally accessed in London. • Brit Global Specialty USA (BGSU) has written US$187.8m of premium, 6.8% of growth over 2015 reflecting the continued development of our US distribution network. Recently launched classes, include those launched in 2016, have added US$16.0m of GWP during the year. We have also increased volumes through organic growth as we capitalise on market opportunities, and have seen new business from retail and wholesale brokers as we continue to diversify our business sources. • Our Bermuda operation, established in late 2013, has selectively written reinsurance business in lines and markets that we believe remain well rated, particularly casualty treaty. Premiums generated by our Bermuda office equate to US$60.5m. • Our China and Singapore operations continue to develop and provide opportunity, we have seen measured growth with overall GWP at US$15.5m. The Singapore office opened in early 2016 and local markets are becoming increasingly important as the London market continues to see intense market competition. Our ability to lead business, combined with our innovative approach to underwriting, supports our success in building long-term and dependable market relationships. This is reflected in our retention rate, which in 2016 increased to 84%. Brit Limited Annual Report 2016 15 Group GWP (US$m) Group combined ratio (%) Group attritional ratio (%) 2500 2000 1500 1000 500 0 1,825.2 1,849.7 2,148.5 1,999.2 1,912.2 93.2 89.5 91.7 85.4 96.4 100 80 60 40 20 60 50 40 30 20 10 51.8 51.3 51.0 55.2 55.5 2012 2013 2014 2015 2016 0 2012 2013 2014 2015 2016 0 2012 2013 2014 2015 2016 Brit Global Specialty Direct GWP (US$m) 2000 Brit Global Specialty Direct Combined ratio (%) 120 1,347.7 1,408.8 1500 1000 500 1,743.8 1,634.0 1,546.6 100 98.1 80 60 40 20 92.0 96.0 94.4 101.1 Brit Global Specialty Direct Attritional ratio (%) 52.3 53.1 51.3 55.4 55.5 60 50 40 30 20 10 0 2012 2013 2014 2015 2016 0 2012 2013 2014 2015 2016 0 2012 2013 2014 2015 2016 Brit Global Specialty Reinsurance GWP (US$m) Brit Global Specialty Reinsurance Combined ratio (%) Brit Global Specialty Reinsurance Attritional ratio (%) 477.0 438.4 404.7 365.1 365.8 500 400 300 200 100 65.1 66.8 75.8 73.6 100 80 82.0 60 40 20 60 50 40 30 20 10 51.1 46.7 49.4 51.9 52.9 0 2012 2013 2014 2015 2016 0 2012 2013 2014 2015 2016 0 2012 2013 2014 2015 2016 STRATEGIC REPORT16 Brit Limited Annual Report 2016 UNDERWRITING REVIEW We continually review our reinsurance protections to ensure effectiveness and have sought to take advantage of the favourable buying conditions in a soft reinsurance market. We have increased our use of proportional reinsurance to manage net appetite in a period of very challenging market conditions whilst maintaining gross scale and relevance. Overall, the combination of strong portfolio management and underwriting discipline has led to us achieving a 96.4% CoR in 2016, a solid underwriting performance given the market backdrop and testimony to the strength of our underwriting in such a competitive environment. Catastrophe losses have impacted the CoR by 4.5pps. Our treaty reinsurance book’s performance has remained strong with a CoR of 73.6%, driven by relatively low catastrophe experience on the property account, combined with continued good performance from our leading casualty account. Our direct book returned a CoR of 101.1%. We believe our strategy makes our business more resilient to such pressures and enables us to continue to generate attractive returns. Brit has the capital strength and the strong risk management capability to navigate these conditions and, as a result, we are confident that our strategy and business model are well-positioned to create long-term value for our clients and shareholders. Discipline remains at the core of our underwriting business with risk selection and capital management remaining fundamentals of our business. Our underwriting expertise and agility as an organisation will allow us to meet the continuing demands ahead. We will continue to focus on retaining core accounts, be proactive in pursuit of prospective new business and management of broker relationships, we will also continue to make good progress with the selective expansion of our global distribution capability and the launch of innovative new products that address client needs. Outlook The outlook for 2017 remains challenging with Brit and the industry facing a number of continued adverse trends, including declining rating adequacy, increased competition, alternative capital and insurer/broker consolidations all impacting market conditions. We expect rates to continue to soften into 2017 but to a lesser extent than in recent years. Brit Limited Annual Report 2016 17 STRATEGIC REPORT18 Brit Limited Annual Report 2016 Brit Limited Annual Report 2016 19 INVESTMENT MANAGEMENT REVIEW 2016 PROVED TO BE ANOTHER CHALLENGING YEAR FOR INSURERS’ INVESTMENT PORTFOLIOS, AS MARKETS RE- SPONDED TO CHANGING ECONOMIC ACTIVITY, CENTRAL BANK INTERVENTION AND POLITICAL UPSET. Overview The initial shocks at the beginning of 2016, resulting from concerns around the level of China’s economic growth, led to a significant sell off in risk assets and further declines in yields, as investors sought the safety of government bonds. While equity markets recovered, the additional shock of Britain’s vote in favour of exiting the European Union resulted in a further fall in yields at the half year leading to strong returns in our defensive long-duration fixed income portfolio. The second half of the year saw a marked reversal of this position. As the US electoral process entered its final stages, the campaign spending promises of both parties and the increased likelihood of a Republican victory, saw significant increases in government bonds both in the lead up to election day and the period immediately afterwards. In anticipation of this scenario, we sold the majority of our longer dated government bonds to protect the portfolio against the risk of capital losses. Performance and approach Return on invested assets (net of fees) Year 2016 2015 2014 2013 2012 % 2.6 0.1 2.9 2.1 2.9 The investment portfolio is managed for the most part by Hamblin Watsa Investment Counsel Limited, a Fairfax subsidiary with an excellent long-term track record, whose sole business is managing investment portfolios of Fairfax group companies. The return on our invested assets was US$102.9m or 2.6% (2015: US$5.0m/0.1%). This was a combination of US$73.7m (2015: US$72.7m) of investment income, US$72.3m of mark-to-market gains (2015: losses of US$50.5m) and return on associated undertakings of US$3.6m (2015: nil), less losses on derivatives of US$32.9m (2015: US$5.3m) and fees of US$13.8m (2015: US$11.9m). The first three quarters of 2016 saw a very strong investment result, driven by a contraction in the yield curve, giving rise to mark-to-market gains on the fixed income portfolio. These gains were partly offset by losses on equities, loan instruments and investment related derivatives. The fourth quarter, however, experienced a significant increase in yield rates as markets responded to the forthcoming US election. This increase resulted in losses on our fixed income book, compared to the Q3 year to date result. As the elections drew near, we sold the majority of our longer dated fixed income positions, crystallising the losses for the quarter, but locking in a solid result for the year. During 2016 the following types of derivatives were used to manage the risks in the portfolio: • Equity put options, purchased in 2015, were used to protect the broader investment portfolio from a material reduction in equity markets. These expired on 31 December 2016; • • Inflation derivatives were held to protect the portfolio from a sustained period of deflation; and Interest rate derivative to protect the portfolio against the impact of further interest rate increases. • At 31 December 2016, the running yield of our portfolio was 0.9%, reflecting the holdings in government securities and the high proportion of our portfolio invested in cash and cash equivalents. STRATEGIC REPORT20 Brit Limited Annual Report 2016 Invested assets – look through basis (US$m) Investment return (net of fees) (%) 3.0 2.5 2.0 1.5 1.0 0.5 2.9 2.9 2.6 2.1 0.1 0 2012 2013 2014 2015 2016 n Government debt securities US$1,831m n Corporate debt securities US$594.5m n Structured products US$14.0m n Loan instruments US$0.0m n Equity securities US$492.0m n Alternative investments US$7.3m n Cash and cash equivalents US$1,027.3m n Investment related derivatives US$5.5m Asset allocation Brit’s invested assets (financial investments, investment in associates, cash and cash equivalents and derivative contracts) at 31 December 2016 were US$3,971.5m (31 December 2015: US$3,973.9m). of the proceeds invested into US Treasury bills, the portfolio at 31 December had a large allocation to cash and cash equivalents (US$1,027.3m/25.9%) with a reduced holding in fixed income securities (US$2,425.4m/61.1%). Brit’s equity allocation was US$492.0m (12.4%). Following the sale in the fourth quarter of the longer dated fixed income securities in the portfolio and the investment Our asset allocation, on both a look-through basis and statutory disclosure basis, is set out in the tables below: 31 December 2016 Look through basis Government debt securities Corporate debt securities Structured products Loan instruments Equity securities Alternative investments Cash and cash equivalents Derivatives Total invested assets (statutory) 31 December 2015 Look through basis Government debt securities Corporate debt securities Structured products Loan instruments Equity securities Alternative investments Cash and cash equivalents Derivatives Total invested assets (statutory) Equity securities US$m Debt securities US$m – 1,829.3 594.4 – 1.0 – – – – 399.8 – – – – – – 399.8 2,424.7 Statutory basis Loan instruments investment funds US$m US$m Specialised Cash and cash equivalents US$m - – – – – – – – – – 1.6 – 0.1 – 13.0 – – – 55.6 7.3 – 1.8 1,025.5 – – 79.4 1,025.5 – – – – 265.5 – – – 1,792.0 144.3 19.7 – – – – – – – – 23.4 – – – – 664.8 259.7 24.9 – 39.9 48.4 56.1 (7.9) 265.5 1,956.0 23.4 1,085.9 – – – – – – 581.0 – 581.0 Associated undertaking US$m Derivative assets US$m Total invested assets (look through) US$m – – – – 36.6 – – – 36.6 – – – – – 28.6 – – 28.6 – 1,830.9 594.5 – 14.0 – – – 492.0 – – 7.3 – 1,027.3 5.5 5.5 5.5 3,971.5 – 2,456.8 404.0 – 44.6 – 23.4 – 305.4 – 77.0 – 637.1 – 25.6 33.5 33.5 3,973.9 INVESTMENT MANAGEMENT REVIEW Brit Limited Annual Report 2016 21 Our investments in specialised investment funds account for US$79.4m or 2.0% (2015: US$1,085.9m/27.2%) of our invested assets on a statutory reporting basis. The reduction in 2016 is driven by the requirement to consolidate for the first time of two key UCITS funds, following an increase in the control over these funds exerted by Brit. These funds are predominantly invested in corporate bonds. The remaining specialised funds in this category cover small allocations to US & European credit as well as specialist equity funds. From an interest rate perspective the duration of our portfolio at 31 December 2016 was 1.1 years (2015: 6.3 years), which is shorter than the duration of our liabilities. This positioning is driven by the uncertain macro environment and the risk that government spending plans and fiscal policy in the US could result in significant increases in yields over the short to medium term. At 31 December 2016, 82.7% of our invested assets were investment grade quality (2015: 87.8%) with the reduction as a result of the increased allocation to equity and funds. An analysis of the credit quality of our invested assets is set out below: Invested assets by rating AAA AA A BBB P-1 and P-2 Other* Total *Other includes equities and investment related derivatives. 2016 % 9.9 56.9 5.3 3.4 7.2 17.3 2015 % 18.3 40.6 7.2 0.5 21.2 12.2 100.0 100.0 STRATEGIC REPORT 22 Brit Limited Annual Report 2016 Brit Limited Annual Report 2016 23 FINANCIAL POSITION AND CAPITAL STRENGTH BRIT’S CAPITAL STRENGTH, PROACTIVE CAPITAL AND RISK MANAGEMENT AND OPERATIONAL EFFICIENCY ARE KEY DIFFERENTIATORS. Financial position At 31 December 2016 our adjusted net tangible assets totalled US$1,064.8m (2015: US$1,074.7m). Summary consolidated statement of financial position Assets Intangible assets Reinsurance contracts Insurance and other receivables Financial investments, investment in associate and cash Investment related derivatives FX related derivatives Other assets Total assets Liabilities Deferred tax on intangible assets Insurance contracts Borrowings FX related derivatives Other liabilities Total liabilities Net assets Adjusted net tangible assets 2016 US$m 2015 US$m 93.9 884.1 718.3 95.1 818.9 691.7 3,966.0 5.5 7.1 300.7 3,940.4 33.5 30.1 311.1 5,975.6 5,920.8 10.7 4,243.5 157.5 11.8 404.1 13.3 4,182.3 185.6 12.5 370.6 4,827.6 4,764.3 1,148.0 1,156.5 1,064.8 1,074.7 In addition to the profit recognised through the consolidated income statement, the other movements in our net assets related to defined benefit pension scheme related losses (US$4.5m); changes in unrealised foreign currency translation losses on foreign operations (US$13.7m charge); share based payment related amounts (US$1.0m net credit); and dividends paid and share buy-back costs during 2016 of US$148.9m. Further analysis of our financial investments, cash and investment related derivatives are set out in the Investment Management Review on page 19. Reserving policy Preserving a strong statement of financial position is critical to the long-term success of an insurance business. The Group maintains appropriate loss reserves to cover its estimated future liabilities. Reserves are estimates that involve actuarial and statistical projections of the expected cost of the ultimate settlement and administration of claims. The reserving process is robust and managed by the Chief Risk Officer and Chief Actuary and under the oversight of the Reserving Committee. Reserving estimates are prepared quarterly and are based on facts and circumstances then known, predictions of future developments, estimates of future trends in claims frequency and severity and other variable factors such as inflation. Movement in these reserves forms an integral element of our operating result. Our reserving policy is to reserve to a ‘conservative best estimate’ and carry an explicit risk margin above that ‘conservative best estimate’. This policy has led to a track record of modest annual reserve releases. In 2016 this trend continued with net releases of US$53.5m (2015: US$28.6m). Maintaining reserves is critical to safeguard future obligations to policyholders and the ‘conservative best estimate’ approach provides a secure foundation. It also provides a secure foundation for the pricing of new business which is particularly critical in a softening rating environment. STRATEGIC REPORT24 Brit Limited Annual Report 2016 Gearing At 31 December 2016, our gearing ratio was 18.9% (2015: 21.1%). During 2016, we renegotiated our revolving credit facility (RCF). While the facility size remains at US$360m, it has been extended until 31 December 2020. The commercial terms negotiated with the banks have resulted in a significant improvement in terms with no significant change to covenant levels. Under our capital policy we have identified a maximum of US$235m (2015: US$235m) of the facility to form part of our capital resources, with the balance available for liquidity funding. At 31 December 2016, a US$80.0m letter of credit (LoC) was in place, of which US$4.0m was collateralised (31 December 2015: US$80.0m/uncollateralised) to support our underwriting activities. At the date of this report, 16 February 2017, the LoC was fully collateralised. At 31 December 2016 and at 31 December 2015 no other drawings were outstanding on the facility. In addition, we have in issue £135.0m of 6.625% subordinated debt with a carrying value of £127.5m/ US$157.5m (31 December 2015: £124.5m/US$185.6m). This instrument, which is listed on the London Stock Exchange, was issued in December 2005, is callable in whole by Brit on 9 December 2020 and matures in 2030. Foreign exchange management At 31 December 2016, our US dollar denominated net assets were 118% of our total net assets, reflecting the currency denomination of the majority of the business we write. Our net assets, analysed by currency, are as follows: Net assets/(liabilities) by currency The reporting currency for the Group’s consolidated Financial Statements is US dollars, as is the functional and reporting currencies of a number of our subsidiaries, including all of our underwriting subsidiaries. A portion of our revenues and expenses, and assets and liabilities, are denominated in currencies other than US dollars, hence we are exposed to fluctuations in the values of those currencies against the US dollar. These fluctuations impact our reported operating results and our assets and liabilities. We have sought to reduce the impact on our stakeholders of the effects of movements in foreign exchange rates by matching the currencies of our liabilities and capital requirements with the assets we hold. As a consequence of this, because we report our results in US dollars, we import some exchange rate volatility into the income statement through the revaluation of our net tangible assets. The Group’s NTA is, however, largely matched against our capital requirement, protecting our shareholders against the risk of additional capital being required as a result of FX volatility. Any excess is held in US dollars. Capital strength Our balance sheet remains strong. At 31 December 2016, Group capital resources totalled US$1,457.3m, giving surplus management capital of US$297.1m or 25.6% (2015: US$329.5m/28.2%) over our Group capital requirement of US$1,160.2m. The position at 31 December is after dividends paid and share buy–back costs during the year of US$148.9m. Solvency II We are in compliance with our regulatory obligations under Solvency II, which came into force on 1 January 2016. Solvency II reporting forms an integral part of each quarter’s close process and we will deliver our reporting obligations at 31 December 2016. Sterling US dollar Euro Canadian dollar Australian dollar Total 2016 % (5.9) 118.3 (8.0) (0.4) (4.0) 100.0 2015 % 6.6 60.7 13.0 22.2 (2.5) 100.0 Brit Limited Annual Report 2016 25 STRATEGIC REPORT26 Brit Limited Annual Report 2016 Overview of results The Group’s income statement, re-analysed to show the key components of our result, is set out below: Gross written premium Net earned premium (Note 1) Underwriting profit (Note 1) Underwriting profit Return on invested assets, net of fees Corporate expenses Finance costs Other items Profit on ordinary activities before tax, FX and corporate activity costs FX movements Corporate activity costs (Note 2) Profit on ordinary activities before tax Tax Discontinued operations Profit for the year (after tax) 2016 US$m 2015 US$m 2014 US$m 2013 US$m 2012 US$m 1,912.2 1,515.1 54.6 1,999.2 1,649.6 137.0 2,148.5 1,601.1 168.3 1,849.7 1,852.2 1,478.4 1,499.1 101.3 215.9 54.6 102.9 (21.3) (18.8) 1.1 118.5 41.3 – 159.8 (2.2) – 157.6 137.0 5.0 (30.0) (20.6) 0.3 91.7 (60.2) (23.6) 7.7 7.9 – 168.3 124.8 (38.8) (22.3) 0.8 232.8 35.8 (22.6) 246.0 (16.7) – 215.9 85.3 (23.2) (23.4) 6.9 261.5 (90.8) (3.1) 167.5 (10.1) (2.2) 101.3 139.8 (22.6) (23.2) 0.8 196.0 (43.6) – 152.5 (8.3) 37.8 15.6 229.3 155.2 182.1 Note 1: Excluding the effects of foreign exchange on non-monetary items. Note 2: Corporate activity costs during 2015 relate to costs incurred as a result of the acquisition of Brit by Fairfax. The 2014 corporate activity costs relate to Brit’s IPO in April 2014. Group performance and total value added We have delivered a strong result for the year. This result was driven by a solid underwriting return, benefitting from a low attritional loss ratio, a low but increased level of large losses and favourable reserve development, a strong investment return and favourable FX movements. Profit on ordinary activities for the year before tax, FX and corporate activity costs was US$118.5m (2015: US$91.7m), profit before tax was US$159.8m (2015: US$7.7m) and profit after tax was US$157.6m (2015: US$15.6m). Return on adjusted net tangible assets (RoNTA), excluding the effects of FX on non-monetary items and corporate activity costs, increased to 11.8% (2015: 9.1%). RoNTA for 2016 after including foreign exchange movements was 15.8% (2015: 3.8%) and total value created for the year was US$139.0m (2015: US$19.2m). Our adjusted net tangible assets at 31 December 2016 totalled US$1,064.8m (2015: US$1,074.7m), after 2016 dividend payments and share buy-back costs of US$148.9m. FINANCIAL PERFORMANCE REVIEW Brit Limited Annual Report 2016 27 Performance measures Our KPIs are set out on page 8. In addition to these KPIs, we have other measures that offer further insight into the detail of our performance. These measures are: • Premium related: Risk adjusted rate change; Retention rate; • Claims related: Claims ratio; Attritional loss ratio; Major claims ratio; Reserve release ratio; and • Underwriting expense related: Underwriting expense ratio; Commission ratio; Operating expense ratio. Underwriting Overview Our underwriting profit for the year amounted to US$54.6m (2015: US$137.0m) and our combined ratio, which excludes the effect of foreign exchange on non-monetary items, was 96.4% (2015: 91.7%). The premiums, claims and expenses components of this result are examined below. Premiums written Premium growth Brit Global Specialty Direct Brit Global Specialty Reinsurance Other underwriting Group 2016 US$m 2015 US$m Growth % 1,546.6 1,634.0 365.1 0.1 365.8 (0.2) 1,912.2 1,999.2 (5.3) 0.2 – (4.4) Growth at constant FX rates % (3.1) 1.3 – (2.3) STRATEGIC REPORT 28 Brit Limited Annual Report 2016 Premiums by class Brit Global Specialty Direct Accident & health Marine Property, political risks & violence (PRV) Property facilities Energy BGSU US specialty Professional lines Specialist liability Specialty lines Aviation Discontinued Total direct Brit Global Specialty Reinsurance Short-tail RI (property treaty) Long-tail RI (casualty treaty) Discontinued lines Total reinsurance Other underwriting Group total 2016 US$m 2015 US$m 114.2 167.6 195.4 277.3 63.1 187.8 229.8 87.9 152.6 70.6 0.3 102.0 182.7 194.6 292.9 93.5 175.1 207.4 105.5 179.1 101.1 0.1 1,546.6 1,634.0 153.5 212.6 (0.3) 365.8 159.1 213.6 (7.5) 365.1 (0.2) 0.1 1,912.2 1,999.2 Gross written premium (GWP) decreased by 4.4% over the same period in 2015 to US$1,912.2m (2015: US$1,999.2m). At constant exchange rates the decrease was 2.3%. Direct business decreased by 5.3% to US$1,546.6m (2015: US$1,634.0m), while reinsurance remained constant at US$365.8m (2015: US$365.1m). The drivers of the 4.4% decrease in Group GWP, which was in line with expectations, are as follows: • Underwriting initiatives: The Group’s underwriting initiatives, launched in 2013, 2014, 2015 and 2016 resulted in a US$39.1m increase in GWP. The main contributors were our professional lines (including cyber and healthcare) and our A&H divisions. FINANCIAL PERFORMANCE REVIEW Brit Limited Annual Report 2016 29 • Prior year premium development: The book again experienced favourable development on prior years. However, 2016 saw lower levels of favourable development, resulting in a reduction of US$55.3m over 2015. and strong discipline from underwriters, offset by growth in new teams and areas where rates remain attractive. These reductions were partly offset by growth in specialty lines, professional lines and BGSU. • Current year premiums: Current year premiums, excluding those derived from the underwriting initiatives highlighted above, reduced by US$29.4m over 2015. This was driven by the challenging rating environment (primarily in energy, property PRV, specialist liability and reinsurance) • Foreign exchange: The impact of foreign exchange resulted in a US$41.4m year on year reduction, which reflects the strengthening during 2016 of the US dollar against a number of currencies in which the Group writes business. FX US$(41.4)m Underwriting initiatives US$39.1m Current year premium US$(29.4)m Prior year premium US$(55.3)m 2015 GWP US$1,999.2m 2016 GWP US$1,912.2m STRATEGIC REPORT 30 Brit Limited Annual Report 2016 Premium ratings Measure Commentary Risk adjusted rate change The risk adjusted rate change shows whether premium rates are increasing, reflecting a hardening market, or decreasing, reflecting a softening market. A hardening market indicates increasing profitability. Track record Risk adjusted rate change (%) 4 3 2 1 0 -1 -2 -3 -4 -5 3.4 0.3 (2.9) (3.3) (4.1) 2012 2013 2014 2015 2016 Overall risk adjusted premium rates for renewal business decreased by 3.3% during 2015 (2015: 4.1%). This reduction was strongly influenced by reinsurance business which experienced rate reductions of 4.8%, driven by a 5.6% rate reduction in property treaty. Rates for direct business fell by 2.9% in the year, with the principal movements being decreases in energy, property, aviation and BGSU specialty. These were partly offset by increases in specialist liability and accident and health. Retention rates Measure Commentary Track record Retention rate The retention rate shows the proportion of our business that renews, on a risk adjusted basis, compared to the previous year. Retention rate (%) 100 80 60 40 20 0 83.0 83.0 82.4 84.3 76.0 2012 2013 2014 2015 2016 Our retention rate for the period was 84.3% (2015: 82.4%). The retention rates we achieved in 2015 and 2016 reflect the successful renewal of a profitable book of business, following the re-underwriting of the book that occurred between 2008 and 2012, through which we rebalanced our book and non-renewed around half of our underwriting portfolio. FINANCIAL PERFORMANCE REVIEWBrit Limited Annual Report 2016 31 Outwards reinsurance Our reinsurance expenditure in 2016 was US$432.0m or 22.6% of GWP (2015: US$369.4m/18.5%), an increase of US$62.6m. The increase in expenditure is principally driven by the increased use of quota shares to manage our net exposure in the current soft market conditions, partially offset by savings on other areas of the programme. Net earned premium Net earned premium (NEP) in 2016, excluding the effects of foreign exchange on non-monetary items, decreased by 8.2% to US$1,515.1m (2015: US$1,649.6m, increase of 3.0%). At constant exchange rates the decrease was 6.1% (2015: increase of 2.2%). The 2015 growth was impacted by a US$70.8m reinsurance premium paid in 2014 in respect of a specific one-off outwards reinsurance contract entered into to provide adverse development cover for a discontinued professional lines account with exposure to Italian medical malpractice. An effect of this contract was to reduce our 2014 attritional ratio by 1.9 percentage points and increase our 2014 underwriting expense ratio by 1.7 percentage points. It did not materially impact our combined ratio. Direct business decreased by 8.9% to US$1,208.6m (2015: US$1,327.4m, increase of 6.4%), while reinsurance decreased by 3.0% to US$285.5m (2015: US$294.2m, increase of 11.4%). Claims Measure Claims ratio Commentary The claims ratio measures the performance of the whole underwriting book, encompassing risks written in the current year and in prior years. Track record Claims ratio (%) 60 50 40 30 20 10 0 56.2 48.5 50.0 53.5 56.5 2012 2013 2014 2015 2016 STRATEGIC REPORT 32 Brit Limited Annual Report 2016 The claims ratio can be further analysed into its underlying components, as follows: Measure Commentary Attritional loss ratio The attritional loss ratio measures the performance of the underlying underwriting book by measuring the effect of attritional claims. Track record Attritional loss ratio (%) 60 50 40 30 20 10 0 51.8 51.3 51.0 55.2 55.5 2012 2013 2014 2015 2016 Major claims ratio The major claims ratio measures the effect of claims arising from major losses on our performance and the 2016 ratio reflects the increased level of major loss activity during the year. Major claims ratio (%) Reserve release ratio The reserve release ratio measures the performance of reserves held on the statement of financial position at the start of the year. A negative ratio indicates an overall net release, which means that prior year claims are performing better than estimated at the start of the year. A positive ratio indicates that over the course of the year the amount required to meet those prior year claims has increased. 7 6 5 4 3 2 1 0 6.1 4.5 4.5 3.2 2.3 2012 2013 2014 nil 2015 2016 Reserve release ratio (%) 0 -1 -2 -3 -4 -5 -6 (1.7) (1.7) (3.3) (3.5) (6.0) 2012 2013 2014 2015 2016 FINANCIAL PERFORMANCE REVIEWBrit Limited Annual Report 2016 33 Our underlying claims experience in 2016 was in line with expectations. The 2016 attritional loss was stable at 55.5% (2015: 55.2%). 2016 saw an increase in catastrophe activity and the Group incurred major claims of US$68.4m (2015: US$nil), as set out below. Major claims are defined as claims in excess, incurred from natural or man-made catastrophes, or from large single risk loss events of US$10.0m (net of reinsurance and allowing for reinstatements). Major losses Alberta wildfires Louisiana floods Hurricane Matthew Other (Note 1) 2016 US$m 2016 CoR% 19.2 10.9 26.3 12.0 68.4 1.3 0.7 1.7 0.8 4.5 Note 1: ‘Other’ includes Japan earthquake, Houston floods and Gatlinburg wildfire. As part of our standard reserving process, we released US$53.5m of claims reserves established for prior year claims, the equivalent of a combined ratio reduction of 3.5% (2015: US$28.6m/1.7%). The main drivers of this release were marine, casualty treaty, property treaty, energy, property PRV and specialist liability, partly offset by strengthening in our professional lines and property facilities divisions. Our statement of financial position remains strong and we continue to operate a robust reserving process. Underwriting expenses Our underwriting expense ratio was 39.9% (2015: 38.2%). Measure Commentary Track record Underwriting expense ratio The underwriting expense ratio measures the cost we incur to acquire every US$1 of premium. There are two key components to this – commission costs and operating expenses. Underwriting expense ratio (%) 40 35 30 25 20 15 10 5 0 37.0 36.9 39.5 38.2 39.9 2012 2013 2014 2015 2016 STRATEGIC REPORT 34 Brit Limited Annual Report 2016 The underwriting expense ratio can be further analysed into its underlying components, as follows: Measure Commentary Commission ratio The commission ratio measures our distribution costs and shows how much of every US$1 of premium is paid to acquire our business. Track record Commission ratio (%) Operating expense ratio The operating expense ratio helps us understand how much it costs us to support the underwriting activities. This ratio shows how much of every US$1 of premium we spend supporting our underwriting activities. 30 25 20 15 10 5 0 25.7 24.9 27.5 26.0 27.2 2012 2013 2014 2015 2016 Operating expense ratio (%) 15 12 9 6 3 0 12.0 12.0 12.2 12.7 11.4 2012 2013 2014 2015 2016 Commission costs were US$411.6m and the commission expense ratio was 27.2% (2015: US$429.2m/26.0%). The ratio was affected principally by changes in business mix, a general increment in acquisitions costs (including business arrangement fees) and reduction in NEP due to increased use of proportional treaties due to the soft market conditions. Our operating expenses are analysed below. FINANCIAL PERFORMANCE REVIEWBrit Limited Annual Report 2016 35 Expenses Our operating expense ratio increased to 12.7% (2015: 12.2%). Operating expenses for the period were as follows: Expense analysis Underlying operating expenses including bonus provisions Project costs, timing differences and other expense adjustments Expenses before corporate activity related costs Corporate activity related costs (Note 1) Total operating expenses 2016 US$m 2015 US$m 217.1 – 217.1 – 217.1 231.8 0.1 231.9 23.8 255.7 Note 1: Corporate activity costs during 2015 relate to costs incurred as a result of the acquisition of Brit by Fairfax. Underlying operating expenses during 2016 decreased by 6.3% to US$217.1m (2015: US$231.9m). The movement at constant exchange rates was an increase of 4.1%, reflecting our predominately Sterling expense base. This increase related to targeted expansion and investment in growth areas, increased regulatory levies and increased IT costs, partly offset by a decrease in amortisation changes. The allocation of operating expenses within the Consolidated Income Statement and the Segmental Information is as follows: Disclosure of operating expenses Acquisition costs Other insurance related expenses Total insurance related expenses Other operating expenses Total operating expenses 2016 US$m 2015 US$m 112.3 83.5 195.8 21.3 217.1 100.1 101.8 201.9 53.8 255.7 STRATEGIC REPORT 36 Brit Limited Annual Report 2016 Investment return The return on our invested assets after deducting external fees was US$102.9m or 2.6% (2015: US$5.0m/0.1%). Our invested assets at 31 December 2016 amounted to US$3,971.6m (2015: US$3,973.9m). Investment return Income Released gains Unrealised gains/(losses) Investment return before fees Investment management fees Investment return net of fees Investment related derivative return Return on associated undetakings Total return Total return 2016 $m 73.7 62.3 10.0 146.0 (13.8) 132.2 (32.9) 3.6 102.9 2015 $m 72.7 58.0 (108.5) 22.2 (11.9) 10.3 (5.3) – 5.0 2.6% 0.1% Our income producing assets performed well and we generated income of US$73.7m during the year, representing a running yield of 0.9% (2015: US$72.7m/1.6%). Our two associated undertakings produced a positive first year return of US$3.6m. • Ambridge Partners LLC, a leading managing general underwriter of transactional insurance products of which a 50% share was acquired on 8 December 2015, contributed US$3.4m to this return; and • Camargue Underwriting Managers Proprietary Limited, a leading managing general underwriter of a range of specialised insurance products and specialist liability solutions in South Africa of which a 50% share was acquired on 30 August 2016, contributed US$0.2m to this return. Further discussion of our investment performance and portfolio is included in the Investment Management Review section of this Strategic Report, commencing on page 19. Foreign exchange As explained on page 24, we manage our currency exposures to mitigate the impact on solvency rather than to achieve a short-term impact on earnings. We experienced a total foreign exchange gain of US$41.3m in 2016 (2015: loss of US$60.2m), reflecting the movement of the US dollar against other currencies in which we trade and hold assets. This total foreign exchange related loss comprised: • An unrealised revaluation gain of US$61.2m (2015: loss of US$85.4m), primarily relating to the mark to market of the capital we hold in non-US dollar currencies to match our risk exposures. The gain primarily results from the strengthening of the US dollar against Sterling (in which we have a short position) and the weakening of the US dollar against the Canadian dollar (long position), partly offset by the strengthening of the US dollar against the Euro (long position); FINANCIAL PERFORMANCE REVIEW Brit Limited Annual Report 2016 37 • Losses of US$19.9m (2015: gain of US$45.0m) on derivative contracts which were entered into to help manage our monetary FX exposures and therefore should be viewed in conjunction with our monetary FX movements; and • No overall gain or loss (2015: loss of US$19.8m), as a result of the IFRS requirement to recognise non-monetary assets and liabilities at historic exchange rates. This adjustment is essentially a timing difference. The adjustment for the full year 2016 comprises the un-wind of the credit carried on the balance sheet at 31 December 2015 (US$3.6m), plus the credit balance established during 2016 (US$3.6m). The allocation of the FX result within the Consolidated Income Statement is as follows: Foreign exchange gains and (losses) Net change in unearned premium provision – non-monetary FX effect Acquisition costs – non-monetary FX effect Net foreign exchange losses – non-monetary (Note 1) Net foreign exchange gains/(losses) – monetary (Note 1) Return on derivative contracts – FX related instruments Total gain/(loss) 2016 US$m 2015 US$m 19.0 (10.0) (9.0) – 61.2 (19.9) 41.3 (11.5) 2.2) (10.5) (19.8) (85.4) 45.0 (40.0) 41.3 (60.2) Note 1: The sum of these two amounts, US$52.2m, is the ‘Net foreign exchange gains’ figure per the Consolidated Income Statement (2015: US$95.9m ‘Net foreign exchange losses’). Tax Our tax on ordinary activities for 2016 resulted in a tax expense of US$2.2m (2015: tax income of US$7.9m), based on a group profit before tax of US$159.8m (2015: US$7.7m). The Group is liable to taxes on its corporate income in a number of jurisdictions, in particular the UK, Gibraltar and the US, where its companies carry on business. A tax charge is calculated in each legal entity across the Group and then consolidated. Therefore, the Group’s effective rate is sensitive to the location of taxable profits and is a composite tax rate reflecting the mix of tax rates charged in those jurisdictions. The 2016 Group rate varies from the weighted average rate in those jurisdictions for a number of factors. The principal factor is the impact of income not subject to tax such as the syndicate’s dividend income. An additional factor is the future reduction in the UK corporation tax rate and its effect on deferred tax liabilities and prior year adjustments, relating primarily to the syndicate’s underwriting results. The effective tax rate is further influenced by non-UK taxes arising in our Lloyd’s syndicate. STRATEGIC REPORT38 Brit Limited Annual Report 2016 Overview The Board monitors the key risks that the company is exposed to against its tolerance level through the quarterly ‘own risk and solvency assessment’ (ORSA) process. This includes both the qualitative assessment of the risk control environment and capital assessment using a stochastic model. The key categories of risk include: • Overarching risk: earnings, solvency and liquidity; and • Individual risk categories: insurance, market, credit, operational and group. The key risks and uncertainties are set out in the following table and the principal risks in the current environment are further described below. Risk category Risk Description Principal risk Overarching Earnings Unexpected earnings volatility leads to unexpected losses. Solvency Liquidity Capital ratio falls below the level targeted by management. Insufficient financial resources available to meet liabilities as they fall due. Insurance Underwriting – pricing Emerging experience is inconsistent with the assumptions and pricing models used. Underwriting – catastrophe Underwriting – reinsurance Reserving Investment Investment market risk Premiums are insufficient to meet the long-term profitability expected. Failure to obtain reinsurance on attractive terms, or failure to recover under reinsurance arrangements. Prior year reserves are insufficient to cover claims (net of reinsurance). Invested assets adversely affected by changes in economic variables, such as interest rates, bond yields, equity returns, credit spreads, credit ratings. Currency Exchange rate fluctuations materially impact our financial performance. Credit Counterparty risk Operational and Group People Deterioration in the creditworthiness of, defaults by, or reputational issues related to, reinsurers or other third parties with whom we transact business. Failure to attract, motivate and retain key Directors, senior underwriters, senior management and other key personnel, on whom our future success is substantially dependent. Outsourcing arrangements Failure on the part of any third party to perform agreed outsourced services, on which we are heavily reliant. PRINCIPAL RISKS AND UNCERTAINTIESBrit Limited Annual Report 2016 39 Principal risks The table below provides additional information on the principal risks in the current environment and how we manage them. Principal risk Mitigation tools Metrics Status Risk adjusted rate change (2016: decrease of 3.3%; 2015: decrease of 4.1%). This risk is particularly relevant in the current softening rating environment. Active rebalancing of the portfolio is a key focus for management. Underwriting – pricing Inadequate pricing could have a material adverse effect on our results for underwriting operations and financial condition. • Strategic focus on underwriting performance rather than on top line growth. • Strong governance processes around strategy and planning. • Pricing discipline is maintained through strict underwriting guidelines, monitoring of the delegated authorities and enforcement of the technical pricing framework. • Efficient use of the outwards reinsurance programme. STRATEGIC REPORT 40 Brit Limited Annual Report 2015 PRINCIPAL RISKS AND UNCERTAINTIES Principal risk Mitigation tools Metrics Status Underwriting – catastrophe A catastrophic event or catastrophic events could result in large insured losses that adversely impact our financial results and potentially our capital position. • Diverse portfolio of risks written between lines of business and geographic location. • Regular monitoring against the Board catastrophe risk appetite by our exposure management team. • Effective outwards reinsurance programme in place, with particular emphasis on managing accumulation of risks. • Clear limits are set for key accumulations and conservative use of line size by our underwriters. • Conservative best estimate reserving philosophy with track record of releases. • Actuarial team recommend reserves independently from underwriting division using established actuarial techniques. • Independent external review of reserving is performed annually. Reserving Estimating insurance reserves is inherently uncertain and, if insufficient, may have a material adverse effect on our results and financial condition. Largest realistic disaster scenarios (1 October 2016 estimated loss in US$m): Event Gross Net Gulf of Mexico windstorm Florida Miami windstorm US North East windstorm San Francisco earthquake Japan earthquake Japan windstorm 829 654 748 716 237 92 191 168 156 282 156 58 European windstorm 228 163 An aggregate catastrophe excess of loss cover is in place to protect the Group against combined property claims from multiple policies resulting from catastrophe events. This is supplemented by specific covers for peril regions, catastrophe swaps and industry loss warranties where they are a cost-efficient means to ensure that the Group remains within its catastrophe risk appetite. Reserve release ratio (2016: 3.5%; 2015: 1.7%). Reserves are held at a ‘conservative best estimate’ and we also carry an explicit risk margin. No change in approach from prior years. Brit Limited Annual Report 2015 41 I S T R A T E G C R E P O R T Principal risk Mitigation tools Metrics Status Return on invested assets, net of fees (2016: 2.6%; 2015: 0.1%). Running yield (2016: 0.9%; 2015: 1.6%). Investment risk Invested assets are susceptible to changes in economic conditions. A decrease in the value of our invested assets may have a material adverse effect on our results, financial condition and liquidity. People • Strong governance processes around investment strategy. • Regular monitoring against the Board investment risk appetite which includes defined limits for solvency, earnings risk and liquidity risk. • Investment guidelines in place for individual asset classes and monitored regularly. We could be adversely affected by the loss of one or more key employees or by an inability to attract and retain qualified personnel. • Our remuneration strategy (including share-based remuneration) is designed to reward talent and success. We have a proven track record in being able to retain high-performing staff. Staff turnover (2016: 8.8%; 2015: 7.0%). • Succession and contingency plans are in place in the event of the loss of a key employee. • Regular monitoring of employee turnover and morale. In the fourth quarter of 2016, following a significant increase in yield rates as markets responded to the forthcoming US election, we sold the majority of our fixed income positions, crystallising the losses for the quarter, but locking in a solid result for the year. Our portfolio at the year end was highly liquid and defensively positioned. The current environment remains competitive with a number of our peers actively seeking talented staff. We actively manage our remuneration and HR policies to ensure we continue to retain and attract the best staff. 42 Brit Limited Annual Report 2016 Introduction In order to generate value, we recognise that our people, culture, social and community strategies must be both sustainable and aligned to the long-term interests of all our stakeholders. We seek to make both a positive contribution to society and to be aware of the long-term consequences of our actions. We also seek to generate new commercial opportunities by developing strong stakeholder relationships and by recruiting and retaining a highly skilled, engaged and motivated workforce. Our people and culture Our people are our greatest asset and managing our talent appropriately contributes significantly to our success. During 2016 we continued to strengthen our highly committed team. Through the attraction and recruitment of new talent and the ongoing development of existing expertise, we continued to embed a culture of achievement in the organisation. This has resulted in employees feeling valued for their contribution as part of a team working towards the same goals. Brit is focused on the FCA’s six consumer outcomes and the fair treatment of customers is at the heart of our business model. We believe our retention rate of 84.3% (2015: 82.4%) demonstrates a high level of customer satisfaction. Our culture is communicated and lived through an established framework that identifies and rewards strong performance. Business plan goals are aligned to our Group vision and used to determine individuals’ objectives, ensuring that all employees understand the part they play in the Group’s success. We are committed to developing the technical, behavioural, management and leadership skills required for our teams to outperform – both individually and collectively. We continue to invest in the future of Brit through our leadership, graduate and intern programmes and our bi-annual succession and talent mapping exercise, all of which aim to grow expertise from within and ensure robust succession plans. Brit Syndicates Limited has Chartered Insurer status through the Chartered Insurance Institute. This prestigious designation signifies to our customers – and the market – that we are committed to the pursuit of the highest standards and demonstrates our adherence to ethical good practice. Brit’s cross-functional Social Committee continued to organise a range of social, community and charitable events for employees during the year. In addition to the social committee events, employees were also invited to participate in sailing events in the Solent during which more than 60 employees from around the world learned how to sail and race against each other. This developed their team and communication skills and was a fantastic opportunity for employees to mix together and meet people from other offices. The 2016 staff turnover rate excluding retirements and redundancies was 8.8% (2015: 7.0%). At 31 December 2016, 31.7% (2015: 33.7%) of staff had completed at least five years of service and 14.7% (2015: 14.2%) had served at least ten years. Social and community We are committed to supporting the communities in which we operate and charities that are meaningful to employees. Our objective is to select charitable giving and community projects based on three criteria: projects should be for a good cause and operate in an area relevant to us, financial involvement should be for the benefit of the good cause, and projects should offer alignment with our strategic priorities. During 2016 we again supported ten charities chosen by employees. The charities selected for 2016 were the Gibraltar Disability Society (Gibraltar), the Royal Hospital Chelsea (UK), Small Steps (UK), Help for Heroes (UK), Vital Project (Columbia), Mind (UK), British Blind Sport (UK), the Children’s Medical & Research Foundation (Ireland), Friends of the Elderly (UK) and the Naomi Berrie Diabetes Center (US). We donated a sum of money to each charity at the start of the year and continued with fund raising activities through the year, including a well-attended quiz night. OUR PEOPLE, CULTURE, SOCIAL, COMMUNITY AND ENVIRONMENTAL MATTERSBrit Limited Annual Report 2016 43 We continue to use a business dining and internal hospitality provider that is committed to the principles of sustainable food procurement. It recognises that it is important to the future wellbeing of the UK that farming communities are supported and able to contribute to their supply chains. We measure and monitor our carbon footprint. In 2016 our carbon emissions per employee reduced by 22.9% to 2.7 tonnes (2015: 3.5 tonnes). The sources of these emissions were as follows: Emission source Gas Electricity Business air travel Business travel other Total carbon footprint 2016 CO2 (tonnes) 2015 CO2 (tonnes) 97 537 863 3 5 890 874 7 1,500 1,776 Number of employees at 31 December excluding all non-executive directors Carbon footprint per employee 550 2.7 507 3.5 We also supported three international charities supporting children’s education programmes: • Decoda: A Canadian charity working to increase the literacy and learning skills of children in foster care. Brit is donating CAD$100k over three years. • The Kibera Girls Education Fund: A Kenya based charity working to rescue girls from the perils of sexual assault and early pregnancy. Brit donated US$200k in 2016. • Creative Corrections Education Foundation: A US charity helping the children of incarcerated parents through education. Brit donated US$50k in 2016. Our Social Committee also organised a number of volunteering days in the local community. We further promote staff involvement in the community by granting every employee two additional days of paid leave a year to volunteer their time to a registered local charity. We also run a payroll giving scheme and match any money raised by employees participating in charitable events. During 2016, Brit donated US$0.7m (2015: US$0.3m) under its charitable initiatives. In addition to this, Brit employees completed 77.5 volunteering days (2015: 66 days). Environmental responsibility During 2016 we recycled 7.2 tonnes of paper waste (2015: 28.5 tonnes) and we sent 63 tonnes of general waste to energy recycling (2015: 144.7 tonnes). These changes reflect recycling activities conducted in 2015 ahead of the move to our new head office and reflect reduced waste in 2016 resulting from more efficient working practices. In 2016 we also recycled 10.2 tonnes of glass (2015: 8.4 tonnes), 32.5 tonnes of cardboard (2015: 28.4 tonnes) and 8.2 tonnes of food waste (2015: 2.7 tonnes). During 2016, in conjunction with our new building managers, we continued to work hard to reduce waste sent to landfill and this work culminated in the building being awarded ISO14001. At December 2016, in line with government legislation, we were fully ESOS compliant after undertaking a stringent audit. STRATEGIC REPORT 44 Brit Limited Annual Report 2016 GOVERNANCE Directors’ Report This report sets out other information of interest to shareholders. It includes information on our significant shareholders, the Directors’ responsibility statement and Directors’ statement on going concern. Corporate Governance Report This report explains our governance framework. Modern Slavery and Human Trafficking Statement This statement sets out the steps taken by us to ensure that slavery and human trafficking are not taking place in our supply chains or in any part of our business. GOVERNANCE DIRECTORS’ REPORT CORPORATE GOVERNANCE REPORT MODERN SLAVERY AND HUMAN TRAFFICKING STATEMENT 45 48 50 DIRECTORS’ REPORT Brit Limited Annual Report 2016 45 The Directors present their report together with the audited consolidated financial statements for the year ended 31 December 2016. Principal activities, review of business and other disclosure Details of the Company’s principal activities and a review of the business are included in the strategic report. Significant changes and events On 3 August 2016, the Company repurchased 13,449,476 Class A Ordinary Shares from OMERS Administration Corporation at a cost of US$58.1m. These shares were subsequently cancelled. Directors On 1 January 2017, Richard Ward stepped down from his role as Chairman, but remains on the Board as Senior Independent Director. On the same date, Mark Cloutier, formerly Group Chief Executive Officer, became Group Executive Chairman, with Matthew Wilson replacing him as Group Chief Executive Officer, and Gordon Campbell joined the Board as a non-executive Director. Ipe Jacob and Bijan Khosrowshahi resigned as directors with effect from 31 December 2016. The following directors held office at the date of this report: Mark Cloutier Matthew Wilson Mark Allan Richard Ward Andrew Barnard Gordon Campbell Jeremy Ehrlich Statement of Directors’ responsibilities The Directors are responsible for preparing the Directors’ Report and the financial statements in accordance with applicable law and regulations. Company law requires that the Directors prepare financial statements for each financial year. Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit and loss of the Company for that period. In preparing these financial statements, the Directors are required to: • Select suitable accounting policies and then apply them consistently; • Make judgements and accounting estimates that are reasonable and prudent; and • Prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business. The Directors confirm that, to the best of their knowledge: • The consolidated financial statements, which have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position, and profit or loss of the group; and • The strategic report includes a fair review of the development and performance of the business and the position of the Group, together with a description of the principal risks and uncertainties that it faces. Dividends On 29 April 2016, the Company paid a dividend of US$26.2 million to the holder of its Class A ordinary shares together with a further dividend of US$3.4m on 3 August. On 21 December 2016, the Company paid a dividend of US$61.3 million to the holder of its Class B ordinary shares. A further dividend to class A shareholders for 2016 of US$0.43 per share amounting to US$45.8m was proposed and agreed at the 15 February 2017 Brit Limited Board Meeting. Share capital The Company’s ordinary issued share capital at 31 December 2016 comprised two classes of ordinary shares, Class A Ordinary and Class B Ordinary, which are fully paid. GOVERNANCE46 Brit Limited Annual Report 2016 DIRECTORS’ REPORT Voting rights The Company’s articles of association provide that a resolution put to the vote of a general meeting must be decided on a show of hands unless a poll is duly demanded in accordance with the articles. Articles of Association The Company’s articles of association may only be amended by a special resolution of shareholders. Shareholders The Company’s two shareholders at the time of this report is as follows: Shareholder FFHL Group Limited OMERS Administration Corporation Units 281,057,706 106,550,524 Class B Ordinary A Ordinary % of total A and B ordinary shares 72.51 27.49 Significant agreements The following agreement which was in force at 31 December 2016, takes effect, alters or terminates on a change of control of the Company. Revolving Credit Facility The Group has a syndicated revolving credit facility (RCF) which provides for US$360.0m of committed multi-currency financing. Amounts under the RCF can be drawn until 30 November 2020, and the RCF terminates on 31 December 2020, on which date all outstanding facilities must be repaid. The RCF also contains a change of control provision under which, upon the occurrence of a change of control, the lenders may refuse to fund utilisation requests under the RCF, cancel their commitments and demand immediate repayment of all outstanding amounts. Employment Brit is an equal opportunities employer. This means we will not unlawfully discriminate against any person on grounds of colour, religion or belief, race or ethnic origin, nationality or national origin, sex or sexual orientation, marital status, disability, age, pregnancy or maternity, or gender reassignment. We have established policies to ensure that there is no discrimination against applicants for a job or whilst in employment. The Company is committed to ensuring equal opportunities in relation to job advertisements, recruitment and selection, assessment of work performance or conduct, disciplinary and grievance procedures, conditions of service, promotion and training, pay and benefits and termination of employment. In the event of employees becoming disabled, every effort is made to ensure their employment with the Group continues and appropriate training arranged. So far as possible, the Company ensures that the training, career development and promotion of any disabled person is identical to that of a colleague who does not suffer from such a disability. The Company maintains procedures by which all employees are systematically encouraged to express matters that may affect them and are provided with information on matters of concern. The Employee Share Scheme, as well as other means provide an opportunity for staff involvement in the Company’s performance. Political donations Neither the Company nor any of its subsidiaries made any political donations during the year. Disclosure of information to the Company’s auditor In accordance with the provisions of section 418 of the Companies Act 2006, each of the persons who are Directors of the Company at the date of approval of this report confirms that: • So far as the Director is aware, there is no relevant audit information (as defined in the Companies Act 2006) of which the Company’s auditor is unaware; and • The Director has taken all the steps that he/she ought to have taken as a Director to make himself/herself aware of any relevant audit information (as defined) and to establish that the Company’s auditor is aware of that information. Brit Limited Annual Report 2016 47 Auditor On 16 May 2016, Ernst & Young LLP (EY) tendered its resignation as auditor of Brit Limited and confirmed there were no circumstances relating to their resignation to bring to the Board’s attention. On 14 June 2016, PricewaterhouseCoopers LLP was appointed as EY’s successor. Post Balance Sheet Events The Company has no post balance sheet events requiring disclosure. Going concern A review of the financial performance of the Group is set out on pages 26 to 37. The financial position of the Group, its cash flows and borrowing facilities are set out on pages 19 to 24. After reviewing the Group’s budgets and medium term plans, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason they continue to adopt the going concern basis in preparing the accounts. Information included in the Strategic Report The below information is not shown in the directors’ report because it is shown in the strategic report instead under s414C(11). • Charitable donations Disclosures regarding charitable donations can be found on pages 42 to 43. • Financial instruments Details of the Group’s risk management framework are set out on pages 38 to 41. By order of the Board Tim Harmer Company Secretary 15 February 2017 Brit Limited: 8821629 GOVERNANCE48 Brit Limited Annual Report 2016 CORPORATE GOVERNANCE REPORT Introduction The Company has in place a memorandum of Corporate Governance that sets out the Corporate Governance principles of the Group based on the UK Corporate Governance Code. Board of Directors The Board currently has seven directors and the full board meets on a regular basis. Independence of Directors Before his resignation as a director with effect from 31 December 2016, the Board considered Ipe Jacob to be an independent non-executive Director of the Company, within the meaning of the Code. Ipe Jacob continues to serve as an independent non-executive director on the board of Brit Syndicates Limited and as chair of the UK audit committee. Mr Jacob also continues as a member of the UK Risk Oversight Committee. The Board considers Richard Ward to be an independent non- executive Director of the Company, within the meaning of the Code. Richard Ward also serves as chair of the board of Brit Syndicates Limited and was appointed chair of the Company’s audit committee with effect from 1 January 2017. Mr Ward is also chair of the Company’s Nomination and Remuneration committees. Gordon Campbell, non-executive Director, was independent on his appointment as a Director of the Company in January 2017 and remains independent. Group Executive Chairman The Group Executive Chairman is responsible for leadership of the Board ensuring its effectiveness on all aspects of its role and setting its agenda. The Group Executive Chairman is responsible for setting the agenda for Board deliberations, with the help of the executive Directors and the Company Secretary, to be primarily focused on strategy, performance, value creation and accountability, and ensure that issues relevant to these areas are reserved for Board decision. The Group Executive Chairman, in conjunction with the Company Secretary, ensures that the Board members receive accurate and timely information. Group Chief Executive Officer The Group Chief Executive Officer is responsible for implementing and executing the strategy of the Group and for generally running the Group’s business. Senior independent non-executive Director During 2016 Ipe Jacob was the senior independent non- executive Director of the Company. Following his resignation on 31 December 2016, Richard Ward was appointed to this position. The senior independent Director was also responsible for carrying out the evaluation of the role of the Chairman during the year. Conflicts of Interest Under the Companies Act 2006, all Directors must seek authorisation before taking up any position with another company that conflicts or may possibly conflict with the Company’s interests. The Directors are required to notify the Company of any conflicts so that they can be considered and if appropriate authorised by the Board. The Board carries out an annual review of conflicts of interest and each authorisation is set out in the conflicts register. Committees of the Board The Board has delegated specific responsibilities to Board committees, notably the Brit Limited Audit, Nomination and Remuneration Committees. Brit Governance Structure as at 31 December 2016 The Governance structure, shown overleaf, is deeply embedded within the business. The Company’s main operating subsidiaries have in place governance principles in accordance with the Group’s Memorandum of Corporate Governance. Audit Committee The Audit Committee is responsible for overseeing the Group’s financial reporting processes, internal control and risk management framework and the work undertaken by the external auditor. Regular updates are provided to the Board by the committee chair. Remuneration Committee The Remuneration Committee is responsible for setting the Group’s remuneration policy. The company aims to reward employees fairly. The Committee is also responsible for setting the remuneration of all executive directors. Nomination Committee The Composition of the Board is reviewed regularly by the Nomination Committee. In considering the Board’s composition, the Committee is mindful of the need to maintain a well-balanced Board in terms of skills, knowledge, experience and background. The appointment of all new Directors is led by the Nominations Committee. Brit Limited Annual Report 2016 49 Goverance Structure Brit Limited Remuneration Committee Brit Insurance Holdings Limited Audit Committee Nomination Committee Executive Committee Underwriting Committee Brit Insurance (Gibraltar) PCC Limited Brit Syndicates Limited BIG Risk Oversight Committee BIG Audit Committee BIG Investment Committee Audit Commitee UK Investment Committee Risk Oversight Committee By order of the Board Tim Harmer Company Secretary 15 February 2017 GOVERNANCE50 Brit Limited Annual Report 2016 MODERN SLAVERY AND HUMAN TRAFFICKING STATEMENT Introduction This statement sets out the steps taken by Brit Limited (Brit) to ensure that slavery and human trafficking are not taking place in our supply chains or in any part of our business. Slavery and human trafficking can occur in many forms, such as forced labour, child labour, domestic servitude, sex trafficking and workplace abuse. Given the nature of the work that we do, we believe that there is a low risk of slavery or human trafficking having any connection with our business. We must, however, not be complacent, and all staff have a responsibility to be aware of any risks in our business and in our wider supply chains and report any concerns to senior management. Our business At Brit, we provide highly specialised insurance products to support our clients across a broad range of complex risks. We have a strong focus on the property, energy and casualty sectors. We have a major presence in Lloyd’s of London, the world’s specialist insurance market provider, and a significant US and international reach. We have local offices in the US, Bermuda, Japan, Singapore and China. We operate globally via our own international distribution network and broker partners. Insurance represents over 80% of our gross written premium, with the remainder coming from treaty reinsurance. The average number of employees working at Brit during 2016 was 539 and profit after tax in 2016 was US$157.6m Our supply chains We source our business through trading relationships with Lloyd’s brokers, wholesale brokers, retail agents and reinsurance intermediaries. Most of our reinsurance business is sourced through global reinsurance brokers. We require that all contractual agreements with third party suppliers to contain obligations to ensure compliance with the Modern Slavery Act 2015. As part of any due diligence exercise during supplier on- boarding or at regular intervals, potential slavery concerns must be assessed and addressed. We have updated both our Procurement and Outsourcing policies to ensure information around our requirements is detailed and available to our wider business. Our policies on slavery and human trafficking We are committed to ensuring that there is no modern slavery or human trafficking in our supply chains or in any part of our business. We believe in paying people fairly and properly for their work. This policy reflects our commitment to acting ethically and with integrity in all our business relationships and to implementing and enforcing effective systems and controls to ensure slavery and human trafficking is not taking place anywhere in our supply chains. Due diligence processes for slavery and human trafficking As part of our initiative to identify and mitigate risk we have in place systems to: • Identify and assess potential risk areas in our supply chains. We give all suppliers a copy of this statement and request a copy of their statement (if they are required to have one). • Mitigate the risk of slavery and human trafficking occurring in our supply chains. We set clear expectations for our suppliers by informing them of our Code of Conduct, which states ‘Brit does not tolerate modern slavery or any form of human trafficking within its business or supply chains. Brit does not allow harsh or inhumane treatment and we expect our suppliers to share our values.’ • Monitor potential risk areas in our supply chains. Staff are encouraged to report any concerns to senior management and there is a risk register operated by the Operational Risk Manager to record any such concerns. • Ensure appropriate recruitment practices are carried out, using reputable employment agencies. We verify the practices of any new recruitment agency as part of our terms of business with them and before accepting any workers from that agency. We also request a copy of the agency’s modern slavery statement (if it is required to have one). We ask any agency supplying us with staff to conduct verification checks on those staff (including verification of identity, references, evidence of qualifications and criminal and financial checks). We also carry out the same checks on direct hires. • Protect whistle blowers. At Brit, workers, customers and suppliers are encouraged to report any concerns related to our activities or supply chains. This includes circumstances which may give rise to increased risk of slavery or human trafficking. Our whistleblowing procedure is designed to make it easy for people to make disclosures without fear of retaliation. Brit Limited Annual Report 2016 51 Training To ensure a high level of understanding of the risks of modern slavery and human trafficking in our supply chains and our business, we will be providing training to appropriate members of staff. Our commitment This statement is made pursuant to section 54(1) of the Modern Slavery Act 2015 and constitutes our Group’s slavery and human trafficking statement for the financial year ending 2016. Following its initial adoption, this Modern Slavery and Human Trafficking Statement will be reviewed by Brit’s Board of Directors at least annually and may be amended from time to time. By order of the Board Tim Harmer Company Secretary 15 February 2017 GOVERNANCE52 Brit Limited Annual Report 2016 CONTENTSBrit Limited Annual Report 2016 53 INDEX TO THE FINANCIAL STATEMENTS INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF BRIT LIMITED CONSOLIDATED FINANCIAL STATEMENTS PARENT COMPANY FINANCIAL STATEMENTS 54 56 135 CONTENTSFINANCIAL STATEMENTS54 Brit Limited Annual Report 2016 Report on the financial statements Our opinion In our opinion: • Brit Limited’s group financial statements and parent company financial statements (the “financial statements”) give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2016 and of the group’s profit and cash flows 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; • the parent company financial statements have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the group financial statements, Article 4 of the IAS Regulation. What we have audited The financial statements, included within the Annual Report, comprise: • the consolidated statement of financial position as at 31 December 2016; • the statement of financial position as at 31 December 2016; • the consolidated income statement and consolidated statement of comprehensive income for the year then ended; • the consolidated statement of cash flows for the year then ended; • the consolidated statement of changes in equity for the year then ended; • the statement of changes in equity for the year then ended; and • the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. The financial reporting framework that has been applied in the preparation of the group financial statements is IFRSs as adopted by the European Union, and applicable law. The financial reporting framework that has been applied in the preparation of the parent company financial statements is United Kingdom Accounting Standards, comprising FRS 102 “The Financial Reporting Standard applicable in the UK and Republic of Ireland” (United Kingdom Generally Accepted Accounting Practice), and applicable law. In applying the financial reporting framework, the directors have made a number of subjective judgements, for example in respect of significant accounting estimates. In making such estimates, they have made assumptions and considered future events. Opinions on other matters prescribed by 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; • the Strategic Report and the Directors’ Report have been prepared in accordance with applicable legal requirements. In addition, in light of the knowledge and understanding of the Group, the parent company and their environment obtained in the course of the audit, we are required to report if we have identified any material misstatements in the Strategic Report and the Directors’ Report. We have nothing to report in this respect. Other matters on which we are required to report by exception Adequacy of accounting records and information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion: • we have not received all the information and explanations we require for our audit; or • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or • the parent company financial statements are not in agreement with the accounting records and returns. We have no exceptions to report arising from this responsibility. INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF BRIT LIMITEDBrit Limited Annual Report 2016 55 Directors’ remuneration Under the Companies Act 2006 we are required to report to you if, in our opinion, certain disclosures of directors’ remuneration specified by law are not made. We have no exceptions to report arising from this responsibility. We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both. In addition, we read all the financial and non‑financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. With respect to the Strategic Report and Directors’ Report, we consider whether those reports include the disclosures required by applicable legal requirements. Mark Bolton (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 15 February 2017 Notes: 1. The maintenance and integrity of the Brit Limited website is the responsibility of the Directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website. 2. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdiction. Responsibilities for the financial statements and the audit Our responsibilities and those of the directors As explained more fully in the Statement of Directors’ Responsibilities set out on page 45, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland) (“ISAs (UK & Ireland)”). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the parent company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. What an audit of financial statements involves We conducted our audit in accordance with ISAs (UK & Ireland). An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: • whether the accounting policies are appropriate to the group’s and the parent company’s circumstances and have been consistently applied and adequately disclosed; • the reasonableness of significant accounting estimates made by the directors; and • the overall presentation of the financial statements. We primarily focus our work in these areas by assessing the directors’ judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements. FINANCIAL STATEMENTS 56 Brit Limited Annual Report 2016 INTRODUCTION TO THE PRIMARY STATEMENTS Consolidated income statement The income statement shows income earned and expenses incurred by all the companies of Brit. Other items are shown in the statement of comprehensive income. The numbers in brackets are costs or losses incurred. Consolidated statement of comprehensive income As well as the profit or loss reported in the income statement, there are a number of other items not reported in the income statement which are instead shown here. These are gains and losses in the Group’s pension scheme, any tax associated with these gains or losses and foreign exchange gains and losses on the translation of foreign operations into US dollars. The statement starts from profit or loss reported in the income statement and adjusts for any gains and losses arising as a result of the pension scheme and foreign operations to show the overall result. Consolidated statement of financial position The statement of financial position is a summary of assets and how the assets have been funded through liabilities and equity investment by shareholders. Consolidated statement of cash flows The cash flow statement shows how we generate cash through our operating activities, how we have spent cash (investing activities) and how we have borrowed or spent cash to fund our business for all the companies in the Group. Consolidated statement of changes in equity The statement of changes in equity shows how the various lines in the equity section of the Group’s statement of financial position have moved during the year. CONTENTSBrit Limited Annual Report 2016 57 INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED INCOME STATEMENT 58 NOTE 14 TAX EXPENSE CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME CONSOLIDATED STATEMENT OF FINANCIAL POSITION CONSOLIDATED STATEMENT OF CASH FLOWS CONSOLIDATED STATEMENT OF CHANGES IN EQUITY NOTES TO THE FINANCIAL STATEMENTS: NOTE 1 GENERAL INFORMATION NOTE 2 NOTE 3 ACCOUNTING POLICIES AND BASIS OF PREPARATION CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS IN APPLYING ACCOUNTING POLICIES NOTE 4 RISK MANAGEMENT POLICIES NOTE 5 SEGMENTAL INFORMATION NOTE 6 INVESTMENT RETURN NOTE 7 RETURN ON DERIVATIVE CONTRACTS NOTE 8 NOTE 9 NET FOREIGN EXCHANGE GAINS/(LOSSES) ACQUISITION COSTS AND OTHER OPERATING EXPENSES NOTE 10 STAFF COSTS NOTE 11 FINANCE COSTS NOTE 12 AUDITOR’S REMUNERATION NOTE 13 INVESTMENTS IN ASSOCIATED UNDERTAKINGS 59 60 61 62 64 64 64 74 76 93 97 97 98 99 99 100 100 101 NOTE 15 INTANGIBLE ASSETS NOTE 16 PROPERTY, PLANT AND EQUIPMENT NOTE 17 DEFERRED ACQUISITION COSTS NOTE 18 DEFERRED TAXATION NOTE 19 INSURANCE AND REINSURANCE CONTRACTS NOTE 20 EMPLOYEE BENEFITS NOTE 21 FINANCIAL INVESTMENTS NOTE 22 DERIVATIVE CONTRACTS NOTE 23 INSURANCE AND OTHER RECEIVABLES NOTE 24 CASH AND CASH EQUIVALENTS NOTE 25 BORROWINGS NOTE 26 INSURANCE AND OTHER PAYABLES NOTE 27 CALLED UP SHARE CAPITAL NOTE 28 DIVIDENDS NOTE 29 COMMITMENTS NOTE 30 CASH FLOWS PROVIDED BY OPERATING ACTIVITIES NOTE 31 SHARE‑BASED PAYMENTS NOTE 32 INTERESTS IN STRUCTURED ENTITIES NOTE 33 ACQUISITION OF STRUCTURED ENTITIES NOTE 34 CONSOLIDATED ENTITIES NOTE 35 RELATED PARTY TRANSACTIONS AND ULTIMATE PARENT COMPANY NOTE 36 GUARANTEES AND CONTINGENT LIABILITIES 102 103 105 106 106 107 111 115 119 121 121 122 122 123 123 124 124 125 128 129 131 132 134 CONTENTSFINANCIAL STATEMENTS58 Brit Limited Annual Report 2016 CONSOLIDATED INCOME STATEMENT For the year ended 31 December 2016 Revenue Gross premiums written Less premiums ceded to reinsurers Premiums written, net of reinsurance Gross amount of change in provision for unearned premiums Reinsurers’ share of change in provision for unearned premiums Net change in provision for unearned premiums Earned premiums, net of reinsurance Investment return Return on derivative contracts Other income Net foreign exchange gains Total revenue Expenses Claims incurred: Claims paid: Gross amount Reinsurers’ share Claims paid, net of reinsurance Change in the provision for claims: Gross amount Reinsurers’ share Net change in the provision for claims Claims incurred, net of reinsurance Acquisition costs Other operating expenses Net foreign exchange losses Total expenses excluding finance costs Operating profit Finance costs Share of net profit of associates Profit on ordinary activities before tax Tax (expense)/income Profit for the year All profits arise from continuing operations. The accompanying Notes are an integral part of the annual accounts. Note 5 5 6 7 8 5 9 9 8 11 14(a) Year ended 31 December 2016 US$m 1,912.2 (432.0) 1,480.2 21.4 32.5 53.9 Year ended 31 December 2015 US$m 1,999.2 (369.4) 1,629.8 (5.8) 14.1 8.3 1,534.1 1,638.1 132.2 (52.8) 1.1 52.2 10.3 39.7 0.3 – 1,666.8 1,688.4 (874.9) 140.7 (734.2) (183.9) 62.0 (121.9) (856.1) (530.9) (104.8) – (871.5) 191.1 (680.4) (211.0) 9.4 (201.6) (882.0) (526.6) (155.6) (95.9) (1,491.8) (1,660.1) 175.0 (18.8) 3.6 159.8 (2.2) 157.6 28.3 (20.6) – 7.7 7.9 15.6 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the year ended 31 December 2016 Brit Limited Annual Report 2016 59 Profit attributable to owners of the parent Other comprehensive income Items not to be reclassified to profit or loss in subsequent periods: Actuarial (losses)/gains on defined benefit pension scheme Deferred tax gain/(charge) relating to actuarial gains on defined benefit pension scheme Items that may be reclassified to profit or loss in subsequent periods: Change in unrealised foreign currency translation losses on foreign operations Total other comprehensive income Total comprehensive income recognised for the year The accompanying Notes are an integral part of the annual accounts. Note 20 14(b) Year ended 31 December 2016 US$m 157.6 Year ended 31 December 2015 US$m 15.6 (5.4) 0.9 (13.7) (18.2) 139.4 3.0 (0.5) (4.9) (2.4) 13.2 FINANCIAL STATEMENTS 60 Brit Limited Annual Report 2016 CONSOLIDATED STATEMENT OF FINANCIAL POSITION At 31 December 2016 Assets Intangible assets Property, plant and equipment Deferred acquisition costs Investments in associated undertakings Reinsurance contracts Employee benefits Deferred taxation Current taxation Financial investments Derivative contracts Insurance and other receivables Cash and cash equivalents Total assets Liabilities and Equity Liabilities Insurance contracts Borrowings Deferred taxation Provisions Current taxation Derivative contracts Insurance and other payables Total liabilities Equity Called up share capital Capital redemption reserve Foreign currency translation reserve Retained earnings Total equity attributable to owners of the parent Total liabilities and equity Note 15 16 17 13 19 20 18 21 22 23 24 19 25 18 22 26 27 31 December 2016 US$m 31 December 2015 US$m 93.9 22.9 219.6 36.6 884.1 42.5 0.4 15.3 2,903.9 12.6 718.3 1,025.5 5,975.6 4,243.5 157.5 25.8 2.4 4.6 11.8 382.0 4,827.6 6.4 0.2 (91.0) 1,232.4 1,148.0 5,975.6 95.1 21.1 222.6 28.6 818.9 52.1 – 15.3 3,330.8 63.6 691.7 581.0 5,920.8 4,182.3 185.6 27.4 3.3 3.2 12.5 350.0 4,764.3 6.6 – (77.3) 1,227.2 1,156.5 5,920.8 The accompanying Notes are an integral part of the annual accounts. These financial statements were approved by the Board of Directors on 15 February 2016 and were signed on its behalf by: Matthew Wilson Group Chief Executive Officer Mark Allan Chief Financial Officer CONSOLIDATED STATEMENT OF CASH FLOWS For the year ended 31 December 2016 Note 30 15 16 Cash flows from operating activities Cash generated from operations Tax paid Interest received Dividends received Net cash inflows from operating activities Cash flows from investing activities Purchase of intangible assets Purchase of property, plant and equipment Investment in associated undertaking Net cash outflows from investing activities Cash flows from financing activities Purchase of class A shares for cancellation Purchase of shares for share‑based payment schemes Interest paid Dividends paid Net cash outflows from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of the year Effect of exchange rate fluctuations on cash and cash equivalents Brit Limited Annual Report 2016 61 Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 579.1 (3.4) 57.8 17.5 651.0 (6.3) (8.3) (4.9) (19.5) (58.1) (3.1) (15.4) (90.8) (167.4) 464.1 581.0 (19.6) 262.0 (0.7) 40.6 30.1 332.0 (7.7) (18.6) (28.6) (54.9) – (10.7) (15.6) (154.1) (180.4) 96.7 501.4 (17.1) 581.0 Cash and cash equivalents at the end of the year 24 1,025.5 The accompanying Notes are an integral part of the annual accounts. FINANCIAL STATEMENTS 62 Brit Limited Annual Report 2016 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2016 At 1 January 2016 Total comprehensive income recognised Repurchase of class A shares Cancellation of share capital Share‑based payments Dividend At 31 December 2016 The accompanying Notes are an integral part of the annual accounts. Called up share capital US$m Capital redemption reserve US$m Note Foreign currency translation reserve US$m Retained earnings US$m Total equity US$m 6.6 – – (0.2) – – 6.4 – – – 0.2 – – 0.2 (77.3) 1,227.2 1,156.5 (13.7) – – – – 153.1 (58.1) – 1.0 (90.8) 139.4 (58.1) – 1.0 (90.8) (91.0) 1,232.4 1,148.0 31 28 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2015 Brit Limited Annual Report 2016 63 At 1 January 2015 Total comprehensive income recognised Transfer to profit on liquidation of subsidiaries Vesting of own shares Share‑based payments Purchase of shares for share‑based payments Dividend At 31 December 2015 Nature and Purpose of Group Reserves Called up share capital US$m Note Foreign currency translation reserve US$m Own shares US$m Retained earnings US$m Total equity US$m 6.6 (1.5) (77.6) 1,363.7 1,291.2 – – – – – – 6.6 – – 1.5 – – – – (4.9) 5.2 – – – – 18.1 – (1.5) 4.9 (3.9) (154.1) 13.2 5.2 – 4.9 (3.9) (154.1) (77.3) 1,227.2 1,156.5 31 31 28 Own shares: Own shares represents the cost of shares held in trust for settling share‑based payments and shares held in treasury. Capital Redemption Reserve: The balance represents the amount by which share capital is diminished in the event of a share cancellation and is required to be recognised in a legal reserve so as to maintain the Group’s capital. Foreign currency translation reserve: The balance on this reserve represents the foreign exchange differences arising from the translation of financial statement information of entities within the Group from functional currencies to the presentational currency of the Group. Retained earnings: Retained earnings represents the cumulative comprehensive income retained by the Group after taxation and after any distributions made from this account. The accompanying Notes are an integral part of the annual accounts. FINANCIAL STATEMENTS 64 Brit Limited Annual Report 2016 The first three Notes provide details of the basis of preparation and accounting policies applied in producing these financial statements and the critical accounting estimates and judgements therein. 1 GENERAL INFORMATION The consolidated financial statements of Brit Limited and its subsidiaries (collectively, the Group) for the year ended 31 December 2016 were authorised for issue in accordance with a resolution of the Directors on 15 February 2017. The Group’s principal activity is the underwriting of general insurance and reinsurance business. Brit Limited (the Company) is a limited company, incorporated and domiciled in England and Wales. Brit Limited was acquired by FFHL Group Limited, a subsidiary of Fairfax Financial Holdings Limited (FFHL), on 5 June 2015. The shares of the Company were delisted from the official list of the London Stock Exchange on 23 June 2015. The Company was re‑registered from a public limited company to a private limited company on 29 June 2015 and the name of the Company changed accordingly. 2 ACCOUNTING POLICIES AND BASIS OF PREPARATION 2.1 Basis of preparation The consolidated financial statements for the year ended 31 December 2016 have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). The accounting policies of the Group have been applied consistently to all years presented, unless otherwise stated. The Group has adopted the following amendments to standards with a date of initial application of 1 January 2016: (a) Presentation of Financial Statements – Amendments to IAS 1 These amendments clarify rather than significantly change existing IAS 1 requirements. The amendments clarify: • materiality requirements; • how specific line items in the statement of profit or loss and other comprehensive income (OCI) and the statement of financial position may be disaggregated; • that entities have flexibility as to the order in which they present the notes to financial statements; and • that the share of OCI of associates and joint ventures accounted for using the equity method must be presented in aggregate as a single line item, and classified between those items that will or will not be subsequently reclassified to profit or loss. These amendments have no impact on the Group. (b) Equity method in separate financial statements – Amendments to IAS 27 This amends IAS 27 to allow the equity method of accounting in separate financial statements. This amendment has no impact on the Group. (c) Clarification of acceptable methods of depreciation and amortisation – Amendments to IAS 16 and IAS 38 This amends IAS 16 to prohibit the use of revenue‑based depreciation methods for PPE. IAS 38 is amended to introduce a rebuttable presumption that revenue is not an appropriate basis for amortisation of an intangible asset. These amendments have no impact on the Group. (d) Accounting for acquisitions of interests in joint operations – Amendments to IFRS 11 The amendments add new guidance to IFRS 11 on accounting for the acquisition of an interest in a joint operation in which the activity of the joint operation constitutes a business, as defined in IFRS 3. Acquirers of such interests are to apply the relevant principles on business combination accounting, as well as disclosing the relevant information specified in these standards for business combinations. These amendments have no impact on the Group. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 65 (e) Consolidated financial statements – Amendments to IFRS 10 These amendments have no impact on the Group. (f) IFRS annual improvements cycle 2012‑2014 Various minor clarifications and amendments to IFRS. These amendments have no impact on the Group. The consolidated financial statements have been prepared on a historical cost basis, except for financial investments and derivative contracts which have been measured at fair value. The consolidated financial statements are presented in US dollars and all values are rounded to the nearest US$0.1m except where otherwise indicated. Certain amounts recorded in the financial information include estimates and assumptions made by management, particularly about insurance liability reserves, investment valuations, interest rates and other factors. Actual results may differ from the estimates made. The consolidated financial statements include the results of the Company and all its subsidiary undertakings (collectively, the Group) made up to the same accounting date. At the date of authorisation of these financial statements, the following standards which have not been applied in these financial statements were in issue but not yet effective: Standard IAS 7 IAS 12 IFRS 2 Statement of Cash Flows (amendments) Recognition of deferred tax assets for unrealised losses (amendments to IAS 12 Income Taxes) Classification and measurement of share‑based Effective Periods commencing on or after 1 January 2017 Periods commencing on or after 1 January 2017 payment transactions (amendments to IFRS 2 Share‑based Payment) Applying IFRS 9 with IFRS 4 (amendments) Financial Instruments (2014) IFRS 4 IFRS 9 IFRS 10, 12, and IAS 28 Investment entities – applying the consolidation exception (amendments) Revenue From Contracts With Customers (2014) Leases (2016) IFRS 15 IFRS 16 Periods commencing on or after 1 January 2018 Periods commencing on or after 1 January 2018 Periods commencing on or after 1 January 2018 Periods commencing on or after 1 January 2018 Periods commencing on or after 1 January 2018 Periods commencing on or after 1 January 2019 In July 2014, the IASB issued the final version of IFRS 9 ‘Financial Instruments’ that replaces IAS 39 ‘Financial Instruments: Recognition and Measurement’ and all previous versions of IFRS 9. IFRS 9 (2014) addresses all three aspects of the IASB’s accounting for financial instruments project, including classification and measurement, impairment and hedge accounting. IFRS 9 is effective for annual periods beginning on or after 1 January 2018, with early application permitted. This standard has not yet been endorsed by the EU. The Group is considering the impact of this standard on its financial statements along with the amendments to IFRS 4 issued in September 2016, which are relevant to determining the date at which IFRS 9 will become effective for the Group. These amendments provide for two approaches for insurers to applying the requirements of IFRS 9, including an optional temporary exemption from applying IFRS 9 until 2021 for those companies whose activities are predominantly connected with insurance. The Group also continues to monitor developments at the IASB in respect of a replacement to IFRS 4 ‘Insurance Contracts’, the issue date of which has not yet been confirmed by the IASB. The Directors anticipate that the adoption of the other standards in future periods will have no material impact on the financial statements of the Group. FINANCIAL STATEMENTS66 Brit Limited Annual Report 2016 2 ACCOUNTING POLICIES AND BASIS OF PREPARATION (continued) 2.2 Basis of consolidation The consolidated accounts include the accounts of the Company, its subsidiaries and associates and the Group’s participation in Lloyd’s syndicates’ assets, liabilities, revenues and expenses. Subsidiaries are those entities (including structured entities) that an investor controls, when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The financial statements of subsidiaries are prepared up to 31 December each year. Consolidation adjustments are made to convert subsidiary accounts from local GAAP into IFRS so as to remove any dissimilar accounting policies that may exist. Subsidiaries are consolidated from the date control is transferred to the Group and cease to be consolidated from the date control is transferred from the Group. All inter‑company balances, profits and transactions are eliminated. Associates are those entities over which the Group has the power to exercise significant influence but not control. The Group’s investment in associated undertakings is accounted for under the equity method of accounting whereby associated undertakings are carried in the statement of financial position at cost plus post‑acquisition changes in the Group’s share of net assets of the associate, less any impairment in value. The Group’s investment in associated undertakings also includes goodwill identified on acquisition less any accumulated impairment loss. The income statement reflects the Group‘s share of the post‑acquisition results of operations of the associated undertaking and the statement of comprehensive income reflects the Group’s share of the comprehensive income of the associated undertaking. The financial statements of associated undertakings are prepared up to 31 December each year. 2.3 Product classification Insurance contracts are those contracts that transfer significant insurance risk. The significance of insurance risk is dependent on both the probability of an insured event and the magnitude of its potential effect to the policyholder. Once a contract has been classified as an insurance contract, it remains an insurance contract for the remainder of its lifetime, even if the insurance risk reduces significantly during this period. Where the Group has issued financial guarantee contracts these have been regarded as insurance contracts and have been accounted for in accordance with IFRS 4 ‘Insurance Contracts’. 2.4 Other accounting policies 2.4.1 Insurance contracts (a) Premiums Premiums written relate to business incepted during the year, together with any differences between booked premiums for prior years and those previously accrued, and include estimates of premiums due but not yet receivable or notified, less an allowance for cancellations. Premiums are accreted to the income statement on a pro rata basis over the term of the related policy, except for those contracts where the period of risk differs significantly from the contract period. In these circumstances, premiums are recognised over the period of risk in proportion to the amount of insurance protection provided. Reinstatement premiums are accreted to the income statement on a pro rata basis over the term of the original policy to which it relates. Premiums are shown net of premium taxes and other levies on premiums. Pipeline premium estimates are typically based on using standard actuarial projection techniques (e.g. Basic Chain Ladder) on the key assumption that historical development of premiums is representative of future development. (b) Profit commissions receivable Profit commission income arising from whole account quota share contracts is recognised when the economic benefits are highly probable. They are netted off commission costs which are included within the ‘acquisition cost’ line in the income statement. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 67 (c) Deferred acquisition costs Commission and other acquisition costs incurred during the financial period that are related to securing new insurance contracts and/or renewing existing insurance contracts, but which relate to subsequent financial periods, are deferred to the extent that they are recoverable out of future revenue margins. Deferred acquisition costs are capitalised and amortised over the life of the policy to which they relate on a basis consistent with the earnings pattern of that policy. (d) Claims incurred Claims incurred comprise claims and claims handling costs paid in the year and changes in the outstanding claims provisions, including provisions for claims incurred but not reported and related expenses, together with any adjustments to claims from prior years. Claims handling costs are mainly external costs related to the negotiation and settlement of claims. (e) Outstanding claims provisions Outstanding claims represent the estimated ultimate cost of settling all claims (including direct and indirect claims settlement costs) arising from events which have occurred up to the date of the statement of financial position, including provision for claims incurred but not reported, less any amounts paid in respect of those claims. The Group does not discount its liabilities for unpaid claims, the ultimate cost of which cannot be known with certainty at the date of the statement of financial position. (f) Provision for unearned premiums The proportion of written premiums that relate to unexpired terms of policies in force at the date of the statement of financial position is deferred as a provision for unearned premiums, generally calculated on a time apportioned basis. The movement in the provision is taken to the income statement in order that revenue is recognised over the period of the risk. (g) Liability adequacy tests At the date of each statement of financial position, liability adequacy tests are performed, to ensure the adequacy of unearned premiums net of related deferred acquisition costs, employing the current estimates of future cash flows under its insurance contracts. If as a result of these tests, the carrying amount of the Group’s insurance liabilities is found to be inadequate in comparison to the value of these future cash flows, the deficiency is charged to the income statement for the period by establishing an unexpired risk provision. The tests are performed at a whole account and portfolio level at the statement of financial position date to ensure the estimated costs of future claims and related deferred acquisition costs do not exceed the unearned premium provision. (h) Reinsurance The Group assumes and cedes reinsurance in the normal course of business. Premiums and claims on reinsurance assumed are recognised in the income statement along the same basis as direct business, taking into account the product classification. Reinsurance premiums ceded and reinsurance recoveries on claims incurred are included in the respective expense and income accounts. Reinsurance outwards premiums are earned according to the nature of the cover. ‘Losses occurring during’ policies are earned evenly over the policy period. ‘Risks attaching’ policies are expensed on the same basis as the inwards business being protected. Reinstatement premiums on both inwards and outwards business are accreted to the income statement on a pro rata basis over the term of the original policy to which they relate. Reinsurance assets include amounts recoverable from reinsurance companies for paid and unpaid losses and loss adjustment expenses, and ceded unearned premiums. Amounts recoverable from reinsurers are calculated with reference to the claims liability associated with the reinsured risks. Revenues and expenses arising from reinsurance agreements are therefore recognised in accordance with the underlying risk of the business reinsured. Gains or losses on buying reinsurance are recognised immediately in the income statement. If a reinsurance asset is impaired, the Group reduces its carrying amount accordingly, and will immediately recognise the impairment loss in the income statement. A reinsurance asset will be deemed to be impaired if there is objective evidence, as a result of an event that occurred after initial recognition of the asset, that the Group may not receive all amounts due to it under the terms of the contract, and that the event has a reliably measurable impact on the amounts that the Group will receive from the reinsurer. FINANCIAL STATEMENTS68 Brit Limited Annual Report 2016 2 ACCOUNTING POLICIES AND BASIS OF PREPARATION (continued) Gains or losses on buying retroactive reinsurance are recognised immediately in the income statement and are not amortised. Premiums ceded and claims reimbursed are presented on a gross basis in the consolidated income statement and statement of financial position as appropriate. (i) Syndicate assets and liabilities For each managed syndicate on which the Group participates, the Group’s proportion of the syndicate’s assets and liabilities has been reflected in its consolidated statement of financial position. Syndicate assets are held subject to trust deeds for the benefit of the syndicate’s insurance creditors. 2.4.2 Revenue recognition (a) Fee and commission income Fee and commission income consists mainly of administration and broking fees charged to third parties. It is recognised in the accounting period in which the service is rendered by reference to completion of the specific transaction, assessed on the basis of the actual service provided as a proportion of the total services to be provided. (b) Investment return Investment income comprises all interest and dividend income and realised and unrealised gains and losses less investment management fees. Interest income is recognised using the effective interest method. Dividend income is recognised when the shareholders’ right to receive the payment is established. Realised gains and losses on investments are calculated as the difference between net sales proceeds and cost and are recognised when the sale transaction occurs. Unrealised gains and losses on investments are calculated as the difference between the valuation at the date of the statement of financial position and the valuation at the last statement of financial position or purchase price, if acquired during the year. Unrealised investment gains and losses include adjustments in respect of unrealised gains and losses recorded in prior years which have been realised during the year and are reported as realised gains and losses in the current year’s income statement. 2.4.3 Recognition and derecognition of financial assets and financial liabilities Financial assets and financial liabilities are recognised when the Group becomes a party to the contractual provisions of the contract. A financial asset is derecognised when either the contractual rights to the asset’s cash flows expire, or the asset is transferred and the transfer qualifies for derecognition under a combination of risks and rewards and control tests. A financial liability is derecognised when it is extinguished which is when the obligation in the contract is discharged, cancelled or expired. All ‘regular way purchases and sales’ of financial assets are recognised on the trade date, i.e. the date that the Group commits to purchase or sell the asset. Regular way purchases and sales are purchases and sales of financial assets that require delivery of assets within the time frame generally established by regulation or convention in the marketplace. 2.4.4 Investments The Group has designated on initial recognition its financial assets held for investment purposes (investments) at fair value through profit or loss (FVTPL). This is in accordance with the Group’s documented investment strategy and consistent with investment risk being assessed on a portfolio basis. Information relating to investments is provided internally to the Group’s Directors and key managers on a fair value basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of financial assets and liabilities traded in active markets (which are the principal markets or the most advantageous markets that maximise the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability) are based on quoted market bid and ask price for both financial assets and financial liabilities respectively. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 69 The fair value of financial assets and liabilities that are not traded in an active market, including over‑the‑counter derivatives, is determined using valuation techniques. The Group uses a variety of methods and makes assumptions that are based on market conditions existing at each reporting date. Valuation techniques include the use of comparable recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and others commonly used by market participants and which make the maximum use of observable inputs. Gains and losses on investments designated as FVTPL are recognised through the income statement. Interest income from investments in bonds and short‑term investments is recognised at the effective interest rate. Interest receivable is shown separately in the statement of financial position based on the debt instruments’ stated rates of interest. 2.4.5 Derivatives Derivative financial instruments include foreign exchange contracts, forward rate agreements, interest rate futures, currency and interest rate swaps and other financial instruments that derive their value mainly from underlying interest rates, foreign exchange rates, credit indices, commodity values or equity instruments. All derivatives are initially recognised in the statement of financial position at their fair value, which represents their cost. They are subsequently remeasured at their fair value, with the method of recognising movements in this value in the income statement. Fair values are obtained from quoted market prices or, if these are not available, by using valuation techniques such as discounted cash flow models or option pricing models. All derivatives are carried as assets when the fair values are positive and as liabilities when the fair values are negative. Derivative contracts may be traded on an exchange or over‑the‑counter (OTC). Exchange‑traded derivatives are standardised and include certain futures and option contracts. OTC derivative contracts are individually negotiated between contracting parties and include forwards and swaps. Derivatives are subject to various risks including market, liquidity and credit risk, similar to those related to the underlying financial instruments. Many OTC transactions are contracted and documented under International Swaps and Derivatives Association (ISDA) master agreements or their equivalent, which are designed to provide legally enforceable set‑off in the event of default, reducing the Group’s exposure to credit risk. The notional or contractual amounts associated with derivative financial instruments are not recorded as assets or liabilities on the statement of financial position as they do not represent the fair value of these transactions. 2.4.6 Intangible assets (a) Syndicate participation rights Lloyd’s syndicate participation rights that have been acquired on acquisition of a subsidiary are initially recognised at fair value. They are considered to have an indefinite useful life as they will provide benefits over an indefinite future period and are therefore not subject to an annual amortisation charge. The continuing value of the underwriting capacity is reviewed for impairment annually by reference to the expected future profit streams to be earned from the respective syndicate, with any impairment in value being charged to the income statement. (b) Computer software Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring into use the specific software. Internal development costs that are directly associated with the production of identifiable and unique software products controlled by the Group are also capitalised where the cost can be measured reliably, the Group intends to and has adequate resources to complete development and the computer software will generate future economic benefits. All computer software costs are finite life assets and amortised on a straight‑line basis over their expected useful lives, not exceeding a period of five years. FINANCIAL STATEMENTS70 Brit Limited Annual Report 2016 2 ACCOUNTING POLICIES AND BASIS OF PREPARATION (continued) (c) Trade names and distribution channels Trade names and distribution channels that have been acquired on acquisition of a subsidiary are initially recognised at fair value. They are deemed to be finite life assets and amortised on a straight‑line basis over their expected useful economic lives, as follows: Trade names Distribution channels 5 years 15 years (d) Renewal rights Renewal rights are recognised at fair value upon acquisition and amortised straight line over their expected useful lives which varies between two and four years. 2.4.7 Property, plant and equipment Property, plant and equipment are carried at cost, less accumulated depreciation and any impairment in value. Depreciation is calculated so as to write‑off the cost over their estimated useful economic lives on a straight‑line basis having regard to the residual value of each asset, as follows: Office refurbishment costs, office machinery, furniture and equipment Computers, servers, data storage devices, networks and other IT infrastructure 5‑15 years 3‑5 years The assets’ residual values and useful lives are reviewed at the date of each statement of financial position and adjusted if appropriate. An item of property, plant and equipment is derecognised upon disposal or when no future economic benefits are expected to arise from the continued use of the asset. Gains and losses on the disposal of property, plant and equipment are determined by comparing proceeds with the carrying amount of the asset and are included in the income statement. Costs for repairs and maintenance are expensed as incurred. Following a change in premises during 2016, useful lives have been revised to reflect the useful economic lives of new assets acquired. 2.4.8 Impairment Syndicate participation rights are not subjected to amortisation but are tested annually for impairment as they are an asset with an indefinite useful life. Other assets, except for assets arising from insurance contracts, are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the carrying value of an asset is impaired, it is reduced to the recoverable amount by an immediate charge to the income statement. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. Value in use is based on discounting cash flows at the Group’s weighted average cost of capital which is loaded where significant uncertainties exist. Assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash‑generating units). Impairment reviews are made by comparing carrying value to recoverable amount. 2.4.9 Cash and cash equivalents Cash and cash equivalents in the statement of financial position include cash in hand, deposits held at call with banks and other short‑term, highly liquid investments with a maturity of three months or less at the date of acquisition. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 71 2.4.10 Income taxes Income tax comprises current and deferred tax. Income tax is recognised in the income statement except where it relates to an item which is recognised in equity. (a) Current income tax Current income tax is the expected tax payable on the taxable profit for the period using tax rates (and laws) enacted or substantively enacted at the date of the statement of financial position and any adjustment to the tax payable in respect of previous periods. The Group calculates current income tax using current income tax rates. (b) Deferred income tax Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, if the deferred income tax arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss, it is not recognised. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the date of the statement of financial position and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled. Deferred income tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred income tax relating to items recognised in other comprehensive income is also recognised in other comprehensive income. Deferred income tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the Group controls the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. Deferred tax assets and liabilities are not discounted. 2.4.11 Employee benefits The Group operates a defined contribution group personal pension plan and several other defined contribution schemes. It also makes payments into a number of personal money purchase pension plans. Contributions in respect of these schemes are charged to the income statement in the period to which they relate. The Group also operates a defined benefit pension scheme. The asset recognised in the statement of financial position in respect of the defined benefit scheme is the fair value of the scheme assets less the present value of the defined benefit obligation which is determined by discounting the estimated future cash outflows. The discount rate is based on market yields at the reporting date of high‑quality corporate bonds that have terms to maturity which approximate to those of the related pension liability. An asset is recognised only to the extent that it is considered available in the form of future refunds from the plan, in particular taking into consideration any minimum funding requirements that apply to the plan. Actuarial gains and losses are recognised immediately through other comprehensive income. The Group determines the net interest expense/income on the net defined benefit liability/asset for the period by applying the discount rate used to measure the defined benefit obligation at the beginning of the annual period to the net defined benefit liability/asset. FINANCIAL STATEMENTS72 Brit Limited Annual Report 2016 2 ACCOUNTING POLICIES AND BASIS OF PREPARATION (continued) Past service costs arising in the period are recognised as an expense at the earlier of the date when the plan amendment or curtailment occurs and the date when the Group recognises related restructuring costs or termination benefits. The Group recognises an accrual in respect of profit‑sharing and bonus plans where a contractual obligation to employees exists or where there is a past practice that has created a constructive obligation. 2.4.12 Share‑based payments The fair value of equity instruments granted under share‑based payment plans are recognised as an expense and spread over the vesting period of the instrument. The total amount to be expensed is determined by reference to the fair value of the awards made at the grant date. At the date of each statement of financial position, the Group revises its estimate of the number of equity instruments that are expected to become exercisable and it recognises the impact of the revision of original estimates, if any, in the income statement. Where the awards have been granted by a parent company and are therefore treated as equity settled a corresponding adjustment is made to equity over the remaining vesting period. Where the awards have been granted by the Company and are therefore treated as cash‑settled, a liability is provided for settlement of the awards. The corresponding adjustment arising on a revision of the original estimate is made to that liability. In addition, the fair value of the award and ultimate expense are adjusted on a change in the market share price of the underlying shares or at the valuation date. 2.4.13 Own shares Where the Company purchases its own share capital, the consideration paid is shown as a deduction from total shareholders’ equity. No gain or loss is recognised in the income statement on the purchase, sale, issue or cancellation of own shares and any consideration paid or received is recognised directly in equity. 2.4.14 Provisions and contingencies Provisions are liabilities with uncertainties in the amount or timing of payments. Provisions are recognised if there is a present obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made at the date of the statement of financial position. A contingent liability is a possible obligation that arises from past events or a present obligation that is not recognised as it is not probable that an outflow of resources will be required to settle the obligation or the amount of obligation cannot be measured with sufficient reliability. A contingent liability is disclosed but not recognised. 2.4.15 Leased assets Where the Group enters into an operating lease, the payments (net of any incentives received from the lessor) are charged to the income statement on a straight‑line basis over the lease term. An operating lease is one in which the risks and rewards remain with the lessor. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 73 2.4.16 Foreign currency translation Items included in the financial statements of the parent and subsidiaries are measured using the functional currency which is the primary economic environment in which the entity operates. The Group presents its consolidated financial statements in US Dollars which is the functional currency of the parent. Foreign currency transactions are recorded in the functional currency for each entity using the exchange rates prevailing at the dates of the transactions or at the average rate for the period when this is a reasonable approximation. Substantially all of the Group’s operations have US dollars as their functional currency. Monetary assets and liabilities denominated in foreign currencies are translated at period end exchange rates. The resulting exchange differences on translation are recorded in the income statement. Non‑monetary assets and liabilities that are measured at historical cost denominated in a foreign currency are not retranslated. The functional currencies of some of the company’s subsidiaries differ from the consolidated group US Dollar presentation currency. As a result, the assets and liabilities of these subsidiaries are translated on consolidation at the rates of exchange prevailing at the balance sheet date. Revenue and expenses are translated at the average rate of exchange for the period. The unrealised gain or loss resulting from this translation is recognised in other comprehensive income and transferred to a foreign currency translation reserve. 2.4.17 Borrowings Borrowings are initially recognised at fair value, net of transaction costs incurred and subsequently stated at amortised cost. Fair value is normally determined by reference to the fair value of the proceeds received. Any difference between the initial carrying amount and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest rate method. 2.4.18 Segmental reporting An operating segment is a component of an entity that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the entity’s chief operating decision maker and for which discrete financial information is available. 2.4.19 Loans and receivables Loans and receivables are financial assets with fixed or determinable payments. Loans and receivables are measured at amortised cost, using the effective interest rate method. 2.4.20 Offsetting of financial instruments Financial assets and liabilities are offset and the net amount reported in the statement of financial position only when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the assets and settle the liability simultaneously. 2.4.21 Dividend and capital distributions Dividend and capital distributions to the Company’s shareholders are recognised in the Group’s financial statements in the period in which they are declared and appropriately approved. 2.4.22 Collateral The Group receives collateral from certain reinsurers and pledges collateral where required for regulatory purposes. Collateral received in the form of cash is recognised as an asset on the statement of financial position with a corresponding liability for the repayment. Non‑cash collateral received is not recognised on the statement of financial position. Collateral pledged is not derecognised from the statement of financial position unless the Group defaults on its obligations under the relevant agreement. FINANCIAL STATEMENTS74 Brit Limited Annual Report 2016 3 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS IN APPLYING ACCOUNTING POLICIES 3.1 Introduction The Group makes various assumptions that affect the reported amounts of assets and liabilities. Estimates and judgements are regularly re‑evaluated and are based on a combination of historical experience and other factors, including exposure analysis, expectations of future experience and expert judgement. 3.2 The ultimate liability arising from claims made under insurance contracts The estimation of the ultimate liability arising from claims made under insurance contracts is the Group’s most critical accounting estimate. There are several sources of uncertainty that need to be considered in the estimate of the amounts that the Group will ultimately pay to settle such claims. Significant areas requiring estimation and judgement include: • Estimates of the amount of any liability in respect of claims notified but not settled and incurred but not reported claims (IBNR) to be included within provisions for inwards insurance and reinsurance contracts; • The corresponding estimate of the amount of outwards reinsurance recoveries which will become due as a result of the estimated claims on inwards business; • The recoverability of amounts due from reinsurers; and • Estimates of the proportion of exposure which has expired in the period as represented by the earned proportion of premiums written. The assumptions used and the manner in which these estimates and judgements are made are set out below, including the reserving process for the estimation of gross, and net of reinsurance, ultimate premiums and claims: • Quarterly statistical data is produced in respect of gross and net premiums and claims (paid and incurred); • Projections of ultimate premiums, reinstatement premiums and claims are produced by the internal actuarial department using standard actuarial projection techniques (e.g. Basic Chain Ladder, Bornhuetter‑Ferguson, Initial Expected Loss Ratio). The Basic Chain Ladder and Bornhuetter‑Ferguson projection methods are based on the key assumption that historical development of premiums and claims is representative of future development. Claims inflation is taken into account in the Initial Expected Loss Ratio selections but is otherwise assumed to be in line with historical inflation trends, unless explicit adjustments for other drivers of inflation such as legislative developments are deemed appropriate. • Some classes of business have characteristics which do not necessarily lend themselves easily to statistical estimation techniques e.g. due to low data volumes. In such cases, for example, a policy‑by‑policy review may also be carried out to supplement statistical estimates; • In the event of catastrophe losses, and prior to detailed claims information becoming available, claims provision estimates are compiled using a combination of output from specific recognised modelling software and detailed reviews of contracts exposed to the event in question; • The initial ultimate selections derived by the actuarial department, along with the underlying key assumptions and methodology, are discussed with class underwriters, divisional underwriting directors and the claims team at ‘Pre‑Committee’ meetings. The actuarial department may make adjustments to the initial ultimates following these meetings; • Following the completion of the ‘Pre‑Committee’ meetings and peer review process within the actuarial department, the ultimate selections (actuarial estimate), assumptions, methodology and uncertainties are presented to the Reserving Committee for discussion and debate; • Following review of the actuarial estimate, the Reserving Committee recommends the committee estimate to be adopted in the financial statements; and • As part of their audit engagement, claims provisions are subject to external actuarial review by Brit’s auditor. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 75 The results of the external actuarial review by Brit’s auditor is presented to both the Reserving Committee and the Audit Committee with key assumptions, methodologies and uncertainties also highlighted. The purpose of the external review is to provide both committees with an independent actuarial view of reserve requirements compared to the recommendations of the internal actuarial department. The estimates and judgements are applied in line with the overall reserving philosophy and seek to state the claims provisions on a best estimate, undiscounted basis. A management risk margin is also applied over and above the actuarial best estimate to allow for the inherent uncertainty within the best estimate reserve position. In addition to claims provisions, the reserve for future loss adjustment expenses is also subject to estimation with consideration being given to the level of internal and third party loss adjustment expenses incurred annually. The estimated loss adjustment expenses are expressed as a percentage of gross claims reserves and the reasonableness of the estimate is assessed through benchmarking. Further judgements are made as to the recoverability of amounts due from reinsurers. Provisions for bad debts are made specifically, based on the solvency of reinsurers, internal and external ratings, payment experience with them and any disputes of which the Group is aware. The carrying value at the date of the statement of financial position of gross claims reported and loss adjustment expenses and claims incurred but not reported were US$3,406.7m (2015: US$3,324.1m) as set out in Note 19 to the accounts. The amount of reinsurance recoveries estimated at that date is US$711.1m (2015: US$678.4m). 3.3 Pipeline premiums Written premiums include pipeline premiums of US$459.4m (2015: US$486.8m) which represent future premiums receivable on in‑force insurance contracts. Pipeline premium estimates are typically based on standard actuarial projection techniques (e.g. Basic Chain Ladder) on the key assumption that historical development of premiums is representative of future development. 3.4 Intangible assets Intangible assets with indefinite useful lives are tested for impairment on an annual basis in accordance with IAS 36 ‘Impairment of Assets’. Determining the assumptions used in the test requires estimation. The indefinite useful life intangible assets of the Group consist of syndicate participation rights and their carrying amount at the date of the statement of financial position was US$70.8m (2015: US$70.8m). For further information, refer to Note 15. 3.5 Financial investments Financial investments are carried in the statement of financial position at fair value. The carrying amount of financial investments at the date of the statement of financial position was US$2,903.9m (2015: US$3,330.8m). Determining the fair value of certain investments requires estimation. The Group value investments using designated methodologies, estimations and assumptions. These securities, which are reported at fair value on the consolidated statement of financial position, represent the majority of the invested assets. The measurement basis for assets carried at fair value is categorised into a ‘fair value hierarchy’ in accordance with the valuation inputs and consistent with IFRS 13 ‘Fair Value Measurement’. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (level one); the middle priority to fair values other than quoted prices based on observable market information (level two); and the lowest priority to unobservable inputs that reflect the assumptions that we consider market participants would normally use (level three). At 31 December 2016, financial investments amounting to US$164.2m (2015: US$61.5m) were classified as level three. The classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. Any change to investment valuations may affect our results of operations and reported financial condition. For further information, refer to Note 21. FINANCIAL STATEMENTS76 Brit Limited Annual Report 2016 3 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS IN APPLYING ACCOUNTING POLICIES (continued) 3.6 Defined benefit plans The amounts recognised in the consolidated financial statements in respect of the Group’s defined benefit pension plan are determined using actuarial valuations, which involves making assumptions that may differ from actual developments in the future. These include the determination of the discount rate, inflation, mortality rates and future pension increases. Due to the complexities involved in the valuation and its long‑term nature, a defined benefit obligation is highly sensitive to changes in these assumptions. All assumptions are reviewed at each reporting date. The carrying amount of the pension asset at the date of the statement of financial position was US$42.5m (2015: US$52.1m). For further information, refer to Note 20. 4 RISK MANAGEMENT POLICIES This Note provides details of key risks that the Group is exposed to and explains the Group’s strategies and the role of management in mitigating these risks. 4.1 Insurance risk Insurance risk arises from the possibility of an adverse financial result due to actual experience being different from that expected when an insurance product was designed and priced. The actual performance of insurance contracts is subject to the inherent uncertainty in the occurrence, timing and amount of the final insurance liabilities. This is the principal risk the Group is exposed to as the Group’s primary function is to underwrite insurance contracts. The risk arises due to the possibility of insurance contracts being under‑priced, under‑reserved or subject to unforeseen catastrophe claims. The areas of insurance risk discussed below include underwriting (including aggregate exposure management), reinsurance and reserving. 4.1.1 Underwriting risk (a) Introduction This is the risk that insurance premiums will not be sufficient to cover the future losses and associated expenses. It arises from the fluctuations in the frequency and severity of financial losses incurred through the underwriting process by the Group as a result of unpredictable events. The Group is also exposed to the risks resulting from its underwriters accepting risks for premiums which are insufficient to cover the ultimate claims which result from such policies. This risk is considered to be heightened in the current competitive underwriting environment which is resulting in significant downwards pressure on premium rates. This trend in premium rates has been factored into the Group’s pricing models and risk management tools and is continually monitored to assess whether any corrective action is required. Additional controls over the underwriting strategy are described in the section below. The Group writes all of its business through Lloyd’s and therefore can take advantage of Lloyd’s centralised infrastructure and service support. Lloyd’s also has an established global distribution framework, with extensive licensing agreements providing the Group access to over 200 territories. Exclusively using the Lloyd’s platform subjects the Group to a number of underwriting risks. The Group relies on the efficient functioning of the Lloyd’s market and if for any reason, Brit Syndicates Limited (BSL) is restricted or otherwise unable to write insurance through the Lloyd’s market, this would have a material adverse effect on the Group’s business and results of operations. In particular, any damage to the brand or reputation of Lloyd’s, increase in tax levies imposed on Lloyd’s participants or deterioration in Lloyd’s asset base when compared with its liabilities may have a material adverse effect on the Group’s ability to write new business. BSL also benefits from the ability to write business based on the Lloyd’s financial rating, which allows the Group to write more business as part of the Lloyd’s platform. A downgrade in Lloyd’s financial strength ratings may have an adverse effect on the Group. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 77 (b) Controls over underwriting strategy The Board sets the Group’s underwriting strategy for accepting and managing underwriting risk. The UK Underwriting Committee meets monthly to drive the underwriting strategy and to monitor performance against the plans. The assessment of underwriting performance is all‑encompassing applying underwriting key performance indicators (KPIs), technical pricing management information (MI), premium monitoring, delegated underwriting operations and claims. The risks are managed by the committee in line with the underwriting risk policy and within the risk tolerance set by the Board. The underwriting risk policy also sets out a number of controls, which are summarised below. The Group carries out a detailed annual business planning process for each of its underwriting units. The resulting plans set out premium, territorial and aggregate limits and reinsurance protection thresholds for all classes of business and represent a key tool in managing concentration risk. Performance against the plans is monitored on a regular basis by the Underwriting Committee as well as by the Boards of the regulated entities. A dedicated Exposure Management Team also performs Realistic Disaster Scenario (RDS) analysis on a regular basis to ensure that the Group’s net losses remain within its risk appetite. The Group has developed underwriting guidelines, limits of authority and business plans which are binding upon all staff authorised to underwrite. These are detailed and specific to underwriters and classes of business. Gross and net line size limits are in place for each class of business with additional restrictions in place on catastrophe exposed business. A proportion of the Group’s insurance risks are written by third parties under delegated underwriting authorities, with the remaining being written through individual risk acceptances or through reinsurance treaties. The third parties are closely vetted in advance and are subject to tight reporting requirements. In addition, the performance of these contracts is closely monitored by underwriters and regular audits are carried out. The technical pricing framework ensures that the pricing process in the Group is appropriate. It ensures pricing methodologies are demonstrable and transparent and that technical (or benchmark) prices are assessed for each risk. The underwriting and actuarial functions work together to maintain the pricing models and assess the difference between technical price and actual price. The framework also ensures that sufficient data is recorded and checked by underwriters to enable the Group to maintain an effective rate monitoring process. Compliance is checked through both a peer review process and, periodically, by the Group’s internal audit department which is entirely independent of the underwriting units. In order to limit risk, the number of reinstatements per policy is limited, deductibles are imposed, policy exclusions are applied and whenever allowed by statute, maximum indemnity limits are put in place per insured event. (c) Underwriting risk profile The core insurance portfolio of property, aviation, marine, energy and casualty covers a variety of largely uncorrelated events and also provides some protection against the underwriting cycle as different classes are at different points in the underwriting cycle. The underwriting portfolio is managed to target top quartile underwriting performance and the mix of business is continually adjusted based on the current environment (including the current pricing strength of each class). This assessment is conducted as part of the business planning and strategy process which operates annually and uses inputs from the technical pricing framework. The business plan is approved by the Board and is monitored monthly. The Group underwrites a well‑diversified portfolio across multiple regions and classes. While underlying risk and the policyholder may be situated anywhere in the world, more than 86% of the GWP of the Group in 2016 was sourced in London. The other business written by the syndicate is sourced through a wholly‑owned service company in the United States, which business accounted for 9.8% of the Group’s annual GWP in 2016. The Group also writes business from its office in Bermuda, with BGSB accounting for 3.2% of the Group’s annual GWP in 2016, and through the Lloyd’s China Platform and the recently established Singapore office. In 2016, 18.5% of the Group’s GWP was reinsured to third parties. FINANCIAL STATEMENTS78 Brit Limited Annual Report 2016 (d) Geographical concentration of premium The Group enters into policies with policyholders from all over the world, with the underlying risk relating to premiums spread worldwide. This allows the Group to benefit from a wide geographic diversification of risk. The three principal locations of the Group’s policyholders are the United States, UK and Ireland and mainland Europe. The concentration of insurance premium before and after reinsurance by the location of the underlying risk is summarised below: 2016 United States United Kingdom Europe (excluding UK) Other (including worldwide) 2015 United States United Kingdom Europe (excluding UK) Other (including worldwide) Gross premiums written US$m Net premiums written US$m 843.1 106.7 110.8 851.6 656.4 100.4 73.8 649.6 1,912.2 1,480.2 857.5 120.3 121.3 900.1 675.3 102.4 83.3 768.8 1,999.2 1,629.8 The nature of the London Market business is such that the insureds and reinsureds are often operating on a multi‑territory or worldwide basis and hence coverage is often provided on a worldwide basis. Premiums written on a multi‑territory or worldwide basis are included in ‘other’ in the table above. (e) Portfolio mix The Group’s third party underwriting takes place through the syndicate underwriting business in a wide variety of business lines. The business lines can be broken down into four principal categories: (i) short‑tail direct insurance; (ii) long‑tail direct insurance; (iii) short‑tail reinsurance; and (iv) long‑tail reinsurance. The breakdown of premium before reinsurance by principal lines of business is summarised below: Short‑tail direct insurance Long‑tail direct insurance Short‑tail reinsurance Long‑tail reinsurance Other Property, marine, energy, accident and health, BGSU, aerospace, terrorism and political Professional lines, specialty lines, specialist liability Property treaty Casualty treaty Other underwriting and other corporate 2016 Gross premiums written % US$m 56% 25% 8% 11% – 1,141.8 492.1 151.5 213.6 0.2 2015 Gross premiums written % 57% 24% 8% 11% <1% US$m 1,076.1 470.3 153.2 212.6 – 1,912.2 100% 1,999.2 100% The Group underwrites a business mix of both insurance and reinsurance, long and short‑tail business across a number of geographic areas which results in a diversification of the Group’s portfolio. The business mix is monitored on an ongoing basis with particular focus on the short‑tail vs. long‑tail split and the proportion of delegated underwriting business. Long‑tail business makes up 35.7% of the portfolio at 31 December 2016 (2015: 35.3%) and delegated underwriting represents 41.5% (2015: 40.4%). Underwriting risk is mainly driven by the syndicate’s US catastrophe exposure. Casualty treaty is also a driver due to its long‑tail exposure. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 79 (i) Short‑tail direct insurance Short‑tail insurance generally refers to lines of business where the claims are typically settled within a short time of the claim being made; therefore, they are typically classes where a large element of the claims is property damage. The Group’s short‑tail business consists of six principal lines of business: Property Marine Energy US specialty Property coverage including business interruption on a worldwide basis and delegated underwriting business predominantly in North America. Coverage for cargo (including specie and fine art), hull (including yacht) and marine liability. Coverage for upstream (offshore) and midstream activities related to oil and gas production. Public and non‑profit package on both a self‑insured retention (SIR) and first dollar basis; property and liability package business for US criminal justice service operations; property direct and facultative reinsurance. Accident and health Coverage for personal accident (including kidnap and ransom), bloodstock and contingency Terrorism and political Coverage for terrorism, political and credit risks, and cyber terrorism. Aviation Coverage for aviation risks, including airlines, general aviation and satellites at both launch and in orbit The key risks on short‑tail business are exposures to catastrophe claims, particularly US windstorms, earthquakes, floods and terrorist events. The property lines are also exposed to an increased frequency of fire and weather related events. Coverage on energy is provided in respect of physical damage and business interruption/loss of income and would be exposed to large individual claims and extreme catastrophe losses. Within US specialty, the syndicate writes business in property direct and facultative reinsurance exposed to wind, earthquake and flood catastrophe claims as well as expanding in a number of niche casualty lines. Accident and health offers further diversification due to low correlation with other business lines. Personal accident has the potential to suffer from large losses due to a high concentration of multiple deaths from a catastrophe or large claims from highly valued insured individuals. Medical expense claims are subject to high inflationary costs and may experience a high claim frequency. Both bloodstock and contingency classes have exposure to multiple claims from a single event/location. Terrorism, aerospace and political classes have key exposures to single catastrophe events and terrorist events or a series of losses. (ii) Long‑tail direct insurance Long‑tail insurance refers to insurance where on average the claims are not settled for several years after the expiry of the policy. The long‑tail direct insurance business can be categorised into two principal lines of business: Casualty Includes cover for financial institutions, legal expenses, directors’ and officers’, and professional lines as well as Cyber, Privacy and Technology. Specialist liability Cover for employers’ liability and public liability both in the UK and internationally but excluding the US. Key exposures on casualty lines lie with increasing claim frequency due to global recessionary events or international systemic malpractice, as well as an increasing prevalence of cyber risk. The specialist liability portfolio is subject to large losses resulting in bodily injury claims. This portfolio is also exposed to the risk of latent claims arising from risks that were not envisaged at the time of writing the policy. FINANCIAL STATEMENTS80 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) (iii) Short‑tail reinsurance The Group’s short‑tail reinsurance business centres around property treaty written in both London and Bermuda. This typically covers catastrophic loss accumulation or individual large loss ceded by insurance and reinsurance company clients. The key exposures which property treaty is exposed to are US windstorms and Californian earthquakes. Property treaty also has exposures to Japanese earthquakes and European windstorms. Property treaty Catastrophe excess of loss, risk excess of loss reinsurance and retrocession. (iv) Long‑tail reinsurance Introduction The Group’s long‑tail reinsurance business centres around casualty treaty. Core lines of business include officers’, workers’ compensation, medical malpractice, accident & health, and other accident classes including property terror. Casualty treaty Casualty and accident treaty reinsurance. Worldwide portfolio, presently written on excess of loss basis. The largest regional block is the US and Canada. The account is a mix of risk, catastrophe and clash business. The key risks this division is exposed to include exposure to man‑made catastrophe claims such as terrorism, increased claim activity in the event of an economic downturn and the potential for latent claims which were not foreseen at the time the policies were underwritten. This division contains the longest tailed liabilities the Group holds, i.e. there can be a significant delay between the notification and final settlement of a claim. This delay can result in the final settlement being subject to significant claims inflation. (v) Aggregate exposure management The Group is exposed to the potential of large claims from natural catastrophe events. The Group’s catastrophe risk tolerance is reviewed and set by the Board on an annual basis. The Board has last reviewed its natural and non‑natural catastrophe risk tolerances in April 2016. Overall, the Group has a maximum catastrophe risk tolerance for major catastrophe events (as measured through world wide all perils 1‑in‑30 AEP) of 25% of Brit Limited Group level net tangible assets. This equates to a maximum acceptable loss (after all reinsurance) of US$268.7m at 31 December 2016. The Group closely monitors aggregation of exposure to natural catastrophe events against agreed risk appetites using stochastic catastrophe modelling tools, along with knowledge of the business, historical loss information, and geographical accumulations. Analysis and monitoring also measures the effectiveness of the Group’s reinsurance programmes. Stress and scenario tests are also run, such as Lloyd’s and internally developed Realistic Disaster Scenarios (RDS). The selection of the RDS is adjusted with development of the business. Below are the key RDS losses to the Group for all classes combined (unaudited): Gulf of Mexico windstorm Florida Miami windstorm US North East windstorm San Francisco earthquake Japan earthquake Japan windstorm European windstorm Estimated industry loss US$m 113,500 128,250 80,500 87,750 44,716 13,329 25,595 Modelled Group loss at 1 October 2016 (Note 1) Net US$m Gross US$m 829 654 748 716 237 92 228 191 168 156 282 156 58 163 Modelled Group loss at 1 October 2015 (Note 1) Net US$m 174 149 155 222 150 52 127 Gross US$m 813 601 737 716 207 79 190 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 81 Note 1: At 31 December 2016 foreign exchange rates. Actual results may differ materially from the losses above given the significant uncertainties within model assumptions, techniques and simulations applied to calculate these event loss estimates. There could also be unmodelled losses which result in actual losses exceeding these figures. Moreover, the portfolio of insured risks changes dynamically over time. (vi) Sensitivity to changes in net claims ratio The Group profit on ordinary activities before tax is sensitive to an independent 1% change in the net claims ratio (excluding the effect of foreign exchange on non‑monetary items) for each class of business as follows: Short‑tail direct insurance Long‑tail direct insurance Short‑tail reinsurance Long‑tail reinsurance Other Movement in profit year ended 31 December 2016 % US$m Movement in profit year ended 31 December 2015 % US$m 9.0 3.1 0.8 2.1 0.2 59% 20% 5% 14% 2% 9.5 3.8 0.8 2.1 0.3 57% 23% 5% 13% 2% 15.2 100% 16.5 100% Subject to taxation, the impact on shareholders’ equity would be the same as that on profit following a change in the net claims ratio. 4.1.2 Reinsurance The Group purchases reinsurance to manage its exposure to individual risks and aggregation of risks arising from individual large claims and catastrophe events. This allows the Group to mitigate exposure to insurance losses against the risk appetite, reduce volatility of reported results and protect capital. Proportional quota share reinsurance is purchased to provide protection against claims arising either from individual large claims or aggregation of losses. Quota share reinsurance is also used to manage the Group’s net exposure to classes of business where the Group’s risk appetite is lower than the efficient operating scale of the class of business on a gross of reinsurance basis. These placements are reviewed on the basis of market conditions. The Group also has in place a comprehensive programme of excess of loss reinsurances to protect itself from severe size or frequency of losses: • Facultative reinsurance is used to reduce risk relating to individual contracts. The amount of cover bought varies by class of business. Facultative reinsurance is also used as a tool to manage the net line size on individual risks to within tolerance. • Risk excess of loss reinsurance is used to protect a range of individual inwards contracts which could give rise to individual large claims. The optimal net retention per risk is assessed for each class of business given the Group’s risk appetite during the business planning exercise. • An aggregate catastrophe excess of loss cover is in place to protect the Group against combined property claims from multiple policies resulting from catastrophe events. This is supplemented by specific covers for peril regions, catastrophe swaps and industry loss warranties where they are a cost‑efficient means to ensure that the Group remains within its catastrophe risk appetite. FINANCIAL STATEMENTS 82 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) Given the fundamental importance of reinsurance protection to the Group’s risk management, the Group has in place internal controls and processes to ensure that the reinsurance arrangements provide appropriate protection of capital and maintain our ability to meet policyholder obligations. The Head of Outwards Reinsurance, the Group CEO, Chief Underwriting Officer and Chief Risk Officer propose external reinsurance arrangements with input from class underwriters for class level reinsurance. The Group CEO, Chief Financial Officer and Chief Underwriting Officer propose reinsurance arrangements with BIG. All reinsurance purchases must be signed off by the Group’s Underwriting Committee. The Head of Outwards Reinsurance monitors and reports on the placement of reinsurance protections. The Group remains exposed to a number of risks relating to its reinsurance programme: • It is possible for extremely severe catastrophe losses to exhaust the reinsurance purchased. Any losses exceeding the reinsurance protection would be borne by the Group. • Some parts of the programme have limited reinstatements which limit the amount that may be recovered from second or subsequent claims. If the entirety of the cover is exhausted, it may not be possible to purchase additional reinsurance at a reasonable price. • A dispute may arise with a reinsurer which may mean the recoveries received are lower than anticipated. These risks are managed through a combination of techniques and controls including exposure management, capital modelling and internal actuarial review of outward reinsurance costs. The counterparty risk in relation to reinsurance purchased is managed by the Credit Committee. This is further discussed in the Credit risk section below. 4.1.3 Reserving risk Reserving risk arises as the actual cost of losses for policyholder obligations incurred before 31 December 2016 from the established reserves due to inaccurate assumptions or unforeseen circumstances. This is a key risk for the Group as the reserves for unpaid losses represent the largest component of the Group’s liabilities and are inherently uncertain. The BSL Reserving Committee is responsible for the management of Syndicate 2987’s reserving risk, and the BIG Management Committee performs a similar function for BIG. The Group has a rigorous process for establishing reserves for insurance claim liabilities and a number of controls are used to mitigate reserving risk. The reserving process starts with controls over claims data which ensure complete and accurate recording of all paid and notified claims. Claims adjusters validate policy terms and conditions, adjust claims and investigate suspicious or disputed claims in accordance with the Group’s claims policy. Case reserves are set for notified claims using the experience of specialist claims adjusters, underwriters and external experts where necessary. Whilst the case reserve is expected to be sufficient to meet the claims amount when it is settled, incurred but not reported (IBNR) claims require additional reserves. This is particularly the case for the longest tailed classes of business where the final settlement can occur several years after the claim occurred. Actuarial triangulation techniques are employed by the Group’s experienced actuaries to establish the IBNR reserve. These techniques project IBNR reserves based on historical development of paid and incurred claims by underwriting year. For the most uncertain claims, the triangulation techniques are supplemented by additional methods to ensure the established reserve is appropriate. The actuarial team work closely with other business functions such as underwriting, claims and exposure management to ensure that they have a full understanding of the emerging claims experience across the Group. Further details on the actuarial methods used can be found in Note 19. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 83 The Group’s reserving policy sets out the approach to estimating claims provisions and is designed to produce accurate and reliable estimates that are consistent over time and across classes of business. The actuarial best estimate set out in the policy is subject to Reserving Committee and Brit Insurance Gibraltar Management Committee sign‑off as part of the formal governance arrangements for the Group. The estimate agreed by the committees is used as a basis for the consolidated financial statements. A management risk margin is also applied over and above the actuarial best estimate to allow for the inherent uncertainty within the best estimate reserve position and wider inherent uncertainty across the economic and insurance environment. Finally, the reserves in the financial statements are presented to the Audit Committee for recommendation to the Board who are responsible for the final sign‑off. As part of their audit engagement, reserves are subject to external actuarial review by Brit’s auditors. The reserves can be more or less than is required to meet the claims arising from earned business. The level of uncertainty varies significantly between the classes written by the Group but typically is highest for those classes where there are significant delays in the settlement of the final claim amount. More specifically, the key areas of uncertainty within the Group’s reserves are considered to be claims from the long‑tailed direct and long‑tailed reinsurance classes. The issues contributing to this heightened uncertainty are common to all entities which write such business. Further details on the reserve profile and claims development tables can be found in Note 19. 4.2 Investment risk management 4.2.1 Introduction This section describes the Group’s approach to managing its investment risk, from both a quantitative and a qualitative perspective. Investment risk includes market risk (which is covered in section 4.3), investment credit risk (which is covered in section 4.4) and liquidity risk (which is covered in section 4.5). 4.2.2 Investment governance framework Investment risk is managed in line with the elements of the Group Risk Management Framework (RMF) – identification, measurement and management. The Board has overall responsibility for determining the investment strategy, including defining the risk tolerance. This is achieved through investment policies and guidelines, which reflect the risk appetite and the business strategy of the Group. The entity Investment Committees have been mandated to review, advise and make recommendations to the respective Boards on investment strategy with a view to optimising investment performance. The Investment strategy is executed through an outsourced investment management agreement, which is in line with prevailing regulations, with Hamblin Watsa Investment Counsel Ltd. (HWIC). The Risk Oversight Committee ensures that the investment risk is managed within the framework and also reports to the Board. An Investment Operations Committee oversees the operational risk that is relevant to the investment management function. Information is provided at least quarterly covering portfolio composition, performance, forecasting and the results of stress and scenario tests. Any operational issues and breaches to the risk appetite framework are reported to the Risk Oversight Committee and the Board. 4.2.3 Risk tolerance Investment risk tolerances are set by the Board, defining the Group’s appetite to investments, solvency risk, concentration risk, credit quality, currency risk and liquidity risk. The appetite to these elements of investment risk is derived from the overall risk appetite and business strategy of the Group and reflects a number of factors, including the current and expected economic climate, capital management strategy, liquidity needs and asset liability matching (ALM) policy. The investment risk tolerance helps determine the strategic asset allocation. Risk metrics are monitored and reported on regularly to ensure that performance is within the Board‑approved levels, and limits continue to remain appropriate, within the governance framework highlighted above. FINANCIAL STATEMENTS84 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) 4.2.4 Solvency matching Assets are considered by both currency and duration profile in relation to the liabilities thereby managing the impact of foreign exchange and interest rate risk on the solvency position. Under this strategy, the total assets of each Group underwriting entity are sought to be held in proportion to the currencies of that entity’s technical provisions. For each Group underwriting entity, a solvency matched benchmark is calculated. This benchmark is the cashflow profile for investments which would minimise the sensitivity of the Group’s solvency position to changes in interest and exchange rates. The Group seeks to implement this through the use of cash, investments and foreign exchange forward contracts in the respective currencies. The investment guidelines for each entity stipulate duration limits and the positioning and sensitivity for both the asset and solvency position is reported quarterly. 4.2.5 Investment management The investment management strategy is delivered, at the entity level, through outsourced investment management Agreements (IMAs) with HWIC and a range of other third party investment managers. The IMAs prescribe the investment parameters within which HWIC are permitted to make asset allocation decisions on behalf of the respective entities. Each of the Group’s investing entities is governed by separate investment policies; these detail the parameters, roles and responsibilities relating the management of each entity’s investment portfolio. 4.3 Market risk 4.3.1 Introduction Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises three types of risk: interest rate risk, currency risk and other price risk. Credit risk on financial investments and cash is covered in the credit risk section. 4.3.2 Interest Rate Risk Introduction Interest rate risk is the risk that the fair value and/or future cash flows of a financial instrument will fluctuate because of changes in interest rates. The Group is exposed to interest rate risk through its investment portfolio, borrowings and cash and cash equivalents. The sensitivity of the price of these financial exposures is indicated by their respective durations. This is defined as the modified duration which is the change in the price of the security subject to a 100 basis points parallel shift in interest rates. The greater the duration of a security, the greater the possible price volatility. The banded durations of the Group’s financial investments and cash and cash equivalents sensitive to interest rate risk are shown in the table below: Duration At 31 December 2016 Cash and cash equivalents Financial Investments At 31 December 2015 Cash and cash equivalents Financial Investments 1 year or less US$m 1 to 3 years US$m 3 to 5 years US$m Over 5 years US$m Equities US$m Total US$m 1,025.5 1,888.8 2,914.3 581.0 1,913.2 2,494.2 – 181.7 181.7 – 257.4 257.4 – 132.7 132.7 – 77.9 77.9 – 300.9 300.9 – 816.8 816.8 – 1,025.5 399.8 2,903.9 399.8 3,929.4 – 265.5 581.0 3,330.8 265.5 3,911.8 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 85 The duration of the investment portfolio is set within an allowable range relative to the targeted duration and monitored on a quarterly basis. As the claims liabilities are measured on an undiscounted basis, the reported liabilities are not sensitive to changes in interest rates. Therefore there is a balance to be struck between targeting a longer duration to protect the solvency position against movements in interest rates, whilst targeting a shorter duration will reduce the possible volatility around the income statement. Sensitivity to changes in investment yields The sensitivity of the profit to the changes in investment yields is set out in the table below. The analysis is based on the information at 31 December 2016. Impact on profit before tax Increase 25 basis points 50 basis points 100 basis points Decrease 25 basis points 50 basis points 100 basis points 2016 US$m 2015 US$m (10.0) (20.0) (40.0) (61.1) (122.1) (244.3) 10.0 20.0 40.0 61.1 122.1 244.3 Subject to taxation, the effect on shareholders’ equity would be the same as the effect on profit. 4.3.3 Currency risk Introduction Currency risk is the risk that movements in exchange rates impact the financial performance or solvency position of the Group. The Group matches assets to liabilities for each of the main currencies. Group capital is held in proportion to the liabilities, to minimise the impact on solvency and distributable earnings from movements in exchange rates. The split of assets and liabilities for each of the Group’s main currencies, converted to US dollars, is set out in the tables below: At 31 December 2016 Total assets Total liabilities Net assets At 31 December 2015 Total assets Total liabilities Net assets USD US$m GBP. conv. US$m CAD $ conv. US$m EUR € conv. US$m AUS $ conv. US$m Total conv. US$m 4,553.2 3,195.3 883.1 950.6 264.8 269.1 209.9 301.6 64.6 5,975.6 111.0 4,827.6 1,357.9 (67.5) (4.3) (91.7) (46.4) 1,148.0 3,743.0 3,040.7 1,111.6 1,035.9 702.3 75.7 467.8 211.0 256.8 462.4 311.9 150.5 136.0 164.8 5,920.8 4,764.3 (28.8) 1,156.5 FINANCIAL STATEMENTS 86 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) The non‑US dollar net assets of the Group may lead to profits or losses (depending on the mix relative to the liabilities), should the US dollar vary relative to these currencies. Foreign currency forward contracts may be used to achieve the desired exposure to each currency. From time to time the Group may also choose to utilise foreign currency options to manage the risk of reported losses due to changes in foreign exchange rates. The details of all foreign currency derivatives contracts entered into are given in Note 22. As a result of the accounting treatment for non‑monetary items, the Group may also experience volatility in its income statement due to fluctuations in exchange rates. In accordance with IFRS, non‑monetary items are recorded at original transaction rates and are not re‑valued at the reporting date. These items include unearned premiums, deferred acquisition costs and reinsurers’ share of unearned premiums. This means these amounts in the statement of financial position are carried at a different exchange rate to the remaining assets and liabilities, with the resulting exchange differences that are created being recognised in the income statement. The Group considers this to be a timing issue which can cause volatility in the income statement. Sensitivity to changes in foreign exchange rates The table below gives an indication of the impact on profit of a percentage movement in the relative strength of the US dollar against the value of Sterling, Canadian dollar, Australian dollar and Euro simultaneously, after taking into consideration the effect of hedged positions. The analysis is based on the information at 31 December 2016. Impact on profit before tax US dollar weakens 10% against other currencies 20% against other currencies US dollar strengthens 10% against other currencies 20% against other currencies 2016 US$m 2015 US$m (38.6) (77.3) 83.6 167.1 38.6 77.3 (83.6) (167.1) Subject to taxation, the effect on shareholders’ equity would be the same as the effect on profit. 4.3.4 Other price risk Introduction This is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than those arising from interest rate risk or currency risk), whether those changes are caused by factors specific to the individual financial instrument or its issuer, or factors affecting all similar financial instruments traded in the market. Financial assets and derivatives that are recognised at their fair value are susceptible to losses due to adverse changes in their prices. This is known as price risk. Listed investments are recognised in the financial statements at quoted bid price. If the market for the investment is not considered to be active, then the Group establishes fair valuation techniques. This includes using recent arm’s length transactions, reference to current fair value of other similar investments, discounted cash flow models and other valuation techniques that are commonly used by market participants. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 87 The prices of fixed and floating rate income securities are predominantly impacted by currency, interest rate and credit risks. Credit risk on investments is discussed in the following section of this Note. The Group invests a proportion of its assets in equities and residential mortgage‑backed securities (RMBS) and Undertaking for Collective Investment in Transferable Securities (UCITS). These investments are limited within the investment guidelines to a diverse, small and manageable part of the Group investment portfolio. Sensitivity to changes in other price risk The sensitivity of the profit to the changes in the prices of equity, residential mortgage‑backed securities (RMBS) and UCITS investments is set out in the table below. The analysis is based on the information at 31 December 2016. Impact on profit before tax Increase in fair value 10% 20% 30% Decrease in fair value 10% 20% 30% 2016 US$m 2015 US$m 47.9 95.8 143.7 35.8 71.7 107.5 (47.9) (95.8) (143.7) (35.8) (71.7) (107.5) Subject to taxation, the effect on shareholders’ equity would be the same as the effect on profit. 4.4 Credit risk This is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation in a timely manner. The main sources of credit risk relate to: • Reinsurers: through the failure to pay valid claims against a reinsurance contract held by the Group. • Brokers and coverholders: where counterparties fail to pass on premiums or claims collected or paid on behalf of the Group. • Investments through the issuer default of all or part of the value of a financial instrument or the market value of that instrument. • Cash and cash equivalents: through the default of the banks holding the cash and cash equivalents. The insurance and non‑insurance related counterparty credit risks are managed separately by the Group. 4.4.1 Investment credit risk Investment credit risk management process The Investment Committee chaired by Simon Lee, a Non‑Executive Director of Brit Syndicates Limited, is responsible for the management of investment credit risk. The investment guidelines and investment policy set out clear limits and controls around the level of investment credit risk. The Group has established concentration guidelines that restrict the exposure to any individual counterparty. The investment guidelines further limit the type, credit quality and maturity profile of both the Group’s cash and investments. In addition, the investment risk framework further limits potential exposure to credit risk through aggregate investment risk limits. FINANCIAL STATEMENTS 88 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) Investment credit risk profile The summary of the investment credit risk exposures for the Group is set out in the tables below: At 31 December 2016 Financial investments Derivative contracts Cash and cash equivalents At 31 December 2015 Financial investments Derivative contracts Cash and cash equivalents AAA US$m AA US$m A US$m P‑1 US$m P‑2 US$m 206.2 1,706.2 – 552.8 – 187.5 212.4 – – – – 236.8 393.7 2,259.0 212.4 236.8 298.9 – 428.8 1,612.1 – – 727.7 1,612.1 288.1 – – 288.1 692.3 – 30.4 722.7 – – 48.4 48.4 – – 121.8 121.8 BBB and below US$m 191.9 – – 191.9 63.2 – – 63.2 Equities US$m Not rated US$m Total US$m 399.8 – – 399.8 265.5 – – 265.5 187.4 2,903.9 12.6 – 1,025.5 12.6 200.0 3,942.0 110.7 63.6 – 3,330.8 63.6 581.0 174.3 3,975.4 The table above gives an indication of the level of credit worthiness of assets that are most exposed to credit risk. The ratings are mainly sourced from Standard & Poor’s and where these are not available an equivalent rating agency. 4.4.2 Insurance credit risk Insurance credit risk management process The Credit Committee chaired by the Chief Financial Officer is responsible for the management of credit risk arising from insurance activities. Some responsibilities for reinsurance related credit decisions have been delegated to the Reinsurance Security Committee chaired by the Head of Group Financial Performance. Reinsurer credit risk is managed by transacting only with reinsurance counterparties that satisfy a minimum level of financial strength or provide appropriate levels of collateral, and have been approved for use by the Reinsurance Security Committee. The reinsurer security list, which sets out the list of approved reinsurance counterparties, is reviewed at least annually and following any significant change in risk profile, which includes any changes to reinsurers’ financial ratings. Credit risk appetite limits are set for reinsurance entities and groups to limit accumulations of risk. These positions are monitored quarterly against current balance sheet exposures and in relation to a number of extreme loss scenarios. Reinsurance aged debt is monitored and managed against the management risk appetite limits set by the Credit Committee. A bad debt provision is held against all non‑rated reinsurers or any reinsurer where there is deemed to be a specific risk of non‑payment. Any breaches of credit risk tolerance and/or appetite are reported to the Risk Oversight Committee and the Board at least quarterly. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 89 Insurance credit risk profile The summary of the insurance credit risk exposures for the Group is set out in the tables below: At 31 December 2016 Reinsurance assets Insurance receivables At 31 December 2015 Reinsurance assets Insurance receivables AAA US$m AA US$m A US$m Collateral US$m Not rated US$m Total US$m 1.9 – 1.9 1.2 – 1.2 406.2 – 406.2 313.9 – 313.9 166.7 – 166.7 201.6 – 201.6 102.4 – 102.4 106.0 – 106.0 33.9 678.7 711.1 678.7 712.6 1,389.8 55.7 638.1 678.4 638.1 693.8 1,316.5 Insurance credit risk arises primarily from reinsurers (whereby reinsurers fail to pay recoveries due to the Group in a timely manner) and brokers and coverholders (whereby intermediaries fail to pass on premiums due to the Group in a timely manner). As at 31 December 2016, collateral of US$382.9m (2015: US$416.2m) is held in third party trust accounts or as a letter of credit (LOC) to guarantee Syndicate 2987 against reinsurance counterparties and is available for immediate drawdown in the event of a default. Of this amount, US$102.4m (2015: US$106.0m) had been drawn against reinsurance assets at 31 December 2016. The following table shows movements in impairment provisions during the year: Impairment provision against reinsurance assets US$m Impairment provision against insurance receivables US$m 2016 Opening provision at 1 January Release for the year Net foreign exchange differences Closing provision at 31 December 2015 Opening provision at 1 January Strengthening/(release) for the year Net foreign exchange differences Closing provision at 31 December The following table shows the amount of insurance receivables past due but not impaired at the end of the year. 0‑3 months past due 4‑6 months past due 7‑9 months past due 10‑12 months past due More than 12 months past due 1.0 – (0.3) 0.7 0.9 0.1 – 1.0 2016 US$m 14.7 1.9 1.6 1.7 1.9 21.8 12.9 (1.2) (0.1) 11.6 13.7 (1.5) 0.7 12.9 2015 US$m 22.4 2.1 1.5 2.0 2.3 30.3 FINANCIAL STATEMENTS 90 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) 4.5 Liquidity risk Liquidity risk is the risk that the Group may encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. The predominant liquidity risk the Group faces is the daily calls on its available cash resources in respect of claims arising from insurance contracts. The Group monitors the levels of cash and cash equivalents on a daily basis, ensuring adequate liquidity to meet the expected cash flow requirements due over the short‑term. The Group also limits the amount of investment in illiquid securities in line with the liquidity policy set by the Board. This involves ensuring sufficient liquidity to withstand claim scenarios at the extreme end of business plan projections, by reference to modelled realistic disaster scenarios. Contingent liquidity also exists in the form of a Group revolving credit facility. The tables below present the fair value of monetary assets and the undiscounted value of monetary liabilities of the Group into their relevant maturing groups based on the remaining period at the end of the year to their contractual maturities or expected repayment dates. Borrowings are stated at their nominal value at maturity. 31 December 2016 Assets Reinsurance assets Financial investments Derivative contracts Insurance receivables Cash and cash equivalents 31 December 2016 Liabilities Insurance contract liabilities Derivative contracts Borrowings Insurance and other payables 31 December 2015 Assets Reinsurance assets Financial investments Derivative contracts Insurance receivables Cash and cash equivalents Statement of financial position US$m Fair values <1 year US$m 1 to 3 years US$m 3 to 5 years US$m >5 years US$m Equities US$m Total US$m 711.1 199.0 2,903.9 1,888.8 12.6 678.7 1,025.5 1,025.5 12.6 678.7 5,331.8 3,804.6 Statement of financial position US$m 233.3 181.7 – – – 415.0 117.4 132.7 – – – 250.1 161.4 300.9 – – – 462.3 Undiscounted values – 711.1 399.8 2,903.9 12.6 – – 678.7 – 1,025.5 399.8 5,331.8 <1 year US$m 1 to 3 years US$m 3 to 5 years US$m >5 years US$m Equities US$m Total US$m 3,406.7 11.8 157.5 382.0 857.4 1,023.7 – – – 11.8 – 382.0 597.8 – – – 927.8 – 166.8 – 3,958.0 1,251.2 1,023.7 597.8 1,094.6 – – – – – 3,406.7 11.8 166.8 382.0 3,967.3 Statement of financial position US$m Fair values <1 year US$m 1 to 3 years US$m 3 to 5 years US$m >5 years US$m Equities US$m Total US$m 678.4 3,330.8 63.6 638.1 581.0 183.1 1,913.2 63.6 638.1 581.0 5,291.9 3,379.0 222.3 257.4 – – – 479.7 119.9 77.9 – – – 197.8 153.1 816.8 – – – 969.9 – 265.5 – – – 678.4 3,330.8 63.6 638.1 581.0 265.5 5,291.9 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 91 31 December 2015 Liabilities Insurance contract liabilities Derivative contracts Borrowings Insurance and other payables Statement of financial position US$m Undiscounted values <1 year US$m 1 to 3 years US$m 3 to 5 years US$m >5 years US$m Equities US$m Total US$m 3,324.1 12.5 185.6 350.0 777.1 12.5 – 350.0 3,872.2 1,139.6 990.0 – – – 990.0 592.6 – – – 964.4 – 199.0 – 592.6 1,163.4 – – – – – 3,324.1 12.5 199.0 350.0 3,885.6 4.6 Operational risk Operational risk is the potential for loss arising from the failure of people, process or technology or the impact of external events. The nature of operational risk means that it is dispersed across all functional areas of Brit. Operational risk exposures are managed through a consistent set of management processes that drive risk identification, assessment, control and monitoring. The Chief Operating Officer chairs the Operational Risk Working Group (ORWG) that provides a dedicated forum for managing operational risk in line with the Operational Risk policy and the risk tolerance and management appetite limits set by the Board and management respectively. This group reports to the Executive Committee and each individual risk committee where it is augmented by operational risk owners within executive management who actively manage operational risk within their respective areas (such as Underwriting, Claims, Investments and Finance). An operational risk management framework is in place to ensure an appropriate standard approach is taken to managing operational risk across the Group. The key elements of this framework are: • Allocation of responsibility for the identification and assessment of operational risk. Standard tools are used to facilitate these assessments; • Definition of standard elements of sound operating controls that are expected to be in place to address all identified operational risks; • A process that integrates with Brit’s internal model to support the setting and monitoring of operational risk appetite and tolerances; • Governance, reporting and escalation for operational risk; • Infrastructure supporting the operational risk management framework; and • Operational risk management training and awareness. 4.7 Capital management Brit defines management entity capital as the amount of capital that the board of each underwriting entity determines that it should hold, taking into account the requirements of shareholders, regulators, policyholders, and the Boards’ solvency risk appetite. The capital policy is set by the entity and Group Boards. Management entity capital requirements are in excess of capital requirements under the Solvency II capital regime, which became effective on 1 January 2016. The capital requirements are based on the output of the internal model which reflects the risk profile of the business. The capital policy requires capital to be held well in excess of regulatory minimum requirements, underpinning Brit’s financial strength. The policy ensures the capital adequacy of the Group as a whole, and each entity, through an efficient capital structure. Brit proactively responds to developments in the financial environment to ensure its capital strength is maintained whilst optimising risk adjusted returns. FINANCIAL STATEMENTS 92 Brit Limited Annual Report 2016 4 RISK MANAGEMENT POLICIES (continued) In addition to the management capital requirements, the Group Board has determined that the Group should maintain a minimum surplus, in excess of the entity management capital requirements, to withstand short‑term shocks without requiring a capital injection. The minimum surplus is calibrated to a 1‑in‑20 one‑year VaR (i.e. it is sufficient to protect against losses over a one‑year period in 19 out of 20 years whilst maintaining management capital). The Group minimum surplus is set with reference to the internal model. The Group’s available capital consists of net tangible assets, subordinated debt, letters of credit and contingent funding. This amounted to US$1,457.3m as at 31 December 2016. This represented a surplus of US$297.0m over the management capital requirements, compared to the Group’s minimum surplus of US$200.0m. All regulatory capital requirements have been complied with during the year by the Group’s individual insurance subsidiaries. The Lloyd’s market is subject to the solvency and capital adequacy requirements of the Prudential Regulation Authority (PRA). Any regulatory intervention by the PRA in respect of Lloyd’s may adversely affect the Group. The PRA may impose more stringent requirements on Lloyd’s which may result in higher capital requirements or a restriction on trading activities for entities within the Group. If Lloyd’s fails to satisfy its solvency test in any year, the PRA may require Lloyd’s to cease trading and/or its members to cease or reduce their underwriting exposure, which may result in a material adverse effect to the Group’s reputation, financial condition and results of operations. During 2016, Brit Global Specialty solely underwrote through the Group’s wholly‑aligned Lloyd’s Syndicate 2987 which benefits from the Lloyd’s credit ratings of A (Excellent) from A.M. Best, AA – (Very Strong) from Fitch and A+ (Strong) from Standard & Poor’s. Any downgrade in Lloyd’s financial strength ratings may have an adverse effect on the Group. The Group’s business plan and underwriting capacity for the Syndicate may be affected by a decrease in the value of the Group’s Funds at Lloyd’s or by recommendations from the Lloyd’s Franchise Board. The Group is also reliant upon the compliance of Lloyd’s with US regulations, including the maintenance by Lloyd’s of its trading licences and approvals in the US. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 93 5 SEGMENTAL INFORMATION This Note breaks down the operating results summarised in the income statement into the main business areas of the Group. It also shows how our revenue is split globally. This analysis is designed to help you understand how each segment of our business has performed and how we have allocated our shareholders’ capital. As at 31 December 2016, the reportable segments identified were as follows: • ‘Brit Global Specialty Direct’, which underwrites the Group’s international and US business, other than treaty reinsurance. In the main, Brit Global Specialty Direct deals with wholesale buyers of insurance, rather than individuals. Risks are large and usually syndicated by several underwriters by means of the subscription market. • ‘Brit Global Specialty Reinsurance’, which underwrites reinsurance business (essentially the insurance of insurance and reinsurance companies) and includes writing non‑proportional cover for major events such as earthquakes or hurricanes. These insurance and reinsurance companies calculate how much risk they want to retain and then pass on their remaining exposure to reinsurers in return for a premium. • ‘Other underwriting’, which comprises excess of loss reinsurance ceded from the strategic business units to a cell of Brit Insurance (Gibraltar) PCC Limited. • ‘Other corporate’, which is made up of residual income and expenditure not allocated to other segments. Foreign exchange differences on non‑monetary items are separately disclosed. This provides a fairer representation of the claims ratios and financial performance of the strategic business units (SBUs) which would otherwise be distorted by the mismatch arising from IFRSs whereby unearned premium, reinsurer’s share of unearned premium and deferred acquisition costs are treated as non‑monetary items and the majority of other assets and liabilities are treated as monetary items. Non‑monetary items are carried at historic exchange rates, while monetary items are translated at closing rates. The Group investment return is managed centrally and an allocation is made to each of the strategic business units based on the average risk free interest rate for the period being applied to the opening insurance funds of each strategic business unit. The annualised average risk free rate applied to insurance funds was 1.5% for the year ended 31 December 2016 (31 December 2015: 1.5%). The ratios set out in the segmental analysis are calculated as follows: • The claims ratio is calculated as claims incurred, net of reinsurance divided by earned premiums, net of reinsurance. • The expense ratio is calculated as acquisition costs and other insurance related expenses divided by earned premiums, net of reinsurance. • The combined ratio is the sum of the claims and expense ratios. FINANCIAL STATEMENTS94 Brit Limited Annual Report 2016 5 SEGMENTAL INFORMATION (continued) Information regarding the Group’s reportable segments is presented below. (a) Statement of profit or loss by segment Year ended 31 December 2016 Brit Global Specialty Direct US$m Brit Global Specialty Reinsurance US$m Other Underwriting US$m Intra Group US$m Total underwriting excluding the effect of foreign exchange on non‑monetary items US$m Effect of foreign exchange on non‑monetary items US$m 1,546.6 365.8 27.3 (27.5) 1,912.2 (377.9) (76.3) (5.3) 27.5 (432.0) – – Total underwriting after the effect of foreign exchange on non‑monetary items US$m 1,912.2 (432.0) 1,168.7 1,548.4 (339.8) 289.5 361.6 (76.1) 22.0 25.2 (4.2) – 1,480.2 (25.4) 1,909.8 (394.7) 25.4 – 1,480.2 23.8 1,933.6 (399.5) (4.8) Other corporate US$m – – – – – Total US$m 1,912.2 (432.0) 1,480.2 1,933.6 (399.5) Gross premiums written Less premiums ceded to reinsurers Premiums written, net of reinsurance Gross earned premiums Reinsurers’ share Earned premiums, net of reinsurance Investment return Return on derivative contracts Other income Net foreign exchange gains 1,208.6 27.5 – – – 285.5 10.5 – – – Total revenue 1,236.1 296.0 21.0 – – – – 21.0 – – – – – – 1,515.1 38.0 – – – 19.0 1,534.1 38.0 – – (9.0) – – – (9.0) – 94.2 (52.8) 1.1 61.2 1,534.1 132.2 (52.8) 1.1 52.2 1,553.1 10.0 1,563.1 103.7 1,666.8 Gross claims incurred Reinsurers’ share Claims incurred, net of reinsurance Acquisition costs – commission Acquisition costs – other Other insurance related expenses Other expenses Total expenses excluding finance costs (918.9) 210.7 (138.0) 14.5 (24.1) (0.3) 22.2 (22.2) (1,058.8) 202.7 – (1,058.8) 202.7 – – (1,058.8) 202.7 – (708.2) (360.3) (88.9) (123.5) (51.1) (19.4) (24.4) (0.2) (1.0) (64.9) (16.1) – – (2.5) – – – – – – (856.1) (411.6) (109.3) (83.5) – – (7.0) (3.0) (856.1) (418.6) (112.3) – – (83.5) – – – – – (21.3) (856.1) (418.6) (112.3) (83.5) (21.3) (1,222.3) (210.1) (28.1) – (1,460.5) (10.0) (1,470.5) (21.3) (1,491.8) Operating profit/(loss) 13.8 85.9 (7.1) – 92.6 – 92.6 82.4 175.0 Finance costs Share of prnet ofit of associate s Profit on ordinary activities before tax Tax income Profit for the year Claims ratio Expense ratio Combined ratio 58.6% 42.5% 101.1% 43.3% 116.2% 30.3% 17.6% 73.6% 133.8% 56.5% 39.9% 96.4% 55.8% 39.9% 95.7% (18.8) 3.6 159.8 (2.2) 157.6 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 95 Year ended 31 December 2015 Gross premiums written Less premiums ceded to reinsurers Premiums written, net of reinsurance Gross earned premiums Reinsurers’ share Earned premiums, net of reinsurance Investment return Return on derivative contracts Other income Total revenue Gross claims incurred Reinsurers’ share Claims incurred, net of reinsurance Acquisition costs – commission Acquisition costs – other Other insurance Brit Global Specialty Direct US$m Brit Global Specialty Reinsurance US$m Other Underwriting US$m Intra Group US$m Total underwriting excluding the effect of foreign exchange on non‑monetary items US$m 1,634.0 365.1 26.0 (25.9) 1,999.2 (319.6) (74.8) (0.9) 25.9 (369.4) Total underwriting after the effect of foreign exchange on non‑monetary items US$m 1,999.2 (369.4) Effect of foreign exchange on non‑monetary items US$m – – 1,314.4 1,636.6 (309.2) 290.3 370.4 (76.2) 1,327.4 26.0 – – 1,353.4 294.2 10.3 – – 304.5 25.1 29.3 (1.3) 28.0 – – – 28.0 – 1,629.8 (29.2) 2,007.1 (357.5) 29.2 – 1,629.8 (13.7) 1,993.4 (355.3) 2.2 1,649.6 36.3 – – (11.5) 1,638.1 36.3 – – – – – (954.4) 235.7 (125.0) (4.3) (33.4) (0.6) 30.3 (30.3) (1,082.5) 200.5 – – (1,082.5) 200.5 1,685.9 (11.5) 1,674.4 14.0 1,688.4 Other corporate US$m – – – – – – (26.0) 39.7 0.3 Total US$m 1,999.2 (369.4) 1,629.8 1,993.4 (355.3) 1,638.1 10.3 39.7 0.3 – – – – – (1,082.5) 200.5 (882.0) (426.5) (100.1) (101.8) (53.8) (95.9) (718.7) (376.8) (79.0) (129.3) (55.3) (15.3) (34.0) 2.9 (5.3) related expenses (79.2) (22.6) Other expenses Net foreign exchange losses Total expenses excluding – – – – – – – finance costs (1,253.7) (222.5) (36.4) Operating profit/(loss) 99.7 82.0 (8.4) Finance costs Profit on ordinary activities before tax Tax income Profit for the year (882.0) (429.2) (99.6) (101.8) – – – 2.7 (0.5) (882.0) (426.5) (100.1) – – (10.5) (101.8) – (10.5) – (53.8) (85.4) (1,512.6) (8.3) (1,520.9) (139.2) (1,660.1) 173.3 (19.8) 153.5 (125.2) 28.3 (20.6) 7.7 7.9 15.6 Claims ratio Expense ratio Combined ratio 54.1% 40.3% 94.4% 43.9% 31.9% 75.8% 121.4% 8.6% 130.0% 53.5% 38.2% 91.7% 53.8% 38.4% 92.2% – – – – – – – – – – – – – FINANCIAL STATEMENTS 96 Brit Limited Annual Report 2016 5 SEGMENTAL INFORMATION (continued) (b) Depreciation, amortisation, impairment and capital expenditure by segment Year ended 31 December 2016 Depreciation of property, plant and equipment Amortisation of intangibles Capital expenditure Year ended 31 December 2015 Depreciation of property, plant and equipment Impairment of property, plant and equipment Amortisation of intangibles Impairment of intangibles Capital expenditure Brit Global Specialty Direct US$m Brit Global Specialty Reinsurance US$m 3.0 4.2 11.8 0.6 1.0 2.8 Brit Global Specialty Direct US$m Brit Global Specialty Reinsurance US$m 2.3 1.4 6.7 0.5 21.0 0.6 0.4 1.7 0.1 5.3 Total US$m 3.6 5.2 14.6 Total US$m 2.9 1.8 8.4 0.6 26.3 Capital expenditure consists of additions of property, plant and equipment and intangible assets but excludes assets recognised on business combinations. (c) Geographical information The Group’s strategic business units operate mainly in four geographical areas, though the business is managed on a worldwide basis. The segmental split shown below is based on the location of the underlying risk. Gross premiums written United States United Kingdom Europe (excluding UK) Other (including worldwide) Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 843.1 106.7 110.8 851.6 857.5 120.3 121.3 900.1 1,912.2 1,999.2 The nature of the London Market business is such that the insureds and reinsureds are often operating on a multi‑territory or worldwide basis and hence coverage is often provided on a worldwide basis. Premiums written on a multi‑territory or worldwide basis are included in ‘Other’ in the table above. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 97 6 INVESTMENT RETURN This Note shows the income we have generated through investing our funds. It also shows the gains and losses that we have generated on various types of investment assets as a result of the movement in their market values. Year ended 31 December 2016 Equity securities Debt securities Loan instruments Specialised investment funds Cash and cash equivalents Total investment return before expenses Investment management expenses Total investment return Year ended 31 December 2015 Equity securities Debt securities Loan instruments Specialised investment funds Cash and cash equivalents Total investment return before expenses Investment management expenses Total investment return Investment income US$m Net realised Net unrealised gains gains/(losses) US$m US$m Total investment return US$m 5.1 66.8 – 1.1 0.7 73.7 (13.8) 59.9 (4.9) 64.1 – 3.1 – 62.3 – 62.3 (39.7) 45.8 – 3.9 – 10.0 – 10.0 (39.5) 176.7 – 8.1 0.7 146.0 (13.8) 132.2 Investment income US$m Net realised gains US$m Net unrealised gains/(losses) US$m Total investment return US$m 0.6 34.8 7.2 29.5 0.6 72.7 (11.9) 60.8 2.0 3.7 1.5 50.8 – 58.0 – 58.0 2.9 (32.5) (16.8) (62.1) – (108.5) – (108.5) 5.5 6.0 (8.1) 18.2 0.6 22.2 (11.9) 10.3 7 RETURN ON DERIVATIVE CONTRACTS This Note shows the effect on the income statement of derivative contracts we were party to during the year. The main reason we entered into these derivative contracts was to help manage our exposure to fluctuations in interest rates and foreign exchange rates. Derivatives are shown analysed between investment related derivatives and currency related derivatives, reflecting the way we manage our business. Interest rate swaps Futures Non‑currency options Investment related derivatives Currency forwards Currency options Currency related derivatives Return on derivative contracts Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 0.8 – (33.7) (32.9) (19.9) – (19.9) (52.8) (0.7) 0.1 (4.7) (5.3) 45.0 – 45.0 39.7 FINANCIAL STATEMENTS 98 Brit Limited Annual Report 2016 8 NET FOREIGN EXCHANGE GAINS/(LOSSES) The Group operates in multiple countries and currencies and is exposed to gains and losses arising as a result of movement in various foreign currency exchange rates. This Note explains the foreign exchange gains or losses as a result of converting the income, expenses, assets and liabilities from foreign currencies to US dollars. The Group recognised foreign exchange gains of US$52.2m (2015: losses of US$95.9m) in the income statement in the period. Foreign exchange gains and losses result from the translation of the Statement of Financial Position to closing exchange rates and the income statement to average exchange rates. However, as an exception to this, IAS 21 ‘The Effects of Changes in Foreign Exchange Rates’ requires that net unearned premiums and deferred acquisition costs (UPR/DAC), being non‑monetary items, remain at historic exchange rates. This creates a foreign exchange mismatch, the financial effects of which are shown in the table below. Gains/(losses) on foreign exchange arising from: Translation of the statement of financial position and income statement Maintaining UPR/DAC items in the statement of financial position at historic rates Maintaining UPR/DAC items in the income statement at historic rates Net foreign exchange gains/(losses) Principal exchange rates applied are set out in the table below. Sterling Canadian dollar Euro Australian dollar Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 61.1 – (8.9) 52.2 (85.4) (19.8) 9.3 (95.9) Year ended 31 December 2016 Closing 0.809 1.341 0.948 1.381 Average 0.738 1.323 0.903 1.343 Year ended 31 December 2015 Closing 0.678 1.389 0.921 1.374 Average 0.654 1.277 0.902 1.330 In accordance with IAS 1 ‘Presentation of Financial statements’, exchange gains and losses are presented on a net basis. They are reported within revenue where they result in a net gain and within expenses where they result in a net loss. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 99 9 ACQUISITION COSTS AND OTHER OPERATING EXPENSES This Note shows the analysis of costs incurred in acquiring and underwriting insurance contracts and the running costs of our business during the year. We have separated out the more material costs in order to provide a more detailed insight into our cost base. Salary, pension and social security costs (Note 10) Other staff related costs Accommodation costs Legal and professional charges IT costs Travel and entertaining Marketing and communications Amortisation and impairment of intangible assets Depreciation and impairment of property, plant and equipment Regulatory levies and charges Costs relating to acquisition by FFHL Group Limited Other Expenses before commissions Commission costs Total acquisition costs and other operating expenses Year ended 31 December 2016 Year ended 31 December 2015 Acquisition costs US$m Other operating expenses US$m 56.0 2.0 6.8 1.5 1.1 4.2 0.3 0.1 0.4 38.1 – 1.8 47.3 8.9 6.9 5.7 19.3 2.8 1.2 4.9 3.2 – – 4.6 112.3 418.6 530.9 104.8 – 104.8 Acquisition costs US$m Other operating expenses US$m 45.0 2.0 7.6 2.0 0.9 4.4 0.3 0.4 0.6 36.4 – 0.5 77.5 7.1 7.7 8.7 19.0 3.1 2.0 8.6 4.1 – 14.2 3.6 100.1 426.5 526.6 155.6 – 155.6 Total US$m 103.3 10.9 13.7 7.2 20.4 7.0 1.5 5.0 3.6 38.1 – 6.4 217.1 418.6 635.7 Total US$m 122.5 9.1 15.3 10.7 19.9 7.5 2.3 9.0 4.7 36.4 14.2 4.1 255.7 426.5 682.2 Salary, pension and social security costs for the year‑ended 31 December 2015 included a further US$9.6m relating to the acquisition by FFHL Group Limited, bringing the total corporate activity costs to US$23.8m. 10 STAFF COSTS This Note gives a breakdown of the total cost of employing our staff (including executive and non‑executive Directors) and gives the average number of people employed by the Group during the year. Wages and salaries Social security costs Pension costs Total staff costs Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 88.3 10.1 4.9 103.3 103.9 12.3 6.3 122.5 FINANCIAL STATEMENTS 100 Brit Limited Annual Report 2016 10 STAFF COSTS (continued) The average number of employees during the year, including executive and non‑executive Directors, was as follows: Front office staff Underwriters Claims staff Other underwriting and direct support staff Total front office staff Back office staff Management Administration Total back office staff Total employees Year ended 31 December 2016 Number Year ended 31 December 2015 Number 175 56 116 347 75 117 192 539 155 55 113 323 71 110 181 504 ‘Management’ includes non‑executive Directors and employees who have other members of staff reporting to them. 11 FINANCE COSTS Finance costs arise from interest due on moneys borrowed by the Group and any other amounts payable in respect of those borrowings or borrowing facilities. The Group’s borrowings consist of a revolving credit facility and listed unsecured subordinated debt, details of which are set out in Note 25. Revolving credit facility and other bank borrowings Subordinated debt Total finance costs 12 AUDITOR’S REMUNERATION Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 4.6 14.2 18.8 4.7 15.9 20.6 The Group engages PricewaterhouseCoopers LLP to perform the audit of the Group. The Group’s auditor has not been engaged to perform additional work. During 2016 PricewaterhouseCoopers LLP replaced Ernst & Young LLP as the Group’s auditors. The remuneration of the auditor or its associates is analysed as follows: Audit of the Group and company financial statements Fees payable for the audit of subsidiaries Total audit Audit related assurance services Total non‑audit services Total audit and non‑audit services Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 0.5 0.9 1.4 – – 1.4 0.7 0.5 1.2 0.6 0.6 1.8 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 101 13 INVESTMENTS IN ASSOCIATED UNDERTAKINGS This Note describes the investments in associates made in 2015 and 2016 and provides the summarised statement of financial positions of the associates. Camargue Underwriting Managers Proprietary Limited On 30 August 2016, the Group acquired 50% of the share capital of the South African company, Camargue Underwriting Managers Proprietary Limited (Camargue) for ZAR65.5m plus £0.3m (US$4.9m) and also entered into a call and a put option to purchase the remaining 50% in 2021. The investment in Camargue is measured using the equity accounting method. The principal place of business of Camargue is the South Africa. Camargue is a leading managing general underwriter of a range of specialised insurance products and specialist liability solutions in South Africa and is an important trading partner for Brit. The summarised statement of financial position of Camargue and reconciliation to the carrying amount is as follows: Statement of financial position Current assets Non‑current assets Total assets Current liabilities Non‑current liabilities Total liabilities Net assets 50% not owned by Brit Acquisition fair value, result since acquisition and other adjustments Carrying value Ambridge Partners LLC 31 December 2016 US$m 2.1 1.4 3.5 (2.0) (0.1) (2.1) 1.4 (0.7) 4.5 5.2 On 8 December 2015, the Group acquired 50% of the members’ interests of Ambridge Partners LLC for US$28.6m and also entered into a call and a put option to purchase the remaining 50% in 2019. The investment in Ambridge Partners LLC is measured using the equity accounting method. The principal place of business of Ambridge Partners LLC is the United States. Ambridge Partners LLC is a leading managing general underwriter of transactional insurance products, writing business on behalf of a broad consortium of Lloyd’s of London syndicates and international insurers including Brit. The summarised statement of financial position of Ambridge Partners LLC and reconciliation to the carrying amount is as follows: Statement of financial position Current assets Non‑current assets Total assets Current liabilities Total liabilities Net assets 50% not owned by Brit Acquisition fair value, result since acquisition and other adjustments Carrying value 31 December 2016 US$m 31 December 2015 US$m 40.9 1.3 42.2 (31.9) (31.9) 10.3 (5.2) 26.3 31.4 33.6 0.2 33.8 (30.6) (30.6) 3.2 (1.6) 27.0 28.6 FINANCIAL STATEMENTS 102 Brit Limited Annual Report 2016 14 TAX EXPENSE Income tax is tax charged on our trading activities during the year. This Note shows the breakdown of tax payable in in the current period (current tax) and also tax that may become payable sometime in the future (deferred tax). (a) Tax (charged)/credited to income statement Current tax: Current taxes on income for the year Overseas tax on income for the year Double tax relief Adjustments in respect of prior years Total current tax Deferred tax: Relating to the origination and reversal of temporary differences Adjustments in respect of prior years Total deferred tax Total tax (charged)/credited to income statement Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m (4.0) (4.0) (8.0) 3.1 2.0 (2.9) (5.2) 5.9 0.7 (2.2) (2.0) (6.3) (8.3) 5.3 2.5 (0.5) 6.9 1.5 8.4 7.9 Overseas tax and double tax relief principally arise from taxes suffered as a result of the Group’s operations at Lloyd’s. Double tax relief is effectively limited to an amount equal to the tax due at the UK tax rate on the same source of income. (b) Tax charged to other comprehensive income Deferred tax charge on actuarial gains on defined benefit pension scheme Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 0.9 (0.5) (c) Tax reconciliation The tax on the Group’s profits before tax differs from the theoretical amount that would arise based on the weighted average rate of tax as follows: Profit on continuing ordinary activities before tax Tax calculated at weighted average rate of tax on income Non‑deductible and non‑taxable items Taxes on income at rates in excess of the domestic rate and where credit is unavailable Effect of temporary differences not recognised Effect of revaluation of deferred tax following change in rate of tax Other items Adjustments to tax charge in respect of prior years Total tax (charged)/credited to income statement Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 159.8 (24.0) 6.6 (0.1) 4.7 3.0 (0.3) 7.9 (2.2) 7.7 4.2 (0.1) (1.0) (1.0) 2.3 (0.5) 4.0 7.9 The weighted average rate of tax is based on the geographic split of profit across Group entities in jurisdictions with differing tax rates. As the mix of taxable profits changes, so will the weighted average rate of tax. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 103 (d) Effect of post balance sheet rate changes UK legislation was substantively enacted on 26 October 2015 to reduce the main rate of UK corporation tax from 20% to 19% from 1 April 2017 and to 18% from 1 April 2020. As legislated in the Finance Act 2016, which was substantively enacted on 9 September 2016, the UK corporation tax rate will reduce further to 17% from 1 April 2020. The reductions in rate from 20% to 19% and then to 17% have been used in the calculation of the UK’s deferred tax assets and liabilities as at 31 December 2016. The effect of the reduction rate from 18% to 17% on deferred tax liabilities is a reduction of approximately US$1.4m. 15 INTANGIBLE ASSETS An intangible asset is an asset without any physical substance but which has long‑term value to our business. Brit’s intangible assets relate to contracts to sell our products through independent brokers and agents (distribution channels) our brand names (trade names), our relationship with our customer base (renewal rights), our rights to underwrite policies at Lloyd’s (syndicate participations) and our internally developed software. With the exception of our syndicate participation rights at Lloyd’s, which we classify as an indefinite life asset, we reduce the value of these assets according to their useful life by way of amortisation. Amortisation is included as an expense in the income statement. Distribution channels US$m Trade names US$m Syndicate participations US$m Renewal rights US$m Software US$m Total US$m Cost: At 1 January 2015 Additions Disposals Foreign exchange effect At 31 December 2015 At 1 January 2016 Additions Disposals Foreign exchange effect At 31 December 2016 Amortisation: At 1 January 2015 Charge for the year Impairment Disposals Foreign exchange effect At 31 December 2015 At 1 January 2016 Charge for the year Disposals Foreign exchange effect At 31 December 2016 Carrying amount: At 31 December 2015 At 31 December 2016 9.8 – – – 9.8 9.8 – – – 9.8 2.4 0.7 – – – 3.1 3.1 0.7 – – 3.8 6.7 6.0 18.9 – – – 18.9 18.9 – – – 18.9 15.7 2.7 – – – 18.4 18.4 0.5 – – 18.9 70.8 – – – 70.8 70.8 – – – 70.8 – – – – – – – – – – – 0.5 – 70.8 70.8 5.8 – – – 5.8 5.8 – – – 5.8 2.8 2.1 – – – 4.9 4.9 0.9 – – 5.8 0.9 – 29.0 7.7 (6.7) (1.2) 28.8 28.8 6.3 (2.1) (4.4) 28.6 16.4 2.9 0.6 (6.7) (0.6) 12.6 12.6 3.1 (2.1) (2.1) 11.5 134.3 7.7 (6.7) (1.2) 134.1 134.1 6.3 (2.1) (4.4) 133.9 37.3 8.4 0.6 (6.7) (0.6) 39.0 39.0 5.2 (2.1) (2.1) 40.0 16.2 17.1 95.1 93.9 FINANCIAL STATEMENTS 104 Brit Limited Annual Report 2016 15 INTANGIBLE ASSETS (continued) Additional information The gross cost of software fully amortised but still in use is US$5.1m (2015: US$7.6m). All software additions in 2016 and 2015 were internally developed. The software amortisation charge for the year of US$3.1m (2015: US$2.9m) is included in the ‘other operating expenses’ line in the income statement. There were no impairments to software in 2016 due to obsolescence (2015: US$0.6m). In 2015, this cost was included in the other operating expenses’ line in the income statement. Assets not yet in use with a total cost of US$4.8m (2015: US$6.1m) are included in software. Further information is given in Note 5(b). Impairment tests for syndicate participations Syndicate participations are indefinite life intangible assets and are therefore reviewed annually for impairment. They have been allocated to cash‑generating units (CGUs) as follows: Global Specialty Direct Global Specialty Reinsurance 31 December 2016 US$m 31 December 2015 US$m 52.7 18.1 70.8 52.7 18.1 70.8 The recoverable amounts of the CGUs have been determined using a value in use calculation. Each value in use calculation uses pre‑tax cash flow projections based on business plans approved by senior management covering a three year period and subsequent cash flows which assume a nil growth rate. These cash flows have been discounted using a risk adjusted pre‑tax discount rate of 8.9% (2015: 10.2%). In each syndicate participation impairment review, the recoverable amount significantly exceeds the carrying value of the CGU including its associated syndicate participations and it is considered that a reasonably possible change in key assumptions will not cause the carrying value of the CGU to exceed its recoverable amount. The key assumptions used for the impairment calculations were that cash flows and profit levels will mainly depend on the level of premiums written by each strategic business unit, the rates at which these premiums are written and the claims activity on both prior and future underwriting years. The business plans reflect senior management’s best estimates based on historical experience, growth rates for the respective insurance industry sector, the insurance pricing cycle and expected results from ongoing and future strategic business unit product and distribution strategies. Commissions and other insurance related expenses are assumed to remain materially in line with current amounts relative to premium levels. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 105 16 PROPERTY, PLANT AND EQUIPMENT This Note gives a breakdown of the type of assets in use in our offices such as computer equipment, office fixtures and fittings and furniture. We reduce the value of these assets according to their useful life by way of depreciation. Depreciation is included as an expense in the income statement. We also carry out an annual assessment of the carrying value of these assets and, if necessary, make an impairment charge to the income statement. Cost: At 1 January 2015 Additions Disposals Foreign exchange effect At 31 December 2015 At 1 January 2016 Additions Disposals Foreign exchange effect At 31 December 2016 Depreciation: At 1 January 2015 Charge for the year Impairment Disposals Foreign exchange effect At 31 December 2015 At 1 January 2016 Charge for the year Disposals Foreign exchange effect At 31 December 2016 Carrying amount: At 31 December 2015 At 31 December 2016 Computers and office machinery, furniture and equipment US$m Office refurbishment US$m 9.0 14.7 (0.1) (0.4) 23.2 23.2 5.3 (7.0) (2.5) 19.0 5.6 1.6 1.6 (0.1) (0.4) 8.3 8.3 1.6 (7.0) (0.3) 2.6 11.7 3.9 (2.5) (0.7) 12.4 12.4 3.0 (2.9) (1.2) 11.3 7.8 1.3 0.2 (2.5) (0.6) 6.2 6.2 2.0 (2.9) (0.5) 4.8 Total US$m 20.7 18.6 (2.6) (1.1) 35.6 35.6 8.3 (9.9) (3.7) 30.3 13.4 2.9 1.8 (2.6) (1.0) 14.5 14.5 3.6 (9.9) (0.8) 7.4 14.9 16.4 6.2 6.5 21.1 22.9 The gross cost of property, plant and equipment fully depreciated but still in use is US$1.7m (2015: US$7.1m). The depreciation charge for the year of US$3.6m (2015: US$2.9m) is included in the ‘other operating expenses’ line in the income statement. There were no impairments to property, plant and equipment in the period (2015: US$1.8m relating to the London office relocation which took place in 2016, included in the ‘other operating expenses’ line in the income statement). Further information is given in Note 5(b). A dilapidations provision of US$2.3m (2015: US$3.3m) has been set up in respect of the refurbishment of rented property. FINANCIAL STATEMENTS 106 Brit Limited Annual Report 2016 17 DEFERRED ACQUISITION COSTS Acquisition costs are costs incurred in underwriting insurance risks and include commissions paid to third parties and some internally generated costs such as underwriter salaries. These costs are deferred and are charged to the income statement over the duration of the contract. We show the movement in these deferred costs and releases to the income statement in this Note. At 1 January Costs deferred during the year Amortisation charge for the year At 31 December 18 DEFERRED TAXATION 2016 US$m 2015 US$m 222.6 527.9 (530.9) 209.5 539.7 (526.6) 219.6 222.6 This Note describes the tax that we may have to pay in the future. Deferred tax arises from differences in the way that tax is calculated for accounting purposes and tax purposes. At 1 January 2015 Movements in the year: (Charged)/credited to income statement Tax relating to components of other comprehensive income (Note 14(b)) Foreign exchange effect At 31 December 2015 At 1 January 2016 Movements in the year: (Charged)/credited to income statement Tax relating to components of other comprehensive income (Note 14(b)) Foreign exchange effect At 31 December 2016 Pensions US$m Intangible assets US$m Underwriting US$m Other US$m Total US$m (8.9) (15.4) (11.9) 0.6 (35.6) (0.5) (0.5) 0.5 (9.4) 2.2 – – 1.2 – – (13.2) (10.7) 5.5 – (0.2) 5.9 8.4 (0.5) 0.3 (27.4) (9.4) (13.2) (10.7) 5.9 (27.4) (0.2) 0.9 1.5 (7.2) 2.9 – (0.4) (0.7) – – (10.7) (11.4) (1.3) – (0.7) 3.9 0.7 0.9 0.4 (25.4) Deferred tax has not been set up in respect of losses carried forward of US$87.0m (2015: US$86.0m) as it is not considered probable that they can be utilised in the foreseeable future. Deferred tax has not been provided in respect of investments in subsidiaries ad associates as no further tax is expected to be payable on dividend distributions of their profits. Deferred tax assets arising on decelerated capital allowances of US$0.5m (2015: US$20.2m) have not been provided for due to uncertainty over the timing of their utilisation. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 107 19 INSURANCE AND REINSURANCE CONTRACTS This Note deals with balances carried in respect of insurance contracts (liabilities) and reinsurance contracts (assets). It examines the statement of financial position, splitting both insurance and reinsurance balances into their component parts, and explains the assumptions applied in arriving at these figures. The Note also shows how our claims have developed over a period (before and after the effects of reinsurance) of time by setting out the cumulative development at the end of each calendar year in respect of claims arising from business written in a particular underwriting year. It ends by analysing the movements in insurance and reinsurance contracts during the year. (a) Balances on insurance and reinsurance contracts Gross Claims reported and loss adjustment expenses Claims incurred but not reported Unearned premiums Total gross liabilities Recoverable from reinsurers Claims reported and loss adjustment expenses Claims incurred but not reported Impairment provision Unearned premiums Total reinsurers’ share of liabilities Net Claims reported and loss adjustment expenses Claims incurred but not reported Impairment provision Unearned premiums Total net insurance liabilities 31 December 2016 US$m 31 December 2015 US$m 1,377.7 2,029.0 3,406.7 836.8 1,401.4 1,922.7 3,324.1 858.2 4,243.5 4,182.3 318.6 393.2 (0.7) 711.1 173.0 884.1 326.0 353.4 (1.0) 678.4 140.5 818.9 1,059.1 1,635.8 0.7 2,695.6 663.8 1,075.4 1,569.3 1.0 2,645.7 717.7 3,359.4 3,363.4 Insurance contracts – assumptions and changes in assumptions Process used to decide on assumptions required The risks associated with these insurance liabilities and in particular with casualty insurance liabilities are complex and subject to a number of variables that complicate quantitative analysis. The Group uses several statistical methods to incorporate the various assumptions made in order to estimate the ultimate costs of claims. The two methods more commonly used are the chain‑ladder and the Bornhuetter‑Ferguson methods. Chain‑ladder methods may be applied to premiums, paid claims or incurred claims (i.e. paid claims plus case estimates). The basic technique involves the analysis of historical claims development factors and the selection of estimated development factors based on these historical patterns. The selected development factors are then applied to cumulative claims data for each underwriting year that is not yet fully developed to produce an estimated ultimate claims cost for each underwriting year. FINANCIAL STATEMENTS 108 Brit Limited Annual Report 2016 19 INSURANCE AND REINSURANCE CONTRACTS (continued) Chain‑ladder techniques are most appropriate for mature classes of business that have a relatively stable development pattern. Chain‑ladder techniques are less suitable in cases in which the insurer does not have a developed claims history for a particular class of business or for underwriting years at early stages of development where the outcome is still highly uncertain. The Bornhuetter‑Ferguson method uses a combination of a benchmark or market‑based estimate and an estimate based on claims experience. The former is based on a measure of exposure such as premiums; the latter is based on the paid or incurred claims to date. The two estimates are combined using a formula that gives more weight to the experience‑based estimate as time passes. This technique is used in situations in which developed claims experience are not available for the projection (recent underwriting years or new classes of business). The choice of selected results for each year of each class of business depends on an assessment of the technique that has been most appropriate to observed historical developments. In certain instances, this has meant that different techniques or combination of techniques have been selected for the individual underwriting year or groups of underwriting years within the same class of business. Standard statistical techniques may not be solely appropriate for assessing ultimate claims for a number of classes of business (e.g. casualty treaty) and particular events (e.g. natural catastrophes), therefore alternative methodologies may be employed to add additional rigour to the process. Examples include reviewing potential exposure on a policy by policy basis and taking account of market intelligence to determine Brit’s share of the loss. In addition to the estimation of claims reserves certain estimates are produced for unearned premiums. For open market business earned premium is calculated at policy level. However, premium derived from delegated underwriting authorities is calculated by applying the 144ths method to estimated premiums applied to the master policy. This assumes that attachments to master policies arise evenly throughout the period of that master policy. Reinsurance outwards premiums are earned according to the nature of the cover. ‘Losses occurring during’ policies are earned evenly over the policy period. ‘Risks attaching’ policies are earned on the same basis as the inwards business being protected. Changes in assumptions The Group did not change its estimation techniques for the insurance contracts disclosed in this Note during the year. Claims development tables The tables below show the development of claims over a period of time on a gross and net of reinsurance basis. The claims development tables have been presented on an underwriting year basis. The tables show the cumulative incurred claims, including both notified and IBNR claims, for each successive underwriting year at the end of each year, together with cumulative paid claims at the end of the current year. The claims have been adjusted to make them comparable on a year by year basis. They have been grossed up to include 100% of the managed syndicate claims rather than the claims that reflects the Group percentage ownership of each syndicate’s underwriting capacity during the respective underwriting years. In addition, claims in currencies other than US dollars have been retranslated at 31 December 2016 exchange rates. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 109 Ultimate gross claims Underwriting year At end of underwriting year One year later Two years later Three years later Four years later Five years later Six years later Seven years later Eight years later Nine years later Total ultimate 2007 and prior years 2008 2009 2010 2011 2012 2013 2014 2015 Intra Group and other underwriting 2016 adjustments Total 84.9% 90.7% 73.6% 75.7% 80.5% 76.2% 69.8% 70.1% 70.4% 76.6% 87.1% 90.4% 75.6% 85.7% 78.2% 71.6% 69.8% 73.5% 71.4% 85.9% 93.0% 72.4% 89.9% 78.5% 72.4% 69.7% 73.2% 93.6% 96.6% 74.1% 90.2% 78.2% 70.5% 69.6% 95.9% 97.5% 74.6% 89.0% 78.7% 73.0% 95.9% 97.3% 75.4% 86.8% 77.2% 96.5% 99.1% 74.8% 86.5% 96.3% 99.4% 75.8% 95.8% 100.0% 93.7% US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m gross claims at 31 December 2016 6,522.9 988.0 738.4 881.5 843.6 947.5 962.8 1,111.6 1,027.4 1,091.3 – 15,115.0 Less accumulated gross paid claims Unearned premium portion of gross ultimate claims Claims handling (6,315.5) (831.4) (622.9) (757.7) (647.0) (614.8) (550.2) (486.8) (250.5) (66.0) – (11,142.8) – – – – – – – – (48.2) (574.2) – (622.4) provision and other corporate adjustments 3.2 2.4 1.8 1.9 3.0 5.0 6.2 9.4 10.9 6.7 6.4 56.9 Total outstanding gross claims at 31 December 2016 Ultimate net claims Underwriting year At end of underwriting year One year later Two years later Three years later Four years later Five years later Six years later Seven years later Eight years later Nine years later 210.6 159.0 117.3 125.7 199.6 337.7 418.8 634.2 739.6 457.8 6.4 3,406.7 2007 and prior years 2008 2009 2010 2011 2012 2013 2014 2015 Intra Group and other underwriting 2016 adjustments Total 87.3% 96.4% 79.5% 79.3% 86.4% 82.6% 75.3% 76.1% 77.6% 83.1% 83.0% 96.5% 78.6% 87.1% 83.9% 78.0% 76.6% 79.3% 80.5% 83.4% 96.9% 75.7% 89.1% 83.1% 77.8% 76.1% 78.3% 87.9% 99.9% 74.1% 89.2% 81.3% 75.7% 76.3% 89.7% 101.6% 74.3% 87.0% 81.4% 76.5% 89.9% 100.7% 75.8% 85.8% 79.8% 90.3% 101.1% 75.8% 85.6% 90.6% 98.7% 76.3% 90.2% 98.6% 88.8% FINANCIAL STATEMENTS 110 Brit Limited Annual Report 2016 19 INSURANCE AND REINSURANCE CONTRACTS (continued) US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m Total ultimate net claims at 31 December 2016 4,687.8 755.1 599.7 697.9 700.5 773.0 790.0 895.3 849.0 812.8 – 11,561.1 Less accumulated gross paid claims Unearned premium portion of gross ultimate claims Claims handling provision, bad debt provision and other corporate adjustments Total outstanding net claims at 31 December 2016 (4,550.8) (679.7) (511.3) (592.7) (543.9) (513.2) (457.0) (418.0) (217.3) (60.3) – (8,544.2) – – – – – – – 0.1 (37.9) (417.0) – (454.8) 2.8 2.4 1.9 3.2 3.0 5.0 6.2 9.4 10.8 6.6 82.2 133.5 139.8 77.8 90.3 108.4 159.6 264.8 339.2 486.8 604.6 342.1 82.2 2,695.6 The percentages in the gross and net triangles are shown on an ultimate loss basis inclusive of catastrophe losses by year of account. The development of the 2008 year of account was impacted by exposure to the financial crisis which resulted in reserving action which has subsequently led to stability in the ratios for a number of years. The 2010 year of account includes the impact of natural catastrophes occurring in 2011 which attached back to policies incepting in the 2010 year of account. Likewise, the 2015 year of account includes the impact of natural catastrophes occurring in 2016 which attached to policies incepting in the 2015 year of account. During 2016, the net aggregate reserve releases from prior years amounted to US$53.5m, which included a strengthening of US$21.5m in respect of 2015 and a reserve release of US$75.0m (140.2% of the net aggregate reserve release) derived from the 2013 and prior underwriting years (2015: US$67.8m/236.9% from the 2012 and prior underwriting years). Reserves in Brit Global Specialty Direct and Brit Global Specialty Reinsurance experienced releases of US$11.4m (2015: releases of US$17.1m) and US$47.5m (2015: releases of US$23.3m) respectively with a strengthening of US$5.4m (2015: strengthening of US$11.8m) within Other Underwriting. (b) Movements in insurance and reinsurance contracts (i) Claims and loss adjustment expenses As at 1 January Cash paid for claims settled in the year Increase in liabilities Net foreign exchange differences As at 31 December 31 December 2016 31 December 2015 Gross US$m Reinsurance US$m Net US$m Gross US$m Reinsurance US$m Net US$m 3,324.1 (875.0) 1,058.8 (101.2) (678.4) 2,645.7 (734.4) 140.6 856.1 (202.7) (71.8) 29.4 3,210.3 (871.5) 1,082.5 (97.2) (694.8) 2,515.5 (680.4) 191.1 882.0 (200.5) (71.4) 25.8 3,406.7 (711.1) 2,695.6 3,324.1 (678.4) 2,645.7 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 111 (ii) Unearned premiums As at 1 January Premiums written in the year Premiums earned during the year As at 31 December 20 EMPLOYEE BENEFITS 31 December 2016 31 December 2015 Gross US$m Reinsurance US$m Net US$m Gross US$m Reinsurance US$m Net US$m 858.2 1,912.2 (1,933.6) (140.5) 717.7 (432.0) 1,480.2 (1,534.1) 399.5 852.4 1,999.2 (1,993.4) (126.4) 726.0 (369.4) 1,629.8 (1,638.1) 355.3 836.8 (173.0) 663.8 858.2 (140.5) 717.7 This Note explains the pension schemes operated by the Group for its employees. For the Group’s defined benefit scheme (in which no further benefits are being accrued), it sets out the amount carried on the Group statement of financial position, gains and losses incurred during the year, amounts paid into the scheme, together with further information about the scheme. For the Group’s two defined contribution schemes, it sets out the costs incurred during the year. (a) Brit Group Services Limited – Defined Benefit Pension Scheme Through Brit Group Services Limited, the Group operates a funded defined benefit pension scheme providing pensions benefits to its members. The scheme closed to new entrants on 4 October 2001 and closed to future accrual of benefits on 31 December 2011. All active members of the defined benefit scheme joined the defined contribution plan for future service. Following closure to future accrual, benefits now increase broadly in line with inflation. The weighted average duration to payment of the scheme’s expected cash flows is 18 years (2015:18 years). The scheme is approved by HMRC for tax purposes, and is operated separately from the Group and managed by an independent Trustee. The Trustee is responsible for payment of the benefits and management of the plan’s assets. The scheme is subject to UK regulations overseen by the Pensions Regulator, which require the Group and Trustee to agree a funding strategy and contribution schedule for the scheme every three years. The most recent triennial review of the scheme was undertaken as at 31 July 2015 and identified a funding surplus of £7.1m. The Group agreed to continue to pay the remainder of the recovery plan agreed following the previous actuarial valuation, namely a contribution of £1.6m on 31 July 2016. The Group has also committed to pay further contributions to the scheme of at least £2.0m a year on each 31 July from 2017 to 2024. These contributions are payable by Brit Group Services Limited and backed‑up by cross‑company guarantees from both Brit Insurance Holdings Limited and Brit Overseas Holdings S.à R.L. Net amount recognised in the statement of financial position for the scheme: Present value of defined benefit obligation Fair value of scheme assets Net pension asset 31 December 2016 US$m 31 December 2015 US$m (193.0) 235.5 (190.9) 243.0 42.5 52.1 FINANCIAL STATEMENTS 112 Brit Limited Annual Report 2016 20 EMPLOYEE BENEFITS (continued) Changes in the net pension asset recognised in the statement of financial position: Opening statement of financial position Credit to income statement Foreign exchange effect Amount recognised outside income statement Contributions paid Closing statement of financial position 31 December 2016 US$m 31 December 2015 US$m 52.1 1.9 (8.3) (5.4) 2.2 42.5 43.4 1.6 (2.8) 3.0 6.9 52.1 A net pension asset is recognised on the balance sheet as there is an unconditional right of the Group to be refunded the surplus in the scheme. The measurement of the net pension asset is impacted by a number of factors, including the actuarial assumptions used, the effects of changes in foreign exchange rates, and the contributions paid to the scheme by the Group. The Group expects to realise the economic benefit of the net pension asset as the obligations and funding requirements change over the life of the scheme. Deferred tax related to the net pension asset is measured using the tax rates expected to apply to the periods during which the asset is recovered, and is presented within the deferred tax line of the balance sheet. Net credit recognised in the income statement comprised: Net interest on net defined benefit asset Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m (1.9) (1.6) This credit has been recognised in the ‘other operating expenses’ line in the income statement. Contributions to the Group’s defined contribution pension arrangements are in addition to those set out in this note and are charged directly to the income statement. The allocation of the scheme’s assets was as follows: Equities Index‑linked UK government bonds Non‑UK index‑linked bonds Fixed interest government bonds Cash and net current assets Gold and gold mining equities Other scheme assets Fair value of scheme assets 31 December 2016 US$m 31 December 2015 US$m 56.4 130.0 8.4 11.6 24.6 2.6 1.9 235.5 76.3 123.5 13.8 12.2 10.7 2.9 3.6 243.0 All scheme assets have quoted prices in active markets. The scheme does not invest directly in property occupied by the Group or in financial securities issued by the Group. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 113 Investment strategy The trustees determine the scheme’s investment strategy after taking appropriate advice from their investment consultants. The management of the assets is delegated to State Street Global Advisors and Ruffer LLP. The Trustee’s investment objective is to ensure that the scheme has adequate resources to meet its liabilities and thereafter to maximise the long‑term total rate of return on the assets. Investment risk is managed by diversifying the assets across asset classes whose return patterns are not highly correlated, and by periodically rebalancing asset classes. The assets include a portfolio of UK index‑linked government bonds which aim to match a significant part of the scheme’s inflation‑linked benefits and therefore help to reduce the Group’s exposure to investment and inflation risks. Movements in the present value of the defined benefit obligation were as follows: Opening defined benefit obligation Interest on defined benefit obligation Remeasurements due to: Changes in financial assumptions Changes in demographic assumptions Experience on benefit obligations Foreign exchange effect Benefits paid Closing defined benefit obligation Movements in the fair value of the scheme assets were as follows: Opening fair value of scheme assets Interest income Actual return excluding interest income Foreign exchange effect Contributions by the employer Benefits paid Closing fair value of scheme assets The principal actuarial assumptions at the year‑end were: Discount rate Retail Prices Index (RPI) inflation Consumer Prices Index (CPI) inflation Pension increases in payment Mortality assumptions: Life expectancy of male aged 60 at statement of financial position date Life expectancy of female aged 60 at statement of financial position date Life expectancy of male age 60 retiring in 20 years’ time Life expectancy of female age 60 retiring in 20 years’ time 31 December 2016 US$m 31 December 2015 US$m 190.9 6.5 219.6 7.6 39.3 – (0.5) (34.0) (9.2) (6.8) 0.9 (6.7) (11.6) (12.1) 193.0 190.9 31 December 2016 US$m 31 December 2015 US$m 243.0 8.4 33.4 (42.3) 2.2 (9.2) 235.5 263.0 9.2 (9.6) (14.4) 6.9 (12.1) 243.0 31 December 2016 31 December 2015 2.8% 3.4% 2.4% 3.2% 27.9 years 30.2 years 29.7 years 32.1 years 3.8% 3.2% 2.2% 3.1% 27.8 years 30.1 years 29.6 years 32.0 years The assumptions used to determine end‑of‑year benefit obligations are also used to calculate the following year’s cost. FINANCIAL STATEMENTS 114 Brit Limited Annual Report 2016 20 EMPLOYEE BENEFITS (continued) Sensitivity analysis: Assumption Change in assumption Discount rate Future RPI inflation increases Future CPI inflation increases Assumed life expectancy at age 60 Decrease by 0.5% Increase by 0.5% Increase by 0.5% Increase by 1 year Change in defined benefit obligation at end of period Increase by US$18.5m Increase by US$13.9m Increase by US$3.5m Increase by US$5.4m The calculations in this section have been carried out using the same method and data as the Group’s pensions and accounting figures with each assumption adjusted as shown above. Each assumption has been varied individually and a combination of changes in assumptions could produce a different result. Risks: The Group is exposed to a number of risks in relation to its defined benefit scheme, the most significant of which are detailed below: Risk Investment strategy Changes in asset values are not matched by changes in the scheme’s defined benefit obligations. For example, if equity values fall with no changes in corporate bond yields, the net pension asset would reduce. Investment returns Future investment returns are lower than anticipated and so additional contributions are required from the Group to pay all the benefits promised. Improvements in life expectancy Scheme members live longer and so benefits are payable for longer than anticipated. Inflation Regulatory Actual inflation is higher and so benefit payments are higher than anticipated. In future the scheme may have backdated claims or liabilities arising from future legislation, emerging practice or court judgments. (b) Brit Group Services Limited – Defined Contribution Personal Pension Plan Brit Group Services Limited operates a defined contribution group personal pension plan. The assets of the scheme are held separately from those of the Group in an independently administered fund. The pension cost charge represents contributions payable by Brit Group Services Limited to the fund and amounted to US$6.1m (2015: US$7.4m). At 31 December 2016 no contributions were payable to the fund (2015: US$nil). (c) Brit Insurance Services USA Inc. – 401(k) Safe Harbor Plan Brit Insurance Services USA Inc. operates a ‘401(k) Safe Harbor Plan’. The assets of the scheme are held separately from those of the Group in an independently administered fund. The pension cost charge represents contributions payable by Brit Insurance Services USA Inc. to the fund and amounted to US$0.5m (2015: US$0.3m). At 31 December 2016 no contributions were payable to the fund (2015: US$nil). NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 115 21 FINANCIAL INVESTMENTS This Note summarises the total value of the financial assets of the Group and shows how much we have invested in each class of asset. It also explains how each asset is categorised under three different levels of hierarchy, the methods used to value assets within each level and assets transferred between levels. Equity securities Debt securities Loan instruments Specialised investment funds 31 December 2016 US$m 31 December 2015 US$m 399.8 2,424.7 – 79.4 265.5 1,956.0 23.4 1,085.9 2,903.9 3,330.8 All financial investments have been designated as held at fair value through profit or loss. Basis for determining the fair value hierarchy of financial instruments The Group has classified the fair value measurements using a fair value hierarchy that reflects the significance of the inputs used in making those measurements. The fair value hierarchy comprises the following levels: (a) Level one – quoted prices (unadjusted) in active markets for identical assets; (b) Level two – inputs other than quoted prices included within level one that are observable for the asset, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and (c) Level three – inputs for the assets that are not based on observable market data (unobservable inputs). Assets are categorised as level one where fair values determined in whole directly by reference to an active market relate to prices which 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, i.e. the market is still active. For assets and liabilities that are recognised at fair value on a recurring basis, the Group determines whether transfers have occurred between levels in the hierarchy by reassessing categorisation (based on the lowest level of input that is significant to the fair value measurement as a whole) at the end of each reporting period. Fair values for level two and level three assets include: • Values provided at the request of the Group by pricing services and which are not publicly available or values provided by external parties which are readily available but relate to assets for which the market is not always active; and • Assets measured on the basis of valuation techniques including a varying degree of assumptions supported by market transactions and observable data. For all assets not quoted in an active market or for which there is no active market, the availability of financial data can vary and is affected by a wide variety of factors, including the type of financial instrument, whether it is new and not yet established in the marketplace, and other characteristics specific to each transaction. To the extent that valuation is based on the models or inputs that are unobservable in the market, the determination of fair value requires more judgement. Accordingly, the degree of judgement exercised is higher for instruments classified in level three and the classification between level two and level three depends highly on the proportion of assumptions used, supported by market transactions and observable data. FINANCIAL STATEMENTS 116 Brit Limited Annual Report 2016 21 FINANCIAL INVESTMENTS (continued) Valuation techniques Level one Inputs represent unadjusted quoted prices for identical instruments exchanged in active markets (where transactions occur with sufficient frequency and volume). The fair values of securities sold short and the majority of the company’s equities are based on published quotes in active markets. These also include government bonds and treasury bills issued in Canada and in the US. Level two Inputs include directly or indirectly observable inputs (other than Level one inputs) such as quoted prices for similar financial instruments exchanged in active markets, quoted prices for identical or similar financial instruments exchanged in inactive markets and other market observable inputs. Level two securities contain certain investments in US and non‑US government agency securities, US and non‑US Corporate debt securities and specialised investment funds. US government agency securities are priced using valuations from independent pricing vendors who use discounted cash flow models supplemented with market and credit research to gather specific information. Market observable inputs for these investments may include broker‑dealer quotes, reported trades, issuer spreads and available bids. Non US government agency securities are priced with OTC quotes or broker‑dealer quotes. Other market observable inputs include benchmark yields and reported trades. Issuer spreads are also available for these types of investments Preferred stocks are priced using a combination of independent pricing service providers and internal valuation models that rely on directly or indirectly observable inputs. The fair values of investments in certain limited partnerships classified as equities on the consolidated balance sheet are based on the net asset values received from the general partner, adjusted for liquidity as required and are classified as Level two when they may be liquidated or redeemed within three months or less of providing notice to the general partner. Otherwise, such investments in limited partnerships are classified as Level three. Level three Level three equities include investments in limited partnerships where the fund’s underlying investments are not traded/quoted in an active market. In some instances, limited partnerships are classified as level three because they may require at least three months of notice to liquidate. Level three debt instruments include corporate loans with unobservable inputs used in the measurement of financial instruments. Management is required to use its own assumptions regarding unobservable inputs as there is little, if any, market activity in these instruments or related observable inputs that can be corroborated at the measurement date. Level three specialised investment funds include securities that are valued using techniques appropriate to each specific investment. The valuation techniques include fair value by reference to net asset values (NAVs) adjusted and issued by fund managers based on their knowledge of underlying investments and credit spreads of counterparties. In some instances, certain investment funds are classified as Level three because they may require at least three months’ notice to liquidate. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSBrit Limited Annual Report 2016 117 Level one US$m Level two US$m Level three US$m Total US$m 201.3 1,462.9 – – 75.3 935.6 – 64.6 123.2 399.8 26.2 2,424.7 – 79.4 – 14.8 1,664.2 1,075.5 164.2 2,903.9 Level one US$m Level two US$m Level three US$m Total US$m 195.6 754.0 – – 52.3 1,158.1 23.4 1,085.9 17.6 43.9 – – 265.5 1,956.0 23.4 1,085.9 949.6 2,319.7 61.5 3,330.8 Disclosures of fair values in accordance with the fair value hierarchy 31 December 2016 Equity securities Debt securities Loan instruments Specialised investment funds 31 December 2015 Equity securities Debt securities Loan instruments Specialised investment funds All unrealised gains of US$10.0m (2015: losses of US$108.5m) and realised gains of US$62.3m (2015: gains of US$58.0m) on financial investments held during the period, are presented in investment return in the consolidated income statement. Transfers between Fair Value Levels Fair values are classified as level one when the financial instrument or derivative is actively traded and a quoted price is available. In accordance with the Group’s policy if an instrument classified as level one subsequently ceases to be actively traded, it is immediately transferred out of level one. In such cases, instruments are classified into level two, unless the measurement of its fair value requires the use of significant unobservable inputs, in which case it is classified as level three. All fair value measurements above are recurring as they are required to be measured and recognised at the end of each reporting period. Transfers from level one to level two No fixed income investments (2015: US$37.7m) and no funds (2015: US$638.3m) were transferred from level one to level two during 2016. The funds were transferred in 2015 due to only limited or no trading taking place during 2015 and therefore they were no longer deemed to be actively traded. Transfers from level two to level one No fixed income investments (2015: US$0.8m) were transferred from level two to level one during 2016. Transfers from level two to level three No fixed income investments (2015: US$1.0m) were transferred from level two to level three during 2016. Transfers from level three to level two A total of US$1.9m of fixed income investments (2015: US$0.5m) and no funds were transferred from level three to level two during 2016 (2015: US$7.0m). These fair value hierarchy movements were principally due to additional observable inputs becoming available for their valuation during 2015 and 2016. FINANCIAL STATEMENTS 118 Brit Limited Annual Report 2016 21 FINANCIAL INVESTMENTS (continued) Reconciliation of movements in level three financial investments measured at fair value At 1 January 2015 Transfers from/(to) level one and level two Total gains recognised in the income statement Purchases Sales proceeds Foreign exchange losses At 31 December 2015 Transfers to level one and level two Total gains/(losses) recognised in the income statement Purchases Sales proceeds Foreign exchange losses At 31 December 2016 Equity securities US$m Debt securities US$m Loan instruments US$m Specialised investment funds US$m – – 0.6 17.5 – (0.5) 17.6 – 4.6 102.3 – (1.3) 123.2 218.4 0.5 0.4 47.4 (221.0) (1.8) 43.9 (1.9) 0.8 4.3 (20.1) (0.8) 26.2 6.4 – – – (6.4) – – – – – – – – 91.3 (7.0) 1.1 – (85.4) – – – (0.2) 15.0 – – 14.8 Total US$m 316.1 (6.5) 2.1 64.9 (312.8) (2.3) 61.5 (1.9) 5.2 121.6 (20.1) (2.1) 164.2 Total net gains recognised in the income statement under ‘investment return’ in respect of level three financial investments for the period amounted to US$5.2m (2015: US$2.1m). Included in this balance are US$5.2m of unrealised gains (2015: losses of US$7.2m) attributable to assets still held at the end of the year. Sensitivity of level three financial investments measured at fair value to changes in key assumptions The following table shows the sensitivity of the fair value of level three financial investments to changes in key assumptions. Equity securities Debt securities Specialised investment funds 31 December 2016 31 December 2015 Effect of possible alternative assumptions (+/–) US$m 4.6 0.9 0.1 Carrying amount US$m 123.2 26.2 14.8 164.2 Effect of possible alternative assumptions (+/–) US$m 0.7 1.3 – Carrying amount US$m 17.6 43.9 – 61.5 In order to determine reasonably possible alternative assumptions, the Group monitored the price of the securities invested to changes on a month by month basis since acquisition or during 2016. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 119 22 DERIVATIVE CONTRACTS This Note summarises the total value of the derivative contracts of the Group. It also explains how each derivative contract is categorised under three different levels of hierarchy, the valuation methods used to value derivative contracts and amounts transferred between levels. At 31 December 2016 and 31 December 2015, the options and interest rate swaps formed part of our investment management strategy, while the currency forwards formed part of our foreign exchange management strategy. The disclosure provided in the tables below include derivatives recorded in the Group’s statement of financial position. Derivative contract assets 31 December 2016 Currency forwards Options Call and put option over Ambridge Partners LLC Call and put option over Camargue Total 31 December 2015 Currency forwards Options Call and put option over Ambridge Partners LLC Total Derivative contract liabilities 31 December 2016 Currency forwards 31 December 2015 Currency forwards Gross amounts of receivables on derivative contract assets US$m Gross amounts of payables on derivative contract assets US$m Derivatives contract assets presented in the statement of financial position US$m 686.9 5.5 51.3 4.8 748.5 (679.8) – (51.3) (4.8) (735.9) Gross amounts of receivables on derivative contract assets US$m Gross amounts of payables on derivative contract assets US$m 830.3 33.5 51.3 915.1 (800.2) – (51.3) (851.5) Gross amounts of payables on derivative contract liabilities US$m Gross amounts of receivables on derivative contract liabilities US$m 7.1 5.5 – – 12.6 Derivatives contract assets presented in the statement of financial position US$m 30.1 33.5 – 63.6 Derivative contract liabilities presented in the statement of financial position US$m (623.5) 611.7 (11.8) Gross amounts of payables on derivative contract liabilities US$m Gross amounts of receivables on derivative contract liabilities US$m Derivative contract liabilities presented in the statement of financial position US$m (352.7) 340.2 (12.5) Disclosures of fair values in accordance with the fair value hierarchy 31 December 2016 Derivative contract assets Derivative contract liabilities 31 December 2015 Derivative contract assets Derivative contract liabilities Level two US$m Level three US$m Total US$m 7.1 (11.8) 5.5 – Level two US$m Level three US$m 43.2 (12.5) 20.4 – 12.6 (11.8) Total US$m 63.6 (12.5) FINANCIAL STATEMENTS 120 Brit Limited Annual Report 2016 22 DERIVATIVE CONTRACTS (continued) Valuation techniques Level two The fair value of the vast majority of the company’s derivative contracts are based primarily on non‑binding third party broker‑dealer quotes that are prepared using Level two inputs. Where third party broker‑dealer quotes are used, typically one quote is obtained from a broker‑dealer with particular expertise in the instrument being priced. The valuation technique used to determine the fair value of currency forwards is derived from observable inputs such as active foreign‑exchange and interest‑rate markets that may require adjustments for certain unobservable inputs. Level three CPI‑linked derivatives are classified as Level three and valued using broker‑dealer quotes which management has determined utilize market observable inputs except for the inflation volatility input which is not market observable. The reasonableness of the fair values of CPI‑linked derivative contracts are assessed by comparing the fair values received from third party broker‑dealers to recent market transactions where available and values determined using third party pricing software based on the Black‑Scholes option pricing model for European‑style options that incorporates market observable and unobservable inputs such as the current value of the relevant CPI underlying the derivative, the inflation swap rate, nominal swap rate and inflation volatility. The fair values of CPI‑linked derivative contracts are sensitive to assumptions such as market expectations of future rates of inflation and related inflation volatilities. Reconciliation of movements in level three derivative contracts measured at fair value At 1 January 2015 Purchases Total gains recognised in the income statement Foreign exchange losses At 31 December 2015 Purchases Total losses recognised in the income statement Foreign exchange gains At 31 December 2016 Put options US$m 3.7 14.7 2.6 (0.6) 20.4 11.3 (32.9) 6.7 5.5 Sensitivity of level three derivatives measured at fair value to changes in key assumptions The following table shows the sensitivity of the fair value of level three derivatives to changes in key assumptions. Put options 31 December 2016 31 December 2015 Effect of possible alternatives assumptions (+/‑) US$m Carrying amount US$m Effect of possible alternatives assumptions (+/‑) US$m Carrying amount US$m 5.5 1.7 20.4 5.9 In order to determine reasonably possible alternative assumptions, the Group adjusted key unobservable model inputs, including inflation volatility inputs (used to measure inflation‑related put options recorded in 2016) and credit risk inputs (used to measure put options over an unlisted investment held by the Group in 2016 and 2015). NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 121 23 INSURANCE AND OTHER RECEIVABLES This Note sets out the various categories of amounts which are owed to the Group. Arising out of direct insurance operations Arising out of reinsurance operations Prepayments Accrued income Outstanding settlements on investments Other assets Other debtors Total 31 December 2016 US$m 31 December 2015 US$m 373.8 304.9 9.1 6.8 1.5 9.9 12.3 718.3 357.4 280.7 10.4 8.2 7.6 6.8 20.6 691.7 Other assets relates to shares purchased to settle share‑based payment awards. For further information, refer to Note 31(d). 24 CASH AND CASH EQUIVALENTS This Note analyses the amounts of cash and cash equivalents. Cash equivalents are investment instruments with less than 90 days left to maturity when purchased by the Group. We have also provided some additional analysis which explains where our cash and cash equivalents are held and why we are holding them. Cash at bank and on deposit Cash equivalents Total The carrying amounts disclosed above, reasonably approximate fair values. The source of these amounts can be further analysed as follows: Classification Definition Cash within segregated fund mandates Lloyd’s Trust Funds Self‑managed cash Short‑term investment funds, money market funds, treasury bills or cash held within segregated mandates. Cash within the Lloyd’s Overseas Deposits Trust Funds held to meet regulatory requirements. Highly liquid instruments held to meet on‑going working capital requirements. Letter of credit cash collateral Cash held as collateral for letters of credit. Derivative operating cash Total Cash within segregated accounts held to meet margin calls and to enable derivative positions to be rolled. 31 December 2016 US$m 31 December 2015 US$m 469.3 556.2 1,025.5 522.3 58.7 581.0 31 December 2016 US$m 31 December 2015 US$m 737.5 170.4 31.5 27.6 238.1 359.6 18.4 14.5 – 8.9 1,025.5 581.0 FINANCIAL STATEMENTS 122 Brit Limited Annual Report 2016 25 BORROWINGS This Note describes the main sources of borrowing available to the Group and the amounts currently borrowed from each of those sources. Non‑current Subordinated debt Revolving credit facility Maturity Call Effective interest rate 2030 2020 – 2020 8.3% LIBOR +1.5% 31 December 2016 31 December 2015 Initial capitalised borrowing costs US$m Amortised cost US$m Fair value US$m Initial capitalised borrowing costs US$m Amortised cost US$m Fair value US$m 2.8 14.7 17.5 157.5 – 157.5 167.9 – 167.9 2.8 14.7 17.5 185.6 – 206.2 – 185.6 206.2 As at 31 December 2016 and 31 December 2015, the fair value of the subordinated debt was determined by reference to trading market values on recognised exchanges and was therefore categorised as a level one measurement in the fair value hierarchy. For further information relating to the fair value hierarchy, refer to Note 21. Subordinated debt The subordinated debt is callable in whole by the Group on 9 December 2020. Following this date the interest rate resets to the higher of: i) 3.4% above the gross redemption yield of the 4.75% Treasury Gilt due 2030 quoted on the reset date; or ii) 3.4% above the gross redemption yield of the 8% Treasury Stock due 2021 quoted on the reset date. The effective interest rate method of accounting has been applied over the term up to the call date. Revolving credit facility The Group has a US$360.0m (2015: US$ 360.0m) revolving credit facility which expires on 31 December 2020. The facility was renegotiated during the year; prior to this change the facility carried an interest rate of LIBOR+2.3% and an expiry date of 31 December 2018. At 31 December 2016, a US$80.0m (2015: US$80.0m), letter of credit had been put in place under the facility while the remainder was undrawn. At 31 December 2016, US$4.0m was collateralised (2015: US$80.0m uncollateralised). 26 INSURANCE AND OTHER PAYABLES This Note sets out the various categories of amounts which are owed by the Group. Arising out of direct insurance operations Arising out of reinsurance operations Other taxes and social security costs Accruals and deferred income Outstanding settlements on investments Other creditors 31 December 2016 US$m 31 December 2015 US$m 10.8 291.5 2.2 50.6 12.7 14.2 382.0 1.5 204.6 2.5 56.0 79.3 6.1 350.0 The carrying amounts disclosed above reasonably approximate fair values as all amounts are payable within one year of the date of the statement of financial position. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 123 27 CALLED UP SHARE CAPITAL This Note sets out the number of shares we have in issue and their nominal value. Ordinary shares: Allotted, issued and fully paid As at 31 December 2015 Purchase and cancellation of own shares As at 31 December 2016 31 December 2016 US$m 31 December 2015 US$m 31 December 2016 1p each Number 31 December 2015 1p each Number 6.4 6.6 387,608,230 401,057,706 US$m Number 6.6 (0.2) 401,057,706 (13,449,476) 6.4 387,608,230 106,550,524 shares are class A shares and the remainder are class B shares. The class A and B shares rank pari passu except that on a distribution of profits by the Company, the class A shareholders are entitled to a cumulative annual dividend which must be settled ahead of any equivalent distribution to class B shareholders. The number of shares reported is for Brit Limited, the parent of the Group. The Group’s ultimate parent, Fairfax, is permitted on an annual basis to purchase a set number of shares from OMERS, the minority shareholder of class A shares in Brit Limited. In August 2016 instead of a B class share dividend being made by Brit Limited to Fairfax, Fairfax assigned the purchase of 13,449,476 A class shares to Brit Limited. A distribution of US$61.5m from reserves for the purchase of 13,449,476 shares from OMERS for cancellation was made on 3 August 2016. The distribution of US$61.5m included the repurchase cost of the shares of US$57.8m, a US$3.4m payment in respect of the pro‑rata accrued dividend on the shares, and stamp duty charges of US$0.3m. A reduction in share capital of £134,495 has been made, being the nominal value of 13.4m shares at 1p each, and a capital redemption reserve of the same amount has been created. The distribution of US$61.5m has been set against distributable reserves (‘cost of share buy‑back’) in accordance with UK Company Law. As a result, Fairfax has increased its percentage shareholding from 69.99% to 72.51%. 28 DIVIDENDS This Note gives details of the amount we have paid to our shareholders during 2016 by way of dividends. A final ordinary dividend of 12.5p per share and a special dividend of 12.5p per share amounting to US$154.1m was delared by the Group in respect of 2014 and paid during 2015. A US$26.2m dividend in respect of the year‑ended 31 December 2015 was paid to the class A shareholders on 29 April 2016 in accordance with the shareholders’ agreement at an amount equal to US$0.43 per share (2015: US$ nil). As part of the share‑buy back transaction a US$3.4m dividend was paid to the class A shareholders on 3 August 2016, representing the pro‑rata accrued dividend outstanding on the shares repurchased in respect of the 2016 accounting period, and based on a dividend entitlement for the full year equal to US$0.43 per share. A US$61.3m dividend was paid to the class B shareholders on 21 December 2016 in accordance with the shareholders’ agreement at an amount equal to US$0.43 per share (2015: nil). A further dividend to class A shareholders for 2016 of US$0.43 per share amounting to US$45.8m was proposed and agreed at the 15 February 2017 Brit Limited Board meeting. FINANCIAL STATEMENTS124 Brit Limited Annual Report 2016 29 COMMITMENTS The Group has various financial commitments resulting from lease arrangements it has entered into. These amounts, which are not provided for on the consolidated statement of financial position, are set out in this Note. Operating lease commitments The Group has entered into a number of operating lease arrangements to lease properties and office equipment. Property leases typically have rent reviews every five years where the lease payments could be increased to reflect market rates. Operating lease payments recognised in the consolidated income statement during 2016 were US$7.3m (2015: US$9.0m). The future minimum lease payments under non‑cancellable operating leases were as follows: Not later than one year Later than one year and not later than five years Later than five years 31 December 2016 US$m 31 December 2015 US$m 6.9 26.2 46.7 79.8 8.5 28.8 64.1 101.4 30 CASH FLOWS PROVIDED BY OPERATING ACTIVITIES The table below shows how our profit for the year translates into cash flows generated from our operating activities. Profit on ordinary activities before tax Adjustments for non‑cash movements: Realised and unrealised (gains)/losses on investments Realised and unrealised losses/(gains) on derivatives Amortisation of intangible assets Impairment of intangible assets Depreciation of property, plant and equipment Impairment of property, plant and equipment Foreign exchange losses on cash and cash equivalents Share of profit after tax of associated undertakings Charges in respect of share‑based payment schemes Interest income Dividend income Foreign currency translation reserve transferred to profit on liquidation of subsidiaries Finance costs on borrowing Changes in working capital: Deferred acquisition costs Insurance and other receivables excluding accrued income Insurance and reinsurance contracts Financial investments Derivative contracts Insurance and other payables Employee benefits Provisions Cash flows provided by operating activities Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 159.8 7.7 (72.3) 52.8 5.2 – 3.6 – 17.8 (3.1) 0.9 (56.4) (17.5) – 18.8 3.0 (28.0) (4.0) 499.3 (2.5) 6.1 (4.0) (0.4) 579.1 50.5 (39.7) 8.4 0.6 2.9 1.8 15.8 – 4.9 (42.6) (30.1) 5.2 20.6 (13.1) 20.6 121.9 143.7 (3.4) (5.7) (8.5) 0.5 262.0 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 125 31 SHARE‑BASED PAYMENTS The Group rewards its employees through various share‑based incentive schemes. This Note explains the different schemes used to facilitate those share‑based payments and the charge recognised in the consolidated income statement in respect of these schemes. The compensation cost recognised in the income statement under International Financial Reporting Standard 2 ‘Share‑based Payments’ for the Group’s share‑based payments arrangements are shown below: Equity‑settled plans Performance Share Plan Brit All‑Employee Share Plan Long‑Term Incentive Plan (Performance Share Plan replacement) Employee Share Ownership Plan Cash‑settled plans Performance Share Plan dividend equivalents settled in cash Long‑Term Incentive Plan Total Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m – – 1.0 1.0 – 1.7 3.7 2.6 1.5 0.7 0.1 0.2 0.1 5.2 The total liability in respect of cash‑settled plans at 31 December 2016 was US$1.8m (2015: US$0.1m). Also, included in the Statement of Changes in Equity is US$1.0m (2015: US$4.9m) in respect of equity settled plans. A further US$1.0m of charges relating to the Employee Share Ownership Plan are equity settled in nature but physically settled in cash and so were not recorded in the Statement of Changes in Equity. (a) Performance Share Plan (PSP) During 2014, selected employees in the senior management team were awarded the right to acquire a defined number of Brit Limited shares at no cost to the employee. On the Fairfax acquisition of Brit Limited, 35% of the shares vested and the remainder were replaced with awards under the Long‑Term Incentive Plan (Performance Share Plan replacement). Reconciliation of movement in the number of awards Outstanding at 1 January Forfeited Vested Lapsed Transferred to Long Term Incentive Plan (Performance Share Plan Replacement) Outstanding at 31 December The weighted average share price at date of vesting during 2015 was 280p. Year ended 31 December 2016 Number of awards Year ended 31 December 2015 Number of awards – 2,596,365 – (40,477) – (894,519) – (163,428) – (1,497,941) – – FINANCIAL STATEMENTS 126 Brit Limited Annual Report 2016 31 SHARE‑BASED PAYMENTS (continued) (b) Brit All‑Employee Share Plan The Brit All‑Employee Share Plan provided for the award of Brit Limited free shares, partnership shares, matching shares and dividend shares. On the Fairfax acquisition of Brit Limited, all of the awards vested. Reconciliation of movement in the number of awards Outstanding at 1 January Forfeited Vested Outstanding at 31 December Year ended 31 December 2016 Number of awards Year ended 31 December 2015 Number of awards – 502,542 – (17,781) – (484,761) – – The weighted average share price at date of vesting during 2015 was 280p. (c) Long‑Term Incentive Plan (Performance Share Plan replacement) On the Fairfax acquisition of Brit Limited, the 65% of PSP awards that did not immediately vest were converted by FFHL into awards under this scheme. The conversion terms allowed for 60% of the 280p Brit Limited acquisition share price to be converted into the equivalent value of options to acquire shares in FFHL at a nil exercise price. Subject to continued service, the options vest in November 2018 and there are a further seven years to exercise the options. The calculation of the compensation cost recognised in the income statement in respect of these awards assumes forfeitures due to employee turnover of 5% per annum prior to vesting, with subsequent adjustments to reflect actual experience. Reconciliation of movement in the number of awards Outstanding at 1 January Granted Forfeited Outstanding at 31 December Year ended 31 December 2016 Number of awards Year ended 31 December 2015 Number of awards 7,865 – (153) 7,712 – 7,865 – 7,865 The weighted average fair value at date of grant for awards granted during 2016 was US$490.17 (2015: US$491.15). In order to settle share‑based payment awards, in 2015 the Group purchased US$10.7m of preference shares in FFHL Share Option 1 Corp and that company has purchased shares in Fairfax Financial Holdings Limited. Of the purchase, US$3.9m related to this scheme and was recorded within equity so as to offset the share‑based payment charges recorded in equity on exercise of the awards. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 127 (d) Long Term Incentive Plan During 2015 and 2016 the Company awarded selected employees options to acquire shares in FFHL at a nil exercise price. Subject to continued service, the options vest five years after the grant date and there are a further five years to exercise the options. The calculation of the compensation cost recognised in the income statement in respect of these awards assumes forfeitures due to employee turnover of 5% per annum prior to vesting, with subsequent adjustments to reflect actual experience. Reconciliation of movement in the number of awards Outstanding at 1 January Granted Forfeited Outstanding at 31 December There were no options exercisable at the end of the year. Year ended 31 December 2016 Number of awards Year ended 31 December 2015 Number of awards 13,503 7,119 (316) – 13,503 – 20,306 13,503 The weighted average fair value at date of grant for awards granted during 2016 was US$490.17 (2015: US$491.15). In order to settle share‑based payment awards, in 2016 the Group purchased US$3.4m (2015: US$10.7m) of preference shares in FFHL Share Option 1 Corp and that company has purchased shares in Fairfax Financial Holdings Limited. Of the purchase, US$3.4m (2015: US$6.8m) related to this scheme and has been recorded within Other Assets so as to offset the share‑based payment recorded as a liability within Other Creditors on exercise of the awards. (e) Employee Share Ownership Plan Under the terms of the ESOP which was established in 2015, eligible employees are given the election to purchase common shares in FFHL in an amount up to 10% of their annual base salary. The Company purchases, on the employee’s behalf, a number of FFHL’s common shares equal in value to 30% of the employee’s contribution. In the event that the Company achieves certain performance targets, additional shares are purchased by the Company for the employee’s benefit, to an amount equal in value to 20% of the employee’s contribution during that year. In respect of both shares purchased by the employees and matched by the Company, during the year ended 31 December 2016, the Company purchased a total of 6,428 common shares in FFHL (2015: 1,137) at an average price of US$528.80 (2015: US$485.15) in respect of this plan. FINANCIAL STATEMENTS 128 Brit Limited Annual Report 2016 32 INTERESTS IN STRUCTURED ENTITIES This Note defines a structured entity and sets out the Group’s interests in such vehicles and how we account for them. A structured entity is defined as an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only, or when the relevant activities are directed by means of contractual arrangements. As part of its investment activities, the Group has the following interests in unconsolidated structured entities: Undertakings for Collective Investments in Transferable Securities (UCITS) Mortgage backed securities Other asset backed structures Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m – 1.0 – 1.0 999.5 18.2 1.5 1,019.2 These assets are included within the debt securities in Note 21 and form part of Financial Investments on the Group statement of financial position. They are carried at fair value. As at 31 December 2015 the Group held investments in three UCITS. From 1 January 2016 the two principal UCITS in which Brit invests have been consolidated by the Group. The Group divested the remaining UCITS investment during the year. The risk that the Group faces in respect of the investments in structured entities is similar to the risk it faces in respect of other financial investments held on the statement of financial position in that the fair value is determined by market supply and demand. This is in turn driven by investor evaluation of the credit risk of the structure and changes in the term structure of interest rates which might change investor expectation of the cash flows associated with the instrument and therefore its value in the market. The maximum exposure to loss in respect of these structured entities would be the carrying value of the instruments that the Group holds. Generally, default rates would have to increase substantially from their current level before the Group would suffer a loss and this assessment is made prior to investing and continually through the holding period for the security. The Group does not invest in securities which have a contingent liability to the borrowers or structures that provide any type of guarantee, revolving credit facility, callable loans or liquidity arrangement facilities to third parties such as overdrafts. The Group has received investment returns from structured products (mortgage backed securities) during 2016 amounting to US$0.2m (2015: US$6.8m) comprised of capital gains only (2015: US$3.4m of interest and $3.4m of capital gains). The Group has provided no financial or other support, other than through the normal purchase of tradeable securities, to structured entities either held at the date of the statement of financial position or held during 2015 or 2016 and has no current intention to do so. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 129 33 ACQUISITION OF STRUCTURED ENTITIES This Note sets out the Group’s acquisition of specific structured vehicles in which it previously had a holding and the consequent impact on the Group’s financial statements. Acquisition of Undertakings for Collective Investments in Transferable Securities (UCITS) The Group has significant investments in two Undertakings for Collective Investments in Transferable Securities (UCITS), Pimco Dynamic Global Investment Grade Credit Fund (Pimco) and Henderson Horizon Core Credit Fund (Henderson). Previously the Group concluded that it did not exercise control over these funds due to the fund manager having sufficient autonomy to direct the activities of the UCITS. During 2015 changes were made to the investment management agreements of these UCITS, effective from 1 January 2016, giving the Group power to be directly involved in the decision‑making of the funds including in respect of the investment decisions. These changes have reduced the level of autonomy of the fund manager and significantly increased the level of control exerted by the Group. Consequently, both UCITS have been consolidated from 1 January 2016. As the Group was the sole investor in these funds in 2015 and the resulting investments were carried at fair value on the Group’s balance sheet, there was no impact on net assets as a result of the consolidation of these funds and no goodwill arises. Of the US$999.5m of UCITS investments recorded by the Group at 31 December 2015 (and referred to in note 32 above), US$772.1m related to Henderson and US$173.1m related to Pimco. The fair value of the identifiable assets and liabilities of the UCITS at 1 January 2016 were as follows: Assets Trade investments Derivative assets Interest and dividends receivable Cash and cash equivalents Liabilities Payables on investments Taxes and expenses payable Derivative liabilities Interest and dividends payable Net assets Henderson 1 January 2016 US$m Pimco 1 January 2016 US$m 737.7 1.2 5.1 85.8 829.8 40.1 0.8 7.4 4.4 52.7 172.6 3.1 1.3 0.6 177.6 1.1 – 3.4 – 4.5 772.1 173.1 FINANCIAL STATEMENTS 130 Brit Limited Annual Report 2016 33 ACQUISITION OF STRUCTURED ENTITIES (continued) The presentational impact on the financial statements of consolidating the UCITS at 31 December 2016 is as follows: Statement of financial position Assets Trade investments Derivative assets Accrued income Cash at bank Liabilities Payable for investments purchased Derivative liabilities Interest and dividends payable Net assets Income statement Net foreign exchange gains Investment return Return on derivative contracts Income As at 31 December 2016 US$m (17.9) 1.3 3.5 31.4 18.3 10.0 7.6 0.7 18.3 – Year ended 31 December 2016 US$m 32.8 2.7 (35.5) – NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 131 34 CONSOLIDATED ENTITIES The principal entities which are members of the Brit Limited Group and whose results and financial positions are consolidated to produce the Group result and financial position are set out in this Note. All subsidiaries of the Company are 100% owned. The subsidiaries of the company at 31 December 2016, together with their main function, are listed below by country of incorporation. The registered address and principal place of business of each entity is The Leadenhall Building, 122 Leadenhall Street, London, EC3V 4AB unless otherwise stated. Subsidiary Principal activity Registered address and principal place of business United Kingdom Brit Insurance Holdings Limited Brit Syndicates Limited Brit UW Limited Brit Insurance Services Limited Brit Investment Holdings Limited Brit Group Services Limited Brit Group Finance Limited BGS Services (Bermuda) Limited Brit Pension Trustee Limited Brit Corporate Services Limited Brit Corporate Secretaries Limited Republic of Ireland Pimco Dynamic Global Investment Intermediate holding company Lloyd’s managing agent Lloyd’s corporate member Service company Service company Group services company Group services company Service company Group services company (Dormant) Group services company (Dormant) Group services company (Dormant) The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building The Leadenhall Building Grade Credit Fund Investment management PIMCO Select Funds Plc, Styne House, Upper Hatch Street, Dublin United States of America Brit Insurance Services USA Inc. Service company Gibraltar Brit Insurance (Gibraltar) PCC Limited Insurance company Brit Group Finance (Gibraltar) Limited Service company 161 N. Clark Street, Suite 3200, Chicago, IL, 60601 Unit 2Aa, Leisure Island Business Centre, 23 Ocean Village Promenade, Ocean Village Unit 2Aa, Leisure Island Business Centre, 23 Ocean Village Promenade, Ocean Village Singapore Brit Global Specialty Singapore Pte. Ltd. Service company 138 Market St., #04‑03 CapitaGreen, 048946 The Netherlands Brit Insurance Holdings B.V. Former holding company The Leadenhall Building Luxembourg Brit Overseas Holdings S.à R.L. Henderson Horizon Core Credit Fund Former holding company Investment management 6 Rue Eugene Ruppert, L‑2453, Luxembourg Henderson Horizon Core Credit Fund, 2 Rue de Bitbourg L‑1273 FINANCIAL STATEMENTS132 Brit Limited Annual Report 2016 35 RELATED PARTY TRANSACTIONS AND ULTIMATE PARENT COMPANY The Group has a number of related parties which includes its principal investors and its Directors. Sometimes it transacts business with these related parties. This Note sets out those transactions. (a) Ultimate Parent Company The ultimate parent company and controlling entity, and the largest group of which the Group is a member, is Fairfax Financial Holdings Limited (FFHL) which is registered in Canada and listed on the Toronto Stock Exchange. The consolidated financial statements for Fairfax are publicly available and can be obtained from the Corporate Secretary, 95 Wellington Street West, Suite 800, Toronto, Ontario, Canada, M5J 2N7 or from the website at www.fairfax.ca. (b) Fairfax Financial Holdings Limited In June 2015, Hamblin Watsa Investment Counsel Limited (HWIC), an affiliate of FFHL, was appointed as an investment manager to a number of Group companies. During the year ended 31 December 2016, the Group incurred and paid investment management fees to HWIC of US$11.2m (period from 5 June to 31 December 2015: US$5.7m). The Group has historically entered into various reinsurance arrangements with affiliates of FFHL. In respect of insurance and ceded outwards reinsurance activity, the amounts included in the income statement relating to trading with affiliates of FFHL were as follows: Gross premiums written Less premiums ceded to reinsurers Premiums written, net of reinsurance Gross amount of change in provision for unearned premiums Reinsurers’ share of change in provision for unearned premiums Net change in provision for unearned premiums Earned premiums, net of reinsurance Gross claims paid Reinsurers’ share of claims paid Claims paid, net of reinsurance Gross change in the provision for claims Reinsurers’ share of change in the provision for claims Net change in the provision for claims Commission income Commission expense Year ended 31 December 2016 US$m Period fro 5 June to 31 December 2015 US$m 7.9 (2.1) 5.8 (0.5) (2.5) (3.0) 2.8 (5.0) 5.1 0.1 – (8.2) (8.2) 1.8 (1.2) 6.8 (3.5) 3.3 3.1 (4.7) (1.6) 1.7 (6.9) 10.5 3.6 2.8 (9.1) (6.3) 2.3 (1.2) NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 133 The amounts included in the statement of financial position outstanding with affiliates of FFHL and its affiliates as at 31 December 2016 were as follows: Debtors arising out of direct insurance and reinsurance operations: Insurance premium receivable Recoverable from reinsurers Creditors arising out of direct insurance and reinsurance operations: Payable to reinsurers Unpaid claims liabilities Deferred acquisition costs Gross unearned premiums Unearned premium recoverable from reinsurers (c) Associated undertakings Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 3.6 50.7 5.9 59.6 (2.4) (44.8) (4.1) (45.9) 0.9 (5.6) 1.0 1.0 (5.2) 3.5 Ambridge Partners LLC On 8 December 2015, the Group acquired 50% of the members’ interests of Ambridge Partners LLC and also entered into a call and a put option to purchase the remaining 50% in 2019. Ambridge Partners LLC is a managing general underwriter of transactional insurance products, writing business on behalf of a range of insurers including Brit. Trading with Ambridge Partners LLC is undertaken on an arm’s‑length basis and is settled in cash. The amounts in the income statement relating to trading with Ambridge Partners LLC for the year to 31 December 2016 included commission for introducing insurance business of US$4.3m (period from 8 December 2015 to 31 December 2015: US$0.4m.) The amount of premiums net of commission in the statement of financial position outstanding from Ambridge Partners LLC as at 31 December 2016 was US$7.4m (2015: US$6.4m). The amount of fees in the statement of financial position payable to Ambridge Partners LLC as at 31 December 2016 was US$0.2m (2015: US$0.2m). Camargue Underwriting Managers Proprietary Limited On 30 August 2016, the Group acquired 50% of the share capital of the South African company, Camargue Underwriting Managers Proprietary Limited (Camargue) and also entered into a call and a put option to purchase the remaining 50% in 2021. Camargue is a leading managing general underwriter of a range of specialised insurance products and specialist liability solutions in South Africa and is an important trading partner for, Brit. Trading with Camargue is undertaken on an arm’s‑length basis and is settled in cash. The amounts in the income statement relating to trading with Camargue for the period from 30 August to 31 December 2016 included commission for introducing insurance business of US$0.2m. Amounts recorded in the statement of financial position in respect of premium net of commissions due from, and fees payable to, Camargue as at 31 December 2016 were not material. FINANCIAL STATEMENTS 134 Brit Limited Annual Report 2016 (d) Key management compensation The amount of the emoluments granted in respect of the financial year to the members of the administrative, managerial and supervisory bodies by reason of their responsibilities, and any commitments arising or entered into in respect of retirement pension for former members of those bodies, are broken down as follows: Salaries and other short‑term employee benefits Post‑employment benefits Share‑based payments Termination benefits Total compensation Year ended 31 December 2016 US$m Year ended 31 December 2015 US$m 7.3 0.2 1.2 0.7 9.4 19.7 0.9 2.1 2.1 24.8 For the purposes of International Accounting Standard 24, ‘Related Party Disclosures’, key managers are defined as the Board of Directors and members of the Executive Committee which is the primary vehicle for implementing Board decisions in respect of UK‑managed operations. 36 GUARANTEES AND CONTINGENT LIABILITIES This Note explains guarantees issued by Group companies and any contingent liabilities they may be exposed to. (a) Lloyd’s Assets have been pledged, as Funds at Lloyd’s, by way of deposits and fixed and floating charges for Brit UW Limited, the corporate member of the Group. As at 31 December 2016 the Funds at Lloyd’s requirement amounted to US$794.6m (2015: US$806.5m). (b) Revolving credit facility The Group has access to a US$360.0m revolving credit facility. For further information, refer to Note 25. Guarantees have been made by Brit Limited and Brit Insurance Holdings Limited to the syndicated banks providing the facility. As at 31 December 2016, a US$80.0m letter of credit had been provided to Lloyd’s (2015: US$80.0m). At 31 December 2016, US$4.0m this letter of credit was collateralised (2015: uncollateralised). (c) Taxation The Group operates in a wide variety of jurisdictions around the world through its Lloyd’s syndicate and uncertainties therefore exist with respect to the interpretation of complex tax laws and practices of those territories. The Group establishes provisions for taxes other than current and deferred income taxes, based upon various factors which are continually evaluated, if there is a present obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate of the amount of the obligation can be made. Income taxes are provided for as set out in accounting policy Note 2.4.10. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Brit Limited Annual Report 2016 135 INTRODUCTION TO THE PARENT COMPANY FINANCIAL STATEMENTS INDEX TO THE PARENT COMPANY FINANCIAL STATEMENTS Statement of financial position The statement of financial position is a summary of assets and how the assets have been funded through liabilities and equity investment by shareholders. Statement of changes in equity The statement of changes in equity shows how the various lines in the equity section of the Company’s statement of financial position have moved during the year. STATEMENT OF FINANCIAL POSITION STATEMENT OF CHANGES IN EQUITY NOTES TO THE FINANCIAL STATEMENTS NOTE 1 ACCOUNTING POLICIES AND BASIS OF PREPARATION NOTE 2 AUDITOR’S REMUNERATION NOTE 3 SHARES IN GROUP UNDERTAKINGS NOTE 4 LOANS TO GROUP UNDERTAKINGS NOTE 5 NOTE 6 NOTE 7 DEBTORS: AMOUNTS FALLING DUE WITHIN ONE YEAR CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR NOTE 8 CALLED UP SHARE CAPITAL NOTE 9 DIRECTORS’ EMOLUMENTS NOTE 10 GUARANTEES AND CONTINGENT LIABILITIES NOTE 11 DIVIDENDS NOTE 12 SHARE–BASED PAYMENTS NOTE 13 DISCLOSURE EXEMPTIONS NOTE 14 ULTIMATE PARENT COMPANY 136 137 138 138 139 139 139 140 140 141 141 142 142 142 142 142 143 CONTENTSFINANCIAL STATEMENTS136 Brit Limited Annual Report 2016 STATEMENT OF FINANCIAL POSITION At 31 December 2016 Fixed assets Investments: Shares in group undertakings Loans to group undertakings Current assets Debtors: Amounts falling due within one year Cash at bank and in hand Current liabilities: Creditors: Amounts falling due within one year Net current (liabilities)/assets Total assets less current liabilities Creditors: amounts falling due after more than one year Net assets Capital and reserves Called up share capital Capital redemption reserve Retained earnings Total equity Note 31 December 2016 US$m 31 December 2015 US$m 3 4 5 6 7 8 1,050.5 127.4 1,177.9 18.6 0.1 18.7 (107.5) (88.8) 1,089.1 (168.7) 920.4 6.4 0.2 913.8 920.4 1,050.5 151.9 1,202.4 33.5 0.1 33.6 (24.1) 9.5 1,211.9 (201.8) 1,010.1 6.6 – 1,003.5 1,010.1 The accompanying Notes are an integral part of these financial statements. These financial statements were approved by the Board of Directors on 15 February 2017 and were signed on its behalf by: Matthew Wilson Group Chief Executive Officer Mark Allan Chief Financial Officer STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2016 Brit Limited Annual Report 2016 137 Called up Share capital US$m Note Capital redemption reserve US$m 1 January 2016 Total comprehensive income for the period Repurchase of class A shares Cancellation of share capital Dividend At 31 December 2016 11 For the period ended 31 December 2015 1 January 2015 Total comprehensive income for the period Dividend At 31 December 2015 6.6 – – (0.2) – 6.4 Note 11 – – – 0.2 – 0.2 Called up Share capital US$m 6.6 – – 6.6 Retained earnings US$m 1,003.5 59.2 (58.1) – (90.8) 913.8 Retained earnings US$m 1,188.7 (31.1) (154.1) 1,003.5 Total equity US$m 1,010.1 59.2 (58.1) – (90.8) 920.4 Total equity US$m 1,195.3 (31.1) (154.1) 1,010.1 FINANCIAL STATEMENTS 138 Brit Limited Annual Report 2016 1 ACCOUNTING POLICIES AND BASIS OF PREPARATION This Note provides details of the basis of preparation and accounting policies applied in producing these parent company financial statements. 1.1 Basis of preparation The Company financial statements present the information about the company as a separate entity. The Company is incorporated and registered in England and Wales with registration number 8821629. The registered office of the company at the date of this report is The Leadenhall Building, 122 Leadenhall Street, London EC3V 4AB. The Company has prepared its financial statements in accordance with Financial Reporting Standard ‘FRS 102’, the Financial Reporting Standard applicable in the United Kingdom and republic of Ireland and provisions of Section 396 of the Companies Act 2006. No individual income statement is presented for the Company, as permitted by Section 408 of the Act. The comprehensive income dealt with in the accounts of the parent company was US$59.2m (2015: US$31.1m). The Company financial statements are presented in US dollars and all values are rounded to the nearest US$0.1m except where otherwise indicated. 1.2 Accounting policies (a) Investments Investments in subsidiary undertakings are stated at cost less provisions for any impairment. (b) Income from fixed asset investments Dividend income is recognised when the shareholders’ right to receive the payment is established. (c) Long term debt Long term debt is recognised initially at transaction price which is the fair value. It is subsequently measured at amortised cost using the effective interest rate method, in accordance with section 11 of FRS 102 (Basic Financial Instruments). Interest payable is recognised using the effective interest rate method. (d) Loans to group undertakings Loans to group undertakings are recognised initially at transaction price which is the fair value, (including transaction costs incurred except in the initial measurement of financial liabilities that are measured at fair value through profit or loss) less amortised cost using effective interest rate method, in accordance with section 11 of FRS 102 (Basic Financial Instruments). Interest receivable is recognised using the effective interest rate method. (e) Expenses All expenses are accounted for on an accruals basis. (f) Foreign currencies Transactions in foreign currencies other than US dollars are converted at the rate of exchange ruling at the date the transaction is processed. Unless otherwise stated, transactions are converted at the average rates of the exchange for the period. Assets and liabilities in currencies other than Sterling are converted at the rate of exchange ruling at 31 December of each year. Exchange differences arising on conversion are dealt with in the income statement. NOTES TO THE FINANCIAL STATEMENTSBrit Limited Annual Report 2016 139 (g) Deferred taxation Deferred tax is recognised in respect of all timing differences which are differences between taxable profits and total comprehensive income that arise from the inclusion of income and expenses in tax assessments in periods different from those in which they are recognised in the financial statements, except that: • Provision is made for deferred tax that would arise on remittance of the retained earnings of overseas subsidiaries, associates and joint ventures only to the extent that, at the Statement of Financial Position date, dividends have been accrued as receivable; • Where there are differences between amounts that can be deducted for tax for assets (other than goodwill) and liabilities compared with the amounts that are recognised for those assets and liabilities in a business combination a deferred tax liability/(asset) shall be recognised. The amount attributed to goodwill is adjusted by the amount of the deferred tax recognised; and • Unrelieved tax losses and other deferred tax assets are recognised only to the extent that the directors consider that it is probable that they will be recovered against the reversal of deferred tax liabilities or other future taxable profits. Deferred tax is measured on an undiscounted basis at the tax rates that are expected to apply in the periods in which timing differences reverse, based on tax rates and laws enacted or substantively enacted at the statement of financial position date. 2 AUDITOR’S REMUNERATION This Note sets out the fees paid in respect of the annual audit performed on the Company. Audit fees borne by the Company amounted to US$15,000 (2015: US$15,000). 3 SHARES IN GROUP UNDERTAKINGS This Note explains the direct shareholdings of the Company in other Group entities. Investment in Brit Insurance Holdings Limited There was no movement in shares in group undertakings in the period. 31 December 2016 US$m 31 December 2015 US$m 1,050.5 1,050.5 The subsidiaries of the Company at 31 December 2016, and their principal activities, are disclosed in the Brit Limited Consolidated Financial Statements. 4 LOANS TO GROUP UNDERTAKINGS This note sets out moneys lent by the Company to other Group companies. Loans to Group undertakings 31 December 2016 US$m 31 December 2015 US$m 127.4 151.9 On 8 September 2014, a long‑term loan to another Group Company was novated to Brit Limited at fair value. The agreement expires on 9 December 2020 and carries interest at an annual interest rate of 7.05%. FINANCIAL STATEMENTS 140 Brit Limited Annual Report 2016 5 DEBTORS: AMOUNTS FALLING DUE WITHIN ONE YEAR This note sets out moneys owed to the Company that are due before 31 December 2017. Interest receivable on loans to Group undertakings Amounts owed by Group undertakings Prepayments 6 CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR This note sets out moneys owed by the Company that are due before 31 December 2017. Amounts owed to Group undertakings Accruals and deferred income 31 December 2016 US$m 31 December 2015 US$m 17.8 – 0.8 18.6 32.2 0.3 1.0 33.5 31 December 2016 US$m 31 December 2015 US$m 106.8 0.7 107.5 22.6 1.5 24.1 7 CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR This note sets out moneys owed by the Company that are due after 31 December 2017. Maturity Call Effective interest rate % Amortised cost US$m Fair value US$m Amortised cost US$m Fair value US$m 31 December 2016 31 December 2015 Subordinated debt 2030 2020 6.29% 168.7 167.9 201.8 206.2 The fair value of the subordinated debt has been determined by reference to trading market values on recognised exchanges and is categorised as Level one in the fair value hierarchy. The subordinated debt was novated to the Company from another Group company on 8 September 2014 at fair value. The subordinated debt is listed and callable in whole by the Company on 9 December 2020. Following this date the interest rate resets to the higher of: i) 3.4% above the gross redemption yield of the 4.75% Treasury Gilt due 2030 quoted on the reset date; or ii) 3.4% above the gross redemption yield of the 8% Treasury Stock due 2021 quoted on the reset date. The effective interest rate method of accounting has been applied over the term up to the call date. NOTES TO THE FINANCIAL STATEMENTS Brit Limited Annual Report 2016 141 8 CALLED UP SHARE CAPITAL This Note sets out the number of shares we have in issue and their nominal value. Ordinary shares: Allotted, Issued and fully paid As at 31 December 2015 Purchase and cancellation of own shares As at 31 December 2016 31 December 2016 US$m 31 December 2015 US$m 31 December 2016 1p each Number 31 December 2015 1p each Number 6.4 6.6 387,608,230 401,057,706 US$m Number 6.6 (0.2) 401,057,706 (13,449,476) 6.4 387,608,230 106,550,524 shares are class A shares and the remainder are class B shares. The class A and B shares rank pari passu except that on a distribution of profits by the Company, the class A shareholders are entitled to a cumulative annual dividend which must be settled ahead of any equivalent distribution to class B shareholders. The Group’s ultimate parent, Fairfax, is permitted on an annual basis to purchase a set number of shares from OMERS, (the minority shareholder of class A shares in Brit Limited). In August 2016, instead of a B class share dividend being made by Brit Limited to Fairfax, Fairfax assigned the purchase of 13,449,476 A class shares to Brit Limited. A distribution of US$61.5m from reserves for the purchase of 13,449,476 shares from OMERS for cancellation was made on 3 August 2016. A reduction in share capital of £134,495 has been made, being the nominal value of 13.4m shares at 1p each and a capital redemption reserve of the same amount has been created. The distribution of US$61.5m has been set against distributable reserves (‘cost of share buy‑back’) in accordance with UK Company Law. As a result, Fairfax has increased its percentage shareholding from 69.99% to 72.51%. 9 DIRECTORS’ EMOLUMENTS This Note gives a breakdown of emoluments paid to directors both in total and in respect of the highest paid director. Aggregate remuneration Aggregate contributions to money purchase pension schemes Total The Directors’ remuneration disclosed above includes the following amounts paid to the highest paid director: Aggregate remuneration Number of Directors with benefits accruing under money purchase pension schemes Number of Directors in respect of whose qualifying services, shares were received or receivable under long term incentive schemes 31 December 2016 US$m 31 December 2015 US$m 5.8 0.1 5.9 9.4 0.1 9.5 2.0 6.5 Number Number 2 3 2 3 Shares were received or receivable by the highest paid director in respect of qualifying services under a long‑term incentive scheme during 2015 and 2016. FINANCIAL STATEMENTS 142 Brit Limited Annual Report 2016 10 GUARANTEES AND CONTINGENT LIABILITIES This Note explains guarantees issued by the company. The company has no contingent liabilities. The Company has access to a US$360.0m (2015: US$360.0m) revolving credit facility. Guarantees have been made by Brit Limited and a subsidiary Company to the syndicated banks providing the facility. 11 DIVIDENDS A final ordinary dividend of 12.5p per share and a special dividend of 12.5p per share amounting to US$154.1m was declared by the Group in respect of 2014 and paid during 2015. A US$26.2m dividend in respect of the year‑ended 31 December 2015 was paid to the class A shareholders on 29 April 2016 in accordance with the shareholders’ agreement at an amount equal to US$0.43 per share (2015: US$ nil). As part of the share‑buy back transaction a US$3.4m dividend was paid to the class A shareholders on 3 August 2016, representing the pro‑rata accrued dividend outstanding on the shares repurchased in respect of the 2016 accounting period, and based on a dividend entitlement for the full year equal to US$0.43 per share. A US$61.3m dividend was paid to the class B shareholders on 21 December 2016 in accordance with the shareholders’ agreement at an amount equal to US$0.43 per share (2015: nil). A further dividend to class A shareholders for 2016 of US$0.43 per share amounting to US$45.8m was proposed and agreed at the 15 February 2017 Brit Limited Board meeting. 12 SHARE–BASED PAYMENTS The Company rewards its employees through various share‑based incentive schemes. This Note explains the different schemes used to facilitate those share‑based payments. During 2015, shares in the Company were used to settle a number of share‑based payment incentive schemes. Further detail in respect of these schemes can be found in Note 31 of the notes accompanying the Brit Limited Group consolidated Financial Statements. 13 DISCLOSURE EXEMPTIONS This Note explains the Company’s approach to qualifying exemptions available in FRS 102. The Company has taken advantage of the disclosure exemptions provided by paragraph 1.12 of FRS 102. Accordingly, these financial statements do not include the following: • Statement of cash flows; • A reconciliation of shares outstanding at the beginning and end of the period; • Specific information relating to financial instruments that is included within equivalent disclosures for the Group; • Specific information relating to share‑based payments that is included within equivalent disclosures for the Group; and • Disclosure of key management personnel compensation. The Brit Limited consolidated Financial Statements and accompanying notes provide further detail in respect of these areas. NOTES TO THE FINANCIAL STATEMENTSBrit Limited Annual Report 2016 143 14 ULTIMATE PARENT COMPANY The ultimate parent company and controlling entity, and the largest group of which the Group is a member, is Fairfax Financial Holdings Limited (Fairfax) which is registered in Canada and listed on the Toronto Stock Exchange. The consolidated financial statements for Fairfax are publicly available and can be obtained from the Corporate Secretary, 95 Wellington Street West, Suite 800, Toronto, Ontario, Canada, M5J 2N7 or from the website at www.fairfax.ca. FINANCIAL STATEMENTS144 Brit Limited Annual Report 2016 Return on net tangible assets before FX movements and corporate activity costs (RoNTA) Return on net tangible assets before foreign exchange movements and corporate activity costs (RoNTA) shows the return being generated by our operations compared to the adjusted net tangible assets deployed in our business. Tax rate PAT Add back: Tax adjusted amortisation Add back: Tax adjusted FX Add back: Tax adjusted deal costs PAT, adjusted for RoNTA calculation Adjusted NTA at start of year External distribution NTA, adjusted for RoNTA calculation RoNTA Comment / financial statements reference Consolidated income statement Amortisation of intangibles, adjusted by the tax rate FX effect for the year, adjusted by the tax rate Corporate activity costs, adjusted by the tax rate See ‘Total Value Created’ section below. Weighted adjustment to reflect distributions during the year. 2016 US$m 2015 US$m 1.4% 8.0% 157.6 5.0 (40.6) – 15.6 7.7 55.5 22.0 122.0 100.8 1,074.6 1,209.6 (44.4) (103.4) 1,030.2 1,106.2 11.8% 9.1% Total value created The total value created measures the increase in adjusted NTA (including distributions) in a year. It reflects the after tax result recorded in the income statement and all other value movements. Total equity attributable to owners of the parent Less: Intangible assets Consolidated statement of financial position Consolidated statement of financial position Net tangible assets Add back deferred tax liability on intangible assets Note 18: Deferred tax Comment / financial statements reference Adjusted net tangible assets Adjusted NTA at end of year Less: Adjusted NTA at start of year Movement in adjusted NTA Add: Distributions (dividends and share purchases) Consolidated statement of changes in equity Total value created 2016 US$m 2015 US$m 1,148.0 (93.9) 1,156.5 (95.1) 1,054.1 10.7 1,061.4 13.3 1,064.8 1,074.7 1,064.8 (1,074.7) 1,074.7 (1,209.6) (9.9) 148.9 139.0 (134.9) 154.1 19.2 RECONCILIATION OF KEY PERFORMANCE INDICATORS TO THE FINANCIAL STATEMENTS Brit Limited Annual Report 2016 145 Combined ratio The combined ratio is our key underwriting metric and measures the profitability of our underwriting. It shows how much of every US$1 of premium is spent in the total costs of sourcing and underwriting the business and settling claims. A combined ratio under 100% indicates underwriting profitability. Earned premium, net of reinsurance Note 5: Segmental information Comment / financial statements reference Attritional losses Major claims Reserve releases Claims incurred, net of reinsurance Note 5: Segmental information Acquisition costs – commissions Acquisition costs – other and Other insurance related expenses Underwriting expenses Underwriting profit Attritional loss ratio Major claims ratio Reserve release ratio Claims ratio Commission ratio Operating expense ratio Note 5: Segmental information Note 5: Segmental information Attritional losses / Earned premium, net of reinsurance Major claims / Earned premium, net of reinsurance Reserve releases / Earned premium, net of reinsurance Note 5: Segmental information Acquisition costs – commissions Acquisition costs – other and Other insurance related expenses Underwriting expense ratio Note 5: Segmental information Combined ratio Claims ratio + Underwriting expense ratio; Note 5: Segmental information 2016 US$m 2015 US$m 1,515.1 1,649.6 (841.2) (68.4) 53.5 (910.6) – 28.6 (856.1) (882.0) (411.6) (429.2) (192.8) (201.4) (604.4) (630.6) 54.6 137.0 55.5% 4.5% –3.5% 56.5% 55.2% 0.0% –1.7% 53.5% 27.2% 26.0% 12.7% 39.9% 12.2% 38.2% 96.4% 91.7% ADDITIONAL INFORMATION 146 Brit Limited Annual Report 2016 Investment return We assess the performance of our investment portfolio by comparing the return generated by our invested assets, net of external investment related expenses, against the value of those invested assets. Share of net profit of associates Return on financial investments and cash and cash equivalents Comment / financial statements reference Note 13: Investment in associated undertakings Note 6: Investment return Return on investment related derivatives Note 7: Return on derivative contracts Return on invested assets Investment in associated undertakings Financial investments Derivative contracts (investment related) Cash and cash equivalents Note 13: Investment in associated undertakings Note 21: Financial investments Note 22: Derivative contracts Note 24: Cash and cash equivalents 2016 US$m 3.6 132.2 (32.9) 102.9 2015 US$m – 10.3 (5.3) 5.0 36.6 2,903.9 5.5 1,025.5 28.6 3,330.8 33.5 581.0 3,971.5 3,973.9 3,973.9 3,971.5 3,972.7 4,028.4 3,973.9 4,001.2 Invested assets Opening invested assets Closing invested assets Average invested assets Return (%) Return on invested assets / Average invested assets 2.6% 0.1% Capital ratio The capital ratio measures the strength of our balance sheet by comparing our available capital resources to the capital we need to hold to meet our management entity capital requirements. It is calculated as follows: Total equity attributable to owners of the parent Consolidated statement of financial position 1,148.0 1,156.5 Comment / financial statements reference 2016 US$m 2015 US$m Less: Intangible assets Consolidated statement of financial position (93.9) (95.1) Net tangible assets Add: Deferred tax liability on intangible assets Note 18: Deferred tax Adjusted net tangible assets Subordinated debt Letters of credit / contingent funding Total available capital resources Management entity capital requirements Excess of resources over management entity capital requirements Capital ratio Consolidated statement of financial position Under our capital policy we have identified a maximum of US$235.0m of our revolving credit facility to form part of our capital resources. The capital required by an entity for business strategy and regulatory requirements. 1,054.1 10.7 1,064.8 157.5 1,061.4 13.2 1,074.6 185.6 235.0 235.0 1,457.3 1,495.2 (1,160.2) (1,165.7) 297.1 329.5 125.6% 128.2% RECONCILIATION OF KEY PERFORMANCE INDICATORS TO THE FINANCIAL STATEMENTS Brit Limited Annual Report 2016 147 Ratio of front office employees to back office employees This measure monitors the efficiency of our business model by comparing the number of front office client‑facing revenue generators and service providers to the number of back office employees. An increase in the ratio would suggest that the back office is becoming more efficient in supporting the client‑facing activities of the front office. Total front office staff Total back office staff Total employees Ratio of front office employees to back Comment / financial statements reference Note 10: Staff costs Note 10: Staff costs Note 10: Staff costs 2016 Number 2015 Number 347 192 539 323 181 504 office employees Total front office staff / Total back office staff 180.7% 178.5% ADDITIONAL INFORMATION148 Brit Limited Annual Report 2016 COMPANY INFORMATION Directors Mr Mark Cloutier – Group Executive Chairman Mr Ipe Jacob – Senior independent non‑executive Director (resigned 31 December 2016) Mr Matthew Wilson – Group Chief Executive Officer Mr Mark Allan – Chief Financial Officer Dr Richard Ward – Senior independent non‑executive Director Mr Andrew Barnard – Non‑executive Director Mr Bijan Khosrowshahi – Non‑executive Director (resigned 31 December 2016) Mr Jeremy Ehrlich – Non‑executive Director Mr Gordon Campbell – Non‑executive Director (appointed 1 January 2017) Company Secretary Mr Tim Harmer Registered Office The Leadenhall Building 122 Leadenhall Street London EC3V 4AB UK Telephone: +44 (0) 20 3857 0000 Website www.britinsurance.com The Company website provides information about Brit Limited including information on the business, annual reports, half yearly reports and announcements to the London Stock Exchange. Registered Number 8821629 Auditor PricewaterhouseCoopers LLP 7 More London Riverside London SE1 2RT A Acquisition costs: Costs incurred in the course of writing business and issuing policies including commissions paid to intermediaries and related internal expenses such as underwriter related costs. Adjusted net tangible assets or adjusted NTA: Total equity, less intangible assets net of the deferred tax liability on those intangible assets. Adjusted net tangible assets per share: Calculated as closing adjusted net tangible assets divided by the number of shares in issue at the balance sheet date less own shares. Aggregate exposure: The expected maximum total of claims that could be incurred by an insurer in respect of any event or series of similar events. Also see ‘realistic disaster scenarios’. Asset allocation: The allocation of our investments across different kinds of asset classes, such as equities, bonds, and cash, in order to achieve a balance between return and risk. Attritional losses: Common losses, as opposed to major or catastrophe losses, incurred from ordinary insurance and/or reinsurance operations. Attritional loss ratio: Attritional losses incurred expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). Available capital resources: Adjusted net tangible assets, subordinated debt and Letters of credit / contingent funding. B BGSB: Brit Global Specialty Bermuda, the business of the Group operating in Bermuda. BGSS: Brit Global Specialty Singapore Pte. Ltd., the business of the Group operating in Singapore. BGSU: Brit Global Specialty USA, the business of the Group operating in the United States, of which BISI is the managing general agent. BIG: Brit Insurance (Gibraltar) PCC Limited, the Group’s captive reinsurer incorporated in Gibraltar. Binder business: Business conducted by a coverholder acting under a binding authority. Binding authority: See ‘delegated underwriting authority’. BISI: Brit Insurance Services USA, Inc., a company incorporated in Illinois, USA. Broker: An intermediary who negotiates contracts of insurance or reinsurance, receiving a commission for placement and other services rendered. Brit Limited Annual Report 2016 149 C Capital ratio: Available capital resources expressed as a percentage of management entity capital requirement. Captive: An entity that provides risk‑mitigation services for other entities within the same Group only. Catastrophe or Cat: Perils including earthquakes, hurricanes, hailstorms, severe winter weather, floods, fires, tornadoes, explosions and other natural or man‑made disasters. Catastrophe losses may also arise from acts of war, acts of terrorism and political instability. Claims: Moneys demanded by an insured for indemnity under an insurance contract. Claims development triangles: Tabulations of claims development data, set out with underwriting years along one axis and calendar years of development along the other. Claims incurred: Claims arising from events that have occurred, regardless of whether or not they have been reported to the insurer. Claims ratio: Calculated as total claims incurred expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). The claims ratio is the aggregate of the reserve release ratio, major claims ratio and the attritional loss ratio. Combined ratio or CoR: Calculated as total claims incurred and total expenses incurred by the underwriting divisions, expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). The combined ratio is the aggregate of the claims ratio and the expense ratio. Commission ratio: Commission expense incurred by the underwriting division expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). Constant FX rates: An increase or decrease in figures between two years after eliminating the effect of FX rate movements. Corporate member: A company providing the capital to support the underwriting activity of a syndicate at Lloyd’s. Brit’s corporate member is Brit UW Limited. Coverholder: An entity authorised by an insurer to enter into a contract of insurance on its behalf. D Deferred acquisition costs or DAC: Costs incurred for the acquisition or renewal of insurance policies which are capitalised and amortised over the term of those policies. Delegated underwriting authority: An authority granted by an underwriter to an agent (known as a coverholder) whereby that agent is entitled to accept, within certain limits, insurance business on behalf of the underwriter. The coverholder has full power to commit the underwriter within the terms of the authority. GLOSSARYGLOSSARY150 Brit Limited Annual Report 2016 E Earned premium: That proportion of a premium which relates to the portion of a risk which has expired during a given period. Excess and Surplus or E&S: A generic US regulatory classification referring to insurance coverage not ordinarily written by insurers fully admitted in various states. The E&S lines business is largely unregulated as to rate and form but insurers must be authorised to write such business in a state by the local regulator. Excess of loss or XL: A type of reinsurance that covers specified losses incurred by the reinsured party in excess of a stated amount (the excess) up to a higher amount of limit, for example US$5m excess of US$1m. Such coverage can operate on a per loss basis or an aggregate basis. Executive Committee or EC: A committee at Brit consisting of the senior management and the CEO. Expense ratio: Calculated as total expenses incurred by the underwriting divisions expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). The expense ratio is the aggregate of the commission ratio and the operating expense ratio. F FCA: The UK Financial Conduct Authority, established pursuant to the Financial Services Act 2012 and responsible for, among other things, the conduct regulation of all firms authorised and regulated under FSMA and the prudential regulation of firms which are not regulated by the PRA. First Dollar: An insurance policy written with low excess and deductible, and written in the admitted market. FSC: The Financial Services Commission of Gibraltar, a statutory corporate body established by the 1989 Financial Services Commission Ordinance (since replaced by the Financial Services Commission Act 2007), responsible for regulating the financial services industry in Gibraltar. Funds at Lloyd’s or FAL: Funds held in trust at Lloyd’s to support a Lloyd’s underwriter’s underwriting activities. G Gearing ratio: Calculated as total borrowings (subordinated debt, revolving credit facility cash drawdowns and uncollateralised drawn letters of credit) divided by adjusted net tangible assets and subordinated debt. Gross written premium or gross premiums written or GWP: Amounts payable by the insured, including any brokerage or commission deducted by intermediaries but excluding any taxes or duties levied on the premium. H Hardening or hard market: An insurance market where prevalent prices are high, with more restrictive terms and conditions offered by insurers. HMRC: Her Majesty’s Revenue and Customs. I Incurred but not reported or IBNR: Claims incurred but not reported, including claims which are incurred but not enough reported (i.e. where the amount of the notification is insufficient). International Accounting Standards or IAS: See ‘International Financial Reporting Standards’. International Financial Reporting Standards or IFRS: Accounting and reporting Standards established by the International Accounting Standards Board, as adopted by the European Commission for use in the European Union. UK listed entities have reported on an IFRS basis since 2005. Invested assets: Financial investments, investment in associated undertakings, cash and cash equivalents and investment related derivatives. Investment related derivatives: Includes options and interest rate swaps. Excludes currency forwards. Investment return: Income, net realised and unrealised gains and losses on financial investments, cash and cash equivalents and investment related derivatives (net of investment management fees). Investment return percentage: Investment return expressed as a percentage of average invested assets, calculated on a month by month basis. L Lead underwriter or lead: A lead underwriter (usually a specialist in the field of the insurance concerned) is the first underwriter to take a portion of a risk, quote an appropriate rate of premium and set terms and conditions. Letter of credit or LoC: A written undertaking by a financial institution to provide funding if required. LIBOR: The daily London Interbank Offered Rate set by the British Banking Association. Line size: The proportion of an insurance or reinsurance risk that is accepted by an underwriter or which an underwriter is willing to accept. Lloyd’s China Platform: The branch of Lloyd’s in Shanghai in the People’s Republic of China operated through Lloyd’s Insurance Company (China) Limited, on which certain Lloyd’s syndicates have representation. Lloyd’s of London: The Society of Lloyd’s and Corporation of Lloyd’s created and governed by the Lloyd’s Acts 1871‑1982, including the Council of Lloyd’s (and its delegates and other persons through whom the Council may act), as the context may require. GLOSSARYLondon Market: The London insurance market, which includes the Lloyd’s market. Long‑tail: The term used to describe business where the difference between the timing of the average premium receipt and the timing of the average claim payment is over three years. M Major claims: Claims in excess of US$10.0m (net of reinsurance and allowing for reinstatement), incurred from natural or man‑made catastrophes, or from large single risk loss events. Major claims ratio: Major claims incurred expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). Management entity capital requirement: The capital required by an entity for business strategy and regulatory requirements. N Net earned premium or NEP: The net written premium adjusted by the change in net unearned premium (i.e. the premium for which insurance exposure has yet to be incurred) for a year. Net tangible assets or NTA: The total assets of a company, minus any intangible assets, less all liabilities. Net written premiums or NWP: Gross premiums written during a specified period less outwards reinsurance premiums ceded. O Operating expense ratio: Calculated as operating expenses incurred by the underwriting divisions expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). Outstanding claims: Claims which have been notified at the balance sheet date but not settled. Own risk and solvency assessment or ORSA: The name given to the entirety of the processes and procedures employed by an insurer to identify, assess, monitor, manage and report the short and long term risks it faces or may face and to determine the capital necessary to ensure that the insurer’s overall solvency needs are met at all times. Brit Limited Annual Report 2016 151 P PRA: The UK Prudential Regulation Authority established pursuant to the Financial Services Act 2012 and responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. Protected cell company or PCC: A company that has been separated into legally distinct portions or cells. The revenue streams, assets and liabilities of each cell are kept separate from all other cells. Each cell has its own separate portion of the PCC’s overall share capital, allowing shareholders to maintain sole ownership of an entire cell. Q Quota share or QS: A type of reinsurance which provides that the reassured shall cede to the reinsurer a specified percentage of all the premiums that it receives in respect of a given section or of all of its underwriting account for a given period in return for which the reinsurer is obliged to pay the same percentage of any claims and specified expenses arising on the reinsured business. R Ratio of front office employees to back office employees: Calculated as the average number of front office staff divided by the average number of back office staff employed during the year. Front office employees are defined as underwriters, other underwriting staff, claims staff and direct support staff. The balance of employees are classified as back office. Realistic Disaster Scenarios or RDS: Specific scenarios which the Group uses to test its ability to settle claims arising from certain types of disaster. Reinsurance: The transfer of some or all of an insurance risk to another insurer. The company transferring the risk is called the ‘ceding company’ and the company assuming the risk is called the ‘assuming company’ or the ‘reinsurer’. Representative office: An office established by Brit to conduct marketing and other non‑transactional operations overseas. Reserves: Outstanding claims and claims incurred but not reported. Reserve releases: The amount of the reserves at the end of the previous period determined as being excess to requirements at the end of the current period. Reserve release ratio: The amount of reserve releases expressed as a percentage of net earned premiums (excluding the effect of foreign exchange movements on non‑monetary items). Retention rate: The ratio, in percent, of the value of premiums relating to risks written in one year renewed in the following year. The data used is risk adjusted (i.e. it allows for changes to terms and conditions). GLOSSARY 152 Brit Limited Annual Report 2016 Return on equity or RoE: See ‘Return on net tangible assets or RoNTA’. Return on net tangible assets before foreign exchange movements and corporate activity costs or RoNTA: Profit after tax before the effects of foreign exchange movements on monetary and non‑monetary items, before the return on currency related derivative contracts, before charges in respect of intangible assets and before costs incurred in respect of corporate activity, expressed as a percentage of adjusted opening net tangible assets. The adjusted opening net tangible assets are also modified on a weighted average basis for capital distributions, share buybacks or share issues during the period. Risk adjusted rate change: Change in premium rates during the year expressed as a percentage of opening premium rates. The data reflects internal estimates by Brit’s underwriters, based on available year‑on year underlying renewal data after allowing for changes to terms and conditions. Risk management framework or RMF: The Group’s own internal framework for risk management. Running yield: The income return, expressed either as a percentage or a monetary amount, on invested assets. S Service companies: Subsidiary companies set up to operate a binding authority on behalf of the Syndicate to write business from non‑Lloyd’s brokers or direct from policymakers. Short‑tail: The term used to describe business where the difference between the timing of the average premium receipt and the timing of the average claim payment is under three years. Softening or soft market: An insurance market where prevalent prices are low, and terms and conditions offered by insurers are less restrictive. Solvency capital requirement or SCR: The higher of the two capital levels required by Solvency II. The SCR is the prudent amount of assets to be held in excess of liabilities and functions as an early warning mechanism if it is breached. The SCR is calculated using either the standard formula or an approved internal model. Solvency matched: The matching of the currencies of the Group’s liabilities and management entity capital requirements with the currencies of the assets held by the Group. Solvency II: A combination of several EU Directives that codify and harmonise EU insurance regulation, primarily concerning the amount of capital that EU insurance companies must hold to reduce the risk of insolvency. Principal components are Directive 2009/138/EC on the taking‑up and pursuit of the business of insurance and reinsurance and Directive 2012/23/EU on the financial position of insurance undertakings. Solvency II will come into force in all EU member states on 1 January 2016. Strategic asset allocation or SAA: The Group’s strategic asset allocation defines the overall Group investment strategy and reflects entity‑level considerations and governance matters. See ‘asset allocation’. Syndicate: A group of underwriting members of Lloyd’s or a single corporate member managed as a unit to underwrite insurance business at Lloyd’s to which a particular syndicate number is assigned by or with the authority of Lloyd’s of London. Brit operates through Lloyd’s Syndicate 2987. T Tail: See ‘short‑tail’ and ‘long‑tail’. Technical price: The price for the risk which is expected to produce the long‑term required return on capital for the Group. The Company: Brit Limited. The Group: Brit Limited and its subsidiaries. The Syndicate: Brit Syndicate 2987. Total available resources: Sum of the closing adjusted net tangible assets, subordinated debt and letters of credit/ contingent funding. Total invested assets: See ‘invested assets’. Total operating expenses: These represent all expenses incurred by the Group, excluding commission costs. Total value created: Calculated as closing adjusted net tangible assets plus dividends paid during the year, less opening adjusted net tangible assets. Treaty: A reinsurance contract pursuant to which the reinsurer is obliged to accept, within agreed limits, all risks underwritten by the reinsured within specified classes of business in a given time period. GLOSSARYBrit Limited Annual Report 2016 153 U Ultimate claims: The total forecast claims expected to arise from a policy or class of business. Ultimate claims include those losses paid, those notified and IBNR. Underlying operating expenses: Calculated as Total operating expenses less project costs and other timing differences. Underlying operating expenses include bonus costs. Underwriting capacity: The maximum premium income which a Lloyd’s syndicate is permitted to underwrite. A capacity figure is assigned to each underwriting year and the relevant premium income is defined as gross written premiums less commissions payable. Underwriting profit: Operating profit generated by our underwriting segments less investment return. Unearned premium reserve or UPR: The portion of premium income written in the calendar year that is attributable to periods after the balance sheet date. It is accounted for as unearned premiums in the underwriting provisions. Unrealised gains or Unrealised losses: Gains or losses that are yet to be crystallised in the form of a cash movement from disposals of invested assets. GLOSSARYDesigned and produced by Bruce Associates Brit Limited The Leadenhall Building, 122 Leadenhall Street, London, EC3V 4AB, UK www.britinsurance.com SEEING THE DIFFERENCE MAKES THE DIFFERENCE 

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